Congressional Study on Tax Rates and Growth Still Flunks the Test

 
 
January 08, 2013

A Flawed Study Misinforms the Debate

Washington, D.C., January 8, 2013—The Tax Foundation has debunked an influential report by the Congressional Research Service which claimed that economic growth is not harmed by high tax rates. The September 2012 report, “Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945,” claimed to establish that there is no connection between increasing marginal tax rates on income and capital gains and the level of economic growth. The report fueled intense debate during the 2012 campaign, with proponents representing it as a scholarly and unbiased examination of the issue. According to a new analysis by Tax Foundation Senior Fellow Stephen Entin, however, the CRS study did not meet such high standards.

The first failure of the CRS report is its omission of other factors that swamp the results, and the failure to hold these “missing variables” constant. “The key to predicting what a change in the tax code does to the economy is to understand what buttons have to be pushed to affect the level of output and income,” says Entin. “One can simulate the effect of each provision in a tax bill, or for the bill as a whole, by measuring its effect on the service price and marginal tax rate on labor income without the difficulty of tracing and correcting for the innumerable conflicting influences on the GDP statistics in a given year.”

Further, the CRS was looking for the wrong result. Instead of looking at the long-term change in the capital stock and the ultimate level of output, the CRS report focused on the short-term rise in investment and the short-term change in the growth rate.

Finally, Entin notes that the CRS focused on the wrong timeframe. “It takes years to retire through attrition the excess capital made redundant by a tax increase. Looking only at the change in investment in the year after the tax cut, rather than the cumulative increase in the stock of capital over time, misses about 95 percent of the impact. You can't predict this fall's apple crop by counting the number of seedlings planted this spring.”

Tax Foundation Fiscal Fact No. 350, “CRS Study on Tax Rates and Growth Still Flunks the Test” by Stephen Entin is available here.

The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Borean, the Tax Foundation’s communications associate, at 202-464-5120 or borean@taxfoundation.org.

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