Figure 3 shows the Clinton
Administration tax rates behavior.
President Clinton raised taxes from 31 percent in 1992 to 39.6 percent
in 1993. Astonishingly, economic growth followed. Of course, what President
Clinton did flies in the face of the tax-cuts-economic-growth connection
argument? And intuitively, defies logic--the logic of the throughput process
from tax cuts to economic growth. It turns this on its head and makes the
opposite argument. Why? Because raising taxes on the top taxpayers does at
least three things: (1) it increases government revenue for a given level of
national income, thus, leading to a decline in the national deficit, (2) it
taps into the low marginal propensity of the rich to consume (give Bill Gates
another buck will not cause him to spending it); (3) it encourages tax
avoidance, leaving taxpayers to increase saving--investment. This latter
assertion means that when tax rates are high you can avoid paying the tax by
not making profits part of personal income. The profits are retained in the
firm and used as investment to grow the business. Finally, President Obama's
willingness to raise taxes in top one percent of income earners is Clintonian
because it assumes as in Figure 3 economic growth would follow.
Figure 3 Clinton Administration
The three figures tell
conflicting stories about the effects of changes in marginal tax rates on economic
growth in the United States. Both the Kennedy and the Reagan tax cuts had
positive effects on growth, although long term the effects seemed to peter out.
On the other hand, raising the top marginal tax rates as Bill Clinton did also
increased economic growth. Higher rates in the Kennedy years and the Clinton
years were consistent with economic growth. Why? To repeat, one reason for this
is: if you are facing a marginal tax rate of 90 percent, you have two choices:
pay it or not declare it as income by leaving it in the company to support
investment for growth. Now, if the top marginal tax rate is cut, what do you do
as a rational human being--you take it and spend it on luxury. No one envies
success. We admire it. When we see a Maserati or a Bentley zip by, we emote
wow! Who hates the Queen for Buckingham Palace because she is rich? The point
is when you lower the tax rates at the top, there follows an increase extravagance
there--car elevators in your come to mind. It is not the specialty and the
custom made items that help the economy to grow; rather it is the mass
production for mass consumption that does.
The graphical analysis above
represents three snippets that hide the in-between (excluded years) behavioral
responses of the data for a longer period 98 years from 1913 to 2011. To make
up for this limitation, I set about to frame a question of the analysis around
the relationship between economic performance and marginal tax rates. The
prelude to the answer is reductions in the top marginal rates don't assist
economic growth, while reductions in the bottom tax rates do--in the long term.
Short term, the rich adjust significantly more rapidly to shocks than the poor.
I could have used any number
of techniques to see if these data series moved together. But one has to be
careful. Because two things (series) that same to move together might at closer
examine be entirely unconnected. Visualize two people
walking along a sidewalk randomly in the same direction. The fact that they are
traveling in the same direction tells you nothing about their ultimate
destination. But there's the counter example of a man walking his dog on a
leash--they are both engaged in a random walk process--the dog sniffs and
wets--but is connected to the man by the leash, and if we know where the man is
going we might infer that the dog is going there, too. We know, for example,
that the actions of President Obama and Mr. Romney are "cointegrated" because
if Mr. Obama says he's wants to cut taxes for the middle class, Governor Romney
will say he wants cuts for everyone; if Mr. Obama says the Affordable Care Act is good, Mr. Romney will say its bad; if
President Obama uses the word redistribution, Mr. Romney says it is class
warfare. The two men are linked by sloganeering and personal attack to garner
votes. It is like a musical counterpoint. And we know they are on a journey in
the same direction although only one will get there. In any event, we like to
think that the actions of the man and his dog are cointegrated, but the two
people walking along the sidewalk are not. What this means is that you don't
want your data to be explosive; that is, drifting away from a central
value--such as mean or variance. Unfortunately, the real GDP data for the United
States from 1913 to 2011 exhibited this explosive tendency--not stable. The top
marginal rate data was stable and the bottom marginal rate was not.
Fortunately, there are relatively easy statistical methodological fixes to this
problem of finding the relationship between these series--one stable and two
unstable.
I will not reproduce the
equation fitted to the data. However, the results show that cutting top
marginal tax rates by 1 percent would reduce economic growth by 0.055; on the other hand, cutting the bottom marginal tax rate
by 1 percent would raise real GDP by -0.161 percent. Think of these numbers
as how sensitive the taxpayers are to changes in marginal tax rates. The
implication of this is significant, because if Romney cut the top marginal rate
by 20 percent real GDP in the U.S. would decline by 1.1 percent; but cutting
the bottom marginal tax rates by 20 percent will raise economic growth by 3.22
percent. On the other hand, suppose Obama raise the top and cut bottom rate by
20 percent each. The net effect on economic growth would be greater--i.e. the
sum of 4.32 (=1.1+3.22) greater for Obama than 2.12 percent for Romney. These
results, of course, are more robust than the graphical analysis and speak more
clearly to policies choices. If the goal is to win political office, the appeal
to voters is to tell them you will cut their taxes. However, if the goal is
economic growth, the policy choice is much clearer - cut rates on the lower end
and even raise them on the upper end of the tax schedule.
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