Peer-reviewed Academic Studies: More Taxes, Less Prosperity

January 18, 2013

Via International Liberty:  Studies indicate that higher taxes lead to less economic growth.  As Dan Mitchell puts it, the Tax Foundation

reviews the academic research on taxes and growth and doesn’t find a single study supporting the notion that higher tax rates are good for prosperity.

. . .

Twenty-three studies found a negative relationship between taxes and growth, by contrast, while three studies didn’t find any relationship.

For those keeping score at home, that’s a score of 0-23-3 . . . .

It is common in certain circles to claim that higher taxes (on the rich or otherwise) are actually good for the economy, and that the somewhat higher tax rates under President Clinton not only coincided with ’90s prosperity, but caused it.  (It is common in these circles to assume that the end of the Cold War; the dot-com boom; and the Republican Revolution in Congress, which resulted in significant welfare reform, did not cause it.)

There are perhaps two ways to try to evaluate whether more taxes, all other things being equal, lead to more prosperity or less.  The first is with abstract reason; the second is empirically.

Abstractly, we can think in terms of incentives.

  • It is universally known in general that if you tax something, you get less of it.  Liberals are perfectly happy to acknowledge this fact when it suits them—e.g., they wanted “cap and trade” to tax carbon emissions so that we would get less of them; states tax cigarettes to discourage smoking; etc.
  • Likewise if we tax work, earning, or wealth creation, naturally we’ll get less of it.

Alternatively, we can try to look at real-world tax rates and prosperity, and study whether there’s a relationship between them.  This is difficult to do, as “Professor Tevyeh” explains, because the world is complex and there are a lot of confounding variables.  Some would say that it’s so complex that it can’t soundly be done at all; others would say that it can be done, but should be done by scientists, rigorously trying to control for other variables, getting a large sample of data, checked by their peers, etc. (and still with a scientist’s humility about the limits of certainty).

Apparently the academic literature on taxes is much more unanimous than those who pine for the Clinton years would have you believe.  Last month William McBride at the Tax Foundation surveyed the literature:

Nearly every empirical study of taxes and economic growth published in a peer reviewed academic journal finds that tax increases harm economic growth. In my review, I examine twenty-six such studies going back to 1983, as shown in Table 1. All but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth.

(Emphasis added.)  He explains further:

The idea that taxes affect economic growth has become politically contentious and the subject of much debate in the press and among advocacy groups. That is in part because there are competing theories about what drives economic growth. Some subscribe to Keynesian, demand-side factors, others Neo-classical, supply-side factors, while yet others subscribe to some mixture of the two or something entirely unique. The facts, historical and geographical variation in key parameters for example, should shed light on the debate.  However, the economy is sufficiently complex that virtually any theory can find some support in the data.

. . .

So what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy. In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth. Of those studies that distinguish between types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.

. . .

In any case, the lesson from the studies conducted is that long-term economic growth is to a significant degree a function of tax policy. Our current economic doldrums are the result of many factors, but having the highest corporate rate in the industrialized world does not help. Nor does the prospect of higher taxes on shareholders and workers. If we intend to spur investment, we should lower taxes on the earnings of capital. If we intend to increase employment, we should lower taxes on workers and the businesses that hire them.

As I recall, John McCain, running for president in 2008, had a whole list of economists who endorsed his tax proposals as better than Obama’s.  I don’t recall that Obama was able to offer any such list—the arguments in his favor were of a different kind (Obama saying he wants to raise the capital-gains tax rate even if that will result in less tax revenue for the government, for the sake of “fairness”).  Now you know why, perhaps.

They say that everyone is conservative in his field of expertise.

If liberals want to maintain that raising taxes is good for the economy (or even just not bad for the economy), it seems to me that they have to choose one of the two epistemologies offered above, abstract reasoning or empiricism.

  • If abstract reasoning, they have to explain either why they think the generally acknowledged rule (if you tax something, you get less of it) doesn’t apply here, or else why they don’t accept the general rule in the first place.
  • If empiricism, they have to explain why their simplistic two-variable laymen’s analyses are more likely to be true than the hard work done by serious researchers subject to peer review.

