Say Anything Blog

Senator Kent Conrad of North Dakota badgered Henry Paulson, nominee for secretary of the Treasury, at Paulson’s confirmation hearing this week. Conrad — armed with poster-sized exhibits of economic misinformation and isolated quotes from the current and prior chairmen of the Federal Reserve — tried to lure the nominee into admitting that tax cuts don’t pay for themselves. Paulson, demonstrating that he is not only a financial heavyweight but an agile debater when among undereducated politicians, focused on the impact of tax cuts on the economy in 2001, and gave credit to President Bush’s first tax cuts for moving the economy out of recession and into expansion. Nice job, Henry!

The assumption that tax cuts don’t pay for themselves is a central tenet of the Democratic party, and also leads to the party’s objection to the president’s tax cuts of 2001 and 2003. Since this belief is so important to Democrats (they rail against any type of tax cuts), it is crucial to take a closer look at the role tax cuts play in “paying for themselves.”

First of all, let’s make the important distinction between tax cuts and tax-rate cuts. Obviously, tax cuts do not pay for themselves. If you reduce the taxes that I pay, I’ll say thank you and that’s it. No effect on my behavior. The president’s tax rebate of 2001 is an example of a one-time transfer to consumers that had little, if any, impact on incentives. On the other hand, cutting tax rates can have dynamic effects that will generate additional tax revenues. In other words, tax-rate cuts can indeed pay for themselves.