Can Tax Cuts Pay for Themselves? An Examination of Dynamic Scoring with Public Capital

Abstract:     
Can a decrease in tax rates increase tax revenues? If so, to what extent? This paper builds upon recent work by Mankiw and Weinzierl (2006) on the issue by incorporating public capital into a dynamic scoring. The significant components of growth effects and transition paths, along with the conditions under which a tax cut can "pay for itself" are illustrated using the familiar Laffer curve. It is shown that the productivity of public capital and the amount of revenue allocated to public capital investment have important impacts on the growth effects, transition paths and Laffer curves. Using standard labor and capital tax rates, the growth effects are shown to offset only 1 percent of the potential revenue loss from a labor tax cut and 46 percent of the potential revenue loss from a capital tax cut. A broader measure of tax rates from Feldstein (2006) shows that growth effects can offset approximately 30 percent of the potential revenue loss from a labor tax cut and approximately 157 percent from a capital tax cut. The latter result indicates that capital tax cuts may be more than just self-financing; they may actually increase tax revenues by 57 percent.

Keywords: tax, public capital, dynamic scoring, Laffer

JEL Classifications: E1, H2, H3, H6

Working Paper Series