Real GDP per Capita and Tax Cuts, Top Marginal Income Tax Rate Edition
by cactus
Real GDP per Capita and Tax Cuts, Top Marginal Income Tax Rate Edition
One often hears that cutting marginal income tax rates, particularly on high individuals, leads to faster economic growth. Let’s dispense with argumentification, opinionizing and pontificatulationizing and graph us some data. Data for this post – top marginal rates from the IRS and real GDP per capita from the Bureau of Economic Analysis.
The first graph shows the annual change in real GDP per capita from one year to the next. I took a few liberties with the graph, namely:
1. I color coded each bar – black means the devil raised taxes, white is for the sweetness and light of a tax cut, and gray means no change to top marginal rates.
2. I included a couple of text boxes. The first shows the average growth in real GDP per capita when you have tax cuts, tax hikes, and no change, and it does so for two periods – 1930 to 2009 and 1952 – 2009.
3. The second text box shows the number of instances of tax cuts, tax hikes, and no change to the tax burden over the two periods.
The graph goes back to 1930 because data on real GDP per capita only goes back to 1929. Here’s what it looks like:
(Graph 1)
Faster economic economic growth occurs in years when you have tax hikes than tax cuts. Wait, that can’t be right. This graph is not showing the Truth! So how do we salvage it? Well, maybe the problem is that it takes awhile for the American public to react to a tax cut. After all, it has to be a huge surprise when a person who has talked about the virtues of tax cuts for thirty years actually (get this!) cuts taxes when he becomes President. I still remember the shock we were all in back when GW cut taxes in 2003 – who could possibly have expected tax cuts from a guy who had cut taxes in 01 and 02 and had been promoting tax cuts as the solution to everything from gout to bad haircuts? So maybe we have to assume that it can take a while for tax cuts to have their glorious effect, allowing us to soar into growthy nirvana.
So the next graph is color coded differently – black means the devil raised taxes, either this year, last year, the year before that, or two, three, or four years before that. White means the same look-back, except this time we’re talking tax cuts. Gray is a situation in which either there’s been no change in the tax rate rate (this year or in the previous four), or both tax cut(s) and tax hike(s) occurred during that period. For instance, from 1939 to 1940, the top rate was raised from 79.0% to 81.1%. It feel to 81.0% in 1941, and then rose to 88% in 1942 and again to 94% in 1944. Because of the tax cut (however infinitesimal) in 1941, 1941 through 1945 are colored gray.
I note that once again, I threw in a couple of text boxes. So here it is:
(Graph 2)
Well, this still cannot possibly be right. Why is the data hiding the True Facts? This is clearly gonna take more digging. So let’s be a bit more systematic and cut to the chase.
The next graph shows the average annual growth rate in real GDP per capita within 0, 1, 2, … and 9 years of a tax cut (with no intervening tax hike) from 1930 to 2009. It also shows the average annual growth rate within 0, 1, 2, … and 9 years of a tax hike (with no intervening tax cut). And of course, it shows the same for periods in which there was no change in the top tax bracket and/or in which there were both tax cuts and tax hikes. Thus, at year 0, growth rates are the one shown in Graph 1. At year 0 to 4, growth rates are the shown in Graph 2. And so on and so forth.
Here’s what that looks like:
(Graph 3)
Well, nine years out and there’s no situation in which tax cuts beat tax hikes.
So one last time to the well… this next graph is similar to Graph 3, but it only includes data for the period from 1952 to 2009.
(Graph 4)
Finally. Some evidence. All of this allows us to state that “carefully selecting data allows one to show that that tax cuts are correlated with rapid growth in the first and second year after the cut, but even that degree of cherry picking indicates that the year of the tax cut, as well as 3 or more years out, growth is faster when taxes are hiked than when they are cut.”
Or we can simply go the Fox News route and say: “Behold the Truth as passed down in the Gospel of St. Ronnie. Tax cuts lead to faster growth.”
I have a few possible explanations for these four graphs. One – the best one – I’m not going to mention since it requires some number crunching to confirm and I simply don’t have the time right now. Maybe in the coming weeks. But here are a few more for the two year positive window on tax cuts:
1. Some of those “going Galt” folks are actually serious. Some of them really do make business decisions based on taxes. But people who make business decisions based on reductions of the income tax don’t know how to run a business. Their initial foray into the business world (or initial expansion) frees up some capital and makes things look good for a while, and then they flop.
2. Similar to 1., except that the business decisions are actually accounting conveniences at first which grow to have real effects a couple years down the road.
3. Those anticipating tax cuts put off converting paper earnings into real taxable earnings until after the tax cuts have gone into effect. Thus, for a few years you have “pent up” profits coming out which disappear after a while.
So why, except for a cherry-picked window, are tax cuts not as good for growth as tax hikes are? A few thoughts:
1. At the margin, given the relative size of the gov’t and private sector, and given that both are made up mostly of very inept and/or corrupt people, the gov’t is not less efficient than the private sector.
2. Less money in the public sector constrains the gov’t at those times when it needs to act and when the private sector won’t or can’t? (E.g., how much less freedom of movement does the gov’t have now than it would had the supluses of the late 90s continued through 2008?)
3. The Megan McArdle hypothesis – if the data shows something different from what we know the truth must be, well, something is wrong with the data and anyone who believes what the data seems to show is craaaazy. Call it a poor man’s version of Maier’s Law, with the entire Austrian school way ahead of the second corollary to that law.
Questions, comments, contributions, donations?
__________________________________
by cactus
Let me anticipate the first really, really dumb comment by someone who completely misinterprets the last graph with a snide presponse:
“Yes, and by that same logic you should always buy spoiled food rather than fresh food. Its cheaper, and for the first minute or two afterwards it will sate your hunger without making you sick. The fact that it makes you violently ill… well, that’s after the second minute, so who cares, right?”
