taxes

Modeling the Economic Effects of Past Tax Bills

While the Tax Foundation typically uses the Taxes and Growth model to forecast the revenue and economic effects of proposed federal tax changes, the model can also be used to “backcast” the effects of past tax changes stretching back to the 1960s.

Modeling the economic and revenue effects of past tax bills can shed light on recent U.S. economic history and the debate over the economic effects of tax reform.

For instance, some economists have been puzzled by the fact that the Tax Reform Act of 1986 appears to have had little effect on the size of the U.S. economy. However, this is exactly the result that the Taxes and Growth model predicts. The model finds that the 1986 act – a mixture of tax cuts on labor and tax increases on capital – would lead to only a 0.2 percent decrease in the size of the economy.

Although determining the actual macroeconomic effects of past tax changes is difficult, comparing the Taxes and Growth model results with observed economic data can serve as an imperfect test of the model’s reliability.

For example, before the passage of the Omnibus Budget Reconciliation Act of 1993, many lawmakers predicted that the tax increases in the bill would cause significant economic damage. However, the Taxes and Growth model predicts that the negative economic effects of the 1993 tax changes would be relatively small, shrinking the long-run size of the U.S. economy by only 1.5 percent. The historical evidence appears to offer greater support to the predictions of the Taxes and Growth model.

The exercise of modeling the economic and revenue effects of past changes can provide context for the current predictions of the Taxes and Growth model. For instance, it becomes clear that several of the tax plans proposed by 2016 presidential candidates would create historically unprecedented economic effects.

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