I was on CNBC earlier today talking about extension of the Bush tax cuts with Larry Kudlow, Mark Calabria from Cato, and a Kudlow co-host who was even more rightwing and kept insisting that cutting taxes on rich people would increase revenue. When you’re talking to conservatives, tax cuts are always the answer so you need to deal with a kaleidoscopic flurry of arguments in favor of said cuts. At the end of the segment, though, Kudlow pivoted to the idea that lower income tax rates on people earning over $250,000 a year would increase savings and investment and therefore boost long-term growth. Calabria agreed it was a shame we don’t talk about this more. Then the segment ended without me being able to talk about it more. Which is too bad, because frankly the counterargument against this one is extremely definitive: debt-financed tax cuts cannot increase savings and investment.
In their excellent paper “Take a Walk on the Supply Side”, Michael Ettlinger & John Irons show that it’s empirically false that Reagan/W Bush tax policies led to superior investment growth than Clinton-era policies.
But there’s a fundamental issue here and that’s simply that you can’t increase savings by borrowing money. If you cut someone’s taxes, that person will increase his savings and increase his consumption. If you cut a low-income person’s taxes, he’ll generally mostly increase consumption. If you cut a high-income person’s taxes, he’ll generally mostly increase savings. But economy-wide saving equals private saving plus government saving, so if you finance a tax cut by borrowing money (the reverse of saving) then the net impact on savings will be at most zero. To increase saving, you’d need to cut taxes on the rich and cut spending by the same amount.
Now it’s true that both Calabria and Kudlow say this is the course of action they favor. Which is good for them. But it’s not what’s on the table legislatively. And as a savings-boosting measure, a debt-financed tax cut is not a close substitute for a deficit-neutral tax cut. Instead, debt-financed tax cuts are guaranteed to lower the savings rate and reduce investment.
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