What I see from Graph 1: 1) We often raise taxes on a rising or anticipated rise in GDP. 2) After we cut taxes we nearly always have a rise in GDP within 1-2 years. 3) After we raise taxes we see a lowering of GDP within 1-2 years. 4) Clinton was the luckiest Prez.
If I am misinterpreting the graph, please tell me how.
Cactus’ presponse applies to your interpretation to graph 1 as well.
To me the most interesting thing about Graph 1 is that, since 1953 the highest GDP per capita occurred in years when the tax rate remained the same: 2.2%, which is better than raising the rate by a ratio of almost 3:2 (!), and better than lowering it by almost 2:1 (!). If there is a message there, maybe it is this: Don’t mess with the tax rates! Reliability is a virtue. Maybe the best thing is for people to know what to expect.
It would be interesting to do these graphs backwards in time. That would do two things: It would provide a control, and it would address the question of the context within which rates increase or decrease. Because of anticipation, perhaps the graphs should be zeroed on the year before the cut.
Ex-gf, please explain my lying eyes.
Min, another good reading!
cactus:
We really do not know why the correlation between Tax Increases and GDP Growth and vice versa works as it does, do we? Your bar charts and line plots certainly points a direction; but, we would have to do another deep dive to ascertain the factors causing GDP growth and what impacts them to make greater sense out of this. Otherwise, it appears you are on to something.
Min:
Stability? and an ability to plan given the stability?
I essentially agree with Cactus’s comments, and they are especially pertinent to the present moment when one’s political party’s solution to every economic problem is “cut taxes on rich people,” and despite all the evidence that it has not worked the last 9 years, that is still their solution because St. Ronnie and his prophet, Jack Kemp, told them it was “TRUE.” However, I also think there are other reasons for our lack of economic growth the last 9 years then a Fiscal policy that has underfunded government at every level and increased inequality (although that is a big one). I also think allowing China into the WTO, the financial services provisions on equal access in the WTO agreement, and the strong Dollar policy was a significant factor in that it ecouraged disinvestment in American manufacturing. Also, the technical revolution in the telecommunications and the Internet, with its huge reduction in costs for international communications suddenly put millions of American “back office” service sector jobs, including previously high paying jobs, in direct competition with large Englisth speaking populations in India, Bangladash, Malaysia, and South Africa. Good for them, not so good for Americans and their wages. But the fact is there is no evidence that Lloyd Blankenfein’s of the world will work less if their 100 million dollar annual income was taxed at the 45% percent rate rather than the current 35% rate. Rather, it might encourage them to keep some of the earnings back in the Bank’s capital or pay to the shareholders as dividends since they would have to split a hire percentage of their loot with Uncle Sam, which would ironically help increase U.S. productivity and growth as opposed to enhancing his estates on the Hamptons or the French Riveria.
CoRev
If you only look at the data from 1953 to 2009, one to two years after a tax cut, growth is faster than one or two years after a tax hike or one or two years after taxes are unchanged. However, if you look three or more years down the line, you are much, much better off with a tax hike.
Of course from graph 3 it is clear that tax hikes beat tax cuts even one or two years later if the entire data sample is used.
You just hit it right on the head, I can’t believe he didn’t understand this one. You really pretend like taxes are exogenously set????
This was so foolish. I cannot believe the author thinks that we might not lower taxes before and during an anticipated recession, and raise them during and before a boom.
Was that so hard? This is economics 101: don’t confuse correlation with causation.
Run asks Cactus, to do the next level of analysis. Not the first time, ehh, Cactus?
Ex-gf, I didn’t make comments re: the length of the rise after a tax cut, but it is somewhat transient. Making that growth rate comparison is not supported by the graphs. I refer you back to the requests to do that next level of analysis. Then maybe we can agree, but from these graphs, not yet.
Ex-gf, I didn’t make comments re: the length of the rise after a tax cut, but it is somewhat transient. Making that growth rate comparison is not supported by the graphs. If this is what you were relying upon, then the correlation and your conclusion is somewhat tortured. I refer you back to the requests to do that next level of analysis. Then maybe we can agree, but from these graphs, not yet.
You fail to mention another possible explanation. Taxes do give incentive to managers. Managers are out for prestige and fame, when there are low taxes they can get high incomes and this is their road to fame. When there are high marginal taxes they look to other outlets to demonstrate their power so they build bigger factories, have bigger exendeture accounts… by lowering top tax brackets you change the rules of conspicous consumption. With lower top marginal tax brackets it makes sense to outsource jobs… since managers can pocket the “profits.” However with higher marginal tax brackets it makes sense to have bigger factories, work forces… because managers can now brag how important they are due to the power they hold over the workers lives.
Just a thought.
OK, you are misinterpreting the graph. There you go.
If we knew that forecasters could reliably predict accelerating growth, your point 1 would be defensible. Does anyone care to demonstrate that forecasters reliably have that ability? An explanation which requires us to be able to see into the future really does need to be accompanied by a demonstration that we can see into the future. Otherwise, it is the worst sort of nonsense.
Let’s also recall that in many cases, the most rapid acceleration in GDP growth comes in the early quarters after recession, when lawmakers tend to be reluctant to raise taxes.
On point 2, let us consider that from any given time, we are more likely to have GDP rising one to 2 years hence, because growth is more common in the US than is recession. To infer a causal link with tax cuts when the effect is likely with or without tax cuts is, again, the worst sort of nonsense. Making this link also ignores everything that cactus demonstrated, and cherry picks in just the way he mocked, without batting an eye.
On point 3, the data simply don’t show what CoRev claims. In any of the lags cactus shows, it is not the case that GDP routinely falls within 1 to 2 years.
Point 4 is just the same old lie that has been used ever since it became obvious that Clinton presideded over better economic performance than Saint Ronny. Since “luck” is not an observable phenomenon, it is the most useful lie.
