Market Overview

The Effect of Marginal Tax Rates on GDP Growth

If you ask proponents of extending the Bush tax cuts why they think this is a good idea, one of the reasons they give is that it would be bad to hike taxes during a recession.  Well, that's been heard before, back when Bill Clinton raised the top marginal rate, and we know what the results were.  Instead of the 1990s being marred by another Great Depression, we saw the best economic growth since World War II.  On top of that, we're not in a recession anymore, according to the NBER.

But let's put that aside.  Proponents of the extension of the tax cuts for those at the top of the income scale say that if you hike taxes on the wealthy, the economy won't grow.

So the question is, does history back up their contention?

In order to find out, we crunched the numbers.  We went to the Bureau of Economic Analysis website and looked up GDP growth for every year since 1930.  Then we went to the Internal Revenue Service website and pulled up the top marginal tax rate for those years.  We then averaged the annual GDP growth rate for various tax levels.  This is a very cursory examination of the numbers, but if the contention of those pushing for the Bush tax cuts to be retained is true, then we should see some correlation between the growth of the economy and tax rates.

We didn't.  In fact, if you use history as your guide, then we should set the top marginal rate at 88 percent.  Why 88 percent?  Because during the time that this was the top marginal rate, the GDP expanded at a rate that even countries like China and Brazil would envy -- 17.5 percent.  And we need to make sure that we set it at 88 percent, not 86.45 percent.  Setting the tax rate at that level historically provided us with GDP contraction of 5.9 percent.

As for the Bush tax cuts spurring economic growth, hardly.  GDP growth with the 35 percent top marginal rate these tax cuts established averaged 1.6 percent.  During the period before those tax cuts, the top marginal rate was 39.6 percent and economic growth averaged 3.9 percent.  Economic growth during that period lagged the period when the top marginal rate was 70 percent and 92 percent, when GDP increased by 4.2 percent annually. 

Proponents of tax cuts often talk about how the economy jumped after Reagan cut taxes from 70 percent to 50 percent.  Well, that makes a great story, but it's just not true.  When tax rates were 70 percent, GDP growth averaged 4.2 percent.  After Reagan cut the top marginal rate to 50 percent, GDP growth was 3.5 percent.

The bottom line, if you use history as your guide, is that there is no correlation between the top marginal tax rate and economic growth.  We have a situation here where 80 years of history counters the arguments of ideologues.  Of course, ideologues won't let the facts dissuade them.  But rational people should.

Of course, irrational people say things like well, there's so much uncertainty surrounding the Bush tax cuts and businesses can't plan for what will happen.  Further, they say, some businesses will be forced to close their doors if the tax cuts aren't extended.

Our contention is that businesses should have planned for the expiration of the tax cuts.  That was part of the legislation when it passed in the beginning of America's Lost Decade.  If a business is so poorly run that it didn't plan for something that it had TEN YEARS to prepare for, then it doesn't deserve to survive.

Ideologues who read this will naturally jump and say that we are calling for an increase of the top marginal rate to 88 percent.  Hardly.  What we are saying is that an examination of the historical record of the past 80 years shows no correlation between the top marginal rate and economic growth.  There is a big difference between the two statements, and if an ideologue wants to pretend there isn't, they're being disingenuous.

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The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

 

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