Dynamic scoring: A back-of-the-envelope guide

Supply-side economists have long argued that tax cuts can generate so much economic growth that they may more than pay for themselves. A new paper from the National Bureau of Economic Research suggests that tax cuts partially pay for themselves.

Basing their formulas on the neoclassical growth model, the authors built several economic models to predict the economic growth effects of various tax cuts. They found that:

In almost all instances, tax cuts are at least partly self-financing.

In the long run, about 17 per cent of a cut in labour taxes is recouped through higher economic growth.

The comparable figure for a cut in capital taxes is about 50 per cent.

The authors are quick to point out that these calculations are, at best, "back of the envelope" calculations. Nevertheless, these rudimentary calculations provide evidence that the true revenue costs of tax cuts are smaller than their initial dollar amount. The authors argue that lawmakers and economists should take these effects into account when making tax policy, regardless of the difficulty.

Source: Matt Nesvisky, Dynamic Scoring: A Back-of-the-Envelope Guide, NBER Digest, July 2005; based upon: Gregory Mankiw and Matthew Weinzierl, Dynamic Scoring: A Back-of-the-Envelope Guide, National Bureau of Economic Research, Working Paper No. 11000, December 2004.

For text: http://www.nber.org/digest/jul05/w11000.html

For abstract: http://papers.nber.org/papers/w11000

For more on Taxes: http://www.ncpa.org/pi/taxes/

FMF Policy Bulletin 18 October 2005