Min,
There are two “great moderation” issues to consider. One is that, during a period of reduced macroeconomic volatility, we also had less frequent tax changes. There have been lots of explanations offered for the now-defunct “great moderation”, so if we are to add steady tax rates based on just the snapshot cactus offers, we need to recognized that we are tossing steady tax rates on a pretty big pile of competing explanations. The other is that what seems to be a period of increasing political polarization has overlapped extensively with the period of the “great moderation”, so that the ability to change tax rates on short notice has been reduced at the same time as macroeconomic volatility has been reduced. There is no good reason to see a causal relation there.
CoRev, naturally, applauds despite the lack of strong evidence for the premise.
Travis, a very common observation regarding ad hoc fiscal policy is that it does not, in fact, respond in a timely manner to changes in growth. We do not lower taxes in anticipation of recession and we do not raise taxes in anticipation of booms. That is why automatic stabilizers and monetary policy have tended to be favored. The lags in recognizing changes in economic direction, lags in legislation and lags in implimentation are all notorious weaknesses in ad hoc fiscal response to the business cycle.
As I noted earlier, the stronger tendency is to cut taxes on the way into a period of growth. The Romers’ observation that tax cuts work to stimulate growth in boom times is based on the fact that tax cuts have been made during booms.
KH, I generally do not respond to your hit and run comments, as you seldom come back. But, it is obvious you are torturing your brain to get the commentary you have provided. Are you even looking at graph 1?
Your comments to point 1, 2 and 4, meaningless. Point 3, huh? Look again, please. How often after one of those BLACK years does GDP rise? How often fall?
KH said: “As I noted earlier, the stronger tendency is to cut taxes on the way into a period of growth.” but graph 1 tells a completley different story.
KH, I just spent two years studying the AGW ?scientists’? actions when the data failed to support their theory. You appear to be doing the same thing, by disbelieving the data and reaching for exotic explanations.
I believe Cactus just showed us that tax policies do work. Now we need him to add the next level of analysis to see how fiscal/monetary policy compares. Overlaying the three might add some clarity, although, I actually believe that it will do otherwise.
Cactus, you’re up!
maybe you should give KH something to respond to.
Tim, what a great thought experiment! Having spent a number of years at large corporations, I can provide anecdotal support. Lower compensated managers build big “enterprises” (the latest BS Bingo word) and higher compensated managers focus on top-line revenue.
Is there an empirical test?
Nice work Cactus
There’s another issue that unfortunately can’t realistically be addressed. It is that GDP growth is not only a function of tax policy, but also of debt, and — worse — on what the borrowed money paid for. Money borrowed to pay for a semiconduter fabrication facility that increases the manufacturing base surely is different than money borrowed to pay for a corporate party in Gstaad.
What I find disturbing is that the per capita debt of Americans — public and private — was relatively constant from the mid 1950s until 1980 and has soared since then. GDP growth on the other hand has obviously lagged since 1980. It is my belief that, were it possible to correct real, per capita GDP for debt, the effectiveness of tax cuts in encouraging growth would look even more dismal.
There are some charts at http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm I think these particular charts are a bit alarmist, but other charts I’ve seen of federal, total government and private debt show the same disconcerting trend. And I see no sign whatsoever that any significant percentage of the new debt represents investment in infrastructure that’ll return profits in the long run.
Folks. If I’m right, these trends — more tax cuts and more borrowing — are not sustainable.
Looking your graph 3 another way….
If as shown tax cuts don’t help GDP, it also appears that they don’t hurt GDP compared to a stable tax regime. In that case why not cut taxes? I don’t need to invoke a GDP correlation to be happier paying lower taxes!
***This is economics 101: don’t confuse correlation with causation.***
Well, actually since it’s 100% pure Keynes, it’s probably not Econ 101 in Chicago.
As I understand it Friedman didn’t disagree with it, but argued that if one put the money supply on automatic pilot and quit tinkering with it, the magnitude of booms and busts would moderate and we could just set taxes at whatever level was required to cover expenditures. If that is what he said, it certainly sounds plausible. Maybe we ought to try it — if we can figure out how to measure the money supply. Which … as I understand it, we can’t.
Yes. The empirical test is the last 30 years of the US economy 🙂 . You can also compare profit in non financial sectors across nations. Nations with lower top end marginal tax rates are most likely going to see increasing profits percentages in financial sector companies as opposed to actual manufacturing companies. The US has gone from somewhwere around 15% of economy profits to financial in the early 80’s to 40% currently. I bet you could tease a proof by looking at data between nations.
I just see a bunch of bars, some going up, and some going down. Moreover, I have no ideal looking at this what the causality is and choosing from 1) In years where there is negative growth they cut taxes, 2) In years with positive growth they feel free to raise taxes, 3) Low taxes cause economic growth compared to if taxes were higher, and 4) high taxes slow economic growth from what they would have been had they been lower. Its just a ball of confusion.
Maybe cross sections would work better. For instance we could compare Ireland against Spain during the same period to see if Ireland got a benefit form cutting taxes.
Cursed,
Nice work Cactus
Why?
The government spends all the additional revenue. People save some of their tax cuts.
What Jevons said. My self-appointed role in life is to see that these discussions remain on something like a legitimate basis. You, CoRev, represent the standard propaganda push-back effort. You find something to say, however implausible, to rebut data, analysis and arguments that don’t fit the view you support. Given the quality of your rebuttals, it is clear you don’t really care whether what you say has anything to do with reality. You just need to get in there and make sure less-informed readers can have doubts about evidence that you don’t like.
Take your answer to me here. The language is dismissive – hit and run, meaningless, turtured – but you haven’t even tryed to take on the argument. And there is that other back-handed bit, about me not sticking around to respond to your response? Wow, you are apparently willing to lie about just about anything. I can be annoyingly tenatious. Sadly, I do work for a living, but claiming that I don’t come back around is utterly, utterly dishonest.
