Economics, Pethokoukis

Study: Making a tax code more progressive hurts economic growth

From the “Macroeconomic Effects of Progressive Taxation” by Tae-hwan Rhee of the Samsung Economic Institute (via the American Economic Association annual meeting):

In this paper, I analyze the progressivity of state income tax in the United States. Using the IRS public use file data and NBER TaxSim, two types of indices – the Suits index and effective progression – are constructed for each of 50 U.S. states and for each year from 1979 to 2004. While federal income tax makes up the bulk of the combined federal plus state tax and drives most of the combined fluctuation over time, the state income tax still has significant variation from year to year and from state to state. Using these indices of progressivity, the relation between macroeconomic growth and income tax progressivity is investigated. Contemporaneous regressions do not show any significant effect in either direction. However, with three years of lag, income tax progressivity has a significant negative effect on the current year’s growth rate, after controlling for the average tax rate and state/year fixed effects. Although these regressions do not prove causality, these findings do support the idea that there is a tradeoff between economic growth and egalitarian redistribution.

Three possible reasons are offered to explain the apparent growth-equality tradeoff:

1. Migration. High income, high productivity people leave a state when the tax code grows more progressive — that is, raises taxes on them.

2. Work incentives. A progressive income tax effectively lowers the wage of higher-income groups, who then substitute leisure for labor.

3. Weaker entrepreneurship. Rhee:

Entrepreneurship can play a role here, too. Starting a new business is risky. The biggest motivation to take this risk is the higher expected income from the start-up than from the current job. A more progressive income tax makes this expected gain smaller after tax, which leads to less risk-taking behavior. This means that a highly progressive tax system might discourage small-scale innovations, leading to lower gross product

 

Are you paying attention, Illinois and California?

4 thoughts on “Study: Making a tax code more progressive hurts economic growth

  1. “Are you paying attention, Illinois and California?”

    Not at all. By your accounting, an open sewer like Mississippi should be an economic paradise.

    It’s not.

    • This article is about the link between more progressivity and lower economic growth NOT that less progressivity creates economic growth.

      “Although these regressions do not prove causality, these findings do support the idea that there is a tradeoff between economic growth and egalitarian redistribution.”

      I swear Max, sometimes your nitpicking comments can be so narrow-minded.

      • “Although these regressions do not prove causality, these findings do support the idea that there is a tradeoff between economic growth and egalitarian redistribution.”

        Translation: “Although we have no empirical data backing up such a specious claim, it does fit into our crackpot narrative, so we are making mention of it here, in order to further enforce the suspicions of our followership.”

  2. I would propose one flat rate tax on ALL income – individuals, businesses, and corporations, and even non-profits, religious organizations (churches), and universities – on gross income (minus “real” expenses – depreciation of equipment does not count (I’ve never seen anybody write a check to ‘Depreciation’.), no deductions for anything (not charities – which have existed back in the 19th Century before we had income taxes – not home mortgage interest). Everybody pays. Even poor people. Everybody has a stake in their country. Maybe we can include a National Sales Tax or a Value Added Tax of just couple of percentage points (2, 3, or 4%). What is important is to get the Federal revenues equal to 17% of GDP – 17% would not be pernicious. That was the goal under Reagan. Right now we need to freeze the Federal budget, not cut it, and get revenues up to 20% or more of GDP until we can get the budget in balance and back to producing surpluses. With annual growth rates of 4% for GDP we can achieve this goal within ten years. All people in an enterprise contribute to the productivity of that enterprise. They should be compensated accordingly. Everybody has a fair share, not necessarily an equal share, that is tied to the productivity of the enterprise and taxed appropriately.

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