Presidents, Taxes and Economic Growth
Presidents, Taxes and Economic Growth
by Mike Kimel
One of the never-ending debates in economics is the extent to which taxes affect the economy. Most people are fairly certain that higher taxes slow growth. They’ve learned this from economists.
To get my own look at the issue, about six years ago, I wrote a post looking at the relationship between the federal tax burden and growth in real GDP, and I did so in the context of Presidential administrations.
To avoid questions about which leads which (i.e., did the tax burden affect the economy, or were tax burdens changed by the political class in response to changing economic conditions), I looked at the change in the federal tax burden over the first two years of a presidential administration and compared that to the % change in the real GDP over years two through eight of that same administration. (I left out administrations that served less than 2 terms.)
That way, if there was a relationship between the two series there would be no question that taxes were leading the economy rather than the other way around. Also, two years is enough time for an administration to impose its policies, but not enough time for reality to set in and for it to start flailing about. Conversely, six years is long enough to see outcomes, and won’t be susceptible to huge movements due to extraordinary positive or negative performance in one outlying year.
Thus, for example, for Reagan, I looked at the annual change in the Federal Tax Burden (i.e., Federal Current Receipts / GDP) between 1980 (before Reagan took office, and therefore the baseline year for Reagan) and 1982, Reagan’s second full year in office. I then compared that to the annualized % change in real GDP from 1982 to 1988.
Going back to 1932, the first year for which there is National Income and Product Accounts data on a full presidential administration generated a graph that looks like this:
Graph 1 (“Corrected mislabeling in the original graphs. Apologies.”)
The lesson here is…. contrary to what most economists will tell you, during administrations which started off by lowering tax burdens, the rest of us suffered through lower economic growth. When administrations started out by raising the tax burden, the rest of us enjoyed greater economic growth. And before you object with something along the lines of “well, maybe the President cut taxes to deal with a recession” bear in mind that no President in our sample, perhaps no President in American history, had to deal with worse starting conditions than FDR.
Also note that leaving out one or another administration changes the slope of the line, but doesn’t make it negative. The biggest outlier seems to be the FDR (pre-war) administration. Removing that data point results in this:
Graph 2
So that mostly rehashes a post from six years ago. But today we are knee deep into the political season, and seven years and change into the Obama administration. How does the Obama administration look so far? The graph below is identical to the first, but it superimposes the Obama administration (data through 2015)
Graph 3
So Obama cut the tax burden in his first two years in office, and subsequently generated mediocre growth. Sure, he took office during the worst economic headwinds since FDR, but his reaction was more GW than FDR. So we’re his results. GIGO remains immune to wishful thinking.
Comments and conclusions:
1. Does this mean that lower taxes lead to slower economic growth rates? It would seem that way. At a minimum, it is safe to say these graphs most definitely fail to support the free lunch scheme that the economics profession has instilled in the American public, namely that paying less in taxes leads to faster economic growth.
2. Why look at tax burdens and not tax rates? Well, simply put, the tax burden is the amount people (and companies) actually pay, and those affect after tax income available for consumption or investment, behavior, and to some extent, the amount the government has to spend and interest rates. Tax rates, tax exemptions, tax deductions, etc., are simply a component of how much people pay. For example, George HW Bush famously reneged on his pledge not to raise tax rates, but the tax burden, the share of income that went to taxes, was lower when he left office than when he left the White House than when took the oath of office. In practical terms, people paid less taxes after 4 years of Poppy Bush’s presidency.
3. How does a a President affect the tax burden? Tax laws are relatively short when compared to what really matters: rules, regulations, what gets challenged by the administration in Court, decisions by the tax Courts, and general behavior by the administration. The administration decides how much effort and the level of resources devoted to enforcement. It’s executive appointees write the rules and regulations. It’s judicial appointees decide the outcome of cases. It is also reasonable to assume that how much a President cares to enforce tax issues is a proxy for how much that President cares to enforce other financial rules and regulations.
4. So what’s the transmission mechanism by which tax burdens can affect growth? As small business owners, my wife and I have a simple strategy to reduce our tax bill: we plow as much of our profits right back into the business. Put another way, the reduction in our taxes is a function of how much we invest. That in turn makes the business grow faster. But as the tax burden falls, our incentive to avoid (or rather postpone) taxes in this way goes down. Lower taxes mean we invest less and increase our consumption. And while they may talk their book, anyone with a profitable business makes the same calculation.