See? Here again, CoRev engaging in sneer-tactics that are wildly misleading. Yes, the propaganda push-back playbook does require that you imply criticism whenever explicit criticism won’t wash. The fact is, cactus writings in preparation for his book involved looking at the data from many points of view, at many levels of disaggregation. When that steadily finer-grained analysis continued to show that Republicans have no claim on superior economic management, the nature of the push-back changed. Actual data analysis continued to show what CoRev and company couldn’t abide, so the new demand was that we all give credence to stories. Clinton was lucky. It was the wrong kind of tax cut. Tax cuts were anticipated so blah, blah, blah. No matter what cactus did, it was never enough. Right out of the propoganda playbook. And, interestingly enough, no rigorous effort by critics to do what they insist cactus must do. No matter how many of the critics objections cactus responded to, he as accused of shallow analysis, but never did the critics offer a data-based rebuttal that held water or an example of the sort of “deeper” analysis they called for. Just made-up stories about oil or the end of the Cold War. Terrible.
Ah, the claim of authority. You just “studied” for two years. That make you right. No evidence. Just your own claim of rightness. What a crock. Again. And again. And again the tricky, and frankly dishonest use of language. Exotic? Say again? What ever is exotic in the point I made? Over your head maybe. Not comforming to your view of things maybe. Exotic? Nice try, boy expert.
I’m pretty certain Friedman repudiated his own “auto-pilot” view late in his career. He assumed a fairly steady velocity of money. If velocity is highly variable, then a fixed rate of money growth doesn’t assure that booms and busts will moderate. He did say that setting taxes at the level to cover expenditures was the right approach, but I’m pretty sure he meant that over the course of a cycle, rather than at any random point in the cycle.
It is a waste of time to argue whether income tax hikes or income tax cuts for high-income Americans are better for future GDP growth.
The utility of the graphs is far more limited: the graphs suggest that the widely-held notion that (top marginal Federal earned income) tax rate cuts stimulate economic growth and (top marginal Federal earned income) tax rate hikes retard economic growth is either not true or is true only in such a limited set of circumstances that we can’t be certain of the effect of a rate change.
While the top marginal earned income tax rate is often the headline number in media coverage of tax policy, that rate doesn’t really capture the changes in tax policy.
The top earned income rate doesn’t capture:
–changes in rates on unearned income
–changes in definitions of taxable and non-taxable income
–changes in the width or number of tax brackets
–changes in payroll tax rates and brackets
–changes in tax credits and tax deductions
–changes in corporate rates/credits/depreciation/etc.
–changes in rates and rules for state and local income and sales taxes
It is a tough enough job to try to determine how changes in the overall tax burden or overall Federal tax burden affects the economy going forward. When your independent variable is something as flighty as the top marginal Federal earned income tax rate, you are almost certain to find no clearly correlated impact on something so massive as the overall US economy.
KH, in all of your snarky comments you have failed to answer my points. Personalizing the response is a certain sign of having hit home. If you actually have a different 1st order interpretation of graph 1, let’s have it. If you use 2nd or 3rd order arguments at least support them.
BTW, why are you hanging around? It really is not your usual style.
***I’m pretty certain Friedman repudiated his own “auto-pilot” view late in his career.***
Thanks. As, is I’m sure, obvious, I’m not an economist. But I am curious about Friedman because he seems to be the one Conservative/Chicago economist that the Salt Water folks do not think to have been demented and/or totally out of touch with reality.
Bingo…we have a winner!
***Moreover, I have no ideal looking at this what the causality is***
I’m not picking on you on this one as that is an intelligent comment. That’d be a large part of Cactus’s point would it not? What we do not see in these charts is the sort of dramatic affects of tax policy on GDP that we might see on a chart of temperature vs air pressure if we (unwisely) attempt to cook a pile of Ammonium Nitrate.
If anything it looks to me like GDP growth might be oscillating largely independent of tax policy. What is unnerving is that the amplitude of the peaks seems to be dropping. What that suggests to me that we need to use some tool other than tax policy if we feel that GDP growth is important/desirable. Perhaps a bit of downsizing of expectations, or a shot of industrial policy every now and then, or a little mercantilism?
***People save some of their tax cuts.***
You’re kidding, right? You might want to Google “US debt public private” and note the rather noticable correlation between tax cuts and BOTH public and private debt.
KH, I don’t think that you know Cactus and I have had a running discussion for several years re: doing a more detailed analysis. So your response is just way off base. Our running discussion involves: how and why are his conclusions happening?
If you care to answer those questions, fine. Have at it! Without that level of analysis his pretty pictures and supporting verbage may be nothing more than unsupported personal conjecture.
Why thank you for the “boy” and “expert.” When are you going to make a case instead of a personal attack?
Sheesh!
Codger said: “What is unnerving is that the amplitude of the peaks seems to be dropping.” Actually I thought that’s what the policy wonks were striving for. Well, also along with fewer peaks and valleys.
gs, said “People save some of their tax cuts.” And then the savinfs institution aggregrates and then lends those savings. I think your comment was re: multipliers. If not I am sorry, but I have always had a problem with the concept.
***Actually I thought that’s what the policy wonks were striving for. Well, also along with fewer peaks and valleys.*** CoRev
Yep. But the wonks that favor that are against tax cuts as a stimulation. The problem is that the tax cuts are supposed to increase GDP enough to pay for themself. They don’t seem to do that.
As an aside, Once government receipts match expenditures, many of the wonks wouldn’t have much problem with tax cuts financed by decreased government spending such as by getting the central government out of the education and policing businesses or hammering our aircraft carriers into fishing reefs. Problem is that we need to actually cut spending, not defer the spending or hide the spending off budget.
CoRev:
Always the contrarian. Don’t skew my words to suit your needs. Cactus has alrady estabkish a direction for this this Lean Six Sigma person and I am asking him what he has found in detail. He has already established that tax cuts do not correlate to GDP growth and for that matter jobs also. He has also established with his data that GDP appears to grow with increases in taxes. An interesting relationship which caused me to ask the “why” question which does not refute the direction Cactus’s graph’s show nor does it signal an issue. I am interested if there is more and if he has taken the data to the next level.
