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

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.

  • $\begingroup$ 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. $\endgroup$ – athos Dec 3 '13 at 0:08
  • $\begingroup$ @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 ;-) $\endgroup$ – vonjd Dec 3 '13 at 9:05
  • $\begingroup$ 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? $\endgroup$ – athos Dec 3 '13 at 13:21
  • $\begingroup$ 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). $\endgroup$ – vonjd Dec 3 '13 at 15:58
  • $\begingroup$ 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! $\endgroup$ – athos Dec 4 '13 at 0:17

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