Friday, 2 November 2012

Does Higher Income Taxes Lead to Increased Growth?

This post is slightly venturing somewhat into the realm of political arguments but facts are facts.  Here is a link to the results of a congressional research into the impact of top marginal income tax rates on growth.  As many are aware, the GOP has been using the claim that lowering income taxes would cause great growth.  However, that is simply not supported by the numbers and history.  While I would like to have lower taxes (who doesn't?), any plan to lower rates while also stimulating growth and lowering deficits is not quite so simple.

Link to the research report PDF.

Summary taken from the Report 

Income tax rates have been at the center of recent policy debates over taxes. Some policymakers 
have argued that raising tax rates, especially on higher income taxpayers, to increase tax revenues 
is part of the solution for long-term debt reduction. For example, the Senate recently passed the 
Middle Class Tax Cut (S. 3412), which would allow the 2001 and 2003 Bush tax cuts to expire 
for taxpayers with income over $250,000 ($200,000 for single taxpayers). The Senate recently 
considered legislation, the Paying a Fair Share Act of 2012 (S. 2230), that would implement the 
“Buffett rule” by raising the tax rate on millionaires. 

Other recent budget and deficit reduction proposals would reduce tax rates. The President’s 2010 
Fiscal Commission recommended reducing the budget deficit and tax rates by broadening the tax 
base—the additional revenues from broadening the tax base would be used for deficit reduction 
and tax rate reductions. The plan advocated by House Budget Committee Chairman Paul Ryan 
that is embodied in the House Budget Resolution (H.Con.Res. 112), the Path to Prosperity, also 
proposes to reduce income tax rates by broadening the tax base. Both plans would broaden the tax 
base by reducing or eliminating tax expenditures. 

Advocates of lower tax rates argue that reduced rates would increase economic growth, increase 
saving and investment, and boost productivity (increase the economic pie). Proponents of higher 
tax rates argue that higher tax revenues are necessary for debt reduction, that tax rates on the rich 
are too low (i.e., they violate the Buffett rule), and that higher tax rates on the rich would 
moderate increasing income inequality (change how the economic pie is distributed). This report 
attempts to clarify whether or not there is an association between the tax rates of the highest 
income taxpayers and economic growth. Data is analyzed to illustrate the association between the 
tax rates of the highest income taxpayers and measures of economic growth. For an overview of 
the broader issues of these relationships see CRS Report R42111, Tax Rates and Economic 
Growth, by Jane G. Gravelle and Donald J. Marples. 

Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it 
is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 
1970s; today it is 15%. The real GDP growth rate averaged 4.2% and real per capita GDP 
increased annually by 2.4% in the 1950s. In the 2000s, the average real GDP growth rate was 
1.7% and real per capita GDP increased annually by less than 1%. There is not conclusive 
evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the 
top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax 
rates have had little association with saving, investment, or productivity growth. However, the top 
tax rate reductions appear to be associated with the increasing concentration of income at the top 
of the income distribution. The share of income accruing to the top 0.1% of U.S. families 
increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 
recession. The evidence does not suggest necessarily a relationship between tax policy with 
regard to the top tax rates and the size of the economic pie, but there may be a relationship to how 
the economic pie is sliced. 

Average Tax Rates of Highest Income Taxpayers From 1945-2010.  Note that today is among the lowest in modern
Top Tax Rates for Various Asset Classes from 1945-2010.

Real GDP Growth as a function of Top Tax Rates - 1945-2010

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