Director of Federal Fiscal Policy
Many policymakers cite as fact that cuts in the top income and capital gains tax rates spur much greater economic growth and that increases in those tax rates significantly hurt growth. A new Congressional Research Service (CRS) report suggests, however, that such easy assumptions are highly problematic.
The report found no statistically significant correlation, all the way back to 1945, between the top capital gains or top marginal income tax rates and: (1) economic growth (in real per capita GDP); (2) private saving; (3) investment; or (4) growth in labor productivity.
CRS did, however, find a correlation between reductions in these tax rates and greater income inequality.
That’s not surprising: as tax policy expert Leonard Burman and my colleague Jared Bernstein have noted, there is no clear link between the top capital gains rate and investment or GDP growth. As Burman has explained, “Many other things have changed at the same time as [capital] gains rates and many other factors affect economic growth. But the [evidence] should dispel the silver bullet theory of capital gains taxes. Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.”
This caution also applies to the CRS report: it’s not airtight statistical proof that cutting capital gains or income tax rates has no effect on growth, savings, investment, or productivity. Other things happening in the economy might have obscured any such effects. But there’s no evidence for some policymakers’ assertion that cutting marginal income tax and capital gains tax rates would have very large, positive effects on the economy.
Indeed, raising tax rates within reasonable bounds on high-income households could help reduce deficits without harming economic growth — and might even help long-term growth by increasing national saving, as we explain here. Furthermore, CBO has concluded that if Congress extends President Bush’s tax cuts from 2001 and 2003 indefinitely without offsetting the costs, the large increases in deficits that would result would likely create a net drag on national saving and economic growth.
As noted, the CRS report finds a statistically significant relationship between cuts in the top tax rates and rising income concentration at the top. As with the relationship between tax rates and economic growth, lots of other factors are at play. But this finding, together with the lack of evidence that those rate cuts spur economic growth, also undermines the argument for top income and capital gains rate cuts.
|Here’s an excerpt from the CRS report* in question:
Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The real GDP growth rate averaged 4.2% and real per capita GDP increased annually by 2.4% in the 1950s. In the 2000s, the average real GDP growth rate was 1.7% and real per capita GDP increased annually by less than 1%. There is not conclusive evidence, however, to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth. Analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. The evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced.
* Thomas L. Hungerford, “Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945,” Congressional Research Service, September 14, 2012