Pethokoukis

Sorry, New York Times, tax cuts sure do lead to economic growth

Image Credit: Images_of_Money (Flickr) (CC BY 2.0)

Image Credit: Images_of_Money (Flickr) (CC BY 2.0)

As Bruce Springsteen puts it so well at the end of “Brilliant Disguise“:

God have mercy on the man,

Who doubts what he’s sure of.

And one thing policymakers and journalists — and voters — should be sure of is that cutting tax rates can be a pretty effective way to boost economic growth. And raising tax rates hurts economic growth. I could point to numerous studies and historical examples. But here’s just one, a study from Christina Romer, President Obama’s former top economist: ”Tax increases appear to have a very large, sustained, and highly significant negative impact on output … [and] tax cuts have very large and persistent positive output effects.”

Now some folks, mostly found on the left, would like to believe this economic reality isn’t so. They would like to believe that America can pay for the coming deluge of entitlement spending by raising taxes on the rich with no impact on economic growth.

Example: this opinion piece from liberal New York Times columnist David Leonhardt, which suggests tax cuts don’t lead to higher economic growth. Basically, his whole argument is one of simple causality. There have been times when high taxes rates and high economic growth have peacefully coexisted. In fact, growth has been higher in the U.S. when taxes have been higher. Leonhardt seems to think this conclusion from a Congressional Research Service is an argument ender:

The top income tax rates have changed considerably since the end of World War II. 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 average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the second World War.

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

But this a very old, very tired argument.

1. Yes, from the late 1940s though the early 1960s, economic growth averaged 3.7% even though top tax rates were around 90% (though effective tax rates were much lower). From 1983 through 2007, when top tax rates were 50% or less, GDP growth averaged around 3.3%.

2. But as I have written frequently, the post-World War II decades were affected by many one-off factors, not the least of which was that they occurred right after a devastating global war that left America’s competitors in ruins. A National Bureau of Economic Research study described the situation this way: “At the end of World War II, the United States was the dominant industrial producer in the world. … This was obviously a transitory situation.”

And as former Bain Capital executive Edward Conard notes in his new book, Unintended Consequences:

The United States was prosperous for a unique set of reasons that are impossible to duplicate today, including a decade-long depression, the destruction of the rest of the world’s infrastructure, a failure of potential foreign competitors to educate their people, and a highly restricted supply of labor. For the sake of mankind, let’s hope those conditions aren’t repeated. It seems to me anyone who makes comparisons between today’s economy and that of the 1950s and 1960s without fully disclosing their differences is deceiving their readers.

3. Starting in the early 1970s, economic growth slowed in advanced economies (perhaps because the benefits from great innovations from the Second Industrial Revolution had run their course.) But growth slowed less in nations that embraced pro-market reforms such as deregulation and lower marginal tax rates. For instance, while U.S. per capita GDP grew by 55% from 1981-2000, French per capita GDP grew by just 39%.

4. Then there are the Clinton years. Clinton raised taxes and the economy did just fine. What about that?

Well, a) when Clinton signed that tax hike bill, the economy had been growing for 9 straight quarters, including by 3.4% annually over the previous six quarters; b) the ’90s saw a big drop in oil prices, from $23 a barrel in 1991 to $12 in 1998, boosting real disposable incomes; c) government spending declined from 22.3% of GDP in 1991 to 18.2% in 2000, meaning fewer resources as a share of the economy were being used unproductively by Washington; d) the late 1990s saw a big cut in the capital gains tax rate to 20% from 28%; e) the late 1990s also saw a big surge in private investment, particularly in the software and business equipment category which contributed a full point to GDP during those years. Did the Clinton tax hikes cause that or was it a combo of the Internet Bubble, Year 2000 preparations, the cap gains cut, and the beginning of a computer networking and communications revolution? My bottom line on the 1990s:

The U.S economy entered the 1990s after undergoing a huge revamp in the 1980s: marginal tax rates were lowered from 70% to 28%, the inflation menace slayed, regulations reduced, and businesses got restructured and way more efficient. Then in the 1990s, government spending and debt were reduced, investment taxes cut, and a technological revolution kicked into high gear. Plus the Soviet Empire collapsed and the cloud of possible nuclear holocaust was lifted. Market capitalism was on the march. People were optimistic as heck about the future. And in the midst of all that, taxes were raised in 1993. So that means taxes should be raised now — and Obama wants to do so in the most economically harmful and inefficient ways — in a time of economic stagnation and pessimism?

Taxes and tax rates aren’t the only things that matter to economic growth, of course. And every tax cut won’t pay for itself. Moreover, government needs enough revenue to pay for defense, basic research, and a safety net.

But taxes are pretty important. And pro-growth tax reform – particularly if the U.S. shifted from an income tax to a consumption tax – could boost employment and income growth and give government more revenue to pay down debt.

Have mercy on the nation that doubts that.

7 thoughts on “Sorry, New York Times, tax cuts sure do lead to economic growth

  1. Tom Sowell had a column on Republicans that can talk. The lone example was Chris Christie. Getting by the liberal gatekeepers is not easy, but I have not read or heard any discussion of economic growth and the implications from any candidate. We need to get this conversation started, or we will always be confronted with the false choice of higher taxes or less service.