***When your independent variable is something as flighty as the top marginal Federal earned income tax rate, you are almost certain to find no clearly correlated impact on something so massive as the overall US economy.***
One percent of the US population earns 22% of the income. Looks to me like you’re going to have a bit of trouble explaining why that isn’t 22% percent of the economy whether the economy is massive or miniscule.
I do agree that there are many dimensions to tax policy. But I don’t see any indication that top marginal tax rate isn’t a pretty decent metric for overall income taxation.
Run, as I said earlier: “An interesting relationship which caused me to ask the “why” question which does not refute the direction Cactus’s graph’s show nor does it signal an issue. I am interested if there is more and if he has taken the data to the next level.” and I also ask how? So, if anything you overreacted to my agreement with you.
Codger, I agree that cutting spending is needed to balance the budget, but that fly in the face of the hard over Keynesians running economics policy.
Cactus,
Where is the tax hike that LBJ passed to Nixon. I don’t see it on your chart.
VtCodger,
I’m not picking on you on this one as that is an intelligent comment.
Are you feeling alright?
If anything it looks to me like GDP growth might be oscillating largely independent of tax policy.
I doubt it’s independent, buy tax policy certainly is not independent of GDP. I’m pretty sure that had Obama inheritied 3-4 economic growth he would have slapped on a large tax hike, the democrats in 1981 with strong economic growth would not have given Reagan his tax cut, and Bill Clinton had 1993 been a recession year never would have increased taxes (Dubya would have cut taxes regardless of the economy).
“There is no good reason to see a causal relation there”
No, indeed. 🙂 Nor did I claim one. I just suggested one that seemed to have more support than either one in question.
BTW, I took a closer look at the data, and derived the following equation for the years 1954 – 2009. I started with 54 because it was in a stable period. I doubt if the shift from 91% to 92% and back was anything but political noise. I derived the following equation:
Expected(GDP(0)) = e^(0.02006 + 0.044 d(TaxRate)) * GDP(-1)
r = 0.085
Whoop de doo! 😉
No correlation worth mentioning.
The ex-GF won’t be back until late, and I just walked in, so let me take care of it.
1) We often raise taxes on a rising or anticipated rise in GDP.
Umm… much of the tax raising occured during the Great Depression. The most recent tax hike, in ’93, was accompanied (before and after) by much talk about how the tax cut itself was going to kill growth. There were no blogs around then, but I’d be shocked if you weren’t convinced that the 93 tax hike was going to hurt the economy.
2) After we cut taxes we nearly always have a rise in GDP within 1-2 years.
See my presponse.
3) After we raise taxes we see a lowering of GDP within 1-2 years.
See my presponse.
4) Clinton was the luckiest Prez.
Why?
Min,
“No correlation worth mentioning. ”
Which is what I’ve been trying to state for years already. (The point of this post is not to advocate infinitely rising taxes.)
“graphs backwards in time”
What do you mean?
CoRev,
We have this running discussion simply because I’m about the only person who will do X and point out the results are, ahem, inconvenient, and then, when told to do Y because the results will be different, do Y and point out the results are, ahem, inconvenient, rinse, repeat, etc.
I’m not done with this topic. I actually was playing around for a few minutes with some follow up data and the results are very, very interesting. You won’t like ’em. cantab will pretendthey mean something 180 degrees different than they really do, but that’s par for his course.
I just have to figure out how to graph multiple dimensions on a 2 D screen. But I’m getting much better at getting across info on graphs.
CoRev,
“I didn’t make comments re: the length of the rise after a tax cut”
Its clear she was responding to this:
“2) After we cut taxes we nearly always have a rise in GDP within 1-2 years. 3) After we raise taxes we see a lowering of GDP within 1-2 years.”
Its hard to interpret that as anything other than making “comments re: the length of the rise after a tax cut.”
And as she notes, that was covered in graphs 2 through 4.
“ I cannot believe the author thinks that we might not lower taxes before and during an anticipated recession, and raise them during and before a boom. “
Its nice to get the softballs every so often. Thanks.
So let’s take the biggest of the tax cuts backwards, shall we?
1. GW. GW campaigned on “times are good and we have to give people their money back.” He was planning to cut taxes (and everybody knew it) regardless of the state of the economy.
2. St. Ronnie. I think if you went back in time to when St. Ronnie was warning us that Medicare was going to destroy the country back in the 60s and asked anyone whether he would cut taxes if he was President, they’d have told you “ayup.” Economic conditions were irrelevant – he wanted taxes cut. He cut them early in his term when the economy sucked and he cut them later in his term when the economy was a bit better.
3. LBJ. LBJ cut the top marginal rate when the economy was a full four years into some monster growth rates.
I can go on, but why? The tax cuts we’ve seen have been ideologically based, not a result of a recession.
It would be an interesting study. A lot on my plate right now, but that goes on the long to-do list.
cursed,
Thanks. The ex-GF could tell you I’m actually pretty pleased with this.
Cantab,
Probably because you don’t understand why.
Yup. And we have yet to get the point where debt has mattered, but its out there.
Mschwager,
“If as shown tax cuts don’t help GDP, it also appears that they don’t hurt GDP compared to a stable tax regime”
Ah, but they do relative to a tax hike regime. Would you advocate that?
A better answer is VTCodger’s above… debt matters. We weren’t at the point where it showed up in the past data, but at some point it does. You don’t need to arrive at a debt crisis to know you won’t like it.
Come on Cantab, why do you keep bringing up time travel. Every week you seem to try it at least once. The first graph allows you to play the causality game. But the second graph looks at economic growth up to four years after the tax change. Graphs 3 and 4 look at economic growth up to 9 years later.
If you really want to go around publicizing the fact that you are unable to tell whether a change in economic growth isn’t affecting tax policy nine years earlier, then at least be clear that’s what you’re doing. Otherwise, you’re just confusing people like VtC who must have been distracted if he didn’t notice you bringing up your Star Trek trick again.