5. Data used in this analysis is stored in this google doc: https://docs.google.com/spreadsheets/d/1kOFjkaCCoqVm_KoiwmHvTHJYi5JsuSJrOa6irpO1XOM/pubhtml
The formulas didn’t copy from Excel, nor did the graphs, but the file contains everything you need to replicate what I did.
Thanks for reading and have a great day!
So , Bernie’s economic plan would likely fall along the FDR / JFK corridor , a region in which Gerald Friedman’s forecast of 5% real gdp growth would feel comfortably at home.
This fearsome scenario has put a slew of panties into wads – the usual crowd of establishment , wealthy elites , like , you know , Krugman , DeLong , the entire Friends of Clinton gang , etc. Desperate to de-wad , they sent the old CEA on a search and destroy , which I predict will backfire , big time. Sorry guys , it’s all too obvious , your naked self-interest is hanging out there for all to see.
How did the Hillary braintrust figure that folks like Goolsbee – who wrote this impeccably-timed doozy ….
http://www.nytimes.com/2007/03/29/business/29scene.html?_r=0
….or Tyson , who had her ass very publicly handed to her on NAFTA / free trade by Sir James Goldsmith….
…would be seen as credible critics ? I view their criticism as additional verification that Bernie must be on the right track.
BTW , don’t miss Matt Klein’s article on this in the FT :
http://ftalphaville.ft.com/2016/02/17/2153540/extreme-doesnt-mean-what-it-used-to-sanders-vs-the-cea/
I have to admit , Klein has been driving the ball out of the park on a regular basis lately. The FT landed themselves a keeper.
Marko,
“So , Bernie’s economic plan would likely fall along the FDR / JFK corridor , a region in which Gerald Friedman’s forecast of 5% real gdp growth would feel comfortably at home. ”
I don’t know. My understanding is that like every other Presidential candidate, Bernie Sanders discusses marginal income tax rates, not tax burdens. Now, one assumes based on the rest of his platform that he would increase the tax burden too.
One other caution… these graphs say it isn’t a surprise that growth rates have been dismal given his tax policies. However, his administration is the easily biggest outlier in terms of distance from the simple trend line. As bad as his tax policies have been, one would expect faster economic growth than we’ve seen under Obama. So either there’s a structural break in the data beginning in 2008, the relationship was spurious to start with, there’s been a bout of bad luck during the Obama administration, or there’s something about the Obama administration’s policies that have resulted in slower growth than expected for that level of tax burden change. In other words – his tax policy fell between Ike and Nixon/Ford, but his growth rates have been more on par with those of GW.
If we assume the graph represents a useful way to think of the world, then that raises questions: what has changed under the Obama administration that has resulted in growth falling below expectations given the tax policies the Obama administration has followed? Are these based on actions of the administration, or are they outside the administration’s control? Would those conditions be more likely to continue or to reverse themselves under a Bernie Sanders (or any other candidate running, for that matter)?
I think the premise is flawed. The Bush tax cuts were not fully in place until 2003. Reagan changed the tax laws almost every year, the last going into effect in 1988.
http://www.politifact.com/virginia/statements/2012/jun/25/gerry-connolly/rep-gerry-connolly-says-reagan-raised-taxes-during/
Furthermore, the tax-to-GDP ratio is itself not an indication of policy, but of prosperity. With a graduated income tax, as more people do better, the tax-to GDP ratio goes up. So the slope is positively biased regardless of administration policy.
Mike,
With regard to your questions on Obama’s growth rates, is there any comparative data on unemployment levels during the time frames? Does it matter? And won’t lowering tax rates lower the tax burden by default? Though it could be that the burden falls most for those that receive the largest decrease in rates.
Warren,
1. A President’s actions don’t end until he leaves office. Regardless of whether GW still had marginal tax rate cuts coming, he still had the biggest cut in the tax burden during his first two years of any administration in the sample. Additionally, the first two years give you an indication of what he will be doing in the remaining 6 years (assuming re-election). It’s not like GW or Reagan all of a sudden reversed course and started following FDR’s economic policies.
