Taxes and economic growth

Two recent New Times columns make the case that lower taxes are not the magic elixir that automatically  leads to economic success. Both worth reading.

Bruce Bartlett, one of the authors of the Reagan tax cuts, in a critique of Donald Trump’s tax cut proposal  provides an insightful overview of tax cuts effects on the national economy. He writes:

Tax rates were very high when Reagan proposed cutting them — much higher than today. The high tax rates from the World War II era had been only partly cut by John F. Kennedy, and the top income-tax rate was 70 percent. Inflation was pushing workers into higher tax brackets when they received cost-of-living pay raises.

According to the Tax Policy Center, the average federal income-tax rate on a family of four with the median income rose from 9.1 percent in 1972 to 11.8 percent in 1981. The marginal tax rate — the tax on the last dollar earned — rose from 19 percent to 24 percent in the same period.

By contrast, the average tax rate on the median family in 2014 was just 5.3 percent, and the marginal rate was 15 percent. Inflation is nonexistent, and no one is being pushed into higher tax brackets by it.

In short, taxes were too high in 1981 and needed to be cut — including for the rich. The tax rates above 50 percent were not bringing in much revenue because wealthy people were likely to invest in tax shelters.

But the Reagan tax cut played only a secondary role in the 1980s boom, which wasn’t really much of a boom. Real G.D.P. grew 37.9 percent in the 1970s, compared with 36.1 percent in the 1980s. The economy felt better because inflation came down extraordinarily quickly, far more quickly than economists in 1980 thought was possible. But this was primarily a result of the Federal Reserve’s tight money policy, not taxes.

The tax cut deserves credit for softening the blow from the reduction in inflation, which brought on a sharp recession in 1981-82. But what we think of as the Reagan boom was the typical rebound from a sharp recession, just as we had seen after all previous postwar recessions. Much credit for growth in the Reagan years must go to the sharp increase in government purchases for his defense buildup.

What many Republicans also forget is that Reagan cared about deficits and supported 11 different tax increases from 1982 to 1988 that collectively took back half of the 1981 tax cut. Although many conservative economists predicted doom from the 1982 tax increase, which equaled 1 percent of G.D.P., the beginning of the boom coincided with its enactment.

These economists also predicted catastrophe from the 1993 tax increase enacted under President Bill Clinton and from the expiration of many of President George W. Bush’s tax cuts in 2013. But in each case financial markets and the economy grew sharply afterward. By contrast, the economy tanked during the Bush years despite numerous large tax cuts.

The final proof that tax cuts are not the be-all and end-all of growth policy is the Tax Reform Act of 1986, which dropped the top income-tax rate to 28 percent. Conservative doctrine predicted an economic boom, but I don’t remember one, nor can I find one in the data.

Eduardo Porter in a column entitled The Case for More Government and Higher Taxes reviews the new book How Big Government Should Be?  He writes:

“A national instinct that small government is always better than large government is grounded not in facts but rather in ideology and politics,” they write. The evidence throughout the history of modern capitalism “shows that more government can lead to greater security, enhanced opportunity and a fairer sharing of national wealth.”

…  Here are some other things Europeans got from their trade-off: lower poverty rates, lower income inequality, longer life spans, lower infant mortality rates, lower teenage pregnancy rates and lower rates of preventable death. And the coolest part, according to Mr. Lindert — one of the authors of the case for big government — is that they achieved this “without any clear loss in G.D.P.”

Even assuming that higher taxes might distort incentives, the authors concluded, negative effects are offset by positive effects that flow from productive government investments in things like health, education, infrastructure and support for mothers to join the labor force.

Exactly! For decades we have been told that lower taxes for both the nation and Michigan were the key to economic growth. As if what the taxes paid for didn’t matter. But the evidence is that public investments do matter. As we have explored frequently high tax places like Minnesota (see our State Policies Matter report) and New York City (here) are some of the nation’s most prosperous places. In large part because those taxes have led to higher human capital by both developing talent and creating places where mobil talent wants to live and work.

 

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Lou Glazer

Lou Glazer is President and co-founder of Michigan Future, Inc., a non-partisan, non-profit organization. Michigan Future’s mission is to be a source of new ideas on how Michigan can succeed as a world class community in a knowledge-driven economy. Its work is funded by Michigan foundations.

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