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I'm reading "Principle of Economics" by Mankiw. In Part III Market and Welfare, Ch 8 "Application: the costs of taxation", it says:

Only 32% of a cut in U.S. labor taxes would be self-financed, the economists note, versus 54% self-financing in Europe. Just over 50% of a cut in U.S. capital taxes would pay for itself, the authors estimate, versus 79% in Europe.

But what does it mean by a tax cut be "self-financing"?

self-financing adj (of a student, business, etc.) financing oneself or itself without external grants or aid

So "self-financing" means someone can sustain without external aid. I just could not get it what a tax needs to be "self-financing"

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This question appears to be off-topic because it is about introductory economics, not quantitative finance. – Joshua Ulrich Dec 2 '13 at 12:24
@JoshuaUlrich but there's no "introductory economics" forum :( – athos Dec 3 '13 at 13:19
up vote 1 down vote accepted

What is meant is the so called Laffer effect or Laffer curve.

The rationale is that when you cut taxes that this will stimulate business and thereby over-compensate the loss in taxes the government originally had.

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i think not. the article is saying US is actually on the left side of the Laffer curve. so US need not cut tax to stimulate business. – athos Dec 3 '13 at 0:08
@athos: You asked what it means when a tax cut is said to be self-financed and this is the answer. Trust me, I have a PhD in economics and I am a professor and teach this stuff ;-) – vonjd Dec 3 '13 at 9:05
of course you have a better judgement on it. allow me rephrase my question, "Only 32% of a cut in U.S. labor taxes would be self-financed," does this mean that in U.S. if the labor tax rate is 32%, it will collect the most tax? – athos Dec 3 '13 at 13:21
If I understand the article correctly it means that the government can cut labour taxes by 32% and still rake in the same amount of taxes (due to accelerating business). Beyond this point, i.e. cutting more than 32%, the government will collect less taxes. (But the article is not very well phrased, in my humble opinion). – vonjd Dec 3 '13 at 15:58
i see. so there are 2 things, first, US is on left side of Laffer curve so a higher rate of tax in that year would raise more taxes; second, after considering business growth, a 32% cut in current tax rate would encourage economy and even harvest more taxes. thanks! – athos Dec 4 '13 at 0:17

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