“When your independent variable is something as flighty as the top marginal Federal earned income tax rate, you are almost certain to find no clearly correlated impact on something so massive as the overall US economy.”
If you’re a regular reader, you probably noticed that in almost every post I write on taxes, I used the overall tax burden, or taxes as a share of GDP, or something similar. But every so often I throw in a marginal tax post too.
“Where is the tax hike that LBJ passed to Nixon.”
1969. Where else would it be?
“I don’t see it on your chart.”
Well, then you’re not looking at 1969.
“Where is the tax hike that LBJ passed to Nixon.”
1969.
“I don’t see it on your chart.”
Well, then you’re not looking at 1969.
I don’t do the time travel thing you keep trying to sell. I’m more of a “time moves in one direction at least insofar as it affects us” kind of guy. You’ll find my posts to be a lot more clear if you realize that I start with that assumption.
Cactus,
Probably because you don’t understand why.
You mean cursed does not understand why? (or the other w’s and the h).
Cactus,
I think everything you do is crap but since Rdam posts your junk its up there for discussion. So we discuss, even though you start you post by trying to intimidate anyone that might critisize it.
Like I said, you bars go up and down in ways that you fail to explain. So what’s your point after all. I’m pretty sure you don’t really have one.
Cactus,
I think everything you do is crap but since Rdam posts your junk its up there for discussion. So we discuss, even though you start you post by trying to intimidate anyone that might critisize it.
Like I said, your bars go up and down in ways that don’t make any sense and that you fail to explain. So what’s your point after all. I’m pretty sure you don’t really have one.
Cactus,
OK, I see LBJ’s tax hike now and the recession the year after.
Is there any reason why would expect top marginal tax rates to have any long run effect at all? Offhand I cannot think of anything in macro theory that would support the claim that govt fiscal policies have any long run effect. Cutting taxes to stimulate economic growth is entirely a short run policy and it’s not supposed to have a lasting effect. An economy’s long run growth is determined by lots of things, but top marginal tax rates ain’t one of them. So on the aggregate demand side of the equation tax rates just don’t matter over the long run.
The conservative argument for tax cuts is based on supply side economics. Now a shock to the aggregate supply curve would have lasting effects. The question is whether or not tax cuts actually shift the aggregate supply curve. If they do, then surely the tax cut would have to be budget neutral and could not adversely affect taxpayers at lower rates. So that’s a pretty thin reed.
Cantab,
“So we discuss, even though you start you post by trying to intimidate anyone that might critisize it.”
The intimidation bit – if you keep pretending that events that happen later can influence events that happen sooner, as you seem to do all the time, I will keep pointing it out.
“Like I said, your bars go up and down in ways that don’t make any sense and that you fail to explain. So what’s your point after all.”
The point is that the bars go up and down in ways that don’t make any sense. Put another way, as I’ve noted time and again, cutting taxes does not lead to faster growth.
Just that. You either get noise, or you may get information about the context in which cuts or raises of the top tax rate occur. Any correlation does not imply that the tax rate changes causes anything, but may be evidence that something causes the tax rate changes. It’s just an easy test using the same data.
Cantab,
Listen, I put up every bit of data, every time I have a post. I don’t hide anything. I note that there are crazy events before some tax cuts and before tax hikes. (See the recession that followed Reagan’s first tax cut, as an example.)
The point is this… I’ve had post after post noting that taxes go up and down, and growth goes up and down, and you simply do not get tax cuts leading to growth. If what you seem to believe is true, then one of these series I’ve looked at should sooner or later show tax cuts leading to faster growth.
But they don’t. One can pick an event here or there, but there’s a counterevent somewhere else. On the average, on the whole, it just doesn’t happen.
CoRev,
And then the savinfs institution aggregrates and then lends those savings
Ugh. Ersatz economics strikes again. Tell me, have you ever heard of the I=S identity? Unless there is an offsetting increase in investment (I), there will be an excess of savings (S). That’s what we have today. That’s what causes recessions. If the private sector does not soak up excess savings, then you need government to step in an do the job. And the way that works is that the govt runs a deficit, then the savings institution takes the excess saving and buys govt debt. As long as we’re in a recession there is no crowding out. If we’re not in a recession, then running a deficit to finance a tax cut increases private saving and increases public dissaving by an exactly offsetting amount.
The concept of the multiplier is not a hard concept. And if you don’t get the intuition, then you should at least trust the math because it’s pretty straightforward. The proof is something that any freshman econ major should be able to do by the first mid-term.
Slugs,
The private economy in the United States is where our wealth comes from. The benefits from current production is either consumed or re-invested. The more you tax the rich the less or their money is available for investment in the high return private sector. If anything we should eliminate the tax free status of municipal bonds to eliminate this distortion of the market.
IIUC, a major reason for the high debt is that the Third World has emerged as the Developing World. Socioeconomically they are where the First World was in the 20th century. (Africa as a whole lags far behind, however.) A lot of that has happened through exports, which we (along with the rest of the Developed World) have bought and are buying. They will probably catch up in the next generation or so. 🙂
A major reason for the increase in private debt in the U. S. is the growing inequality. There is much more to the story, of course.
I agree that these trends will end. My guesses: Like Japan, China will one day open factories in the U. S. As for the growing inequality, we will either accept it and enter the serving class, or we will rebel, possibly with some social upheaval.
Cactus, from your own graph 1, 8 of the 12 tax increases showed and immediate drop in GDP. Only three of the fourteen tax cuts resulted in drops in GDP with the remaining ten showing rises, and one no change. One of those downturns was the RR tax cuts, so we know what was going on then. So from that quick look graph 1, seems to indicate tax cuts mostly good, tax rises not so good for the GDP
I don’t know what you thought you were showing us, but in just eye balling your graph 1, it does not show a negative impact for tax cuts unless we start 2-3 year lag reviews. It does show an almost immediate increase of GDP when compared to the implementing year. Since many tax cuts are done in response to recessionary conditions, it appears that they are in general beneficial for the short term.