2. A rising tax burden is definitely not a measure of prosperity. Nobody thinks that 1932 – 1940 was a period of prosperity. FDR increased the tax burden (and far more than any other admin in the sample) not because he thought the country was rich in the period from 1932 to 1934. Similarly, Reagan’s tax policies were predicated on his view that they were needed to deal with the economic malaise. GW, on the other hand, famously kept changing his justification for his unchanging tax policies – first we needed tax cuts to give people back their money, when the economy turned we needed tax cuts to boost the economy.
Nanute,
I think unemployment rates go back until the 1950s. I’d have to look them up. But the orthodox story is that tax policy affects economic growth including unemployment rates.
Additionally, lowering tax rates doesn’t lower tax burdens by default. The classic example during most of our lifetimes was GHW Bush violating his “read my lips” promise, and yet still reducing the tax burden during his time in office.
“…what has changed under the Obama administration that has resulted in growth falling below expectations given the tax policies the Obama administration has followed? ”
Mike ,
Maybe the relationship breaks down when you cross the ZLB. General non-responsiveness to monetary policy , or specifically the relative failure of alternative measures like QE , might have been enough to knock Obama off the trend line.
The ZLB seems to break down lots of once-reliable relationships , everywhere.
Marko,
You may be right about ZLB. The model implicitly assumes that monetary policy either doesn’t matter or behaves as if it doesn’t by falling into line (perhaps because the Fed’s behavior is usually more or less rational). But under ZLB assumptions that monetary policy are always what the doctor ordered may fail.
If you’re using tax burden – which is probably more precise than rates – is there any way of factoring in states and their impact?
Shifts at the Federal level in both taxation and spending drive actions at the state level. Also, many red states have shifted the burden significantly from progressive taxes on income to consumption taxes like sales tax. Here in North Carolina my income tax burden dropped with lowered rates but because a bunch of new items were subjected to sales tax my overall tax burden went up. The impact on that front falls hardest on the heart of the middle class and down.
I don’t see a direct link between tax burden and growth in productivity — or an automatic link between the right balance between supply and demand and the tax burden.
This essay sounds too much like supply side economics.
Should have added: Listen to Lawrence Summers: unused cash that could be used for investment is piling up all around. The problem he is worried about …
… a lack of full utilization not growth …
… is lagging demand which taxing and spending can help resolve.
Mark Jamison,
Using state level data superimposed on the federal data might help in coming up with more precise fits. Or it might raise and/or answer other questions. Example… During a period where the Federal Tax burden is rising, is it better to live in a jurisdiction where the state is rising or falling?
Dennis Drew,
With respect, the graphs point to a story that is very different from that of supply side economics. And I believe I have described a transmission mechanism that fits real world facts. As I noted, higher tax burdens incentivize business owners to reinvest profits. I can only tell you it is how my wife and I deal with taxes and other business owners (of all political stripes) I know seem to do the same thing. But if I am wrong, tell me how.
“With respect, the graphs point to a story that is very different from that of supply side economics. And I believe I have described a transmission mechanism that fits real world facts.”
With respect, no, they don’t. They point to an artifact of graduated tax rates. When the economy is growing, more people get into the higher tax brackets, thus increasing the “tax burden” as defined as a percentage of GDP.
“As I noted, higher tax burdens incentivize business owners to reinvest profits.”
No, higher tax RATES do that. Let’s say you produce $100k in product — that is your contribution to GDP. You’re running a 10% profit, and have a 50% tax rate. Your tax-to-production ratio is 5%. If you can plow that $10k back into the company and not pay the $5k in taxes, you would probably do that.
Now, let’s kick that up a bit. You produce $100k in product with a 20% profit. The tax rate is 25%. Your tax-to-production ratio is still 5%. Now you need to put $20k back into the company to avoid that $5k in taxes.
Your shareholders might want some of that in dividends (i.e., your wife might want a vacation in Maui).
Warren,
Sure, if marginal tax brackets stay the same, and taxable incomes increase, people move into higher tax brackets. But tax brackets aren’t the end all be all. I’ve mentioned GHW Bush several times so far, so one more time… from 1988 to 1992, marginal income tax rates famously went up, the tax burden (less famously) went down, and real GDP went up.
