	Introduction

Concerns that the economy might be heading toward a recession have led some policymakers to consider economic stimulus legislation. Proponents of the tax cuts passed in 2001, 2002, and 2003 argued that they would have salutary effects on the economy. Most estimates predicted that the tax cuts would increase economic growth in the short-term and reduce it in the long run. Its major revenue-side provision was accelerated depreciation for business investment. It also reduced the tax rates on dividend and capital gains income. Table 1 gives the estimated revenue loss of the tax cuts and their key provisions as scored by the Joint Committee on Taxation at the time the tax cuts were enacted. Certain provisions that are large in the long run are small to date and will not be explored, most notably the repeal of the estate tax. In 2003, they increased 0.5 percentage points to 1.6% of GDP. Because government spending rose as a percentage of GDP in the years when taxes were cut, these tax cuts can be characterized as wholly deficit-financed tax cuts (financed by increasing the deficit or decreasing the surplus). Economists can observe how the economy performed after a tax cut, but because they cannot observe the counterfactual—how the economy would have performed in the absence of a tax cut—there is no direct way to tell what contribution the tax cut made to the economy's performance. If the deficit is the result of tax cuts, aggregate spending is boosted by the tax cut's recipient to the extent that the tax cut is spent (not saved or invested in financial securities). Since the 2001 tax cuts took place during a recession and the 2002-2003 tax cuts took place during a period of sluggish recovery characterized by an economy operating below full employment, the Keynesian framework is a valid one to capture, at least in part, the effects of these tax cuts on the economy. These include the child tax credit and marriage penalty relief for most taxpayers. There tends to be no modeling of monetary policy since there are no short term effects. (No estimates of JCWAA's effects were found.) Like all intertemporal models, a permanent deficit-financed tax cut is inconsistent with the model because it would have caused the national debt to grow indefinitely. Auerbach assumed that the tax cut would result in higher taxes at some point in the future and ran simulations in which either the tax on labor or the tax on capital was raised; an increase in the wage tax reduced output more than an increase in the capital tax. The life cycle model predicted that GDP would be increased by a cumulative total of 0.2% over the first five years, and decreased by a cumulative total over the next five years by 0.1% if the tax cuts were financed by reduced government transfer payments (e.g., Social Security) after 2013 and reduced 0.2% if financed by higher taxes after 2013. On average, the proposals would increase GDP by 0.2% in the MA model and 1.4% in the GI model. These estimates were made before the tax cut occurred, and were not based on actual ex-post data. Unfortunately, there is no consensus among macroeconomists as to which one model is most suitable for policy simulations, and no model with a strong track record in accurately projecting economic events. The effect of growth in other macroeconomic models is considered next. Investment, National Saving, Interest Rates, and Growth in the Solow Model

Deficit-financed tax cuts reduce public saving; unless this is offset by higher private saving or borrowing from abroad, national saving will be reduced and interest rates will rise. Typically, the trade deficit declines when growth has been low.
Recession concerns have led policymakers to consider economic stimulus legislation. These proposals have raised questions about the economic effects of past policy changes. Congress enacted major tax cuts in 2001, 2002, and 2003. The acts reduced marginal income tax rates; reduced taxes on married couples, dividends, capital gains, and on estates and gifts; increased the child tax credit; and accelerated depreciation for business investment. The tax cuts resulted in an estimated revenue loss of 0.4% of GDP in 2001, 1.1% in 2002, and 1.6% in 2003. Since government spending rose as taxes were cut, the cuts can be characterized as deficit financed.
It is hard to be certain what effects the tax cuts have had on the economy because there is no way to compare actual events to the counterfactual case where the tax cuts were not enacted. The most common method of estimating a tax cut's effect is to feed it into a macroeconomic model of the economy and see what the model predicts. Note that this is typically done before the fact: economic estimates of the tax cut's effect are not based on actual ex post data. These estimates are highly uncertain because there is no one macroeconomic model that adequately captures all of the economy's dynamics, no consensus among macroeconomists as to which one model is most suitable for policy simulations, and no model with a strong track record in accurately projecting economic events.
Most estimates predicted that the tax cuts would increase economic growth in the short-term and reduce it in the long run. For example, the Joint Committee on Taxation predicted that the 2003 tax cut would increase GDP by an average of 0.2% to 0.5% in the first five years and decrease it by -0.1% to -0.2% over the next five years. Keynesian models find the largest positive short-term effect of the tax cuts on the economy. But these effects are completely temporary because they focus on how tax cuts boost aggregate spending; in the long run, prices adjust, and production rather than spending determines the level of output. In neo-classical (Solow) growth models, deficit-financed tax cuts reduce national saving, thereby reducing national income because capital investment can only be financed through national saving or foreign borrowing. If the latter occurs, the result will be an increased trade deficit. In intertemporal models, a deficit-financed tax cut is unsustainable: it must be offset in the future by a tax increase or spending cut to prevent the national debt from growing indefinitely. Thus, in these models, tax cuts followed by tax increases lead individuals to shift work and saving into the low-tax period, increasing growth then, and out of the high-tax period, reducing growth then.
The period encompassing the tax cuts featured a recession of average duration but below-average depth, an initially sluggish recovery, a deep and unusually long decline in employment, a small decline in hours worked, a sharp and long lasting contraction in investment spending, a significant decline in national saving, and an unusually large trade deficit. Opponents see this as evidence that the tax cuts were ineffective; proponents argue that the economy would have performed worse in their absence. Also consider that some, perhaps most, of the recovery was due to monetary rather than fiscal stimulus.