EclectEcon

On his blog, Greg Mankiw reproduces his WSJ column with Robert Carroll about the growth effects of tax cuts. The overall conclusion is that if tax cuts induce more private investment, then economic growth will be promoted and people will be better off (in a material sense) in the future. And, not surprisingly, cuts to capital gains and dividend taxes do the most to promote private investment.

But what if the tax cuts are not accompanied by reductions in gubmnt spending? What if, eventually, tax cuts today mean tax increases in the future (possibly to deter foreigners from dumping all their holdings of US gubmnt debt?)?

The results are strikingly different. Instead of increasing by 0.7% in the long run, GNP now falls by 0.9%. Tax relief is good for growth, but only if the tax reductions are financed by spending restraint.

In other words, Ricardian Equivalence is a real world phenomenon to be reckoned with if people expect gubmnts will not reduce their spending. Mankiw adds:

One exception: Lower taxes on dividends and capital gains promote growth, even if they require higher income taxes.

Good luck trying to convince interventionist redistributionists about this conclusion.

Update: For more, see the analysis at Econbrowser