If I am reading you correctly, you seem to feel that the tax burden is just a proxy, and not a good one, for what you feel really matters, namely the marginal tax rate. So ask yourself – which administrations made the biggest changes to the marginal income tax rates? Marginal tax rates under Reagan fell from 70% in 1980 to 50% in 1982 – so Reagan would be either at the far right or the far left of any graph showing a relationship between marginal tax rates changes in the first two years v. growth in the remaining six years. Also, you’d find Clinton just about at the opposite end of the spectrum. Think about what that graph would look like and what the fit would be.
I didn’t create my little model to fit the data, but it fits reasonably well. On the other hand, using marginal tax rates instead of tax burdens would clearly result in an awful fit, which tells you that (as I noted in the post) tax burdens are telling us something marginal tax rates aren’t.
As to this being similar to supply side economics… supply side economics purports to show that lower marginal tax rates lead to faster economic growth. I don’t see how to reach anything resembling that conclusion from my little model.
Finally… as to the business example…. yes, to some extent an individual thinks in terms of the marginal tax rate, but only to some extent. In simple terms, the marginal income tax rate is applied to taxable income. Taxable income, in turn, can vary dramatically depending on who was recently appointed as commissioner of the IRS and a whole host of other jobs, which is precisely how you can end up with higher marginal income tax rates and lower tax burdens at the same time.
How have you been,Mike?
CoRev,
Pretty well. Busy. I’m too old to have a kindergartener hanging around the house but its a lot of fun, except that the walking petri dish has infected me with diseases that I could have sworn were wiped out decades ago. On the work front, I have a job I enjoy a lot which is also nice. Geographically, I somehow ended up back in SoCal which seems to keep happening to me. All in all, things are well. How is everything with you?
Just so we all are working with the same data,
Personal Income Tax Rates: http://taxfoundation.org/sites/default/files/docs/fed_individual_rate_history_nominal.pdf
Revenue as %GDP: http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=205
So, Bush the First added the 31% bracket in 1991. The income tax burden, defined as %GDP, declined (wait — Bush CUT taxes?), and did not see the 7.9% it did in 1990 until 1996, a full three years after Clinton added the 36.0% and 39.6% brackets in 1993.
Let’s go back to Reagan. The 1981 bill did nothing to tax rates. The came down in 1982, 1984, 1987, and 1988. But the personal income tax burden hit a low of 7.5% in 1984. It did not get that low again until (you guessed it!) 1992, when Bush I lowered taxes — errrr, raised taxes — errrr, lowered the tax BURDEN by raising the tax RATE.
Let’s jump ahead to Clinton the First. (So I’m being presumptuous. Let me have my fun.) He raised tax rates in 1993, and the tax burden did go up — all the way to an all-time high of 9.9% in 2000. (Sounds like we’re seeing a optimal set of rates, there.) How is it that the tax burden increased in those years, when the tax rates did not change? A booming economy put people into higher tax brackets! Did they feel more burdened than before? NO, because they were making more than before!
Bush the Second cut tax rates again, and the tax burden fall again. President Obama (no way there’s going to be an Obama the Second, so he does not get “the First”) put them back to Clinton the First levels, and we are seeing the tax burden climb back up again.
I submit that we have, experimentally, found the approximate peak of the Laffer Curve. If the point of the tax code if revenue collection, the current rates seem to be doing about the best we can expect. The 91% tax bracket never got us over 8% of GDP in income taxes, so there is no reason to expect it to do so in the future.
Warren,
1. We are using a different tax burden. I am using total current Federal collections as a share of GDP. You are talking about personal income tax burden.
2. If I am reading you correctly, I think what you are trying to get at is the fallacy that has been referred to as Hauser’s Law. I’ve covered that here: http://angrybearblog.strategydemo.com/2010/11/hausers-law-is-extremely-misleading.html
Mike, doing well for an old man. I’m at that stage in life when the kids call to just check and see if we are …. Yes, WE for 50 years. Cherish the years while the kids are young. They pass so fast. All phases of life are exciting and fulfilling, and made more so with grand kids when you’re lucky enough to relive some of it with them. Enjoy life!
