John Taylor in Favor of Higher Marginal Income Tax Rates? If Not, Why Not?
by Mike Kimel
John Taylor in Favor of Higher Marginal Income Tax Rates? If Not, Why Not?
A couple of weeks ago, John Taylor posted a graph showing that since 1990, there has been a negative correlation between the Investment to GDP ratio and unemployment.
There’s been some back and forth between Taylor and some of the other big boys (some of it summarized at Mark Thoma’s Economists View, and even Krugman has weighed in).
Lots of fun is being had by all, but it seems everyone, especially John Taylor, is missing a key point. If, as he states in his post, “the most effective way to reduce unemployment is to raise investment as a share of GDP” and if we want to reduce unemployment, then we should be raising the top marginal tax rate.. After all, going back to 1929 (that’s as far back as the Bureau of Economic Analysis has data), there’s a quadratic relationship between the top marginal income tax rate and the ratio of private investment to private consumption.
As I note in the post in which that analysis is done (complete with a nice graph):
correlation between the top marginal tax rate the ratio of investment to consumption for top marginal tax rates below 50% is 55%. That is to say, an increase in tax rates increases the ratio of investment to consumption when tax rates are below 50%.
So… raise top marginal rate —> more investment —> lower unemployment. I imagine John Taylor’s endorsement of higher marginal tax rates should come any moment now.
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Cross-posted at the Presimetrics blog.
Indeed. As I asked on another blog, why are the people who are calling for reducing gov’t spending to spur private investment not also calling for higher taxes? It would seem that the logic of their argument demands it.
And you show empirical evidence, too. 🙂
A higher marginal tax rate would shift capital away from low return to high return investments, thereby generating more income for the economy, higher wages, and the like. This suggests that we’re on the low end of the Laffer curve. Raising the top tax rate sounds like a plan to me.
Min these people just know individual economic behavior and therefore Kimel and his infernal data must be wrong or irrelevant, at least to them. At the level of analyzing business decisions (not macroeconomics), one question that Kimel raises is this: do business owners plow more of their receipts/earnings back into their companies to make them bigger/better, and put less of this money into their pockets for various other uses, when the top marginal tax rate on their income is high?
Ah. One correction. Its not “Kimel’s data.” I simply pulled data from the IRS and the BEA.
The fact that the data comes from widely respected sources that nobody really disputes and the analysis done is simple (i.e., just a graph using every single available observation) should make the results relatively uncontroversial, or at least should put the onus on those who dispute the results to show why they wrong.
Why so many folks of a certain political persuasion do everything in their power to impede growth is beyond my understanding. To use a line folks of that ilk kept using on the rest of us for many years, why do they hate America?
It’s not only your macroeconomic statistical results, Mike. Does anybody dispute the hypothesis regarding business decisions?
Does anybody dispute the hypothesis regarding business decisions?
No. Unless you count every economist, every person who understands even rudientary finance, every business owner, and every person who has a logical mind, who understands that if you lower the returns from investment, via taxation, you lower the amount of investment. (This is the reason for preferential tax treatment of dividends and capital gains, ACRS etc. – to encourage investment).
Mike’s novel theory that high tax rates force owners to keep money in the business, ignores the facts that 1) the business is already taxed at the higher rates and so has less money to invest, 2) those higher tax rates deflate the business furture investment returns and 3) forcing owners to hold profits in the business as cash to avoid high taxation further depresses their return.
What Mike has, apparently, is some correlations that can be readily, and more compellingly, explained by other factors.
“What Mike has, apparently, is some correlations that can be readily, and more compellingly, explained by other factors.”
Do you mean other compelling factors such as the gravitational pull of the moon? Or might such factors be a high level of unreported profit in the form of cash receipts? Maybe it’s just sampling error. Possibly the most compelling factor that Kimmel has failed to recognize is religious faith, the need to enrich one of God’s children by sheer will. Which of these other factors might explain the data in a more compelling manner? If this expansion on Sammy’s theme seems a bit absurd it is because Sammy’s premise is rediculus.
