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

by alexvanbuskirk

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

By James Pethokoukis @ AEI (September 17, 2012)

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.