Thursday, November 5, 2009

Taxes And Economic Growth

An examination of presidential policy over the last 30 years indicates that tax cuts may not be the most effective means of stimulating economic growth in the United States. The data suggests that the tax increases signed by President Reagan and President Clinton did more to promote economic growth and recovery than any of the tax cuts signed since 1980. See the following post from Economist's View.

Do tax cuts spur economic growth?
Tax Cuts and Recoveries, by David Leonhardt, Economix: One big question about the 1983-84 economic boom (a boom I mention in my Wednesday column) is: Was it the tax cut?

Ronald Reagan signed a large tax cut in the summer of 1981, while the economy was in recession. Within a year and a half, the economy was booming. Conservatives, understandably, like to argue that the tax cut helped cause the boom.

I’m open to that argument. ... What’s unclear is how big an effect tax rates have.

In 1982, with the economy in the second part of its double-dip recession, Reagan signed a tax increase, meant to reduce the deficit. Here’s Bruce Bartlett, writing at Forbes.com:

According to a recent Treasury Department study, Ronald Reagan proposed the largest peacetime tax increase in American history as part of a budget deal to get the federal deficit under control. The Tax Equity and Fiscal Responsibility Act (TEFRA) ... took effect on Jan. 1, 1983.

During debate on TEFRA, many conservatives predicted economic disaster. They argued that raising taxes in the midst of a severe recession was exactly the wrong thing to do. ... Said Rep. Newt Gingrich, “I think it will make the economy sicker.” The Chamber of Commerce ... said it had “no doubt that it will curb the economic recovery everyone wants.”

Looking at the data, however, it is very hard to see any evidence that TEFRA had a negative effect on growth. Indeed, one could easily make a case that its enactment stimulated growth.

A little more than a decade later, Mr. Gingrich made the same argument about Bill Clinton’s tax increase. But ... the ... late 1990s expansion was the fastest of any in the past forty years.

Mr. Clinton’s successor, George W. Bush, signed a large tax cut during his first year in office — as Mr. Reagan did. But Mr. Bush never signed a tax increase to reduce the deficit. And growth in the Bush years was slower than in the Reagan years or the Clinton years, even before the financial crisis hit.

The history seems to suggest that tax cuts are not the most reliable strategy for spurring growth, at least in the United States, where top income-tax rates are not sky high.

But maybe readers can offer an analysis that explains this history and still makes the case for tax cuts as the main engine of economic recoveries. ...

Just one quick note - for those anxious about the deficit and eager to do something about it, the Reagan experience shouldn't be used as an excuse to start raising taxes too soon. The time will come when deficit spending is no longer needed to spur the economy and at that point we should reverse course, but we shouldn't make the mistake of 1937-38 when an attempt to balance the budget too soon in the recovery caused the economy to fall back into recession.

This post has been republished from Mark Thoma's blog Economist's View.

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1 comments:

November 5, 2009 at 8:26 AM Brad said...

I'd argue that stability is a key factor in economic growth and balanced budgets enhance the perception of stability.

I'd also say that tax hikes, like tax cuts, invariably hit the upper classes the most. As such, tax hikes have a somewhat redistributionist effect being that the burden of government is born by the wealthy to an even greater degree. The lower classes, who have a greater propensity to consume larger portions of their income are receiving somewhat of a break. Government spending remains (high), providing additional good jobs and the end result is somewhat increased lower and middle class demand for goods/services resulting in economic growth.

The interesting thing is that the wealthy still benefit overall, having a large share of their wealth tied to investments which are doing well in the growing economy.

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