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The Anti-Laffer: New Research Shows Tax Cuts Don’t Help Growth, Tax Increases Don’t Hurt Growth

Study: raising taxes on rich doesn't hurt economy (image: oh02)

Since I buried the NYT (actually, I just belatedly welcomed them to the party), let me now praise them. Eduardo Porter has an excellent and important article on the relationship between tax rates and economic growth. Here’s a surprise, it’s nothing like conservatives want you to believe.

It is true that high-income Americans carry the biggest tax burden. While fewer than 1 in 20 families make more than $200,000, they pay almost half of all federal taxes.

However they feel about the tax man, there is a case to be made that they can pay much more. The reason has nothing to do with fairness, justice or ideology. It is about economics and math […]

For 30 years, any proposal to raise taxes had to overcome an unshakable belief that higher taxes inevitably led to less growth. The belief survived the Clinton administration, when taxes rose and the economy surged. It survived George W. Bush’s administration, when taxes were cut yet growth sagged.

But now, a growing body of research suggests not only that the government could raise much more revenue by sharply raising the top tax rates paid by the richest Americans, but it could do so without slowing economic growth. Top tax rates could go as high as 80 percent or more.

The research comes from both directions. As Porter writes, Emmanuel Saez of Cal-Berkeley has research showing that the Laffer curve is set far, far too low. Higher marginal tax rates on the wealthy will not cause massive tax avoidance or a reduction of work from high-income earners such that economic growth would slow. The peak of where raising taxes can reduce revenue is simply much higher than the 35% nominal tax rate of the present day in the US. Saez and Peter Diamond of MIT (the former Fed Governor nominee) posited last November that the top tax rate could be increased to 76% without losing revenue, and to 48% even with the same loopholes we have today. My favorite conclusion of theirs was that the rich don’t really contribute all that much to economic growth: [cont’d]

Perhaps the most controversial conclusion, made by Mr. Saez and two colleagues in another study published last December, is that while the rich would respond to a big tax increase by shielding income from the tax man and maybe working less, this would not slow the economy at all. That’s because a lot of what the rich do does not, in fact, generate economic growth. So if they reduced their effort in response to higher taxes, the economy wouldn’t suffer.

In other words, losing the rent-seeking behavior of the rich from the economy will only help it.

At the other end of the spectrum, Ezra Klein notes that, in addition to tax increases not harming growth, tax cuts don’t help it, according to a new research paper.

Low tax rates can be seen as a desirable policy goal for a variety of reasons. Your views on justice and desert may require a system of taxation that allows people to keep as much as possible of what they earn. Or you may have strong opinions on property rights, self-property, self-reliance and the “undeserving poor.” In this paper, however, I will examine the merits of another and prima facie more convincing rationale, namely that low levels of taxation — especially low levels of taxation on the income or wealth of the so-called productive segments of society — are beneficial for economic growth. I criticize both the theoretical underpinnings of this view and its factual basis .?.?. It may even be the case that low tax rates have unwanted harmful consequences instead of the assumed beneficial ones.

It’s going to take a long, long time to turn these ideas into conventional wisdom. But it’s well worth the fight. We’re going to have to address this debate very soon, when the Bush tax cuts near expiration in December. The defenders will all say that letting them expire will crush economic growth. That’s just not the case. Tax cuts do little for growth. Tax increases do nothing to harm it. They just allow the government to invest and transfer and improve opportunity in a more comprehensive way, which is in itself more growth-promoting.

We need to make this the anti-Laffer.

CommunityThe Bullpen

The Anti-Laffer: New Research Shows Tax Cuts Don’t Help Growth, Tax Increases Don’t Hurt Growth

Since I buried the NYT (actually, I just belatedly welcomed them to the party), let me now praise them. Eduardo Porter has an excellent and important article on the relationship between tax rates and economic growth. Here’s a surprise, it’s nothing like conservatives want you to believe.

It is true that high-income Americans carry the biggest tax burden. While fewer than 1 in 20 families make more than $200,000, they pay almost half of all federal taxes.

However they feel about the tax man, there is a case to be made that they can pay much more. The reason has nothing to do with fairness, justice or ideology. It is about economics and math […]

For 30 years, any proposal to raise taxes had to overcome an unshakable belief that higher taxes inevitably led to less growth. The belief survived the Clinton administration, when taxes rose and the economy surged. It survived George W. Bush’s administration, when taxes were cut yet growth sagged.

But now, a growing body of research suggests not only that the government could raise much more revenue by sharply raising the top tax rates paid by the richest Americans, but it could do so without slowing economic growth. Top tax rates could go as high as 80 percent or more.

The research comes from both directions. As Porter writes, Emmanuel Saez of Cal-Berkeley has research showing that the Laffer curve is set far, far too low. Higher marginal tax rates on the wealthy will not cause massive tax avoidance or a reduction of work from high-income earners such that economic growth would slow. The peak of where raising taxes can reduce revenue is simply much higher than the 35% nominal tax rate of the present day in the US. Saez and Peter Diamond of MIT (the former Fed Governor nominee) posited last November that the top tax rate could be increased to 76% without losing revenue, and to 48% even with the same loopholes we have today. My favorite conclusion of theirs was that the rich don’t really contribute all that much to economic growth:

Perhaps the most controversial conclusion, made by Mr. Saez and two colleagues in another study published last December, is that while the rich would respond to a big tax increase by shielding income from the tax man and maybe working less, this would not slow the economy at all. That’s because a lot of what the rich do does not, in fact, generate economic growth. So if they reduced their effort in response to higher taxes, the economy wouldn’t suffer.

In other words, losing the rent-seeking behavior of the rich from the economy will only help it.

At the other end of the spectrum, Ezra Klein notes that, in addition to tax increases not harming growth, tax cuts don’t help it, according to a new research paper.

Low tax rates can be seen as a desirable policy goal for a variety of reasons. Your views on justice and desert may require a system of taxation that allows people to keep as much as possible of what they earn. Or you may have strong opinions on property rights, self-property, self-reliance and the “undeserving poor.” In this paper, however, I will examine the merits of another and prima facie more convincing rationale, namely that low levels of taxation — especially low levels of taxation on the income or wealth of the so-called productive segments of society — are beneficial for economic growth. I criticize both the theoretical underpinnings of this view and its factual basis .?.?. It may even be the case that low tax rates have unwanted harmful consequences instead of the assumed beneficial ones.

It’s going to take a long, long time to turn these ideas into conventional wisdom. But it’s well worth the fight. We’re going to have to address this debate very soon, when the Bush tax cuts near expiration in December. The defenders will all say that letting them expire will crush economic growth. That’s just not the case. Tax cuts do little for growth. Tax increases do nothing to harm it. They just allow the government to invest and transfer and improve opportunity in a more comprehensive way, which is in itself more growth-promoting.

We need to make this the anti-Laffer.

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David Dayen

David Dayen