Tuesday, June 26, 2012

Do low taxes promote growth? - part 2

Recently we pointed to dramatic empirical evidence showing that tax-cutting doesn't appear to be the route to economic growth. The graphs provided showed cross-country comparisons supporting the thesis.

Now Bloomberg is reporting on a study by the Institute for Taxation and Economic Policy (ITEP) asking a similar (but slightly different) question with respect to U.S. states. The conclusion:
The BGOV Barometer shows the nine states with the highest personal income taxes on residents outperformed or kept pace on average with the nine that don’t tax their residents’ incomes
. . .
Per-capita economic output increased an average 10.1 percent in the nine “high-rate” states (while) the average growth rate for the nine no-tax states was 8.7 percent.
. . .
Median household income declined an average 0.7 percent among the nine “high-rate” states, compared with a 3.5 percent drop in the nine states without such a levy. The study found no difference in the average unemployment rate between the two groups of states.
This is a slightly different result from the cross-country comparison we blogged earlier, where the metric was tax as a share of GDP, and the result was a rather neutral one: that if you are a high-tax country you are likely to grow just as fast as if you are a low-tax one (though we pointed out that if you adjust for inequality, then you will get a result that is more like the ITEP study.)

The FT's Martin Wolf noted in our earlier blog:
"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."
Now Bloomberg adds a few quotes, such as this one, which chime with Wolf's:
“Being low-tax doesn’t generate economic competitiveness or long-term economic viability,” said Ralph Martire, executive director at the nonpartisan Center for Tax and Budget Accountability in Chicago.
and another fairly obvious point:
“States that have higher overall taxes have better capacity to weather economic downturns,” Martire said. “Then they can maintain their spending on the salary of workers, who then go out and spend their paychecks on the local economy.”
And there is an important proviso - one which we routinely try to insert in studies such as these:
The study doesn’t prove that high income taxes will stimulate growth, ITEP’s Davis said. Rather, it shows “there’s no evidence” that cutting income taxes will boost growth.
Exactly. And we will finish with Wolf's words, from our last blog:
"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."

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