by William McBride
February 13, 2013
The Congressional Budget Office (CBO) takes a sanguine view of the long-term effects of recent tax increases on high-income earners and investors. CBO’s long-term model of economic growth is driven by capital and labor, as it should be according to the standard neoclassical understanding. However, CBO wrongly assumes that capital and labor grow in the long run independently of taxes on capital and labor. Obviously, taxes are a cost and they should be taken into account in CBO’s model just as they are by investors, employers, and workers. Because of this omission, CBO underestimates the long-term drag on economic growth that will result from recent increases in the tax costs of investing, hiring, and working. If we assume CBO’s other assumptions about the economy are correct, that means economic growth will be slower and high unemployment and low tax revenue will persist longer than CBO predicts, probably beyond 2017.