Do taxes affect economic growth

[Wesley_Clark]

Is there any hard evidence that tax rates or tax cuts have positive or negative effects on economic growth? I can’t find hard evidence for either position

[Measure_for_Measure]

Try looking at an Introductory Macroeconomics text.

Briefly, during a recession, tax cuts (or increased government spending) can both stimulate the economy, by increasing total demand for goods and services.
When the economy is operating at full capacity, things get more complicated.

There are also “supply side” issues, which relate to Labor Economics. Here, the effects of tax cuts are theoretically ambiguous. Empirically, I understand the strongest effects are on married women, but I have no cite and have not googled for one.

The effects of taxes on savings are another aspect. Oddly enough, they may depend upon the inflation rate.

[Little_Nemo]

Taxes are obviously an expense and, like any expense, have a negative effect on a business.

On the other hand, money collected from taxes does not disappear. It gets spent by the government. So some businesses receive more money that was originally collected by taxes than they paid out in taxes.

[BrainGlutton]

In theory there’s something called the “Laffer Curve” which shows an “optimal” tax rate for revenue purposes. The problem is, nobody really knows what it looks like. All we can say is that the optimal rate lies somewhere between 0% taxes (no revenue because of no taxes) and 100% (no revenue because of no economic activity). From http://en.wikipedia.org/wiki/Laffer_curve:

The Laffer curve and supply side economics inspired the Kemp-Roth Tax Cut of 1981. Supply-side advocates of tax cuts claimed that lower tax rates would generate more revenue because government was operating on the right-hand side of the curve. Conventional economic paradigms acknowledge the basic notion of the Laffer curve, but argue that government was operating on the left-hand side of the curve, so a tax cut would thus lower revenue. The central question is the elasticity of work with respect to tax rates. For example, Pecorino (1995) argued that the peak occurred at tax rates around 65%, and summarized the controversy as:

Just about everyone can agree that if an increase in tax rates leads to a decrease in tax revenues, then taxes are too high. It is also generally agreed that at some level of taxation, revenues will turn down. Determining the level of taxation where revenues are maximized is more controversial.

At least one empirical study, looking at actual historical data on tax rates, GDP, and revenue, placed the ‘optimal’ tax rate (the point at which another marginal tax rate increase would decrease tax revenue) as high as 80%. Paul Samuelson argues in his popular economic textbook that Ronald Reagan was correct in a very limited sense to view the intuition underlying the Laffer curve as accurate, because as a successful actor, Reagan was subject to marginal tax rates as high as 90% during World War II. The point is that in a progressive tax system, any given person’s perspective on the validity of the Laffer curve will be influenced by the marginal tax rate to which that person’s income is subject.

In the United States, some claimed that both tax cuts and government spending policies of the 1980s were the cause of large budget deficits. Others claim that the data actually shows United States government revenues increased during that period, suggesting that deficits were unrelated to tax cuts, and should be attributed to increased spending alone. The counter-argument is that the income only increased along with growth in GNP at a rate roughly consistent with other 20th century decades. At the same time the federal government commitments to services such as Social Security rose along with population growth. During the Clinton administration government revenues and GNP increased at an even higher rate despite increases in taxes.

David Stockman, Reagan’s budget director during his first administration and one of the early proponents of supply-side economics, maintained that the Laffer curve was not to be taken literally - at least not in the economic environment of the 1980s United States. In “The Triumph of Politics” he writes:

“[T]he whole California gang had taken [the Laffer curve] literally (and primitively). The way they talked, they seemed to expect that once the supply-side tax cut was in effect, additional revenue would start to fall, manna-like, from the heavens. Since January, I had been explaining that there is no literal Laffer curve.”

[jshore]

Another problem with the Laffer curve is it is too simplistic a concept anyway. In reality, the entire tax code can’t be reduced to a one-dimensional graph. It is thus a very schematic representation for what is really a much more complicated concept…That is not to say it is completely useless, but one does have to keep in mind its being an extreme simplification.

[Sam_Stone]

I agree with that completely. The tax code IS complex, and you can’t make blanket statements like, “raising taxes cuts growth”, or “lowering taxes increases revenue”.

