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IMA Tax Policy Blog

Modeling the Economic Effects of Seven Historic Tax Reforms

By Colby Pastre, The Tax Foundation . . .

The relationship between federal tax policy and the U.S. economy is one of the most contentious debates in American politics today. Often, the debate boils down to competing interpretations of U.S. economic history. Some analysts claim that past tax reforms had a significant impact on the economy, while others point to different reforms and claim they had little economic effect at all.

Today (Sept. 14, 2016), the nonpartisan Tax Foundation released a new study that uses its Taxes and Growth model to analyze seven major tax reforms since the 1960’s, providing a baseline for how we can expect certain tax changes to affect the economy.

Key findings of the report include:

While the Tax Foundation typically uses the Taxes and Growth model to forecast the revenue and economic effects of proposed federal tax changes, the model can also be used to “backcast” the effects of past tax changes stretching back to the 1960s.

Modeling the economic and revenue effects of past tax bills can shed light on recent U.S. economic history and the debate over the economic effects of tax reform.

For instance, some economists have been puzzled by the fact that the Tax Reform Act of 1986 appears to have had little effect on the size of the U.S. economy. However, this is exactly the result that the Taxes and Growth model predicts. The model finds that the 1986 act — a mixture of tax cuts on labor and tax increases on capital — would lead to a negligible 0.2 percent decrease in the size of the economy.

Although determining the actual macroeconomic effects of past tax changes is difficult, comparing the Taxes and Growth model results with observed economic data can serve as an imperfect test of the model’s reliability.

For example, before the passage of the Omnibus Budget Reconciliation Act of 1993, many lawmakers predicted that the tax increases in the bill would cause significant economic damage. However, the Taxes and Growth model predicts that the negative economic effects of the 1993 tax changes would be relatively small, shrinking the long-run size of the U.S. economy by only 1.5 percent. The historical evidence appears to offer greater sup-port to the predictions of the Taxes and Growth model.

The exercise of modeling the economic and revenue effects of past changes can provide con-text for the current predictions of the Taxes and Growth model. For instance, it becomes clear that several of the tax plans proposed by 2016 presidential candidates would create historically unprecedented economic effects.

For each of the following reforms, we calculate topline economic and revenue effects as well as walkthrough detailed model results for individual tax provisions:

The Revenue Acts of 1962 and 1964 (the “Kennedy tax cuts”),

The Economic Recovery Tax Act of 1981 (ERTA, the “Kemp-Roth tax cut,” or the “Reagan tax cut”),

The Tax Reform Act of 1986 (TRA 86, or the “Reagan tax reform”),

The Omnibus Budget Reconciliation Act of 1993 (the “Clinton tax increase”),

The Taxpayer Relief Act of 1997 (the “Clinton tax cut”),

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, or “the 2001 Bush tax cut”), and

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, or “the 2003 Bush tax cut”)

“Some economists point to the Kennedy or Reagan tax cuts as examples of tax changes that spurred the economy, while others highlight the Clinton tax increases as evidence that taxes have little economic effect,” notes Tax Foundation Analyst, Scott Greenberg. “But, to properly evaluate the relationship between taxes and the economy, it is not enough to survey the empirical effects of past tax changes. It is also necessary to develop some set of rules for how we expect each tax change to affect the economy, to which our historical observations can be compared.”

Full Report: Modeling the Economic Effects of Past Tax Bills

Source: The Tax Foundation, the nation’s leading independent tax policy research organization. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and local levels.