Politics

Analysis

An economic theory from the ‘70s comes to life once again

What the first President George Bush (above) once called “voodoo economics” is back, as Trump’s advisers argue that deep cuts in corporate taxes will ultimately pay for themselves with an explosion of new business and job creation.

David Rodgers/Globe Staff

What the first President George Bush (above) once called “voodoo economics” is back, as Trump’s advisers argue that deep cuts in corporate taxes will ultimately pay for themselves with an explosion of new business and job creation.

WASHINGTON — A white cloth napkin, now displayed in the National Museum of American History, helped change the course of modern economics. On it, the economist Arthur Laffer in 1974 sketched a curve meant to illustrate his theory that cutting taxes would spur enough economic growth to generate new tax revenue.

More than 40 years after those scribblings, President Donald Trump is reviving the so-called Laffer curve as he is set to announce the broad outlines of a tax overhaul on Wednesday. What the first President George Bush once called “voodoo economics” is back, as Trump’s advisers argue that deep cuts in corporate taxes will ultimately pay for themselves with an explosion of new business and job creation.

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The exact contours of the plan remained murky and Trump will not produce a fully realized proposal Wednesday. But what the president has called a tax reform plan is looking more like a tax cut plan, showering taxpayers with rate reductions without offsetting the full cost by closing loopholes or raising taxes elsewhere. In the short run, such a plan would add many billions of dollars to the national deficit. Trump contends that it will be worth it in the long run.

“The tax plan will pay for itself with economic growth,” Steven Mnuchin, the Treasury secretary and main architect of the plan, told reporters this week.

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The scope of the president’s plan, as it has leaked out in recent days, has excited the markets even as it has worried fiscal hawks. If this feels like a familiar debate, it is because it has played out repeatedly in the past four decades as the dominant Republican orthodoxy shifted from deficit reduction to tax cuts.

Presidents Ronald Reagan and George W. Bush both cut taxes deeply on the promise of economic payoffs, putting aside concerns about deficits, which grew during their tenures. Trump at points during the campaign talked tough about deficits, promising not only to eliminate them but also to wipe out in just eight years the entire $19 trillion in national debt that has accumulated over the history of the United States — a pledge so wildly unrealistic that even he has since dropped it.

Indeed, since taking office, Trump has made no sustained effort to rein in deficit spending. In his first partial spending plan, called a skinny budget, he proposed $54 billion in cuts to domestic and foreign spending programs, some of them quite deep, to pay for $54 billion in additional military spending. That would leave the bottom line unchanged. In the current fiscal year, which started under former President Barack Obama, the government is spending $559 billion more than it is taking in through taxes, according to the Congressional Budget Office.

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Trump’s plan reportedly will cut corporate tax rates to 15 percent from 35 percent, and cut taxes for small businesses and other firms that pay through personal income taxes as well. The administration has also promised tax breaks for middle-income Americans. And the plan may be paired with an expansive spending proposal to build new roads, bridges and other infrastructure.

Mnuchin argues that an ambitious tax cut would unleash businesses that now feel constrained by one of the highest corporate tax rates in the world. Corporations would be freed to build plants and create jobs in the United States instead of in foreign countries, and would bring home money that currently is sheltered overseas.

While a corporate tax rate cut of the dimension Trump envisions would reduce tax revenues by more than $2 trillion over the next 10 years, Mnuchin noted that an increase in economic growth of a little more than 1 percentage point would generate close to the same amount. The goal, he said, was to produce a sustained national growth rate of 3 percent, instead of the 1.8 percent now projected over the next decade. That would not include the cost of personal income tax cuts.

The question comes down to how the effect of a tax cut is measured. Under what is called static scoring, changes are judged without assuming any difference in growth. Under what is called dynamic scoring, assumptions are made about how much growth will change.

“Under dynamic scoring, this will pay for itself,” Mnuchin said at a public forum last weekend. “Under static scoring, there will be short-term issues.”

Critics scoffed at the math.

“There is not a shred of evidence to support the secretary’s pay-for-itself claim,” said Jared Bernstein, a top White House economics adviser under Obama. “Sure, significantly faster growth would spin off more revenues. But there’s simply no empirical linkage between tax cuts and growth that’s both a lot faster and sustained.”

Douglas Holtz-Eakin, a former Congressional Budget Office director who advised Sen. John McCain’s Republican presidential campaign in 2008, was equally skeptical.

“I can imagine cutting the rate to 15 percent,” he said. “I can imagine growing a percentage point faster. I can imagine raising $2 trillion in revenue. I can’t imagine them being one and the same policy.”

N. Gregory Mankiw, a Harvard University economist who was chairman of the President’s Council of Economic Advisers under the younger Bush, said tax cut supporters exaggerate the possible growth benefits while opponents overemphasize the budgetary cost.

“A reasonable rule of thumb, in my judgment, is that about one-third of the cost of tax cuts is recouped via faster economic growth,” he said.

One-third, of course, is not the same as fully paid for, which is one reason some Republicans on Capitol Hill are concerned.

“I certainly want to see corporate taxes decreased,” Rep. Leonard Lance, R-N.J., said on CNN. “I’m not sure we can go down to 15 percent.”

The Committee for a Responsible Federal Budget, an advocacy group focused on reducing deficits, said that Trump’s tax plan was more likely to increase growth by 0.2 percentage points than by the higher estimates Mnuchin forecast.

“These tax cuts, of course, would not pay for themselves,” the group said in a statement. “As we’ve explained before, there is little evidence to suggest any major tax cut could pay for itself with economic growth alone.”

But one fan of Trump’s approach is Laffer, now 76 and still every bit the believer in the virtues of lower taxes as he was the night he went to a restaurant in 1974 with three fellow conservatives named Dick Cheney, Donald H. Rumsfeld and Jude Wanniski and outlined his thinking on that famous napkin.

He said that he would urge Trump to close loopholes and eliminate tax shelters as he slashed rates, but that even without doing so, a corporate tax rate cut would generate cascades of tax revenue. The businesses themselves would no longer look for ways to avoid paying, and so report more of their income.

“We would bring people back and we would create jobs without tariffs and without protectionism,” Laffer said by telephone. “I’m a big believer in using honey rather than vinegar, and incentives are much better. I think it would be a flood of businesses coming back in short order, and it would stop inversions” — when companies move overseas for tax reasons.

He also said greater economic activity would increase revenues from other taxes, including those on personal income and sales. Moreover, he said, with more jobs would come lower expenses for welfare.

“It’s a slam dunk,” Laffer said. “It’s a no-brainer.”

Politically, at least. He noted that both Reagan and the second Bush won re-election.

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