Since I couldn’t get by graph 1, the other three did not get other than a cursory review.
BTW, have you announced the name of the co-author yet?
Cantab,
Go review the Ramsey and Solow growth models. Savings does not increase the long run growth rate. The best that your warmed over Harrod growth model can do is to give us the savings level needed for a warranted growth rate. But as I said, savings means the sum of private savings and public savings. If you run a deficit to finance a tax cut, then you have not increased total saving.
As to growth, most per capita growth comes from multifactor productivity and not capital deepening. If you cut govt spending on education, then you will almost certainly hurt multifactor productivity a lot more than you will help capital deepening.
Finally, it’s not at all clear that private investment has higher returns than public investment. Consumer surplus from private investment is determined by horizontally summing individual demand curves. Consumer surplus from many public investment projects is determined by vertically summing individual demand curves.
Why not cut taxes? The bank bailout may have saved the banks, but it did little to stimulate the economy. Now the problem is unemployment. Also, as was pointed out on this blog some days ago by Divorced One Like Bush, stores need customers with money. The big bankers and fat cats are not going to supply that. If you do not have a job, or do not make enough money, a tax cut is not going to do you much good right now. (The problem with a payroll tax cut or holiday is the way social security is set up. It would in effect take money from the workers themselves. Why bail out the fat cats and leave the workers to fend for themselves?)
Cactus, as I said earlier, graphs 2-4 were useless to me after seeing graph 1.
CoRev,
That sounds like a teabagger version of Keynesian economics. Keynesians advocate running a deficit during recessions and surpluses during boom times. In other words, you worry about balancing the budget over the business cycle and not over the fiscal year.
And wasn’t it Dick Cheney who said Reagan proved that deficits don’t matter?
2slugs said: “Cutting taxes to stimulate economic growth is entirely a short run policy and it’s not supposed to have a lasting effect.” and I think that is exactly what graph 1 shows. It also seems to show that raising taxes has the opposite short term effect.
CoRev:
You have no agreement with me as you are asking from a different perspective than what I am asking. You are asking to refute and I to learn more as I have already accepted the validity of his observation. World of difference.
cactus:
It is nice work. I am sorry I asked questions only to be used.
My explanation: a certain amount of government and redistribution–and the taxation to pay for it–is necessary for a modern, high-productivity, industrialized economy to thrive.
The US has been at 28% of GDP forever (state, local, federal combined)–lower than any other prosperous country except japan and (barely) Korea. EU15 countries at at 30-50%, 40% average. (And they’ve been growing just as fast as we have for 30+ years.)
Basically we’ve been teetering on the bottom edge of a sustainable situation for a long time. W tipped us over the bottom.
correcton,
Rdan
Cactus,
Your posts have never made and sense and you keep reposting this one again and again in slightly different ways. In its last for you claimed that the republicans had bad economic policy. I refuted you with the Romer paper, so here you are again, morphing your junk analysis into yet another form.
Even the hyper liberals in this administration don’t buy you’re “raising taxes” does not matter angle. The all say that taxes do matter and that’s why you don’t raise them in a recession. In a boom time they just hope that nobody notices the lost economic output.
Slug,
Go review the Ramsey and Solow growth models.
That’s exactly what I did before making the post. Government taxes and spending are for government consumption, and according to the model you either consumer or invest, tax and spend government comsumption takes away capital that might have been invested in the private sector. This hurts economic growth.
Run, you’re kidding aren’t you? Answering our questions has nothign to do with perspective. I am trying to learn from Cactus, but I am less impressed with pretty picture than the reasoning behind and then from them.
Cantab,
You’re going around in circles. Government spending can be on consumption or public investment. There is nothing sacred about private sector investment…just because it’s private investment does not mean it has a higher rate of return.
And go reread the Solow growth model. Here, this might help:
http://en.wikipedia.org/wiki/Exogenous_growth_model
And here’s the money line: There is now permanently higher capital and productivity per worker, but economic growth is the same as before the savings increase.
CoRev,
That’s called countercyclical demand management fiscal policy. Tax cuts working on the aggregate demand curve. Of course, tax cuts are not a particularly effective way to stimulate weak aggregate demand, but it’s better than nothing….although not by much.
Steve Roth,
W tipped us over the bottom.
Interesting choice of words. Sort of like Krugman’s line about the upper hand being on the other foot.
Slugs,
There is nothing sacred about private sector investment…just because it’s private investment does not mean it has a higher rate of return.
Actually it is sacred since it’s the source of all but a trivial amount of revenue that produces both government and private consumption and investment.
slugs,
There is nothing sacred about private sector investment…just because it’s private investment does not mean it has a higher rate of return.
Actually it is sacred since it’s the source of all just about all the revenue that pays for both government and private consumption and investment.
Cantie, I guess 2slugs was comparing today with his preferred model.
CoRev:
No, you are not attempting to get to the next level. Your whole discussion here is not predicated on finding more information now or in the past and you are suspect. I would add disingenuous. “Our” is not the word to use unless you have a mouse in your pocket. I ask for different reasons then you do.
“Since I couldn’t get by graph 1, the other three did not get other than a cursory review.”
The other graphs are showing the longer time horizon. Think of the problem this way. For the time frame we have, its easy to show that running up the deficit increases economic growth.
The problem is, running up the deficit creates debt, and debt that continues growing faster than the GDP at that, which in turn makes that debt eventually unsustainable. For the period for which we have data, the US did not reach that point. But its folly to pretend that point doesn’t exist. So as much as in the short term running up the debt is better than paying it down, in the long run, the positions reverse.
Now, the time horizon for tax cuts and tax hikes is shorter. Ignoring data from 1930 to 1952, it seems tax cuts are more beneficial in the immediate term. But as the other graphs show, the point of the flip (assuming only 1952 – 2009 data and not the data from before that) is about 3 years out – that’s when tax cuts start looking worse than tax hikes.