You can find situations were a small tax devastates an entire industry. For example, the luxury tax was a fiasco that severely damaged industries that build luxury goods, to the point where tax revenue did drop. On the other hand, if low taxes prevented funding a critical institution such as the military, the courts, or the police, and that had a chilling effect on the market, then raising taxes to fund them might actually increase economic output.

Another example might be when a country’s debt situation becomes so crushing that the market starts to react in an extremely negative way. In that case, raising taxes to pay off the deficit might stabilize the market and improve efficiency. Some might argue that this is the case today, but then they’ll be making the same arguments the supply siders do, only on the opposite side. Trying to prove whether the deficit is big enough for that to be the case is difficult.

[Weird_AL_Einstein]

@Wesley Clark

Is there any hard evidence that tax rates or tax cuts have positive or negative effects on economic growth? I can’t find hard evidence for either position

Do you really need “hard evidence”? This seems like something you could figure out just using logic. I mean, either tax rates affect economic activity, or they don’t. If you assume they don’t, then you have to assume that economic activity would be the same (holding all other variables steady) under a tax rate of 100% or even higher, as under a tax rate of 0%.

This assumption leads directly into what economists call, in their highly specialized, technical terminology, “cloud cuckoo land”. The assumption is absurd, in other words, so it is therefor safe to assume that tax rates do affect economic activity.

[smiling_bandit]

On the other hand, money collected from taxes does not disappear. It gets spent by the government.

The problem, of course, is that government spending tends to be more inefficient than private. Unlike most libertarians, I won’t say that government spending is neccessarily bad: spent well, goverment dollars going to education and infrastructure can be very good things.

[BrainGlutton]

@smiling bandit

The problem, of course, is that government spending tends to be more inefficient than private.

But money lost to inefficiency doesn’t disappear either. It always ends up in somebody’s pocket – and usually it doesn’t stay there long.

[Little_Nemo]

The problem, of course, is that government spending tends to be more inefficient than private. Unlike most libertarians, I won’t say that government spending is neccessarily bad: spent well, goverment dollars going to education and infrastructure can be very good things.

That’s ridiculous. The federal government spends more money in a day than a private citizen can spend in a lifetime. The government is the most efficient money spending entity ever created.

[Wesley_Clark]

@Weird_AL_Einstein

Do you really need “hard evidence”? This seems like something you could figure out just using logic. I mean, either tax rates affect economic activity, or they don’t. If you assume they don’t, then you have to assume that economic activity would be the same (holding all other variables steady) under a tax rate of 100% or even higher, as under a tax rate of 0%.

This assumption leads directly into what economists call, in their highly specialized, technical terminology, “cloud cuckoo land”. The assumption is absurd, in other words, so it is therefor safe to assume that tax rates do affect economic activity.

I do need hard evidence because places like Sweden have almost double the US’s tax rate and they are not stuck in economic hell. If you take money from people from taxes instead of them buying goods & services the money still goes into the economy it just takes a different route to get there.

[Capt.Ridley_s_Shooting_Party]

@Little Nemo

That’s ridiculous. The federal government spends more money in a day than a private citizen can spend in a lifetime. The government is the most efficient money spending entity ever created.

But surely that’s a non sequitir? Efficiency in spending (or lack of it) has absolutely nothing to do with how much is being spent.

[Capt.Ridley_s_Shooting_Party]

I guess it’s also a non sequitur :smack:

[smiling_bandit]

But money lost to inefficiency doesn’t disappear either. It always ends up in somebody’s pocket – and usually it doesn’t stay there long.

But in the long run, it creates waste. It’s not about money; it’s about value. When the government gets involved, it often starts destroying value ihstead of creating it. Sure, the money doesn’t go anywhere on paper. But if the government doesn’t do something that helps the infrastructure, it’s usually creating economic distortions. If nothing else, quite a lot of the money will go to people who produce little to no value: bureaucrats.

This isn’t to say that bureaucracies are worthless. But an individual bureaucrat creates little to no value, and usch organizations tend to be significantly overstaffed.

I do need hard evidence because places like Sweden have almost double the US’s tax rate and they are not stuck in economic hell.

As I understand it, Sweden has managed to become comfortable, but isn’t really growing. In addition, they have a sky-high real unemployment rate, apparently masked by pretending the unemployed are on government medical.

[jshore]

@smiling bandit

This isn’t to say that bureaucracies are worthless. But an individual bureaucrat creates little to no value, and usch organizations tend to be significantly overstaffed.

