The Wall Street Journal reports on a new paper by the Congressional Research Service. It looks at the effects of cuts on top marginal rates. Do they lead to economic growth?
Just in time for the year-end debate over extending the Bush tax cuts for high earners: a new report concludes that tax cuts for the rich don’t seem to be associated with economic growth.
The report, from the Congressional Research Service, finds that tax cuts for high earners can be linked to a different outcome: income inequality…..
The top individual tax rate for high earners has generally declined since World War II, and is at 35% currently, down from 94% in 1945, the report noted. Although capital gains tax rates have been more variable, the current 15% rate is the lowest in more than 65 years. The capital gains rate was 25% before 1965.
The government researchers found that “the top tax rates do not necessarily have a demonstrably significant relationship with investment.” The researchers also said that the correlation between economic growth and the top tax rates “is not strong,” and that any links “could be coincidental or spurious because of changes to the U.S. economy over the past 65 years.”
What about arguments that “some income inequality is necessary to encourage innovation and entrepreneurship—the possibility of large rewards and high income are incentives to bear the risks?” The researchers note the argument, but say that the most statistically significant link is between income inequality and tax cuts on the rich.
“As the top tax rates are reduced, the share of income accruing to the top of the income distribution increases; that is, income disparities increase,” government researchers said.
CRS analysts also said that “capital gains and dividends have become a larger share of total income over the past decade and a half while earnings have become a smaller share.” This phenomenon, the researchers said, suggests that labor may grab a larger share of the pie when the top individual and capital-gains tax rates are higher.
An earlier report by Thomas Hungerford had noted that the decrease in tax rates on capital gains and dividends (along with an increase in capital gains and dividends) had been the source of much of the inequality seen in our recent history, outweighing income taxes and changes in labor income.
This will be countered by other studies suggesting that there might be a link between lower rates and increased output. However, when one has conflicting studies in this area, and no obvious linkage, I think it probable that if there is some link between lower top rates and growth, it is a weak one. Other factors such as regulation and innovation likely far outweigh them. I think this just reinforces the idea that incentives matter. For the individual, there is incentive to increase personal wealth. Economic growth may or may not, the subprime crisis being a good example, ensue. The pursuit of wealth is not the same thing as increasing economic growth.
This may be increasingly important as there is a building body of evidence that inequality of income, at some level, leads to decreased economic growth. I think that the existing literature is not yet convincing at this time that at our levels of income this is a major factor in our slow down. At the extremes, think banana republic, this is fairly obvious, but we are not at those kinds of levels, yet. (H/T Thoma)