For Tax Cuts, Two Possible Paths

In Taxes On

One example of this is a debate over whether a tax cut will be retroactive. Suppose that a bill passes in November or December cutting individual income tax rates. Should the lower taxes apply to income earned in 2017, or only to that earned in 2018 and beyond?

It’s easy to see why the smart thing politically would be to apply the lower rates to 2017; more money would show up in taxpayers’ refund checks in the spring of 2018, ahead of the midterm elections. When the George W. Bush administration passed tax cuts in 2001 and 2003, it took that approach.

But it also defies the economic theory about why tax cuts might be advantageous for the economy. The entire conservative philosophy behind lowering taxes is that when the government takes less, it encourages people to invest more and work harder, increasing the nation’s economic potential.

There is a continuing debate over how powerful those effects really are, yet it at least is a coherent theory of how tax cuts can generate economic growth. If a retroactive tax cut passes in November, however, no one can go back in time to January and suddenly put in more hours or invest more.

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