I hate to break the news to you, but there are large bureaucracies in the private sector to. I speak from personal experience.

As I understand it, Sweden has managed to become comfortable, but isn’t really growing. In addition, they have a sky-high real unemployment rate, apparently masked by pretending the unemployed are on government medical.

Cite? [And, you might also want to consider other Scandinavian countries too.] In the U.S., by the way, the unemployment rate is masked by not counting those who have gotten frustrated and are no longer actively looking for work.

[JThunder]

@BrainGlutton

In theory there’s something called the “Laffer Curve” which shows an “optimal” tax rate for revenue purposes. The problem is, nobody really knows what it looks like.

Sounds like a laffable concept to me.

[XT]

@jshore

by the way, the unemployment rate is masked by not counting those who have gotten frustrated and are no longer actively looking for work.

Since you asked for a cite I’d like to see on that this is a statistically significantly percentage of those who are unemployed. I’ve seen this arguement made several times in these debates but I’ve never seen any hard data to back this claim up. If you don’t have hard numbers, what percentage of unemployed do you estimate are being masked by this effect?

-XT

[Weird_AL_Einstein]

@Wesley Clark

I do need hard evidence because places like Sweden have almost double the US’s tax rate and they are not stuck in economic hell. If you take money from people from taxes instead of them buying goods & services the money still goes into the economy it just takes a different route to get there.

You didn’t really address my point. Do you think that if Sweden raised it’s tax rate to 100% it’s economic activity would continue just as before?

[Jonathan_Chance]

@xtisme

Since you asked for a cite I’d like to see on that this is a statistically significantly percentage of those who are unemployed. I’ve seen this arguement made several times in these debates but I’ve never seen any hard data to back this claim up. If you don’t have hard numbers, what percentage of unemployed do you estimate are being masked by this effect?

-XT

Not wanting to join the fight. But, like X, I find this idea deserves some searching.

Here’s what I found:

From Z Magazine.

For this and other reasons, the U.S. Bureau of Labor Statistics (BLS) provides a series of “alternative unemployment measures,” which go almost entirely ignored and unreported by the major media and news organizations. One of the alternative measures shows that if both involuntary part-timers and discouraged workers were added to the unemployment rate as officially measured, the rate for November 2003 would stand at 9.5 percent of the labor force, instead of the official 5.9 percent.

From The Concise Encyclopedia of Economics:

Each month, the federal government’s Bureau of Labor Statistics randomly surveys sixty thousand individuals around the nation. If respondents say they are both out of work and seeking employment, they are counted as unemployed members of the labor force. Jobless respondents who have chosen not to continue looking for work are considered out of the labor force and therefore are not counted as unemployed. Almost half of all unemployment spells end because people leave the labor force. Ironically, those who drop out of the labor force—whether because they are discouraged, have household responsibilities, or are sick—actually make unemployment rates look better; the unemployment rate includes only people within the labor force who are out of work.

And an older piece from the Bureau of Labor Statistics. Warning: PDF.

So it sure looks, at first blush, as if there’s a significant number of ‘discouraged’ unemployed out there. From the BLS site we get (depending on how you crunch the numbers) between 10% and 50% of the ‘official’ unemployment rate. The other sites above seem to bear this out or may skew higher.

[mazinger_z]

@Wesley Clark

I do need hard evidence because places like Sweden have almost double the US’s tax rate and they are not stuck in economic hell. If you take money from people from taxes instead of them buying goods & services the money still goes into the economy it just takes a different route to get there.

In some other economic thread (sorry, I forgot which), I was going to post something about how Norway/Scandinavian countries isn’t really that rich, but the hamsters ate my post, and I didn’t feel like fact checking the NY Times article (I still don’t). Anyway, here is the article, which one of my college friends originally sent me to discuss the $50 pizza it’s short and a good read.

If these numbers hold, and if the pace of growth is as slow as it is, I hypothesize that economically, these high tax states will keep these states stuck in the late 20th century (except for cell phones).

Meanwhile, the references to Norway as “the world’s richest country” keep on coming. An April 2 article in Dagsavisen, a major Oslo daily, asked: How is it that “in the world’s richest country we’re tearing down social services that were built up when Norway was much poorer?”

Whether that is economic hell or not (professionals tend to say yes, or eventually yes) is up to debate.