What She Said…Tax Cuts, Investments, and Growth

September 22nd, 2012 at 4:33 am

I agree with Chye-Ching Huang, who agrees with the Congressional Research Service, Len Burman, and me: over the long, historical record of special tax treatment for investment incomes and tax cuts to the top marginal tax rates, one simply doesn’t find significant correlations with greater investment, savings, productivity, or income growth.

Lowering the top tax rates do correlate with something, though: higher income inequality.

This seems germane on a day when we’re talking—as I just did on the Martin Bashir show—about the reasons why some folks with very high incomes pay very low tax rates.

Source: Hungerford, CRS

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9 comments in reply to "What She Said…Tax Cuts, Investments, and Growth"

  1. Martin says:

    Jared, I have difficulty believing your first claim:

    “special tax treatment for investment incomes and tax cuts to the top marginal tax rates simply don’t correlate with greater investment, savings, productivity, or income growth.”

    I do not have difficulty believing that you cannot find such a correlation; what I do have difficulty believing is that if you would kick it up to 100% that there would be no lower investment, savings, and productivity. If the conclusion is that it does not matter, why not kick the rate up to 100%?

    I am serious, no trolling here, I really do want to know what the policy implications are of such a view and why you would not kick it up to 100% then. Yes some of it might be re-classified as labor-income then, but some of it couldn’t be, so it seems to me that there is some free revenue there. So why not kick it up to 100%?

    • Jared Bernstein says:

      That’s an excellent point. I should have written: “the historical record shows…” As you can glean from the figure there’s been considerable variation over time in the tax rates, and it is that variation from which the finding of no significant correlation is drawn.

      I’ll fix.

      • Martin says:

        Thanks. I am still a bit puzzled though what it means for policy though.

        I mean from the public finance literature I understood, if I recall correctly, that the optimal tax rate on capital is zero or close to it; from browsing the New Dynamic version of it I understood that it is non-zero provided the rate is contingent on labor income over time.

        The historical evidence you cite however seems to imply that if rates have any effect, then that effect is very small.

        This view also seems to be supported by anecdotal evidence from people such as Mark Cuban http://blogmaverick.com/2012/09/17/the-cure-to-our-economic-problems-2/:

        “The cure for what ails us is the Entrepreneurial Spirit of this country. We are a nation of people who encourage , support and invest in those of any and all age, race and gender who will use their ingenuity and come up with a new idea.(…)

        Entrepreneurs live to be entrepreneurs. I have never had a discussion with anyone about starting a business that included tax rates. Ever. If anyone that wanted an investment from me made a point of discussing tax rates as an impact on their business, I wouldnt invest in them. Ever.”

        Similarly, I believe McCloskey would also support a similar view in her book the Bourgeois Dignity when she dismisses the view that capital accumulation is what made us really rich, and suggests that it was positive rhetoric about entrepreneurship/bourgeois values instead that drove innovation.

        The allocative and dynamic efficiency of a tax system in the end is tiny when compared with the gains due to innovation. Given this I would probably tax capital the same way we tax labor, at least we get rid of some of that wasteful avoidance activity then.

        • Martin says:

          Addendum: High tax rates in that view would then be only harmful when these would indicate or signal a negative view of entrepreneurship.

          How do you interpret the evidence for policy, beyond that correcting inequality seems cheaper than it is commonly presumed, and therefore we should have more of it?

    • pjr says:

      Mike Kimel at AngryBear has done some excellent statistical analysis in postings over the years on the relationship between economic growth and the top income tax marginal rate. He has found that the historical relationship is negative when the top rates exceed roughly 70 percent, and positive when the top rates have been below that. (He subsequently developed an hypothesis regarding the positive relationship that makes sense to business owners if not economists–in brief, perhaps low top marginal income tax rates encourage owners to take money out of a business for other uses, like personal consumption, real estate investments here or overseas, etcetera.)

  2. readerOfTeaLeaves says:

    Yikies, I find those graph comparisons confusing!
    For starters, the left x-axis is a scale of 20 – 100.
    The right x-axis is a scale of 15-35.
    My Saturday Morning brain is not good at visualizing how to equate those two scales… arggh!

    Consequently, it’s impossible for me to grasp the full implications of the condensed effects that I suspect are supposed to be revealed in the right graph.

    • Jared Bernstein says:

      Sorry–I should have said more about them–I just found the link, though, and will add it. The figures just show how over time, higher marginal tax rates on income and capital gains are associated with lower levels of income inequality and visa versa. The statistical results in the paper support this: the significant correlations are NOT between changes in marginal tax rates and growth, investment, etc. but between such changes and higher inequality.

  3. Josh says:

    What would the graphs look like if you plotted effective tax rate instead of top marginal tax rate? Raising the top marginal rate while opening a ton of tax deductions or lower the top tax rate while closing all deductions are two very different things that your analysis doesn’t cover. However, plotting effective or paid tax rate would.