When Taxes Go Up; So Does the Economy (Growth and Jobs)

Quotes from the bibliography…. Others may differ in how it gets called, but I call it empirical evidence.

Tax increases used to enhance public services can be the best way to spur the economy. By stimulating growth, generating jobs, and providing direct benefits to residents, improvements in state and local public services can be one of the most effective strategies to advance the quality of life of citizens.

Back in 1982, Ronald Reagan was persuaded that the deficit was such a severe impediment to growth that a tax increase to reduce it would be economically beneficial. Many in his party strenuously objected, citing research by Republican economists.It would be hard to find an economic forecast that was more wrong in every respect. Looking at real gross domestic product, it grew 4.5 percent in 1983 and 7.2 percent in 1984 – an exceptionally strong performance. The stock market had one of its best years ever in 1983 – both the Dow Jones Industrial Average and the S&P 500 Index rose 35 percent. There was no increase in the rate of inflation, which was exactly the same in 1983 and 1984 as it was in 1982. The unemployment rate fell from 10.6 percent in December 1982 to 8.1 percent by December 1983 and 7.1 percent in December 1984..

In 2003, the Finnish government wanted to boost employment in the northern part of the country. So it abolished some equivalents of our NI(National Insurance) for firms in northern regions. This saved the average firm there around 4% of its wage bill. Did this create jobs? The beauty of this plan was that it gave us a natural experiment. Because the tax cut only applied to firms in part of the country, it‘s possible to compare these to firms elsewhere in the country, to see if the lower “tax on jobs” created employment.the average firm that got the tax break created less than one-tenth of a job as a result. This experiment has been replicated elsewhere. Sweden has also tried regional variations in the equivalent of NI contributions, and has also found no great employment effects.

On August 20, 1993, Laffer told his clients, “Clinton’s tax bill will do about as much damage to the U.S. economy as could feasibly be done in the current political environment.” He said that interest rates would rise and the stock market would fall.Once again, it would be hard to find a forecast that was more completely wrong. The unemployment rate fell from 7.1 percent in January 1993 to 5.4 percent by December 1994. Real GDP growth rose from 2.9 percent in 1993 to 4.1 percent in 1994. Stock prices rose and interest rates fell. More importantly, the 1993 tax increase and accompanying spending controls, which were opposed by every Republican in Congress, laid the foundation for the phenomenal growth of the late 1990s that actually produced budget surpluses before Republican tax cuts in the 2000s dissipated them.

“High GDP countries are high tax countries,” said Joel Slemrod, an economist at the University of Michigan’s Ross School of Business.

When marginal rates were relatively high, unemployment is low. When marginal rates are relatively low, unemployment is high. If the theory of high tax cuts worked to produce jobs it would be fine with me, but the evidence doesn’t support the theory.

A study from the Congressional Research Service — the non-partisan research office for Congress — shows that “there is little evidence over the past 65 years that tax cuts for the highest earners are associated with savings, investment or productivity growth.” In fact, the study found that higher tax rates for the wealthy are statistically associated with higher levels of growth.

There is one part of the economy, however, that is changed by tax cuts for the rich: inequality. The study says that the biggest change in the distribution of U.S. income has been with the top 0.1 percent of earners – not the one percent. The share of total income going to the top 0.1 percent hovered around 4 percent during the 1950s, 1960s and 1970s, then rose to 12 percent by the mid-2000s. During this period, the average tax rate paid by the 0.1 percent fell from more than 40 percent to below 25 percent. The study said that “as top tax rates are reduced, the share of income accruing to the top of the income distribution increases” and that “these relationships are statistically significant.”

Last September, the Congressional Research Service published a report countering Republican claims that lowering top tax rates would lead, or had led, to higher economic growth. “Changes over the past 65 years in the top marginal rate and the top capital gains tax rate do not appear correlated with economic growth,” the report concluded. Republican Minority Leader Mitch McConnell responded by having the report suppressed, but its findings were incontrovertible.

The weaker argument goes like this: The modern American economy is driven by consumer demand; the consumer sector, which includes services, is where new jobs emerge, and where growth is spurred. During economic downturns, purchases of consumer durables, including automobiles and new houses (which economists technically label investment), have been most likely to ignite a recovery. The lower a person’s income, the more likely he or she will use additional income to consume goods and services; the higher the income, the more likely it will be saved. In Keynesian terms, middle and lower income taxpayers have a much high marginal propensity to consume. Therefore, it makes much more sense to give them rather than the wealthy a tax break. The stronger argument shows that with incomes soaring in the upper brackets, it is a good idea to raise tax rates on the wealthy.