Thanks for setting me straight Sammy. That is why I like Angry Bear so much. My friends and self-employed entrepreneur acquaintances are just as stupid and illogical as me, so I didn’t want to trust their opinions. (That includes someone with a doctorate who teaches business and management graduate-level courses and categorically tells me that Kimel is corrrect–what a putz!)
PJR, what you have shown is ther are now three who beleive Mike’s analysis, oh and Jack. Doesn’t make it any more correct.
Correct CoRev although its more than three. It also doesn’t make it incorrect. Which is why I asked the question and appreciate Sammy’s explanation of why he thinks Kimel is wrong.
I’ve heard conservatives claim for decades that taxation amounts to a drag on productive investment and growth. The simplified theory says that capitalism resolves inputs like investment and labor and innovation with outputs like assets, wages, and patents or other trade secrets. The taxation supposedly steals from the inputs thus reducing the amount available for ‘outputs”. (okay I said it was simplified)
To which my usual question is: “Ok why does taxation cause a drag but not profits?”
PJR,
You have a friend that teaches business at the graduate level who believes that higher marginal tax rates increase investment? I am very, very surprised as this goes against the entire academic body of work in Finance.
I did a google search on “higher marginal tax rates increase investment” and could find no one else putting forward the same notion (and lots and lots to the contrary), although I did find numerous cross postings at liberal blogs (congrats Mike).
Mike,
Every Psycology book claims, at least that I know of, that if you punish a behavior you get less of that behavior….Why is it any different in Economics?
Yerom et al.
The reason higher marginal tax rates lead to more investment is simple human nature. Higher marginal tax rates penalize taking money out of the business for the purpose of consumption. The alternative, of course, is investment.
Yoram,
To follow up… I presume every psych textbook also says if you punish a behavior (here taking money out of the business for consumption) you will get more of the alternative behavior (here investment). And of course this is completely consistent with the data.
I am having a hard time seeing the problem.
sammy – “I did a google search on “higher marginal tax rates increase investment” and could find no one else putting forward the same notion (and lots and lots to the contrary), although I did find numerous cross postings at liberal blogs (congrats Mike).”
I found the same thing. What does that tell us?
There is no assurance whatsoever that any investment growth supposedly resulting from a higher marginal tax rate would provide further investments in the United States of America.
Perhaps we should be discussing where the investment growth would occur.
It’s interesting that this point is absent from the discussion.
The implied notion that investment growth would supposedly only occur in the United States is questionable if not complete nonsense.
This is the type of problem that is overlooked whenever people start pretending that the U.S. economy is a closed economic system.
MG,
Now I get it. Mike inadvertently dropped a word from his statement:
“raise top marginal rate —> more investment OVERSEAS—> lower unemployment OVERSEAS”
This is a statement that I would agree with, and one supported by the research in finance and economics. 🙂
Sure, some investment from higher tax rates go overseas. But consider a small chain of grocery stores. If the owners reinvest in the business they avoid paying taxes on that. Unless that business branches off into something completely different it is hard to see how they can start investing in China, say. (Speaking as a small business owner, human beings have limited bandwidth.)
I imagine overseas investment is more likely for individuals who have already removed money from their business, not having been discouraged by low tax rates. I haven’t checked the data but I think there has been a lot more overseas investment since tax rates dropped during the Reagan era than before, but teasing out the effect of better communication would be difficult.
MG… so you did the Google search. What does it tell you? In your answer please account for the graphical relationship I noted and which nobody else has. Is the data wrong too?
MG… you may recall how I said we were in a recession on March of 08 when just about nobody else was saying it. Or that I said in Dec of 08 (Dan posted that one in Jan by mistake) that the recession would end in the first half of the year.
Should we assume I was wrong because a Google search at those times would have shown me standing just about alone?
