Do lower taxes cause faster GDP growth? Your answer will hinge on what economic theory you subscribe to. The fundamental idea of supply-side economics is that tax cuts cause economic growth. This theory is grounded in the idea of expanding the tax base which in turn will produce more tax revenue for the government. The opposite of supply-side economics is demand-side economics. The fundamental idea of demand- side economics is about growing the demand of the consumer. The idea is that the fastest way to increase demand is to increase the relative wealth of the people who want to make purchases – the middle and lower classes. This theory is grounded in the idea that higher taxes on the wealthy and on corporations will allow wealth to be more evenly dispersed to the middle class and the poor.
Over the years, there has been tax cuts and tax reforms enacted with the attempt to spur economic growth. Most large tax reduction measures came during an economic cycle that had much higher inflation and unemployment than we do today.
The Revenue Act of 1964 emerged from Congress and was signed by President Johnson in 1964. This tax reform was first proposed by President Kennedy prior to his assassination 1963. This tax package was implemented to deal with an economy stuck at a 7.3% unemployment rate and an unsatisfactory growth rate of below 3%. With the tax cuts of 1964, GDP did grow at least over the short-term with GDP coming in at 8.5% in 1965. By 1967 however, GDP growth was back below 3%.
During the Reagan presidency, there were two tax reform measures implemented – 1981 and then again in 1986. Both tax measures led the US into one of the largest economic expansions in history. After the recession of 1982, the economy grew at 7.8% in 1983 and continued growing at 3% or more until 1989.
There’s no clear consensus among economist on the role that tax cuts have on GDP growth. In the past, tax cuts normally flowed into the economy rather quickly. Using history as a guide, we should see the impact of the Trump tax cuts on the economy as soon as the next few quarters. There are precedents that suggest tax reform can propel economic growth. However, in the past major tax reduction measures were implemented during periods of high unemployment and higher than normal inflation. It’s reasonable to believe we’ll see a growth in GDP over the short-term – 2018 and 2019. The impact the Trump tax cuts will have on longer term GDP growth is less clear. A long-term economic boon that we saw during the 1980s is not likely considering where we are in the economic cycle.