Should-Read: Matt O’Brien: Republicans are looking for proof their tax cuts will pay for themselves. They won’t find it

Should-Read: Why are the Tax Foundation’s numbers so much different than everybody else’s? And why do I now classify their model as “unprofessional”? Because the U.S. is not a “small open economy with perfect capital mobility” and because the neoclassical long run takes much more than 30 years to arrive. Here we have a good, short explainer: Matt O’Brien: Republicans are looking for proof their tax cuts will pay for themselves. They won’t find it: “The Tax Foundation… starts from the premise that the United States isn’t a big open economy like it actually is, but rather a small open one like Ireland…

…How does that change things?… Corporate tax cuts would make foreign investors send mountains of money into the country until, very quickly, the only investments left were ones that offered the same after-tax return as everywhere else in the world. On top of that, it doesn’t think tax cuts could ever be bad for growth by leading to, say, higher debt or higher interest rates from the Fed…. Even then, it’s hard to figure how it gets its numbers. “I’ve always been puzzled by their model,” Kent Smetters, a former Bush economist who is now the director of the Penn Wharton Budget Model, told me, “but there aren’t enough details for me to understand it.”… Greg Leiserson… has pointed out… the Tax Foundation made a number of mistakes, one of which it’s since corrected.

But there’s also what seems to be a more fundamental problem: The foundation seems to be assuming things that shouldn’t be assumed together…. The estate tax. The Tax Foundation thinks getting rid of it would help quite a bit… 0.7 percentage points of the 3.5 points of extra growth…. You can say taxing uber-wealthy heirs is bad for growth, because they’re the ones who have the money to make the investments we need. What you can’t do, though, is say that about a small open economy. In that case, people overseas would step in…. So repealing the estate tax shouldn’t matter…. The second red flag…. [In] the small open economy model… you’d expect the share of investment income going to foreigners to go up…. The Tax Foundation, though, assumes that the share of investment income going to foreigners wouldn’t increase at all, even though the share of investment coming from foreigners would….

It seems like the Tax Foundation has taken a simple idea and applied it in ways that don’t quite work together…. The assumptions built into the idea that the corporate tax is particularly bad for growth are different from the ones that tell you the estate tax is…. To make it all fit… ad hoc justifications…. I asked the foundation if… it could mathematically reconcile these things—and it doesn’t…


Brad DeLong


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