Then when did the total tax burden peak? Why, 2000! Just as it did for the personal income taxes. The only year that was higher was 1944 — corporate income taxes were WAY up. Business was booming. (Rule of Acquisition #34: WAR IS GOOD FOR BUSINESS)
Of course, the deficit was rather high that year, too.
In any event, the pattern for total receipts tracks the receipts from individual income taxes quite well, and does not change the results of my analysis above.
Warren,
Notice that in 2000 the marginal income tax rates were very, very far from their peak. Hence my point that the tax burden is not merely a function of the marginal tax rate.
Additionally, while you are fixated on the Laffer curve issue of where government revenue is maximized, the far more important question is how to maximize economic growth. There is no reason to assume those two things happen at the same point, and multiple reasons to believe otherwise. The graphs In this post are an attempt to help answer how to maximize economic growth, not government revenue.
But then your premise is again flawed, because the government cannot set the percentage of GDP that will be taken. It can only set the tax rates. That is what you need to concentrate on. (BTW, growth in the Clinton the First years was pretty good, as I recall.)
Warren,
Since you mention the Clinton years, recall the 1997 “taxpayer relief act” which lowered long term marginal capital gains.
Now, go back to the Hauser’s Law graph and look at the Clinton years. Notice that every single year the tax burden increased. That doesn’t seem consistent with your story – a significant decrease in capital gains taxes should have reduced the tax burden if the only control the government has over the tax burden is through the tax rate. (Bear in mind, real GDP growth rates were 4.1% plus or minus half a percent from 1994 to 2000 (barring 1995), so it isn’t the denominator that made the difference.) If your story were correct, I’d expect at least a year or two of decreasing tax burdens following the decrease in marginal income tax rates. It didn’t happen.
On the other hand, a tax burden rising every single year is very consistent with an administration consolidating its control over an issue it cared about, namely tax regulation, year after year.
No, sir, you are simply misunderstanding my point. You say, “[A] significant decrease in capital gains taxes should have reduced the tax burden if the only control the government has over the tax burden is through the tax rate.”
I said no such thing. It depend on which side of the Laffer curve you are on. If you are on the side with a negative slope (as the Capital Gains tax was), then reducing rates increases revenue (i.e., increases the tax burden). Reducing the tax rate increases the activity being taxed.
Yes, the tax burden (%GDP) cannot be controlled directly, only the tax rates can. But it is a non-linear control.
“[A} tax burden rising every single year is very consistent with an administration consolidating its control over an issue it cared about, namely tax regulation….”
While that’s a nice theory, the IRS budget peaked in 1995, and did not return to that level until 2001. That does not sound like an administration’s “consolidating its control.”
http://freedomandprosperity.org/wp-content/uploads/2014/07/IRS-Budget.jpg
Warren – “It can only set the tax rates.”
The government can and does do many other things besides set tax rates which impact economic growth.
“If you are on the side with a negative slope (as the Capital Gains tax was), then reducing rates increases revenue (i.e., increases the tax burden). Reducing the tax rate increases the activity being taxed.”
Laffer curve theory says yes to this: “Reducing the tax rate increases the activity being taxed”
It doesn’t say this: ” increases the tax burden”
The idea behind the Laffer curve is that if tax rates are too high, cutting them encourages economic activity which results in more taxes being collected. Despite the fact that a smaller proportion of income is being collected, tax revenues increase. Put another way, the numerator in the tax burden (i.e, the amount being collected) increases, but it is only because the denominator (i.e., GDP) is increasing more. That is what the Laffer curve says. Now I’m not the one who brought it up, nor do I use it to argue my point, but if you want to bring the Laffer curve into this discussion, then the Laffer curve implies that the tax burden should have decreased during the tail end of the Clinton era with the cut in the marginal tax rate on capital gains. This is just another way that the Laffer is inconsistent with the real
Sorry…. my cat jumped onto my keyboard and cut off the last comment. The last sentence should read:
“This is just another way that the Laffer curve is inconsistent with the real world.”