Co-author has not been announced at this forum yet. I’m not sure if he’s mentioned it to his employer yet. (He’s a journalist.)
That said, you know my name… and the book is available on pre-order at a few (but not all) book sellers on-line. His name is on the cover.
You mean check for whether growth causes tax changes? I had a different post for next week in mind if I had the time but maybe I’ll write this up instead.
Two drivers, one drives a Lamborghini and one drives a Prius, are in a race. They have to drive 2000 miles. Winner gets $1 million.
If you simply measure their speed coming off the starting line, you’ll be under the mistaken impression that the Lamoborghini is going to win. But at 4 miles to the gallon, the Lamoborghini is going to waste way too much time being stopped. (And as we know, these days Priuses don’t actually stop.)
Your mistake is in looking at the specs and declaring the race over.
Cantab,
That Romer is contradicted by the facts on a given issue doesn’t mean that citing her refutes the facts.
And frankly, I don’t care what anyone says (liberal, conservative, or whatever) – if they are contradicted by the facts, they are wrong. Period.
My posts have never made sense because they show, in as simple a way as I am capable of doing, what happened. And what happened is not what you believe.
This doesnt even come close to telling the whole story. It’s not just a change in marginal rates in federal income taxes. Look at the FY2011 budget. It raises the marginal rate back to Clinton levels for families making >$250K, sure. But it also eliminates tax credits and tax deductions for that same group too. It also creates multiple new refundable tax credits available to everyone except that same group, including the 60 million people who have zero income tax liability. Then there’s also the increase in capital gains taxes for that same group too. This is by far the dumbest increase of them all. We already know that as a voluntary tax, it will NOT generate increased revenues to the govt. It will just lock in money and capital will not flow as efficiently. You can soak the rich all you want. It’s not enough to pay for this abomination of a budget. Over the next few months, when the dollar rally continues, commoditiec collapse, the S&P gives up all the gains since last spring, and while we are still shedding jobs, the worst thing you can do is start proposing tax hikes, especially on capital gains.
This doesnt even come close to telling the whole story. It’s not just a change in marginal rates in federal income taxes. Look at the FY2011 budget. It raises the marginal rate back to Clinton levels for families making >$250K, sure. But it also eliminates tax credits and tax deductions for that same group too. It also creates multiple new refundable tax credits available to everyone except that same group, including the 60 million people who have zero income tax liability. Then there’s also the increase in capital gains taxes for that same group too. This is by far the dumbest increase of them all. We already know that as a voluntary tax, it will NOT generate increased revenues to the govt. It will just lock in money and capital will not flow as efficiently. You can soak the rich all you want. It’s not enough to pay for this abomination of a budget. Over the next few months, when the dollar rally continues, commoditiec collapse, the S&P gives up all the gains since last spring, and while we are still shedding jobs, the worst thing you can do is start proposing tax hikes, especially on capital gains.
One of the big reasons I refer to the top marginal rate as a “flighty” variable is that the taxable income level at which the top rate kicks in has varied widely over the years.
Consider 1932, when the top rate jumped from 25% to 63%. A crushing tax increase during the Depression? Maybe, maybe not. The 25% kicked in at $200,000 and up. The 63% was for taxable income over $1,000,000.
Cactus has avoided some of the flightiness by ignoring the level of the rate, and analyzing only directional changes.
A shorter version of my answer would be to say “look at Hauser’s law”. Turning to Wikipedia for convenience:
“In economics, Hauser’s Law is a theory that states that in the United States, federal tax revenues will always be equal to approximately 19.5% of GDP, regardless of what the top marginal tax rate is. It is not a theory in the formal sense but a macroeconomic observation informed by over 40 years of data, and, per WSJ 080520, verified by the next 15 years of data (up to 2007); like Okun’s Law rather than, say, Snell’s Law in optics.”
The 19.5% doesn’t include FICA payroll taxes, but those taxes are independent of top marginal rates anyway.
Cantie, this is the reason I have with the multiplier(s) concept. How can the math work out ehn only one half of the equation is considered. A Fed Govt multiplier based only upon Govt spending might prove higher than an equal private sector amount in spending, but when the other half of the equation is added (each Fed Govt dollar spent is deducted from private sector spending) and has a typically uncalculated overhead/handling charge, I just can not see the validity of the claim.
“This doesnt even come close to telling the whole story.”
Which is exactly why in most of my posts on taxes I look at the change in the entire tax burden, not just the marginal tax rate. But when I do that, invariably someone says look at the marginal tax rate. And when I look at the marginal tax rate, there’s always someone telling me to look at the overall tax burden.
And the results are the same… cutting taxes (by whatever measure) is not the way to get economic growth.
Min
I think you make a good point. People should know what to expect. We should stop tying taxation to govt spending. Tax only for the reason of controlling private demand, right now that would mean REDUCING taxation since we definitely need more demand both private AND public.
The main problem now is we have a minority party that simply wants to hold the current administration to a different standard than its held for the last 8 years. While it rightly wants to cut taxes it wrongly wishes to tie that to decreased public spending.
Spending should be based on what we need/want/is available for purchase/can be produced, taxation should simply be a means of inflation control.
It is not quite as simple as looking at the top marginal rate. For instance, in the Clinton years the top marginal rate was increased slightly, but the capital gains rate was cut.
The Internet Boom ensued with much income shifted to Cap Gains throught the use of options as payment. Just look at the compostion of revenue collected. A reduction in cap gains is a bigger driver of investment in business that a cut in ordinary income or visa versa. Hence a better driver of GDP.
Many are referring to GDP and not “GDP per capita” as it states. Big difference. Using population, which is not a predictor of economy, as a denominator is misleading for analyzing growth. It should only be used to compare one country to another. Since the GDP typically always grows, it should be comparing growth rates of different years compared to the tax law changes that preceded those years.