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)
Link to original CRS report.
http://graphics8.nytimes.com/news/business/0915taxesandeconomy.pdf
“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.”
I think it’s fair to note that the introduction of Medicare, Medicaid, welfare, subsidized housing, labor and enviromental regulations as well as lawfare resulted in lowered income of working Americans.
Medicare was introduced in 1970. Welfare has been around longer. Decreases in income for the lower 99% begin about 1980., correlating with the era of the conservative GOP preisdent and suppply side economics.
Medicare was introduced in 1965. Most of welfare was put in effect in the 1960ie and 1970ies (SSI started in 1974). Enviromental regulations became all the rage in the 1970ies. If you look at the median household income in US, it’s not difficult to see that the 1970ies were the time of income stagnation. The median income was $45,499 in 1969 (real dollars), and it was $45,260 in 1981. You surely cannot blame this stagnation on Reagan, conservatives and supply side economics.
http://www.davemanuel.com/median-household-income.php
“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.”
It’s rarely discussed, but the actual tax collections from the rich were rising after the tax rates were cut. So it’s no surprise that rich pay today more in taxes as percent of GDP than in the past.
Theirs were the only incomes rising. If everyone else’s incomes are stagnant, then their share of taxes had to rise.
Steve
By cutting tax rates, the US government was able to collect more money from the rich. Explain who is harmed by this.
“By cutting tax rates, the US government was able to collect more money from the rich. Explain who is harmed by this.” (H-A)
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You’re 100% right that tax RATE cuts have always increased tax revenues, but that has probably hurt all of us by spurring on MORE government spending!
The goal should not have been Laffer’s “Cut rates until to the lowest point at which they still increase government revenues,” in his view appx 22%, BUT instead we probably should’ve followed Rothbard’s advice to cut rates to the point that they REDUCE government revenues so that government is forced to spend less.
While NO ONE is harmed by tax cuts, EVERYONE is harmed by tax increases that stunt investment and job creation.
http://www.nytimes.com/2012/09/16/opinion/sunday/do-tax-cuts-lead-to-economic-growth.html?_r=2&nl=todaysheadlines&emc=edit_th_20120916
Interesting piece with several points.
-Similarly, a new report from the nonpartisan Congressional Research Service found that, over the past 65 years, changes in the top tax rate “do not appear correlated with economic growth
-Mr. Romney and Mr. Ryan, to be sure, are not calling for a simple repeat of the Bush tax cuts. They say they favor a complete overhaul of the tax code, reducing tax rates by one-fifth (taking the top rate down to 28 percent) and shrinking various tax breaks. Many economists think such an overhaul could do more good than the Bush tax cuts, by simplifying the tax code.
-When the top marginal rate was 70 percent or higher, as it was from 1940 to 1980, tax cuts really could make a big difference, notes Donald Marron, director of the highly regarded Tax Policy Center and another former Bush administration official. When the top rate is 35 percent, as it is today, a tax cut packs much less economic punch.
Re: marginal utility of incentives–it costs a LOT more to encourage Bill Gates to make another billion than to encourage your cashier at Wal-Mart to make another $10/hr. And, on the other hand (there are data on this), a few days behind bars early in his criminal career could probably have kept Bernie Madoff on the straight and narrow, while the average housing project resident may actually view the state penal system as an improvement on his current digs. Which means that state has to spend a LOT of money to make it any worse. It is cheaper to offer the carrot to poor people and the stick to rich people, but since the poor people have little impact on our legal system, things don’t work out that way.
“marginal utility of incentives–it costs a LOT more to encourage Bill Gates to make another billion than to encourage your cashier at Wal-Mart to make another $10/hr. ”
Lower top marginal tax rates produced higher tax revenue from the rich people. They did not have same effects from poor. Empirical evidence disproves your claim.
Moreover, people working for minimum wages pay no federal income taxes, so it’s impossible to cut their taxes. Last but not least, it’s easy and cheap to promote work from the bottom 50% – remove all welfare, and make pay them some minimum amount of “patriotic federal income tax”. That would work wonders.