  2. “d) the late 1990s saw a big cut in the capital gains tax rate to 20% from 28%”

    It seems to me you are implying cut capital gains tax to more investment to more jobs. If so, could this be an example of that not working?

    http://phx.corporate-ir.net/phoenix.zhtml?c=124138&p=RssLanding&cat=news&id=1736060

    Energizer Holdings, Inc. Announces Preliminary Results Of Comprehensive Review Of Cost Structure And Operating Model

    •Reduction of the global workforce; (plus other things)

    Capital gain ENR up $7.30 to $75.22 from $67.92

    Capital gain and less employment.

  3. The average annual growth rate in real GDP, from 1792 – 1922, was 4% when Government Revenue averaged 2.8% of GDP.

    The average annual growth rate in real GDP, from 1952 – 2002, was 3.4% when Government Revenue averaged 18% of GDP.

    A 542% increase in the tax rate resulted in a 15% reduction in economic growth.

    It seems to me that this data indicates that tax rates have no appreciable long term effect on economic growth.

  4. Can we at least try cutting spending, please! Somehow the one time stimulus of $700+ Billion has been added to our base line budget… WTH! This explains our Trillion+ deficits. As a consumer, my family is squeezed from every direction. We are not in the top tax bracket but hubby makes too much for any assistance for my college attending autistic son. Fortunately, we found a degree at a UH satellite that he can earn while living and working at home. Gas prices have not merely doubled for us, they quadrupled because we have double drivers as well. Auto insurance has gone up at least 8 times what it was. Although, hubby gets reliable raises they have not kept up with the rise in food and energy prices. And all those illegal aliens here who do not have to carry insurance because the police and ICE give them a free pass just keep increasing the cost of insurance for the law abiding legal citizen. Not to mention their children get free lunches and free education paid for by my property taxes among other taxes. Budget continues to be squeezed… Can’t fix the hot tub or make unnecessary purchases because we are so restricted by high energy costs and rising food prices. And then the health care boondoggle will gobsmack us in the new year, along with Taxmegedon. Sigh, thankfully we have back up savings but I do not think they will last another for years of Obama.

  5. I agree with the point that the 1950s and ’60s are not comparable to the current period that were included in the CRS study. But Leonhardt’s analysis focused on the 1990s and 2000s. In explaining the growth in the Clinton years, you invoke

    “b) the ’90s saw a big drop in oil prices, from $23 a barrel in 1991 to $12 in 1998, boosting real disposable incomes;”

    The years you’ve selected don’t correspond to the Clinton years. Using data from the Energy Information Administration, the average oil price when Clinton took office was $27 (in 2012 dollars), peaked in late 1996 at $33, then fell to $13 in late 1998, but then increased to $40 in late 2000. For the most part these prices were low and stable compared to the 1980s and 2000s.

    The oil price declines were far larger during Reagan’s term. Oil prices peaked at $101 in February 1981, and declined to $22 in July 1986 and then fluctuated around $30 per barrel till Jan 1989.

    Because of lower energy prices and efficiency gains, total expenditures on energy in the US declined 5.7% of GDP during Reagan’s term. Tax cuts reduced federal revenues only 2.3% at best. Thus, cheaper energy and more efficient use provided greater increase in disposable income than Reagan’s tax cuts.

    I haven’t seen any serious discussion about this so I wrote about it here:
    http://www.washingtonmonthly.com/ten-miles-square/2012/05/like_president_reagan_obama_or037617.php

    I also note that Feldstein and Elmandorf concluded that the Reagan Recovery of 1983-84 was largely due to monetary expansion and corporate tax changes that favored investment, but not the general income tax cut. http://www.businessweek.com/articles/2012-09-20/do-personal-income-tax-cuts-grow-the-economy-again-no-dot

    Finally, you said nothing about why the Bush tax cuts resulted in relatively anemic growth. You could invoke rising energy prices, in addition to the factors mentioned in Leonhardt’s article or by Bruce Bartlett: http://www.thefiscaltimes.com/Columns/2010/09/17/Bush-Tax-Cuts-No-Economic-Help.aspx

  6. During WWII, post depression, the folks back home made a decent income woring on munitions and other items for the war effort. Unfortunately, there was little they could buy. New cars were not available and even buying new tires for your existing car was difficult at best. Record numbers of families paid off their homes and saved their money. When the war ended they could finally spend. The excessive tax on their income was irrelivent because they were spending savings more than income. During the Clinton years you had the new dot come rich, Dellionares and the like. People who had for years been broke. Now they had more money than they had ever imagined because they worked at Apple, Microsoft, Dell… Whether they had 5 million to spend or 6 million to spend was irrelevant. They never imagined they would have had 1 million to spend. So the fact the Government took and additional 250K didn’t matter. This is why the comparisons to these time periods of high taxes is deceptive.

  7. From the referenced Romer & Romer paper:
    “We also find suggestive evidence that tax increases to reduce an inherited budget deficit do not have the large output costs associated with other exogenous tax increases.”

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