In 1890, consumer purchases accounted for about 36 percent of GDP; in 1925, 40 percent. (Similarly in China today, consumption accounts for only about a third of GDP and investment for half.) But in the United States today, consumer purchases account for about 70 percent of GDP, and investment for only 15 or 20 percent. And the growth of consumption at the expense of investment hasn’t entailed any decline in output, including that of capital goods. As a result, the consumer sector no longer has to sacrifice its output and income in order to fund a capital goods sector that is growing more rapidly than it is. And instead of the economy once being driven by the demand for capital goods, it is driven by the demand for consumer goods and services. The danger to the older economy was conspicuous consumption by capitalists and growing wage demands from workers, which threatened the funds available for investment in capital goods. The looming danger in the new economy is the failure of capitalists to consume or invest, and the failure of workers crippled by debt or unemployment or falling wages, to consume.

Government economic policy has to be, or at least should be, very different in this economy. It should not consist of giving tax breaks to the middle class and the wealthy, but of redistributing income downward–whether through tax policy, social programs, or labor regulations. If it doesn’t do that, or worse still, if it acts as if it were 1925 and encourages a growing gap between the rich and everyone else, it will threaten consumer demand. During the Coolidge and Hoover administrations, the top one percent increased their share of total income by 19 percent. And that happened, too, in George W. Bush’s administration. Such policies not only slow a recovery, but spur a slowdown by putting money in the wrong hands.

Regressive policies can also lead to financial crises. When firms suffer from global overcapacity or merely from domestic overproduction – when a glut arises of automobiles, ships, textiles semiconductors or fiber optic cable — as happened in the late 1920s and again in the earlier part of the last decade, the wealthy, joined by corporate treasurers and bankers, have tended to pour their money into speculation rather than productive investment. The financial sector has become a casino for the rich, where they have gambled away funds that could have fueled the economy. So redistributing income through tax policy isn’t just fair; it is one way to began restructuring the economy to prevent future slowdowns and crashes.

Reagan took office with a 7.5 percent unemployment rate. By September 1982 it had climbed to more than 10 percent and didn’t drop below 7 percent till halfway through his second term. From 1979 through 2004 the real after-tax income of the poorest fifth of the country rose by a paltry 9 percent, while that of the richest fifth rose by 69 percent. Over roughly the same period CEO pay rose by about 500 percent.Which brings us to the con. A string of millionaire candidates for public office has duped a good chunk of the electorate into thinking the way to create jobs and otherwise solve the problems of the middle class is to cut the taxes of the wealthy. That’s absurd. If the massive tax cuts of the Reagan era didn’t do the average worker much good, trimming another percent or two now sure won’t. What it will do is leave more money in the pockets of the comfortably affluent.

The empirical evidence is that cuts in government services in order to avoid tax increases will result in a reduction in incomes and therefore jobs. Claims to the contrary are based on research that is deliberately shoddy.

North Carolinians Would Pay Cost of Corporate Tax Cuts but Receive Few Benefits… The Fiscal Research Division of the General Assembly estimates that a recent proposal to cut the state corporate income tax rate from its current 6.9 percent to 4.75 percent would cost the state $307 million in the next fiscal year, with the annual cost rising to $410 million after five years. Businesses care more about having a well‐educated, highly productive workforce, access to markets and suppliers, sound infrastructure, and high quality of life for their employees than they do about taxes. corporate profits are currently at record highs, and corporations are still not hiring new workers. Cutting the state corporate income tax rate will simply raise corporate profits even higher with no promise or evidence that these profitable corporations will create jobs. In fact, rising dividend payouts and high executive bonuses suggest that much of the after‐tax savings resulting from a corporate tax cut will flow straight to out‐of‐state investors and corporate managers headquartered in other states.

Opponents say these new taxes will be passed on to consumers. They are wrong. Economists have clearly demonstrated that taxes come out of corporate profits. If a corporation raises its prices in order to pass on a tax, the law of supply and demand dictates customers will purchase less. Fewer purchases mean less profit, the same result as if the corporation had simply paid the tax. A higher price also creates a new market for another savvy business to start up and offer the same product or service at the initial lower price. The corporation would be forced to return to the lower price in order to compete. Taxes are a cost of doing business. Costs come out of profits. They do not impact the price, or the value, of a good or service. People will only pay what they will pay, no more. A business’ cost is of no concern to a consumer when they are deciding how to spend money.

Since 1945, the increases in the Federal deficit went up 4.2% under Democratic administrations; and 36.4% under Republican presidents (source CBO). That is not as relevant as the fact that the deficit increase was coincidental with GOP presidents who reduced taxes – most notably Reagan (deficit up11.2% & 5.9% in his two terms); George H. W. Bush (6.5%); and especially George W. Bush (up 9% and10.7%). While it may be argued, this is not necessarily related to “job creation”, it is related to increases in GDP (debt/GDP ratio) or relative robustness of the economy. These presidents cut taxes, increased debt, but the economy did not grow accordingly.

