Taxes and Growth: Why Tax Cuts do not Necessarily Stimulate Economic Growth

Tax cuts are typically politically popular. And, they are often justified by their potential to stimulate economic activity. The concept is that lower tax rates lead to higher real GDP growth, and faster GDP growth leads to higher tax revenues down the road. The link between lower tax rates and future economic growth is, however, exceedingly tenuous. The statistical evidence for tax cuts leading to higher economic growth is mixed and not very convincing. A number of the critical assumptions in the economic theory of tax cuts are often ignored. When one replaces these heroic assumptions with a more realistic view of the world, it goes a very long way in helping to explain why tax cuts do not seem to contribute to economic growth, when the intuition is otherwise. Even so and despite the lack of impact on economic growth, tax cuts unambiguously seem to help equity markets and raise share prices…