Thursday, July 11, 2013

Do lower top taxes raise growth? (episode 273,000)

Via @Frances_Coppola, a fun little post about taxes and growth. It starts by looking at the interminable arguments about whether higher taxes raise or reduce growth. Our answer usually is: there seems to be only a very weak effect, at best, though there are mild suggestions that tax cuts have been associated with somewhat lower growth. (See here, or here, or here, or here, just for instance.)

But this new post makes some interesting points. It looks at the UK, which saw a big cut in the top marginal tax rate from 60 to 40 percent in 1988. In the previous 22 years, real GDP grew by 2.6% per year, and in the following 22 years slowed to 2.4% a year*.
"There are three possible reactions to this:

1. The tax cut actually made no difference to growth: 0.2 percentage points is well within the sort of difference we'd expect from random fluctations. Indeed, it's possible that there are almost no feasible policies which noticeably affect trend growth.

2. The tax cut actually reduced GDP growth. This might be because the income effect encouraged wealth creators to retire early, or because it incentivized rent-seeking or the growth of a banking sector which thrived only by creating risk pollution.

3. The tax cut on its own would have raised GDP growth, but other factors offset this benefit."
So far, so good.

Now the tax-cutters-at-all-costs need to argue point 3.

But here they get straight into choppy waters - because the relentless tax-cutting ideology is traditionally served up alongside a lot of other baggage: that the Thatcherite reforms of the 1980s and 1990s -- a reduction in trades union power; privatisation; the abandonment of wage and price controls; rapid financial and trade globalisation, the explosive growth in tax havens, lower corporate tax rates; and perhaps inflation targeting - must have been good for growth. But it wasn't: growth slowed slightly. So:
"To claim that Lawson's tax cuts boosted GDP growth thus requires one to argue either that the many pro-market reforms of the 80s and 90s had no great beneficial effect or even a negative effect, or that some other factor greatly depressed growth and offset all these benefits. This requires some arguing."
TJN doesn't generally take a view one way or another on that kind of Thatcher-styled 'baggage,' as it's outside our core focus, but, well, the argument here seems logical.

And one more thing. The tax-cutters aren't really tax-cutters at all: what they routinely call for is for taxes on the rich to be cut (that is, corporation taxes, capital taxes, top marginal income tax rates) while raising taxes on the poor (VAT, say, which has risen from 8%, first introduced in 1973, to 20%, since January 2011.) And the end result? This picture gives a flavour.

To understand what the picture is saying, it is from this graph, from the UK's Office for National Statistics, which explains the overall picture of apparently ever more regressive taxation. (Update, July 12: with more details available here.)

These tax-cutters-at-all-costs may well be paid-up members of the evidence-averse New Church of Finance.


Anonymous said...

There is a fourth choice: Growth is being mis-measured, and therefore what you think you know is false.

What do I mean by that? GDP does not really measure anything. It is an aggregate number based on the mark-up of goods. The GDP total can be any number, and have no reflection of any change in quantity or quality of transactions.

For example, an apple can cost 2 cents, 8 cents, 12 cents or 32 cents. If you sell ten of them, then the GDP is 20 cents, 80 cents, 120 cents or 320 cents, respectively. Nothing changed except for the numbers being applied. There was no 'growth,' only self-illusion.

Changing the tax rate acts similarly to the profit percentages being applied to the apple. It can be any percentage. The GDP only measures the value applied, and not growth.

5:56 am  

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