Jesus Christ all mighty. When are the fools of the world going to stop seeing taxation as punishment. It is part of the cost of dong business and the cost of being a citizen. And negative reinforcement has unpredictable consequences, hence the limited application of such a paradigm to real world applications. Simply taking a smug stance and declaring a point does not make the point a valid concept. Invest, work hard and you may prosper. If so be happy for your good fortune and pay your taxes. You don’t get a free ride because you’re an entrepreneur. The government makes all of our lives safe and more comfortable. You made a profit, you enjoyed a good income. Pay your f__king taxes and stop making up bull shit excuses not to do so.
Sammy this person does not teach macroeconomics nor a hypothetical “what to do if Obama raises the tax rate on your business profits” but said this to me: IF the tax rate was much higher than today for someone running a small business (with profits putting the person in the top tax bracket), then the businessman should defer more of his profits in favor of creating larger future profits and a more valuable business, such as through expansion (assuming many things, of course, like potential for greater profits). The assumption was that it’s a restaurant, dry cleaners, shop, something local. Anyway, this is pretty much what Kimel said. Others have said this to me, too. They may be wrong, I truly dunno. In my mind it raised at least two initial questions: first, is this “rational” thinking in theory and second, is this how businessmen think in practice. The answers could differ. You are telling me the answers are no and no.
I tried the internet research thingy too, for what that’s worth on this topic, which apparently is little. Maybe there’s more in academic business journals. I also looked for advice to businessmen just to see the thinking–advisors make clear the tradeoff between paying yourself cash versus growing your company (and its value as an alternative form of compensation), but nothing on whether a hypothetical change to tax rates would change this calculus as my professor friend claimed.
Jack,
Pay your f__king taxes and stop making up bull shit excuses not to do so.
If you don’t pay your f___king taxes, the government will forcibly extract them from you and send you to jail. So paying your taxes is a GIVEN. The question we are discussing is “what does that do to the economy?”
We have federal revenues of $2.2T and expeditures of $3.7T. So we have to raise revenues (read “taxes”) close to 100% to bring the budget into balance. This implies top marginalFederal tax rates of nearly 80%. If you add on state income tax rates of 10% and FICA of 12% well that is pretty much a 100% marginal tax rate.
How much investment will be increased then?
Either that or we can cut spending.
Sammy,
Obama is the first dem president since ww2 to increase debt/gdp. On the Rep side Ford, Reagan and the the two Bushes did that. I hope you were as incensed then.
Sammy you must be historically correct and this reduces incentives to spend on what is categorized as capital investments rather than expenses. In recent years however a small business can fully deduct most types of capital investments in the year that they are acquired, up to a limit–currently a half million dollars, which isn’t chump change for a small businessman. Of course, this (seemingly wise) tax deduction option may go away.
Sammy and MG,
An additional thought. I believe many (just about all?) investment tax credits seem to apply the same whether the investment is here or abroad. If these credits did not apply abroad (I.e., a “tax hike”) on foreign investment what would happen?
Same for tax cuts I believe, and the money from lower rates. Especially since the question of cuts and lower rates equating to more investment early in the discussion implied domestic investment, and now the question of where the money goes is superimposed on Mike’s assertion but not Sammy’s. Bad set of logics. Tsk tsk.
The lack of precision in the counter to Mike makes it impossible to debate reasonably. There are serious discussions on the lower and upper bounds of the so called Laffer curve and easy to find. And plenty on Laffer. But not here. Sammy defines ‘high marginal rate’ with no attempt to define percentagesn except current practice.
Dan,
There is every likelihood that the majority of upper income investments are already tied to global investment projects and opportunities. Adding more investment to the same or similar global opportunities will provide no major investment growth in the United States.
Where does anyone think that additional investment in domestic U.S. opportunities will be applied? Where is there a shortage of existing investment in the U.S. which provides a high rate of return on such investments? Where are the U.S. investment opportunities that match the investment rate of return on global investment projects?
