Taxing Rich At Higher Rates Good For Economy

The centerpiece of Mitt Romney's domestic policy agenda, which he shares with most Republican candidates for federal office. Republican politicians like Romney have argued that reducing the top marginal income tax rates and, in particular, the top marginal capital gains tax rates, on the affluent will increase economic growth and create jobs.

There are all sorts of theoretical reasons why this is a plausible idea. But, the empirical evidence flatly contradicts this claim. To the extent that increasing top marginal marginal tax rate on income and on capital gains has any impact on economic growth, historically, higher top margial tax rates on the income and capital gains of the affluent promote economic growth.

[L]ooking at the raw correlation between top marginal tax rates and growth can be helpful for getting a rough sense of the likely impacts of higher taxation on growth. One recent paper by Pikkety, Saez, and Stantcheva looks at the correlation between top marginal tax rates and growth and finds the growth is higher when top marginal tax rates are higher. . . .

A rise in the top marginal tax rate from 0 to 100 percent is correlated with a rise in per capita growth of 5.85 percentage points per year. One reason that this simple correlation might overstate the impact of the marginal tax rate on growth is that the top growth years were in the early 40s when the government was spending heavily and when the country was finally recovering from the Great Depression. If we look only at the post war period (after 1946), a rise from 0 to 100 percent in the top marginal tax rate is associated with an increase of only 2.69 percentage points of growth. Moreover, the statistical significance of the relationship becomes marginal, as the p-value rises from 0.017 to 0.122. On the other hand, if we look at the time period encompassing 1960 to the present, a rise in the top rate from 0 to 100 percent is correlated with a rise in per capita growth of 3.03 percentage points of growth per year, and the relationship becomes more statistically significant (with a p-value of 0.064 percent). Finally, if we look only at the years since 1980, a rise from 0 to 100 percent in the top marginal tax rate is associated with an increase in growth of 3.87 percentage points. In this case, the relationship is statistically insignificant (with a p-value of 0.392 percent), in part because the sample size is small.

While we cannot say that there is a robust significant positive relationship between tax rates and growth, it is still interesting that regardless of when we start the sample, higher top marginal tax rates are associated with higher not lower growth. Moreover, a narrative reading of postwar US economic history leads to the same conclusion. The period of highest growth in the United States was in the post-war era when top marginal tax rates were 94% (under President Truman) and 91% (through 1963). As top marginal rates dropped, so did growth. Moreover, except for 1984, a recovery year, the highest per capita growth rates since 1980 were all in the late 1990s, after the top marginal tax rate had been increased from 28% under President Reagan to 31% under the first President Bush and then 39.6% under President Clinton.

One possible reaction to this finding is that what matters more than the top marginal tax rate on income is the capital gains tax rate but growth has also been higher when the capital gains tax rate has been higher.*

So, what does this tell us? Of course, it would be silly to make the argument that increasing top marginal rates from 0 to 100 percent increased per capita growth by almost 6 percentage points per year. No doubt there are other factors that could confound the relationship between tax rates and growth. However, the changes in top marginal tax rates over the period are quite large so it seems likely that if raising top marginal rates did have a large negative impact on growth, we should be able to see it in the correlations. Thus, it also seems silly to argue that higher taxes on the rich have a large negative impact on growth, given that historically growth is, if anything, positively correlated with the top marginal rate.

From here citing Ethan Kaplan of the University of Maryland (via email) (emphasis added).

* The money paragraphs in the quoted material from a Forbes magazine article comparing capital gains tax rates and economic growth rates states (emphasis added):

If you read the editorial page of the Wall Street Journal (or surf around the nether regions of Forbes.com), you may come to the conclusion that no aspect of tax policy is more important for economic growth than the way we tax capital gains. You’d be wrong.

The chart displayed above shows top tax rates on long-term capital gains and economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, you’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series. The correlation is 0.12, the wrong sign and not statistically different from zero. I’ve tried lags up to five years and also looking at moving averages of the tax rates and growth. There is never a statistically significant relationship.

Lowering top marginal income tax rates and top marginal capital gains tax rates has a decisive distributional effect, lowering tax burdens on the very most affluent Americans. But, it demonstrably does not encourage econmic growth and it does not creat jobs.