PGL notes that the argument made by supply-side tax cut advocates centers on the notion that cutting taxes on capital income will encourage risk-taking and thus increase capital formation – i.e., cause an investment boom. PGL’s post nicely points out some theoretical problems with this argument.
But there are huge empirical problems with the argument, as well. One type of evidence that I’ve already written about is a cross-country comparison. An international comparison of capital income taxes and growth shows no correlation, in stark contrast to the claims that supply-siders make.
We see the same lack of prima facie evidence looking at the time-series data. The following picture shows the annual growth rate of private fixed nonresidential investment – i.e., all investment other than inventory accumulation and new houses. Can you see an unusual investment boom following the cut in capital income taxes in 2003? I can’t.
If you’d like to see the data quantified more precisely, then take a look at the following table. The top half of the table shows the average growth rates in investment over the past six economic expansions. The current expansion (through 2005:Q3) is not noteable for rapid investment growth.
But perhaps you would prefer to only look at the performance of investment since 2003, believing that the tax cut has only caused investment to boom since enacted in that year. In that case, focus your attention on the bottom half of the table. In order to make an apples-to-apples comparison, the bottom half of the table calculates the average growth in investment for each of the past 6 economic expansions excluding the first year of recovery (which typically has a lower rate of investment growth).
Again, there seems to be no sign of a particular investment boom. In fact, only one economic expansion since 1960 had weaker investment growth than we’ve seen since 2003. (Perhaps coincidentally, the expansion with the weakest investment growth was the expansion of the 1980s, following the much-admired Reagan tax cuts of the early 1980s.)
Neither this, nor my earlier cross-country comparison of the correlation between tax rates on capital income, are rigorous statistical analyses. But supply-side tax cut advocates do not use such rigorous statistical analyses to provide evidence for their point of view – they try to use superficial correlations to make their case.
So the point of this exercise is to simply demonstrate that even the superficial correlations that supply-side advocates so love to talk about, whether international or over time, do not support the notion that tax cuts in capital income generate a boom in investment and economic growth.