TSS original: Domitrovic rebuts Bartlett on tax rates.

Low taxes are a proven winner
By Brian Domitrovic
Aug. 20, 2011

In the wake of the big Warren Buffet push for higher taxes, a number of commentators have striven to argue that higher marginal tax rates correlate historically with greater economic growth. Bruce Bartlett made the point this week at the Fiscal Times, and it has been a mainstay on the Presimetrics blog.

As goes the years since the Reagan Revolution, it is important to be careful when associating what with what. To look at the cases in turn:

1. Bartlett notes that while the lowest tax rate of the period (indeed since 1932), 28%, held for three years, 1988-1990, growth was only OK in this interval, at 4.1, 3.6, and 1.6% per year respectively.

It is, however, not judicious to connect the economic performance of 1990 with the 28% tax rate. A few months into the year, all the talk was of a capital-gains tax cut, but then the president (Bush 41) pivoted, saying tax increases were on the table. There was robust growth in the first quarter of 1990 – 4.2% – and then a slide into negativity by year’s end.

In other words, while the 28% rate was in effect and not in question, growth hummed at the fine rate of 4% all along. Furthermore, this growth came after years of a historic boom; it was a boom on top of a boom, a statistical rarity. The record of the 28% top rate is of nothing but very good things.

2. The early 1990s saw two tax increases, Bush’s of 1990 and Clinton’s taken retroactively to New Year’s 1993. Growth was nil in the remainder of 1990 and in 1991 and then rebounded to clear positive territory, 3.4%, in 1992.

Here was growth, then, that at its best did not even reach the average level of the 28%-rate era (the top rate was now 31%). Moreover, the immediately preceding years to 1992 had been recessionary, meaning that less output was necessary for a unit of growth than had been the case in the 28% period, which had come on the heels of a boom.

Growth fell in 1993, the year Clinton took the top rate past 39%, at last went up to the 28%-era average of 4.1% in 1994, then sunk again, to 2.5%, in 1995. From 1996 to 2000, growth was consistently above 4%.

As a statistical run, it is odd to see the small numbers following the recession and the large numbers coming later. This inverts the usual mathematical inertia, where the depth of the recession denominator makes early growth easier and growth upon a boom harder. But that is what you get, 1993-2000.

This, again, is a cue to look at contexts. From 1995 on, Republicans insisted on tax cuts, got some (on the capital gains side) and asked for more. The only possible movement on taxes, as the budget surplus swelled to $230 billion, was for a tax cut. Economic growth in this heady environment was only logical.

3. Then a tax cut of any distinction did not come. Bush 43 effectively left the marginal rate where it was from 2001-2003, and growth promptly plummeted, to the 1% range in 2001 and 2002. When finally a tax cut came in 2003, there was a nice 4-year boom.

In the meantime, the Fed had seized control of macroeconomic policy, and we know the rest of the story: the monetary rather than the fiscal side has since striven to call the tune.

Therefore the conclusion Bartlett arrives at, and there are analogues on Presimetrics, “that higher tax rates on the wealthy stimulate growth,” does not withstand scrutiny on two important grounds. If you sequence the growth rates correctly from 1988 on, it’s clear that lower rates are beneficial. And if you consider the magnitudes of the denominators in the growth fraction, the same conclusion is supported.