Top Marginal Tax Rates and Economic Growth
Top marginal taxation and economic growth by Santo Milasi and Robert Waldmann has (finally) been published
here in Applied Economics
ABSTRACT
The article explores the relationship between top marginal tax rates on personal income and economic growth. Using a data set of consistently measured top marginal tax rates for a panel of 18 OECD countries over the period 1965–2009, this article finds evidence in favour of a quadratic top tax–growth relationship. This represents the first reported evidence of a nonmonotonic significant relationship between top marginal income tax rates and economic growth. The point estimates of the regressions suggest that the marginal effect of higher top tax rates becomes negative above a growth-maximizing tax rate in the order of 60%. As top marginal tax rates observed after 1980 are below the estimated growth-maximizing level in most of the countries considered, a positive linear relationship between top marginal tax rates and GDP growth is found over the sub-period 1980–2009. Overall, results show that raising top marginal tax rates which are below their growth maximizing has the largest positive impact on growth when the related additional revenues are used to finance productive public expenditure, reduce budget deficits or reduce some other form of distortionary taxation.
Update: Also US States say Carl Davis and Nick Buffie at T€he Institute On Taxation and Public Policy. “States without personal income taxes lag behind states with the highest top tax rates”
That can be hard to prove considering that the high era of top marginal tax rates occurred when the economy was basically in war mode until 1989.
BS,
Even if you assume the “war mode” extended out to Grenada, which makes for one hell of a stretch, that particular engagement went to 1983. What happened in 1989? If you really want to push the “Cold War” = “war footing” then you might as well claim 1991, when the Soviet Union fell. But then, could the USSR threaten the US as much as, say, China today?
But be that as it may, even in this fictional war mode, we did get to observe what happened at the lowest top marginal rates (28%) in the post WW2 era during the Reagan admin. We saw what happened to the economy then. And in your definition, that’s “war mode” to “war mode.”
Here’s a thought.
We expect government to spend on education, health, infrastructure, …, – things that indirectly enhance a productive economy.
The money that people spend on food and shelter so they can be good workers is in the same category, but buying a bigger TV has no secondary benefits. Nor does that trip to Disneyland.
So, up to a point, an added dollar of government spending is more productive than the consumer spending it displaced.
DEar Bert Schlitz “the economy” ??? You do know the paper uses an international dataset & usually “the economy” refers to the economy of one country.
War mode would be relevant if military spending were a major share of total demand. One would not expect such spending to cause high growth over decades (if so then let’s spend to protect ourselves from martians). The levels are miniscule compared to WWII spending (especially for the 17 countries in the data set whcih aren’t the USA).
Did you read the paper ?
“the first reported evidence”
fairness requires me to mention a book by Mike Kimel which I thought would fit that description. but i didn’t read the paper.
as for BS, i suppose he needs to be answered, but it is reasonably clear that not only has he not read the paper, he hasn’t thought about anything since the right wing think tanks told him God’s eternal truths.
What is new is that we look at nonlinearity (oh hell mostly the quadratic term) in top tax rates. I mean also this is for 18 countries. Evidence from the USA is only 1/18th of it.
I have replied on the wartime economy business. Doesn’t apply to most of the countries in the sample (it actually doesn’t really apply to any of them).
Australia, Canada, Denmark, Finland, Germany, Ireland, Italy, Japan, New Zealand, Normway, Spain, Sweden, Switzerland were at peace throughout the sample period. Many of these countries had low defence spending throughout. In theory, defence spending should cause a temporary increase due to high demand and also slow growth in the long term.
I have almost a sense that some people in the USA have trouble believing there really are other countries out here.
Well,
Sweden supplied steel to the germans. I suppose that could be counted as defense spending.
But more important: if the war caused the high growth in GDP with high taxes, what reason is there to suppose that high taxes and government spending dedicated to things that didn’t blow up or get blown up wouldn’t have generated even higher growth?
Dear Coberly
The data set starts in 1960 (as did I born the day after Kennedy was elected).
Indeed, there is no reason to believe that high taxes used to fund defence spending including military R&D promote growth as much as high taxes used to fund non defence spending including non-military R&D,
But in any case, the high marginal tax data mostly are high marginal taxes in countries which were at peace and had a lower ratio of defence spending to GDP than the US has had in its low marginal tax period.
Also the regressions include period dummies so the result is comparing growth say 1970-75 in different countries with different top marginal tax rates. The result is not just that growth and top marginal tax rates used to be higher. It is that during an interval in time, growth is faster for the country with a top marginal tax rate closer to 60% (or whatever it depends on the specification). Also there are country dummies, so it isn’t just that some countries grow faster than others.
The war time economy argument is 100% false. It has no overlap with the actual empirical work. not quite 100% of comments on blogs are arguments worthy of serious consideration (I hasten to add that I am thinking of mr Schlitz not you)
Waldmann
thanks for the reply. it’s nice to find myself in agreement with someone who actually knows what he is talking about.
i assume your “not quite 100%” is not a typo but dry humor.
I want to say I have never been a rabid opponent of defense spending. In a fallen world it is probably necessary, and some of the research has undoubtedly helped the economy.
I would speculate that to the extent the war ended the Depression, it is government spending, including defense spending, that has kept depressions since then shallow and short…. not pfree enterprise, claims to the contrary notwithstanding.
And I have never been a rabid opponent of free enterprise. Just an opponent of rabid free enterprise.
I go back long before 1960, not that it has done me any good.