How is this situation dissimilar to the supposed expectation that investments in solar and wind energy would be applied and would remain in the United States? Obviously, that didn’t work out in the United States or Spain.
I believe that people would be very surprised where the big dollar investments are occurring. It’s not on Main Street, USA from what I have read.
Here is one way lower tax rates could reduce investment:Gale, William G., and Peter R. Orszag. 2005. “Deficits, Interest Rates, and the User Cost of Capital: A Reconsideration of the Effects of Tax Policy on Investment.” National Tax Journal 58, no. 3: 409.
“We extend the traditional approach by considering a reduction in taxes that generates an increase in the budget deficit; the expanded budget deficit may raise interest rates and the opportunity cost of investment. This provides a mechanism through which tax cuts can raise the cost of capital. Representative calculations show that, even with relatively modest interest rate effects, the net effect of making the Administration’s recent tax cuts permanent or a 10 percent reduction in individual income tax rates would be to raise the user cost of capital. Thus, sustained tax cuts can raise the cost of capital and reduce investment.”
Also, couldn’t higher tax rates lead directly to higher employment (skipping other forms of investment), since wage costs are an expense?
Julie,
The Gale Orszag paper…. I guess your google-fu skills are better than Sammy’s and MG’s. Thanks for the find. (Not that I have read the paper so I don’t know if I agree with what they do but clearly I’m not the only voice in the universe saying higher taxes can lead to greater investment.)
“Also, couldn’t higher tax rates lead directly to higher employment (skipping other forms of investment), since wage costs are an expense?”
Hmmm…. yes, I think so. (Subject to wages being treated as an expense – I am no accountant but that sounds like I remember it.)
cactus (i.e., Mike Kimel – I have to get around to changing the name that goes with this $#%# google account – I haven’t been writing anonymously for a long time now)
Mike Kimel (cactus) has posted a number of comments on this thread that are no longer here. I noticed this yesterday and again today. What happened to the comments?
Ummm…. I noticed the what MG noticed about my comments disappearing. I had a couple comments about the whole nobody else showing up in google searches by Sammy and MG. One for instance, noted how I called the recession in March of 08, and then said its end would come in the first half of 09, and that if you had googled that you wouldn’t find anyone else saying the same thing at the time.
That said, I chalked the odd behavior up to a) I have been on the road and b) I have posted mostly from my phone in the past thirty six hours.
What if the problem in this supposition were the required: “…high rate of return on such investments?”
In a world where safe investing means virtually zero return (ZIRP) aren’t all the high return investments essentially casino bets? Is this not what is driving the speculation in virtually every commodity?
I keep chuckling at the idea of smart money when so much of it seems to end up in the hands of the Madoffs, Enrons, Worldcoms, Countrywides etc.
Your same theory says that if you lower the tax on savings you get more savings.
But we have been trying this theory since 1980 and the saving rate collapsed– every time we created another tax advantage for savings the savings rate seemed to fall.
Actually, there are two economic theories. One, liked yours is based on the maximization assumption.
The other is based on a form of behavioral economics that people have savings goals — for example having a million dollar stock portfolio at retirement. But under this theory when you increase the returns on investments, via lower taxes for example, the individual can reduce the ammount of savings — annual contribution to the portfolio from current income — needed to achieve that goal.
Guess which approach the recent US economic data supports?
Yet, you and others continue to advocate the lower tax approach as if there was no question that the data supports your theory.
The Kimel Curve is starting to look a lot like the Laffer Curve, only backed by data instead of being drawn on an apocryphal napkin.
I do get tired of this little bit of sarcasm. Having been in touch with with a number of big names who have read the book…actually studied the research, since it doesn’t read lightly…I will try to get permission to indicate approval or sympathy for the premises involved…for now I can say plainly you are simply wrong in your assumption Corevm but that is based on my experience. Mike’s ‘research’ is used as a start.
Psych 101 books aren’t useful Yerom. Please read more advanced material.