Riedl’s Myth 8, Part A

Riedl Myth 8

Continuing the look at Brian Riedl’s ten myths, we get to Myth 8.

“Myth #8: Tax cuts help the economy by “putting money in people’s pockets.”
Fact: Pro-growth tax cuts support incentives for productive behavior.”

The more I look at this one, the more important it seems to me, so I’d like to devote two posts to it. In this post, I’m going to look at numbers and show that Riedl is simply wrong about what tax cuts do. (Unless, of course, one assumes that collectively Americans are nuts.) In the next day or two, I will provide reasons why the data doesn’t show what Riedl expects it to show.

Let’s see whether “pro-growth tax cuts” are “pro-growth” – let’s see whether they cause people to behave in a productive fashion. Two ways come to mind:

1. See how tax rates correlate with changes in real GDP per capita
2. See how tax rates correlate with changes in unemployment

The first one is a no-brainer. We all know real GDP per capita was faster in the 50s and 60s when the tax rates were much higher than it is now. The growth rate in real GDP per capita from 1950 to 1980 was about 2.57% per year, while from 1980 to 2005 it was only 1.93%.

Real GDP per capita data used in this post is annual data obtained from BEA NIPA Table 7.1. Regular readers will also recall I’ve already had a post showing that going back to 1950, there is a slight positive correlation between tax rates and real GDP per capita growth rates.

But let’s assume that perhaps something changed around 1980. Reagan ushered in a new era, after all.

So… what does the correlation look like between growth rates in real GDP per capita and tax rates? Table 1 looks at the correlation between the lowest marginal tax rates and the growth rate in real GDP per capita for the period from 1981 to 2005, for the period from 1982 to 2005, etc., through 1992 to 2005. (I wanted to ensure at least two presidencies got included) It also shows the correlation between the highest marginal tax rate and the growth rate in real GDP per capita for the same periods. At the very least, we can say that the correlation between tax rates and growth in real GDP per capita does not appear to be negative, and it doesn’t seem a stretch to say the correlations are positive.

Another thing to consider is with employment. Presumably, if Riedl is correct, cutting taxes creates incentives – so people are more likely to hire more workers, and more people are likely to be willing to get jobs. Presumably, if the incentives are right, even retirees will come back to work.

Table 2 is similar to Table 1, except instead of looking at growth rate in real GDP per capita, it looks at average yearly labor force participation rates. Once again, I’m not sure how the data can be interpreted in such a way as to support Riedl’s story.

Which brings me back to a point I’ve made before. The tax cutting story sounds plausible, and its one that we’d all like to believe because there’s a free lunch in it. (I.e., cut taxes and things get better.) The problem is that it doesn’t match known facts in the US since WW2. (Long time readers know I’ve looked at this many times and many ways.) It might be fine for Slovenia’s transition from “Communism” to “Capitalism” but it sure as heck doesn’t apply here – and it might not be the best model for Slovenia either.

In the next day or two, I’ll have a post in the next day or two explaining what I think is wrong with the theory and why it doesn’t match the data.

Meanwhile, if anyone wants my spreadsheets, just drop me a line.

Update… corrected link to labor force participation survey. Sorry about that.