John Irons's Blog


Economic News, Data and Analysis

Taxes and Economic Growth

Interesting post over at Angry Bear on tax rates and economic growth. He looks at several simple correlations between tax rates (or changes in rates) and GDP growth.
Generally speaking, he finds that very high marginal tax rates (above 90 percent) coincide with lower growth, but otherwise, there is little evidence to support the notion that lower marginal taxes (on income or capital gains) are associated with faster economic growth.
Of course, it’s much harder to determine causality with this kind of analysis, and there are plenty of econometric problems since longer term trends (caused by factors other than taxes) can create spurious correlations. And economic theory also says that the impact depends on what the revenue is used for (e.g. R&D, public investments, deficit reduction, or military spending).
But given the data, the burden of proof should be on the shoulders of those who claim that lower taxes (in the range we are currently in) would result in higher long-run economic growth.

Tax Rates and Economic Growth – A Look at the Data on Marginal Tax Rates, Capital Gains Tax Rates, and Real GDP per Capita
This post looks at the relationship between tax rates and economic growth. Because this is a controversial subject, I will approach this methodically, and also (where possible) approach the problem (and the solution) from more than one angle. It makes for a long post, so be forewarned. If you want to read it, make sure your chair is comfortable.
Here’s the plan… First, look at how the top marginal income tax rate, the bottom marginal income tax rate, and the top capital gains tax rate evolved over time beginning in Ike’s term graphically. Next, look at the growth rate of real GDP per capita observed at these different tax rates. Where possible, when a “maximum” or optimal point is uncovered, use correlations between tax rates and growth rates to confirm whether that point truly is a maximum.
[…lots of graphs and simple time-series correlations …]
So… what can we conclude from all this? Well, there isn’t much evidence that cutting tax rates, at least to high income earners and on capital gains, will lead to faster growth. In fact, it would seem that since Nixon’s time, tax rates have been below the “optimal” level for generating growth, possibly even leading to slower growth over the past thirty five years or so.

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