More public spending, not tax cuts, for sustainable growth
and Douglas Elmendorf, the former Democrat-appointed Congressional Budget Office director, have shown that the 1981 tax cuts had virtually no net impact on growth.
Similarly, the 2001 and 2003 Bush tax cuts on ordinary incomes, capital gains, dividends and estates also failed to stimulate much growth, if any. In both cases, growth mainly came from other expansionary policies.
The OECD and the IMF also both doubt that tax cuts significantly induce investments. Cross-country research has found no relationship between changes in the top marginal tax rates and economic growth between 1960 and 2010. During this half-century period, although the US cut its top tax rate by over 40 percentage points, it only grew by just over 2% a year on average. In contrast, Germany and Denmark, which barely changed their top rates at all, experienced similar growth rates.
Thus, tax cuts do not magically improve economic growth. Instead, the government should focus on building more economic capacity with new investments in infrastructure, research and development (R&D), education, and anti-poverty programmes. As the IMF’s 2014 World Economic Outlook showed, the impacts of public investment are greatest during periods of low growth. assistance programmes have other positive impacts. Investments in education result in a more skilled workforce, raising productivity and earnings as well as spurring innovation. Extra years of schooling are correlated with significant per capita income increases.
Investments in early childhood, including health and education, also enhance economic benefits. The earlier the interventions, the more cost-effective they tend to be; hence, OECD policymakers now promote preschool childcare and education.
Children enjoying early high-quality care and education programmes are less likely to engage in criminal behaviour later in life; they are also more likely to graduate from secondary school and university. Reducing preschool costs also effectively raise mothers’ net incomes, inducing them to return to employment.
But the revenue boost from greater growth and productivity due to such social programmes may not be enough to prevent rising deficits or debt. However, there are many ways to deal with revenue shortfalls, including new taxes as well as better regulations and enforcement to stem tax evasion. Progressive social protection programmes and universal health care provisioning also help improve equity.