Friday, June 15, 2012

Do low taxes promote growth and prevent crises?

We missed this article a couple of weeks ago from Martin Wolf in the FT, but it is a good one, looking at the debate (may we say hysteria?) in the United States over tax levels.

Wolf says these are 'second or even third order issues.' Why does he say this? Well, take a look at a couple of graphs: this one, for instance:


Now that shows no clear relationship. If you squint, and focus obsessively on those three outlying points, you might want to try and argue that the line slopes downwards - though it doesn't (and if you were to strip out those three apparent outliers, it would slope upwards.) And Wolf says:
"The spread in the average tax ratio is quite large, at 26 per cent of GDP, from Japan to Denmark. It is even quite surprising that such a spread seems to have no effect on economic performance."
So how does this picture shape up over time? Well, in a picture:


Even more unarguable: The line is flat. There is a striking outlier here - and that is Ireland. And who would model their economy on the Ireland model these days? Wolf summarises:
"There is no relation between the share of government revenue and the rate of growth of real output per head (that is, productivity) over the 1989-2011 period. The “regression line” is flat. We see low tax countries with low productivity growth (Japan) and high tax countries with high productivity growth (Finland and Sweden)."
Not only that - and Wolf doesn't get into this - but these graphs look only at average GDP per head; it does not address the issue of inequality. If we were to plot median income per head, or some other measure that takes better account of inequality and the lives of ordinary people, it seems only reasonable to expect that the low-tax countries, which are more unequal, with wealth piled up at the top 1 percent, would perform worse than in these graphs, and the lines would therefore slope upwards. (When we get some time, we'll dig up what data we can find on this.)

And then he points to the fact that the countries of Europe which have the highest shares of taxes in their economies are the most crisis-free ones, while the low-tax economies such as Ireland, Italy and Spain, are the most crisis-hit. The crisis is clearly not one of welfare states.

Wolf adds:
"The conclusion to be drawn is that a tax burden within the range of 30 per cent to 55 per cent of GDP) tells one nothing about a country’s economic performance. It is far more a reflection of different social preferences about the role of the state. What matters far more are culture, quality of institutions, including law, levels of education, quality of businesses, openness to trade, strength of competition and so forth."
There is no rocket science here - reputable economists have known this for a long time.

Hat tip: here, via here.

2 Comments:

Anonymous Anonymous said...

What if the relationship is nonlinear?

10:05 am  
Anonymous Mark Randall @ tax help said...

This means that if we were to lower our taxes, we also could be in a deep crisis?

10:12 am  

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