by Mike Kimel
The Effect of Individual Income Tax Rates on the Economy, Part 5: 1968 – 1988
This post is the fourth in a series that looks at the relationship between real economic growth and the top individual marginal tax rate. The first looked at the period from 1901 to 1928, the second from 1929 to 1940, the third from 1940 to 1950, and the fifth looked at 1950 – 1968.
Before I begin, a quick recap… both the 1901 – 1928 period and the 1929 – 1940 failed to show the textbook relationship between taxes and growth. In fact, it seems that for both those periods, there was at least a bit of support for the notion that growth was faster in periods of rising tax rates than in periods when tax rates were coming down. In the 1940 – 1950 period, we did observe slower economic growth following a tax hike and faster economic growth followed a tax reduction. However, that happened when the top marginal tax rate was boosted above 90%. Interestingly enough, though the so-called “Kennedy Tax Cuts” are often used as one of the prime exhibits on the benefits of cutting taxes, a look at the 1950 – 1968 period yields no such conclusion. Growth rates were already rising before the tax cuts occurred in 1964 and 1965, reached a peak when the tax cuts took place, and started shrinking immediately afterwards.
Real GDP figures used in this post come from Bureau of Economic Analysis. Top individual marginal tax rate figures used in this post come from the IRS. As in previous posts, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate. Let me stress this point again as I’ve been getting people e-mailing me to tell me I’ve got the growth rates shifted a year. That is correct, and is being done on purpose (and is shown on the graph labels). To avoid questions of causality, the growth rate in year X used in this post is the growth rate from year X to year X+1. And when I say “to avoid questions of causality” – you’d be amazed at how many people write me when I don’t do this and insist that sure, higher tax rates seem to be correlated with faster growth, but that’s because when growth is faster governments feel more willing to charge higher tax rates.
So let’s get started below the fold:
Let’s put up a diagram showing growth rates and tax rates for the period from 1968 to 1988. But we almost don’t have to do it. We all know what happened. We’ve been told so many times. Tax rates were very high in the late 60s and 70s. And then came the Lone Ranger Reagan, and, and lo, Reagan cut taxes. The result is that the economy began to grow like never before. Sure, the story is strikingly similar to the one about the tax cuts in the 1960s, and we know from the last post how that turned out. But still, the Reagan story is even more widely accepted, so here’s the graph that accompanies the story:
Wait. That can’t be right. Something is wrong with the data because it doesn’t match the narrative!!! Yes, there was a tax cut and the economy started growing. But the only growth that was unusually strong for the time period occurred in one single year, from 1983 to 1984. And immediately afterwards it dropped and kept dropping.
In 1987, there was a small pickup in growth which accompanied a further tax cut (50% to 38.5%), but the year after, when the top marginal tax rate dropped further (to 28%), growth fell again.
Strip away the rhetoric, and it would seem the “evidence” for the benefits of Reaganomics, for the most part, are that following the small tax cut in 1981 (70% to 69.25%) and the bigger one in 1982 (69.25% to 50%), there was one seemingly extraordinary year of growth from 1983 to 1984. I could swear the narrative usually isn’t stated in this way.
But let’s take a close-up of the Reagan years and put them (and the one extraordinary year) in perspective. In the next graph we have the 1980 -1988, but for comparison, I’ve included the growth rate from 1938 to 1939. That happens to be the third slowest year of the pre-WW2 New Deal era. Here’s what it looks like:
Now, you may be able to noodle out why I picked the third slowest year of FDR’s first 8 years from the graph – see, it turns out that Reagan’s best year was faster than FDR’s worst, and FDR’s second worst pre-WW2 years, but that’s about it.
Redoing Figure 2 and adding in FDR’s best pre-WW2 New Deal year: 1940 to 1941, produces this graph:
Doesn’t look at all like what you learn in school, eh? How about what you hear on Fox? Or from El Rushbo? What about from Rick Perry? Heck, you don’t even hear about this from liberals.
What you will hear is denial, and on the rare occasions where someone is willing to accept the data, excuses. Now, I’m sympathetic to the idea that FDR and Reagan were Presidents at very different times, that perhaps FDR had higher potential growth due to a bounceback effect (I don’t buy it, but I’m sympathetic to the idea). I also don’t find it offensive if someone states that times and laws were different, and even if Reagan had FDR’s approach to government in mind, he could never have enacted the same policies that FDR applied. What I am not sympathetic to are people who tell us about how well Reagan’s policies worked and who also insist that FDR ruined the economy or made it worse. People who make such claims can only fall into two categories, the “good” one being the misinformed.
So to sum up… so far in this series… it seems the evidence has been at least weakly against the idea that tax cuts lead to faster economic growth in the 1901 – 1928, 1929 – 1940, and 1950 – 1968 periods. The 1940 – 1950 period does seem to behave consistently with that notion, though it is worth noting that it happened when tax rates were above 90%. The period from 1950 – 1968, despite the frequent obfuscatory comments from certain sectors, also completely fails to support the notion that lower tax rates are followed by faster economic growth. And frankly, the 1970s and 1980s don’t help the cause either.
Because the Reagan years play such an important role in the way we do economic policy in this country, we’ll revisit them in the next post in the series.
As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel (note that I’m not from the wealthy branch of the family that can afford two “m”s – make sure you only put one “m” in there) at gmail period com.