Journalists Too Quick to Conclude There is No Tradeoff between Taxes and Growth

September 13, 2012

It must be election season, because there is a lot of wishful thinking out there.  David Cay Johnston uses my words to argue there is no economic boost to be had from cutting taxes on high income earners:

“Studies examining the impact of cutting personal income tax rates on job growth or economic activity generally have been inconclusive, said Will McBride, chief economist for the Tax Foundation.”

I spoke to Nanette Byrnes for this story, but this does not fully characterize what I told her.  It is true there are a lot of studies that find only a weak statistical connection between personal income taxes and economic growth, including my own regression analysis of OECD countries.  However, in the same study which will be published shortly, I find a strong statistical connection between corporate income taxes and economic growth.   This is in line with other research, such as that by Gordon and Lee

The OECD finds a hierarchy of taxes in terms of damage done to the economy: corporate income taxes are most harmful, followed by personal income taxes, then consumption, and property taxes.  The OECD also finds a clear tradeoff between economic growth and progressivity in personal income taxes, i.e. countries that put more of the tax burden on high income earners experience slower economic growth.   That would be us, with the most progressive income tax system in the industrialized world.

This work is summarized in my earlier study of economic growth in OECD countries, in which I find also the same result that corporate income taxes are most harmful followed by high personal income taxes.  My technique there is simple correlation, and in my new study I do correct for every imaginable other factor contributing to economic growth and that does blow away the significance of personal income taxes.

Economic growth is a big, complicated thing.  Just because researchers can’t find one factor that robustly determines growth in every case regardless of conditions, doesn’t mean we are flying blind.  Taxes matter, certain taxes matter more than others.  So do other factors, like the interest rate, as we’re finding out today from Ben Bernanke, and the condition of our export markets in Europe and Asia.  Regulations matter, perhaps even more so than taxes, but they are hard to measure accurately.  Education matters, but also hard to accurately measure.  Efficient use of government spending matters, and my results do show that entitlement spending is a major drag on economic growth. 

There are things we know about economic growth, centuries old theories that are supported by loads of evidence.  Let’s not pretend that we know nothing, and that we can therefore tax the rich into oblivion without any tradeoff.  The tradeoff is economic growth, very likely.

Now, as for the specific study cited by Johnston, which finds little growth benefit from cutting taxes on the top 10 percent of earners, I have not delved deeply into it.  But on the surface, I wonder about number of observations, i.e. do we have enough data to conclude anything?  How many exogenous episodes were there of significant tax changes for the top 10 percent?  I’ll look into it further.

Follow William McBride on Twitter @EconoWill

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