> Laffer curve theory says yes to this: “Reducing the tax rate increases
> the activity being taxed”
> It doesn’t say this: ” increases the tax burden”
You have that backward. The Laffer Curve is Revenue vs. Rate. As you can see here, the Growth Maximizing point is NOT the peak in the curve.
http://www.forbes.com/sites/danielmitchell/2012/04/15/the-laffer-curve-shows-that-tax-increases-are-a-very-bad-idea-even-if-they-generate-more-tax-revenue/#380e90056307
> [The] Laffer curve implies that the tax burden should have decreased
> during the tail end of the Clinton era with the cut in the marginal tax rate
> on capital gains.
That is correct only if the rates were previously on that portion of the Laffer Curve with the positive slope (left of the point of maximum revenue). That the decrease in the capital gains rate resulted in an increase in revenue merely indicates that we were on the negative slope part of the curve (right of the point of maximum revenue).
The Laffer Curve in itself is not predictive, only descriptive. It’s outlines can only be approximated based on tax rates and the resulting revenue.
The link you provided simply points to a stylized graph by Daniel Mitchell. Slapping a point on a graph and claiming it is the growth maximizing tax rate on the Laffer curve is a very different thing from showing, with data, that the Laffer curve fits the data, or that the growth maximizing point is where he claims it is. So you have gone from arguing on the basis of the Laffer curve, which simply does not fit US data (I cannot say whether it fits other countries – I have only tried using US data), to arguing on the basis of a point placed (with no supporting evidence) on an arbitrary point on a graph that doesn’t fit US data. Forgive me, but this is too close to an argument about how many angels can dance on the head of a pin for my liking. (Stating it is descriptive and not predictive is another way say of stating it is merely a “just so” story.)
The fact of the matter is this… administrations that cut the tax the burden in their first two years in office generated faster economic growth in their remaining years in office than administrations that increased the tax burden.
Now, you claim that is simply because rising incomes lead to people moving up to higher tax brackets. Fair enough. But if you are correct, then the conclusion one reaches from the graphs in the post is that during administrations in which the first two years of growth were rapid, the remaining six years also had rapid growth. Conversely, when there was slow growth during the first two years of an administration, there was also slow growth during the remaining six years. In other words, your interpretation provides a simple testable hypothesis, namely that the length of the business cycle is precisely as long as an administration is in office. Aside from the fact that this doesn’t match what the NBER reports, it seems a bit too coincidental.
Mike:
Welcome back. I enjoyed reading your post and analysis. Hope you hang around and do more. We still have our “Jays” at AB and we tolerate to a point. If you get tired, of answering let us know.
Let be sure that I am clear on definitions and results.
Tax Burden = federal current receipts / real GDP
Federal current receipts includes other sources of income besides personal income tax.
The tax burden increases whenever federal current receipts increase more than real GDP.
Similarly, tax burden increases if federal current receipts decrease LESS than real GDP.
And since personal income tax is only one element of federal current receipts, it may go in the opposite direction of federal current receipts and/or, may go in the opposite direction of tax burden.
Therefore it is very possible for a person’s individual tax burden to increase, while the tax burden of the overall country decreases. It depends on where the revenue comes from, and what benefits the economy gains from those sources.
run,
Nice to be back. Not sure how regular this will be; but hopefully more than just once every four to six years.
Jerry,
Most of what you wrote is correct, except that both the federal current receipts and the gdp are nominal. While GDP is reported both in real and nominal terms, the NIPA tables only report receipts in nominal terms. I like to keep things “apples to apples” and I like to use data straight from the horse’s mouth, wherever possible, hence I used nominal GDP.
Also, hopefully I am not being overly pendatic, but I would not have written this sentence: “It depends on where the revenue comes from, and what benefits the economy gains from those sources.” Income is what someone will pay for an activity, not necessarily how that activity will benefit the economy. For example, someone might be a master at setting fires that appear to be accidental to arson investigators, and that talent could yield them a fairly strong income, but it is unlikely that the economy benefits from that talent to the degree to which the person gets paid for it.
Mike:
Once and a while would be kool also.
Point taken. What is the difference between real and nominal GDP, and the ordinate on the graphs is labeled …real GDP…
“[You] have gone from arguing on the basis of the Laffer curve, which simply does not fit US data….”
It fits fine. The Clinton/Obama tax rates do seem to provide the highest revenue as a % of GDP of any we have tried so far. The lower tax rates of the Reagan years provided less revenue, and the higher taxes of the Eisenhower years provided less revenue.
