Rosen: What about growth?

Harvey Rosen, a public finance expert at Princeton, argued that the Romney tax plan will increase economic growth dramatically, which in turn would raise revenue and negate the need for tax increases on the middle-class. He finds that if the Romney plan increases economic growth by 3 percentage points relative to where it would be under current policies — a huge, and many economists think implausible, boost — then Romney’s numbers might work out. But behind his analysis lurk two assumptions that might not add up.

Rosen bases his growth estimates on a study of Romney’s plan done by Rice economist John Diamond. Diamond assumes that Romney’s plan is implemented under conditions of full employment. That’s important because it means that if you eliminate tax breaks for one industry and they have to fire workers, those workers can relatively easily find jobs in another industry. But barring a miraculous labor market recovery in the next few months, that won’t be the situation when Romney takes office. In the current world, wiping out tax breaks for an industry could lead to displaced workers who simply join the ranks of the unemployed, dragging down growth.

But more damaging for Rosen’s case is that Diamond’s study assumes that Romney’s plan is revenue-neutral before you take economic growth into account.* That is, Diamond assumes that the tax cuts have been fully paid for first, and that’s part of why they do so much for growth. Rosen, conversely, is making the case that you don’t need to fully pay for the tax cuts because growth will fill in the gap. So the Diamond-Romney tax plan and the Rosen-Romney tax plan are quite different, and growth estimates that apply to the first don’t necessarily apply to the second.

Note footnote at bottom of article:

* Thanks to UC Berkeley’s Alan Auerbach for pointing out these assumptions in the Diamond estimate to me.