“High Tax Rates Won’t Slow Growth” – Really?

On April 24, the Wall Street Journal carried an article by two highly esteemed economists, Peter Diamond from MIT, a Nobel laureate, and Emmanuel Saez of UC Berkeley, a John Bates Clark medalist.  The title above the article was the title shown here, except for the “Really?” part – that’s mine.  I do not easily take issue with two such learned economists, since I am not an economist at all.  I did learn my economics from Nobel laureates, however, so I feel justified in speaking out.

The authors’ work has suggested to them that the revenue maximizing individual marginal tax rate – the apex on Laffer’s curve – is “in or near the range of 50%-70%.”  From this they conclude that raising taxes on the rich will likely produce more revenue for the government, at least until we hit the marginal rate of 50%, and perhaps higher.

To explain why they believe this will not slow economic growth, the authors point to the fact that, in postwar U.S., higher tax rates “tend to go with” higher growth, not lower.  Please!  Tend to go with?  Is this the best standard they can find to justify their claim?  Not, “cause higher growth,” not even, “are significantly related to higher growth.”  Just tend to go with?

They do present data, of course, showing higher growth in the 1950-1980 range, when tax rates were “at or above 70%,” and lower growth since that time, when tax rates “were relatively low.”  There were, however, some external factors in play that could also have affected growth.  With regard to the earlier time period, for example, nearly every major economy in the world except the U.S. had just been destroyed by war.  Not too hard to make good money when the competition has been flattened.  Some have argued, in fact, that the decline in our growth rate in the 1970-1980’s time frame was due to the fact that, after we helped the rest of the world rebuild its manufacturing capacity, its technology was well ahead of our own, allowing them to take a temporary productivity lead.

A second factor that could have impacted the drop in GDP growth could be the growing size and influence of government in the economy.  In 1950, we spent one-third of our budget on Human Resources (health, education, welfare, etc.).  In 2011, that category had risen to two-thirds of the budget.  This is non-productive expenditure that is a drag on GDP.  It should not surprise that GDP growth would slow down.  Thank goodness taxes were low in the latter period.

The authors admit that their data “in no way” proves that higher tax rates encourage growth.  Then why present them?  Is that the best the economic community can do to explain taxes and growth?  Why not step back a little and ask what economics has to say about lower personal income (through higher taxes)?  Simply, that lower income pushes GDP down.  Why is it useful to push some dubious relationship of higher taxes and higher GDP when even the most loyal Keynesian would find fault?

Unfortunately, it gets worse.  In a nonsensical attempt to explain how the increased revenue from higher taxes works its way into higher GDP, the authors suggest that, if part of the revenue goes to repay federal debt, then “more of savings go into capital investment, enhancing growth.”  Who can imagine actually beginning to repay our debt with budget deficits over $1 trillion?  The best we can hope for in the next thirty years is that we stop increasing the debt. 

And even if debt were repaid, the idea that more of the higher tax revenue would go into capital investment is a stretch.  They try to explain it by suggesting that those from whom the higher taxes are taken would only have invested a portion of it anyway, the rest going to consumption.  But if all of the revenues were used to repay debt, there would be no growth in consumption by those in the lower tax brackets, so it still looks like a downward push on GDP. 

Finally, the authors suggest some of the revenues could go to public investments with a high return, like education, infrastructure, and research.  They forgot to mention green energy.  The fact is the government is uniquely unable to influence education in a positive way based on their prior “investment” results in the field.  Everybody wants to talk about infrastructure as if bridges were falling down all around us.  I have no doubt we may have deferred maintenance on our infrastructure for some time, owing to the greater percentage of the budget allocated to Human Services, but I am not feeling that collapse is imminent.  In fact, I am far more worried about financial collapse.

In some way I would like to be wrong in my critique of these highly regarded economists.  I am sure I have missed the subtlety in some of their arguments.  But not so sure that I won’t publish the critique.

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