Taxes and economic growth

Like most of America, Michigan’s chief economic growth strategy for at least two decades has been cutting taxes. As you know, our research has indicated that what a state and its local governments tax and how much has little or no predictive value in explaining whether a state or its regions are prosperous or not. In fact, higher tax states and regions tend to be more prosperous.

Tax cuts, particularly for upper income Americans, have been the centerpiece of the nation’s economic growth strategy since the Bush tax cuts.The non partisan Congressional Research Service has just published a study on what effect the top marginal tax rate and capital gains (and now dividends) tax rate has on the American economy. Basically they find that lower top marginal tax rates or lower investment earnings tax rates do not lead to a stronger economy. What it does do is increase income inequality.

You can read a summary of the report from the Atlantic here. And even better, if you have the time, check out the full report here.

The report looks at the effect of top tax rates from 1945-2010 in five areas: economic growth, savings, investment, productivity and income inequality. As they write: “Advocates of lower tax rates argue that reduced rates would increase economic growth, increase saving and investment, and boost productivity (increase the economic pie). Proponents of higher tax rates argue that higher tax revenues are necessary for debt reduction, that tax rates on the rich are too low (i.e., they violate the Buffett rule), and that higher tax rates on the rich would moderate increasing income inequality (change how the economic pie is distributed).”

The report also provides the history of the top and capital gains tax rates. “Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the second World War.”

So what has this decades long tax cutting on the incomes of the most affluent Americans yielded? The report concludes:

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. (Emphasis added) The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. As measured by IRS data, the share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the top 0.1% fell from over 50% in 1945 to about 25% in 2009. Tax policy could have a relation to how the economic pie is sliced—lower top tax rates may be associated with greater income disparities.

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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.