Evaluation of the effects of reduced personal and corporate tax rates on the growth rates of the U.S. economy

Abstract

Using several variants of a Marshallian Macroeconomic Model (MMM), see Zellner and Israilevich (2005) and Ngoie and Zellner (2010), this paper investigates how various tax rate reductions may help stimulate the U.S. economy while not adversely affecting aggregate U.S. debt. Variants of our MMM that are shown to fit past data and to perform well in forecasting experiments are employed to evaluate the effects of alternative tax policies. Using quarterly data, our one-sector MMM has been able to predict the 2008 downturn and the 2009Q3 upturn of the U.S. economy. Among other results, this study, using transfer and impulse response functions associated with our MMM, finds that permanent 5 percentage points cut in the personal income and corporate profits tax rates will cause the U.S. real gross domestic product (GDP) growth rate to rise by 3.0 percentage points with a standard error of 0.6 percentage points. Also, while this policy change leads to positive growth of the government sector, its share of total real GDP is slightly reduced. This is understandable since short run effects of tax cuts include the transfer of tax revenue from the government to the private sector. The private sector is allowed to manage a larger portion of its revenue, while government is forced to cut public spending on social programs with little growth enhancing effects. This broadens private economic activities overall. Further, these tax rate policy changes stimulate the growth of the federal tax base considerably, which helps to reduce annual budget deficits and the federal debt.