Saturday, March 07, 2009

Fun with Charting Tax Rates and Growth

Just for fun, I plotted the top marginal federal tax rate from 1947 through 2006 against real GDP growth for each year. Here is what I get:

GDP data come from BEA; Federal Tax Data from Brookings and the Urban Institute. The correlation is actually slightly positive (about .098). I am not suggesting that higher marginal tax rates cause economic growth. But it is awfully hard for me to see where a ten percent increase in marginal tax rates for the wealthiest among us will bring about economic ruin.


David Barker said...

Simultaneity? It could be that tax rates are lowered in response to slow growth, creating a positive correlation.

Anonymous said...

The important takeaway is that high tax rates doesn't of necessity slow growth. In fact, the marginal tax rate seems not to make much of a difference. Bring back the 90% bracket and let's take care of everyone's health!


The Oriole Way said...

In response to David Barker, what happens if the data is time shifted 12 months into the future?

Michael said...
This comment has been removed by the author.
Michael said...

What's R^2 or the results of an F-test on that data, it looks hardly correlated at all.

Steve Roth said...

Hi Richard:

Great to see you tackling this question. An even better experiment looks at multiple countries--government size versus growth in GDP per capita--over long periods.

The results are pretty resounding and conclusive:

Looking forward to reading more of your blog.


Anonymous said...

And the reason is quite obvious: in general, tax revenue either pays down government debt, which returns money to the private sector, or goes to government spending projects, which also returns money to the private sector. Tax revenue does not magically disappear once it leaves taxpayers' hands, it is funneled directly back into the economy. Therefore it should be little surprise that tax rates have little if any effect on economic growth. The only difference is that funds that might otherwise have been used for private investment or consumption are instead used for government investment or consumption, which depending on the individual case may be either better or worse for the overall economy. For example, it might have been better for the overall economy if the funds that were used for real estate speculation by the private sector were instead used by the government to invest in assets with certain value such as infrastructure, energy security and conservation projects, education and healthcare.

Sometimes the private sector invests more wisely than the government and sometimes it doesn't. It is up to us to determine which is the case on an individual basis rather than by making broad unsupported claims on the basis of ideology.

David Barker said...

Anonymous neglects deadweight loss from taxation. Wealth really does magically disappear!

Anonymous said...

Presupposing the existence of deadweight loss assumes the market can find a better allocation of resources than the government. I ask you, is 8% unemployment a sign of good resource allocation?

David Barker said...

Yes - it's creative destruction. Governments keep people on the same job whether or not conditions change. Markets adjust to changing circumstances. Temporary unemployment is a cost of transition.

Anonymous said...

Is it possible that Art Laffer was right, and that it is a curve. It seems plausible that raising marginal rates from 35% to 40% would not have a negative effect on GDP growth, and that it may even correlate to GDP growth. Maybe even taking it from 40% to 45% or 50% would be okay, but I find it hard to imagine that raising marginal rates above 50% would not lead to diminishing revenues, and reduced incentive to be productive upon reaching a certain level of income. No less then Paul Krugman indicated that he thought that raising rates above 50% leads to reduced productivity at higher incomes, more cheating, and eventually decreased Government revenue.(See his interview with Charlie Rose. I am thinking it could be found on youtube or PBS online.)

Anonymous said...

Governments keep people on the same job whether or not conditions change. Markets adjust to changing circumstances. Temporary unemployment is a cost of transition.

Uh... wouldn't that make government employment more efficient?

Anonymous said...

Yes - it's creative destruction.

So was the Bolshevik revolution. You gotta admit those guys were creative.

Governments keep people on the same job whether or not conditions change.

Yes, because the jobs that the government fills--delivering mail, defending our borders, teaching our children--are in sectors that society depends on whether the Dow is up or down. The government does not staff Best Buy.

Of course, the stimulus does provide extra temporary employment on the government's dime, so that does sorta refute your claim.

Markets adjust to changing circumstances.

Indeed they do. They don't always adjust in time to avoid catastrophe, of course, but that's neither here nor there.

Temporary unemployment is a cost of transition.

Indeed it is. And it would of course cause great damage to hire such temporarily unemployed people to build roads or fix schools because they should instead be busy staying at home watching Oprah, because that's what the market has decided is the best use of their resources.