7 Responses to “Peer-reviewed Academic Studies: More Taxes, Less Prosperity”

  1. Snoodickle Says:

    What exactly do you mean by taxes? I don’t think anyone has ever argued that higher taxes on the middle class is good for the economy. As I understand it, I don’t even think that liberals are arguing that taxing the rich is “good” for the economy in the sense that it promotes economic growth (I’m certainly not arguing it), but that it is necessary to generate more revenue to close the gap on a major budget shortfall. In that sense, if raising taxes slightly on the rich helps cut the deficit and ultimately is a key component of a balanced budget, then of course raising taxes is good for the economy in that specific factual scenario. I think that most respected economists, including Professor Tevyeh, acknowledge that more revenue is essential to solving our debt problem.

    P.S. I’ve offered you a theory on how the more taxes, less of it theory doesn’t apply to economic output. Let’s say for example that the government raises the tax rate to 99%. That means that someone making 10 million a year is only keeping $100,000 of his money. What is the natural incentive for this person at this point? Aside from leaving the United States, and leaving his business, family and everything he knows behind, is he going to work less or work more? The answer is more. He now has every incentive in the world to make 100 million a year instead of 10, as that is the only way he will become a millionaire again.

  2. roberta4949 Says:

    for me if I pay more taxes for working more? then I will work less to avoid that burden, progressive taxes and all, a business man will just move overseas or stop production and go into something else. ultimatly the taxes will fall on the working poor and non working poor alike as this will raise prices won’t it on the goods we need and want? where does it say the people are responsible for the gov debts? no where did I read that. purpose of taxation is not always about funding anything but about control isnt it? when does the gov need the money more than the productive classes? sure you need some taxes but the thing about taxation is that once they get the money they want to spend it even if that item spent on is not needed by the public. gov only grows bigger and bigger just like the bible says it is described as a vicious wild beast, which is violent and has an unending appetite to consume it’s people. never satisfied.

  3. Snoodickle, I think the biggest problem with your theory is that it proves too much.

    — If it were true, why would it not apply equally well to everyone, not just the rich? You seem to be conceding that these data are sound with respect to everyone but the rich. So you think (though you’ve cited no studies of your own) that there must be a hidden exception whereby the observed pattern (higher taxes, less productivity) does not apply to the rich?

    — If it were true, why would it not apply equally well to things other than money? If I’m a smoker and I smoke a pack a day, and a pack costs $5.00, I’ll spend $5 a day on cigarettes. If the state raises cigarette taxes so much that a pack now costs me $10, on your theory I’ll start spending twice as much ($10 a day) on my cigarette habit, no questions asked. In reality, variables interact with each other, and on average people will smoke less, because the government has made it cost them more. (Do you disagree?)

    Or forget about taxes—on your theory, it shouldn’t matter whether a big-screen TV costs $100 or $1,000; the same number of people would buy them either way, because those people want a big-screen TV, totally irrespective of the cost. It doesn’t make any sense.

    Other problems with your theory include one that you and Roberta mentioned (and that Lector Constans pointed out when you made this argument before), that some people will move to a different tax jurisdiction if you hit them hard enough. E.g., iconic French actor Gerard Depardieu bought a home in Belgium and became a Russian citizen after France’s Socialist Party president, Francois Hollande, tried to impose a 75% tax on the rich. (He explains in that second link that he wasn’t trying to “escape the taxman”, just “he was leaving because success was now being punished in France.” Maybe the distinction made more sense in the original French.)

    Importantly, the alternative course of action you propose is simply not possible. A person can work a little harder than before, perhaps, but a person (especially one making a lot of money already, which usually means he’s already working long hours and working very hard) cannot suddenly start being ten times as productive as before just because the government is seizing his earnings and he wants to remain rich. Even if he could, as they say, you earn all that money, but have no time to spend it—in other words, his lifestyle cannot remotely remain the same as before, no matter what he does.

    • Snoodickle Says:

      I didn’t say I thought the theory was correct; I was merely providing an alternative theory that you hadn’t considered.

  4. Kevin Says:

    Do any of you really think someone making $10 million a year is “working hard” at all? I’d be very much surprised to see someone making that much money off an hourly rate. More likely it is a salary for a top-level executive, and even more likely that it is “off the top” income from stock options, hedge fund management fees, et cetera. At that point the concept of working harder, or even doing more, doesn’t make any sense – the constraint on income is not how much he does but how much money is there to be made altogether (and, to a certain extent, whether he makes any mistakes/is unlucky). What will happen if his taxes increase is that he will keep doing what he was, or not. If not, someone else will step in to do it instead, and you can’t really prove a priori that the real world will actually be worse off in this case.

    • Are you arguing that taxing earnings more won’t make people (our hypothetical current worker or his hypothetical replacement, either one) less likely to do that work, or that you don’t think it would hurt the economy if it did?

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