Tax Rates, Tax Cuts, and the Growth of GDP per Capita, Again
Honestly, I’m tired about arguing about taxes. I wrote a few posts in the past on the topic, and other Angry Bears have done the same. No matter what data you post, there are always some people who insist that they’ve done some secret analysis (they don’t post their numbers or how they arrived at them) that shows that cutting taxes is always good for whatever ails the economy, and in particular, that cutting taxes creates growth.
Nobody argues that when tax rates are very high, cutting them will spur the economy. I also assume nobody reasonable argues that when tax rates are very low, cutting them will not boost the economy. (Will anyone work harder because their marginal rate dropped from 3% to 2%?) The question left unanswered, of course, is – what is “high” and what is “low” when it comes to tax rates.
If you look at data from 1950 to 2005, one thing stands out. If you split the sample in half, you find that the annual percentage increase in real GDP per capita from 1950 to 1977 was 3.1%, and from 1978 to 2005 was 2.4%, and yet the average highest (individual) marginal tax rate was 81% in the first half, and 43% in the second half.
But what of tax cuts themselves? Do they help? Sure, when taxes are too high, cutting them is going to boost growth. But again, the question arises… what is too high, and what is too low? So let’s look only at the second half of the sample, when the highest marginal rate ranged from 70% (1978, 1979) to 28% (1988 – 1990).
Below is a table showing the annual growth rate in real GDP per capita from 1978 to 2005, following decreases, increases, and no change in the tax rate. The first row shows the average growth rate in the year of a tax cut, tax hike, or no change. The second row shows the average yearly growth rate over two years following a tax cut, tax hike, or no change.
_________tax cut______tax hike______tax unchanged
1 year_______ 1.64 ______ 2.36 ______ 1.94
2 years______ 2.26 ______ 1.86 ______ 1.77
3 years______ 2.27 ______ 2.15 ______ 1.82
4 years______ 2.15 ______ 2.22 ______ 1.92
5 years______ 2.24 ______ 2.37 ______ 2.01
6 years______ 2.32 ______ 2.58 ______ 2.07
7 years______ 2.39 ______ 2.67 ______ 2.08
8 years______ 2.35 ______ 2.55 ______ 2.12
So what does this show? Years in which there was a tax hike showed faster than growth than years in which taxes remained unchanged, and years in which there was a tax cut brought up the rear. Over a period of two years… in the two years following a tax cut, growth rates were higher than under tax hikes or no change in taxes. In the two years following a tax cut, growth rates were higher than under tax hikes or no change in taxes. But… over a period of four years, five years, six years, seven years, and eight years, tax cuts resulted in slower growth rates than tax hikes.
Thus, two and three years after the fact, a tax cut outperformed a tax hike in the sample, but over longer periods of time, tax cuts did not result in higher growth rates. Using median yearly growth rates produces similar findings, as does starting in 1981, when Reagan took office.
It is important to remember – these results applied to data for the past 27 years or so. They may not apply in other times or places. But they do indicate that tax cuts led to slower, not faster growth rates, from 1978 to 2005.
Real GDP per capita (NIPA Table 7.1)
Highest marginal tax rates
As always, my spreadsheets are available to anyone who wants them.
Update… Reader M Jed notes that use of plain averages is inappropriate for percentage growth rates. He is correct. This post was updated using geometric averages.