Policymakers seeking to spur persistently faster economic growth sometimes make claims about the long-term benefits of fundamental tax reform, which economic theory often suggests can be a potent force over many years. However, the more tractable and plausible tax reforms that become law have historically offered weaker impacts on economic growth. After the fact, the evidence is that these politically feasible tax reforms and tax legislation that have already been enacted uniformly fail to spark even moderate expansions in the long-term size of the economy.
In broad strokes, tax reform has the potential to have long-term effects on the economy through three principal channels: (1) changing the amount of tax revenue collected by the federal government, (2) altering incentives to improve economic efficiency or better align behavior with societal goals, and (3) redistributing income. All three types of effects can affect—positively or negatively—long-term gross domestic product (GDP). Nonetheless, the major tax reforms enacted in recent decades historically have had extremely small effects on long-term aggregate output.
And yet the estimated effect on aggregate output often receives more attention than the significant effects on revenues, behavior, and income distribution. In our view, this is a mistake. During the forthcoming policy debate necessitated by the sunsets in the Tax Cuts and Jobs Act (TCJA), we believe that scrutiny of the inevitable estimates of GDP impacts should take a backseat to these other effects.
During the forthcoming policy debate necessitated by the sunsets in the Tax Cuts and Jobs Act (TCJA), we believe that scrutiny of the inevitable estimates of GDP impacts should take a backseat to these other effects.
In this essay we intentionally center on the long-term impacts of tax reform rather than on the short-term effects that may come from tax policy shifts designed to stimulate the economy. When policymakers enact tax changes that take effect quickly, such as an immediate cut in tax rates, aggregate demand typically responds and can lead to short-term boosts to GDP. For example, during recent downturns, Congress legislated household tax rebates that boosted consumption and, subsequently, near-term growth. We are setting near-term effects aside, and instead we focus on estimates of how enacted tax reforms have affected the productive capacity of the economy over the longer term.
Over the past four decades, Congress has substantially reformed the tax code eight times, most recently in 2017 with the TCJA. Our review of major tax reforms since 1986 shows that the most comprehensively estimated impacts of those reforms have ranged between a 0.5 percent increase to a 0.5 percent decrease in the long-term level of output. Although these estimates are highly uncertain, we walk through some practical reasons why the effect of tax reform on aggregate output is relatively small.
We argue that, when tax reform is projected to have a minor impact on aggregate output in the long run, considerations of those effects should be secondary relative to effects on federal tax revenues, changes in behavior to further broader societal goals, and distribution of income. It is particularly shortsighted if a focus on small negative aggregate economic effects precludes the passage of well-designed tax policy that would achieve other priorities.