Individual income tax revenue, as a percent of GDP, seemed to peak at the rates of the Clinton and Obama administrations.
As for growth — it was pretty good under Clinton, as I recall. Kennedy also lowered taxes, and we saw good GDP growth in the 1960’s. Obama, not so much.
Run,
I will try.
Jerry Critter,
The tax burden is apples to apples. But
nominal gov’t collections / nominal GDP = real gov’t collections / real GDP
I.e., nominal tax burden = real tax burden, since they’re both just ratios
Therefore its apples to apples to compare the tax burden to either nominal growth or real growth, but real growth is more meaningful, so that was the choice I made.
Warren,
If the Laffer curve fit the data, you’d have seen it done. It turns out that if you fit the data available for the US economy, without cherry picking data, the coefficients have the wrong sign. You end up not with what is usually depicted, but a U shaped curve.
http://angrybearblog.strategydemo.com/2011/10/laffer-curve-and-kimel-curve.html
That’s the dirty secret. That’s why people talk about the Laffer curve, but nobody actually shows it fit to the data. Because the data tells a story that is literally the opposite of what Laffer and his acolytes tell you. It’s not complicated. The data is out there. Anyone can do it.
Mike- I came up with something like you point 4. Transmission mechanism when thinking about the history of Sears & Roebuck. The demise of which is striking because it began as taxes went down. Meanwhile, a little investment is all it would have taken to beat Walmart, a fact proven by Amazon who, after all, IS Sears, circa 1890.
I think economists get this totally wrong because they think people are motivated by money. But for CEOs who make more than small countries spend, money is just a way of keeping score.
So when marginal rates are high, they look to other ways to keep score: employing tens of thousands of people to build and maintain a giant phallic symbol in the South Loop.
Interesting link Mike. It would appear that not only is the Laffer curve not predictive, it is not descriptive either. It simply reinforces people’s misconceptions.
Thornton,
Agree with everything you wrote but one quibble… Sears Roebuck went downhill roughly at the same time as they abandoned the giant phallic symbol in the South Loop and decamped for that giant campus in Hoffman Estates. (Full disclosure – i spent 2.5 years in that giant campus in Hoffman Estates.)
Interesting. I think there’s also something to be said for companies doing better when they locate in cities, but that might not pan out.
Let’s look at that article:
———————————————
(1) tax collections / GDP = A + B*tax rate + C*tax rate squared + some other stuff if desired
A, B, and C are estimated statistically using a tool such as regression analysis.
If you plug in numbers, and find that B is positive and statistically significant and C is negative and statistically significant, then it turns out that you can trace out a quadratic relationship between tax collections / GDP and tax rates. i.e., tax collections / GDP is a function of tax rates that looks like an upside down U.
– See more at: http://angrybearblog.strategydemo.com/2011/10/laffer-curve-and-kimel-curve.html#sthash.PmgIut0H.dpuf
———————————————–
Oh, dear. You have the math quite backward. A negative coefficient to the x^2 tern gives a negative second derivative, which means the curve is concave DOWNWARD, and is a local MAXIMUM, just as the Laffer curve expects.
Let’s look at a concrete example. A parabolic curve (as you have above) with f(0) = 0 (no tax, no income), and f(1)=0. (100% tax, no income.)
To be parabolic, of course, the maximum will have to be at x=0.5. Let’s assume the max revenue is 0.2 (approximately the 20% we saw under Clinton the First).
That gives is A=0, B=0.8, C=-0.8.
This matches your statement that, “B is positive and statistically significant and C is negative and statistically significant”, and is a parabola open DOWNWARD.
You have it exactly BACKWARD.
Sorry, forgot the link: http://mathworld.wolfram.com/SecondDerivativeTest.html
Warren,
Just a couple of points. One, an upside down U is a maximum. What Mike said is correct. You misinterpreted it.
Secondly read his post a little further down. He says, “The problem is… the data isn’t quite amenable to shoehorning into the desired shape. The fit of the model sucks, B is negative, C is positive…”
As you have correctly stated, a positive C produces a minimum value.
Mike does not have it backwards. You need to improve your reading and comprehension skills.
My deepest apologies — you are indeed correct!
Please accept my apologies, Mike — having a Brain Fart, I guess!