This is a question I recently posed to a friend: Why do politicians (on both sides of the fence) keep asking how tax cuts are going to be paid for?
It seems to me that recent history has shown that tax cuts pay for themselves. Am I missing something here?
Because my knowledge of economics is basic at best, the question caused me to do some research. In the interest of full disclosure, my status as a MAGA fanatic may (said sarcastically) have influenced my research, which is presented below.
An eminent economist, Dr. Arthur Laffer, studied my precise question and reached the conclusion that tax cuts pay for themselves. Laffer, through the development of his famous Laffer Curve (illustrated below), concluded that reductions in federal taxes cause increased economic growth, which, in the long run, causes increased tax revenues. The curve, created in 1974, is used to reinforce the argument that cutting tax rates results in increased tax revenue.
T*, the highest point on the curve, is the optimal tax rate.
Laffer further argued that tax cuts have two effects on the federal budget: the immediate arithmetic effect (every tax dollar cut results directly in one less tax dollar) and the long-term economic effect (which has a multiplier effect: a tax cut increases income for businesses and taxpayers, who spend it, which increases demand, which creates more business activity, which causes an increase in production and employment, which increases tax revenues).
Laffer’s conclusions influenced President Ronald Reagan’s economic policy, which resulted in one of the largest tax cuts in history. Annual tax receipts actually grew during Reagan’s tenure. Total tax revenue was $517 billion in 1980. Total tax revenue nearly doubled to $909 billion by 1988. As can be seen in the graph below, Laffer was correct. Total tax revenues between 1981 and 1990 rose despite tax rate reductions.
shape of the Laffer curve and where on the curve current tax rates fall. The shape of the curve is a function of taxable income elasticity (taxable income changes) in response to changes in the rate of taxation.
calculated that the federal government collected $4.9 trillion of federal tax revenue in 2024, up almost $1.5 trillion since 2017, the year before the Tax Cuts and Jobs Act (TCJA) of 2017 became law. Tax revenues were up 40 percent in five years. Additionally, the evidence through the first three years of the tax cut shows that the share of taxes paid by the wealthiest 1 percent rose as well. So much for this being a tax giveaway for the rich, Pocahontas.
These tax revenue amounts were compared with estimates of what the Trump tax cuts were expected to “cost.” Instead of an expected $1-trillion revenue “loss,” the tax receipts over this period were almost precisely what they would have been if taxes had not been cut at all.
The Laffer Curve prediction was correct about the Trump tax cut. The tax cuts produced higher growth and higher tax revenue collections with lower tax rates (the long-term economic, multiplicative effect).
The Google A.I. Copilot says there is little empirical evidence of the accuracy of the Laffer Curve. I guess that opinion depends upon what Copilot considers as “little.”
Why are Laffer’s conclusions important today? Two reasons: current proposed tax cuts and tariffs.
Current Proposed Tax Cuts
The TCJA will expire this year. Extending it is effectively a tax cut. Lowering taxes raises disposable income, allowing the consumer to spend more, which increases the gross domestic product. Reducing tax rates to spur economic growth is a policy that espouses that lower tax rates give people more after-tax income that will be used to buy more goods and services. This is what’s known as a demand-side or trickle-down economic policy. Reduced tax rates boost savings and investment, which lead to further production and reduced unemployment.
Business tax cuts reduce taxes on company profits. The goal of these cuts is to give firms more money to invest in growth, wages, and hiring. It gives corporations more money to invest back into their businesses, which, in turn, helps create new jobs. Tax cuts on small business help entrepreneurs start new businesses, which add jobs, since small businesses create 64 percent of all new private-sector jobs.
Tariffs
A tariff is actually an import tax levied by a government on goods and services imported from other countries. So the above research about taxes applies to tariffs as well.
Revenues raised by tariffs will, according to the Tax Foundation, fall short of what’s needed to fully “pay for” the revenue losses of making the TCJA permanent. However, Peter Navarro, senior trade adviser to President Trump, speaking about the president’s tariff plan, said, “We’re going to raise about $100 billion with the auto tariffs alone. … Other tariffs are going to raise about $600 billion a year, about $6 trillion over a 10-year period, and we’re going to have tax cuts. It’s the biggest tax cut in American history for the middle class, for the blue collar.” Navarro said the revenue brought in from tariffs on cars and auto parts would be so massive that it would eventually be passed on to consumers in the form of tax cuts.
He also said the “bigger picture” of tariffs is “restoring” the American manufacturing base.
Since tariffs are taxes, and since Laffer’s track record on taxes is accurate, I’ll wager that Navarro is correct. (Note: I couldn’t find any direct Laffer-Navarro connection, so my conclusion is based upon a “White House spill-over” effect.)
Fox News Sunday host Shannon Bream noted that Americans are concerned that Trump’s tariffs are going to raise the price of everyday goods. To address the concern, Larry Kudlow is calling for a “tariff dividend” for Americans by taking the White House’s estimated $600 billion and giving it directly to taxpayers, thus effectively “paying for” the increased tariff (tax) costs.
Bottom line: Democrats (and most left-leaning economists) would have you believe that revenue collection and spending is zero-sum, that tax cuts have to be “paid for,” offset by new revenue sources and/or new budget spending cuts. My (biased?) research, however, illustrates that Laffer is correct: In the long term, tax cuts pay for themselves.
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Jesus Christ is King
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