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Do Lower Taxes Goose Growth?

Tax Day Photo by Joe Raedle/Getty Images

Paul Solman answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Thursday’s query:

Mike Beaver: I listened to your discussion of tax rates vs. growth, but there was no easy way to see the relationship. Could you provide a graph of tax rates and GDP growth for the present back to at least WWII?

Paul Solman: Three graphs for the price of one, Mike. First, a graph of the top marginal income tax rate plotted against the growth of GDP per capita. Below that, a graph of total income tax burden per person (capita), plotted against the same growth measure, GDP per capita. And finally graph No. 3: total American tax burden per person, again plotted against GDP per person.

Before I get to the conclusions, indulge me as I explain the key variables. (For those who already understand them, please feel free to skip ahead to the asterisk.)

The top marginal tax rate is the highest rate at which income is taxed, past a certain level. The threshold for 2012 — for a married couple filing a joint return — will be $388,350 of taxable income, after all deductions are taken. Thus only extra or “marginal” dollars earned above a $388,350 “floor” will be taxed at 35 percent.

On taxable income over $217,450 but less than $388,350, the rate is 33 percent.

$142,700 to $217,450: 28 percent.

$70,700 to $142,700: 25 percent.

On taxable income between $17,400 and $70,700, the couple pays only 15 percent.

On taxable income from $0 to $17,400, just 10 percent.

(The 47 percent who, according to Mitt Romney, don’t pay taxes have deductions that offset their gross income entirely and/or an Earned Income Tax Credit, a program initiated to offset the disproportionate Social Security, aka “payroll,” tax burden on the have-lesses. Remember that the median household income in this country is about $50,000 a year, meaning that half of all households earn less.)

As for “GDP per capita,” that’s the “Gross” (total) “Product” (output) of the “Domestic” (American) economy in any given year, divided by that year’s population — the number of heads (roughly, “capita,” without subjecting you to the vagaries of Latin declension). In other words, how much did the economy produce in a year per person? So key and venerable is this measure that Adam Smith featured it, right up front in his “Wealth of Nations”:

“as this produce, or what is purchased with it, bears a greater or smaller proportion to the number of those who are to consume it, the nation will be better or worse supplied with all the necessaries and conveniences for which it has occasion.”

* OK, with our definitions now in order, let’s look at the data — three ways.

First, GDP per capita, in blue, plotted against the top marginal income tax rate (in red), over the entire history of the permanent income tax. It is true that if the lines moved in tandem in a CO-relationship, there would be a causal connection? Not necessarily. If even the lines moved in lockstep, it wouldn’t prove that tax rates cause economic growth. But it would suggest that they have an influence. So now the question: Can you discern any correlation here at all? Or is the best one can offer Columbia Law Professor Alex Raskolnikov’s verdict here on the NewsHour last year: the “relationship is complicated.”

Graph No. 2 plots the income tax paid per person against GDP per capita. Here, there is definitely a correlation. The more we pay, the richer we are. It would be hard to argue that we’re growing because of higher taxes. The plausible interpretation runs in the other direction: we’re paying higher taxes because we’re richer. The graph does not suggest, however, that lower income taxes per person goose per capita growth.

But of course income taxes are hardly the only ones we pay. So graph 3 looks at all taxes per average person. It winds up looking an awful lot like graph 2.

What can we say in the end? There are a thousand subtle stories to tell about taxes and economic growth. Surely at some stratospheric level, taxes would retard it: 100 percent say, as Arthur Laffer deftly sketched here in January. Surely, at rock bottom — say 0 percent — we’d have abandoned government entirely and risked descent into Thomas Hobbes’ nasty, brutal state of nature and a war of all against all. Always, then, the question is striking the right balance. With U.S. GDP per capita actually no higher than it was in 2005 and growing at zero percent even as I write, can anything be done with taxes to get it growing again?

For a column that covers some of the same ground and features a graph of its own, see Dave Leonhardt in the New York Times.

This entry is cross-posted on the Rundown– NewsHour’s blog of news and insight.

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