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-- Brad Delong

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Wednesday, January 29, 2014

Republican State of Disunion: Taxes Edition

The Republican response to the President's State of the Union message was delivered by Washington State Rep. Cathy McMorris Rodgers.  It was personal, platitude-ridden, overtly religious, twee, and devoid of policy content or anything else of relevant substance - other than a naked assertion that BHO's policies are making life harder in myriad unspecified ways. In other words, it was the most you could expect from an intellectually bankrupt party whose only agenda item is to make the President fail.

To be fair, she did offer one concrete recommendation: to lower taxes.  The concept that lowering taxes would be beneficial at this point is one of those zombie ideas that not only won't die, but continues to eat peoples' brains.  For example, in a recent AB comment stream, this idea was put forth: "Substantial tax cuts worked under Kennedy, Reagan, and Bush. Given the much higher level of household debt, a bold tax cut was needed more than ever."

As I've demonstrated before, and shortly will again with actual facts and data, there is no reason to believe that lowering taxes improves the economy.    But first, let's remember two important details.  First, over 45% of Americans don't pay any federal income tax.  The Wall Street Journal calls them "Lucky Duckies."  Imagine the great good fortune of making so little money that you don't qualify to be taxed on your earnings.  Second, as Bruce Bartlett pointed out 4 years ago, "tax filers with adjusted gross incomes between $40,000 and $50,000 have an average federal income tax burden of just 1.7%. Those with adjusted gross incomes between $50,000 and $75,000 have an average burden of 4.2%."

So the opportunity to have tax cuts do much to promote real economic growth is somewhere between slim and nonexistent.

Let's look at the actual information we have on tax rates and Real GDP growth.*  Graph 1 shows the top marginal rate in blue and the capital gains rate in green from 1950 through 2011.  Also included in brown [right scale] is the YoY percent change in RGDP [annual data] and a linear RGDP growth trend line.  The major trend in each of these phenomena slants down over time.

Graph 1 - Tax Rates and GDP Growth since 1950

Graph 2 is a scatterplot of RGDP growth vs top marginal tax rate, same annual data as in graph 1.

 Graph 2 - Scatterplot of RGDP Growth vs. Top Marginal Tax Rate

The points are color-coded Red for Republican administrations, and blue for Democratic administrations.  Again, a trend line is included, showing a positive slope.  I find it interesting that the space below the trend line is dominated by red dots.  You might not.  The data arranges itself  in columns because the tax rates tend to remain constant for several years at a time.  There is a great deal of scatter since many things besides the tax rate influence the economy.  The simultaneous general abandonment of a Keynesian approach over the period is notable in this regard.

It might be a bit simplistic to think that a current tax rate influences GDP growth in the immediate year, so I took some long averages and redid the scatterplot.   Graph 3 is a plot of the 8-year averages of both top marginal tax rate and RGDP growth.  This has the additional advantage knocking down the data columns.


Graph 3 - Scatterplot of RGDP Growth vs. Top Rate, 8-Yr Avgs.

The 8th year of each administration that lasted that long is indicated with a red dot for Republican and a bright blue dot for Democrat.  Make of it what you will.  The general trend over time is from the top right to the lower left of the graph, and the highlighted dots appear in strict right to left chronological order, from Ike at the right though Kennedy-Johnson, Nixon-Ford, Reagan and Clinton to G. W. Bush at the left. A similar graph of 13-year averages tells the same story, but with all of the the dots landing closer to the trend line.

It does appear from graph 3 that lowering the top rate from 91% to 70% might have been associated with higher RGDP growth.  But, note from graph 2 that the spread of RGDP values at 91% is far greater, and that the highest individual RGDP values are at the higher tax rates.  The 50's, when most of the 91% values occurred, were characterized by a series of economic shocks and recessions as the U.S. returned to peace time conditions and absorbed several million WW II veterans into the work force.

Graph 4 is a close-up view of the 8-Yr average graph starting with the Reagan administration.

Graph 4 -  RGDP Growth vs. Top Rate, 8-Yr Avgs.from Reagan on

The eight years of the Reagan administration are indicated with red dots, GHW Bush in orange, Clinton in bright blue, and GW Bush in purple.  The later is most notable for making the 8 year average of RGDP growth dive off a cliff.  And before you get too excited about the transient RGDP increase in the late Reagan years, remember he also ran deficits that dwarfed anything seen up to that time.

The record of the Clinton years not withstanding, I'm not going to get into a post-hoc discussion of higher taxes causing higher growth - though the data up to at least the 70% level is consistent with that assertion.  Correlation is not causation.  On the other hand, the absence of correlation absolutely refutes causation. What one may say with absolute certainty is that in the post WW II United States, tax cuts have never led to a sustainable increase in RGDP growth.  The lone possible exception is the cut in the 60's from 91% to 70%.  It's plausible that cutting from an extremely high tax rate might be beneficial, but, due to the extreme volatility of the early post WW II period, the effect in that case is not at all clear.

So if anyone tries to tell you that cutting taxes in the current set of conditions will stimulate growth, feel free to show them this post.

_________________________________________

* Top marginal tax rates from Citizens for Tax Justice.
Capital Gains Tax rates from the Tax Policy Center.
RGDP data from FRED



2 comments:

The Arthurian said...

"So the opportunity to have tax cuts do much to promote real economic growth is somewhere between slim and nonexistent."

An excellent, powerful conclusion to the lucky duckies paragraph.

I also liked your "absence of correlation" line.

//

If the call for tax cuts is argued to be needed to boost growth, then one might expect to see growth rates falling and tax rates falling, too, as in Graph 3.

Some might argue that the tax cuts were insufficient (just as Krugman argues that the stimulus was insufficient).

//

"... what one may say with absolute certainty is that in the post WW II United States, tax cuts have not led to increased GDP growth."

Your good buddy Scott Sumner said:
"I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy." ref ref

Sumner would likely say GDP growth would have been lower without the tax cuts. Makes ya want to pull yer hair out, no?

Good post.

Jazzbumpa said...

Thanks Art -

This post has been a work in progress, and I revised it again this morning.

This is the final form and I'm posting it at Angry Bear today.

I don't even read Sumner any more. It's just not worth the effort.

Cheers!
JzB