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Study Reveals that Income Tax Changes May Have Small Effects on Long Term Economic Growth

September 26, 2014

Based on historical evidence and simulation analyses, changes to individual income tax that are not financed by immediate spending cuts will have little positive impact on growth, according to a recent study co-authored by William Gale, Arjay and Frances Miller chair in federal economic policy at Brookings Institution and co-director of the Tax Policy Center, and Andrew A. Samwick, professor of economics and director of the Nelson A. Rockefeller Center for Public Policy and Social Sciences at Dartmouth College. The study, "Effects of Income Tax Changes on Economic Growth," was published this month by the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution.

The study analyzes two types of tax changes: reductions in individual income tax rates without any offsetting tax increases or spending cuts; and income tax reform that broadens the income tax base and reduces statutory income tax rates, while maintaining overall revenue levels and the distribution of tax burdens.

As part of the study's empirical analysis, the co-authors evaluate: the differences between taxes before and after World War II; the impact of major tax cuts in 1981, 2001, and 2003; the tax increases that took place in 1990 and 1993; and the effectiveness of "tax reform," which they conclude is a rare event in modern U.S. history, if defined as base-broadening, rate-reducing changes that are neutral with respect to pre-existing revenue levels and distributional burdens of taxation.

"It is possible to use the tax code to encourage economic growth. However, the usual discussions of tax reform focus principally on across-the-board reductions in the tax rates on individual labor income without offsetting spending reductions. Such changes have the potential for only small or fleeting effects on economic activity and in practice may reduce growth," says Samwick. "To positively affect growth, policy makers can focus on incentives to invest in new, productive capital – whether property, plant and equipment; education and skills; or public infrastructure."

Dartmouth Economics Professor Andrew Samwick is available to comment at andrew.samwick@dartmouth.edu or (603) 646-2893.

Last Updated: 9/9/15