In short, the premise and the promise that giving substantial tax breaks to the very wealthy will stimulate the economy, and “create new jobs”, simply has no basis in fact or reality. What it has done, factually, is to increase the deficits whenever it has been tried.

At an House Finance, Ways and Means Committee meeting during the last big tax debate, one legislator asked the Economic Development Cabinet spokesperson why North Carolina is out-competing Tennessee in recruiting new businesses even though they have higher taxes overall and a personal income tax to boot. One of the reasons stated was North Carolina’s excellent educational system and a university system that is one of the best in the nation. Tennessee on the other hand ranks 49th in education spending per capita and 48th in high school graduation rates. The simple fact is, education of the local work force is more important to recruiting new business than having low taxes.

While the benefits of tax cuts and incentives are debatable, their costs are clearer: Tax cuts and incentives cause state and local governments collectively to lose billions of dollars annually in tax revenues. Because of the lost tax revenues, tax incentives force state and local governments to cut back on the quantity or quality of public services. These reductions can damage the economy because businesses often need these public services to thrive. Indeed, there is evidence that state and local tax cuts, accompanied by reductions in public services, cause job loss and economic decline.

Opponents of raising the taxes that high-income households face often point to findings that high-income taxpayers respond to tax-rate increases by reporting less income to the Internal Revenue Service (IRS) as evidence that high marginal tax rates impose significant costs on the economy. However, an important study by tax economists Joel Slemrod and Alan Auerbach found that such reductions in reported income largely reflect timing and other tax avoidance strategies that taxpayers adopt to minimize their taxable income, not changes in real work, savings, and investment behavior.

A marginal rate increase may encourage some business owners to work less because the after-tax return to work declines, but some will choose to work more, to maintain a level of after-tax income similar to what they had before the tax increase. The evidence suggests that these two opposing responses largely cancel each other out.

History shows that higher taxes are compatible with economic growth and job creation: job creation and GDP growth were significantly stronger following the Clinton tax increases than following the Bush tax cuts. Further, the Congressional Budget office (CBO) concludes that letting the Bush-era tax cuts expire on schedule would strengthen long-term economic growth, on balance, if policymakers used the revenue saved to reduce deficits. In other words, any negative impact on economic growth from increasing taxes on high-income people would be more than offset by the positive effects of using the resulting revenue gain to reduce the budget deficit. Tax increases can also be used to fund, or to forestall cuts in, productive public investments in areas that support growth such as public education, basic research, and infrastructure.

President Bill Clinton faced vociferous opposition to his 1993 budget plan, which raised the top tax rates from 31 percent to 39.6 percent. Republicans called it the “Kevorkian Plan.” So, what happened? Unparalleled economic growth. The nation’s unemployment dropped from 6.9 percent to 4 percent. The deficit shrank, and in 1998, the federal government boasted a surplus for the first time since 1969.

The vast majority of households that move to a different county or state indicate employment, family, and housing-related matters are the main reason behind their move. The limited available research on the impact of taxes on cross-state migration suggests that taxes do not play a very important role. At most, 0.7 percent of those affected by the “millionaire tax” had left New Jersey for tax reasons since 2004. While their departure cost New Jersey $38 million in annual revenue, the money collected from the remaining 99.3 percent has added nearly a billion dollars a year to New Jersey’s coffers. The net economic gain from instituting the tax has been an average of $857 million a year.

Canada’s largest corporations—are making 50% more profit and paying 20% less tax than they did a decade ago. However, in terms of job creation, they did not keep up with the average growth of employment in the economy as a whole. From 2005 to 2010, the number of employed Canadians rose 6% while the number of jobs created by the companies in the study grew by only 5%. In essence, the largest beneficiaries of corporate tax cuts are dragging down Canadian employment growth. If those 198 companies paid the same tax rate as they had in 2000, federal and provincial governments would have collected an additional $12 billion/year in revenue.

Business fixed capital spending has declined notably as a share of GDP and as a share of corporate cash flow since the early 1980s—despite repeated tax cuts that have reduced the combined federal-provincial corporate tax rate from 50% to just 29.5% in 2010. According to the study, the Conservatives’ proposed 3-point reduction in corporate tax rates would cost the public purse $6 billion per year, yet only stimulate about $600 million of new business investment annually.

If the federal government spent $6 billion on public infrastructure instead of corporate tax cuts, the total increase in investment would be more than ten times as great as the increase in private investment from tax cuts alone. This includes the new public investment itself ($6 billion), as well as an additional $520 million in private business investment that would be stimulated through the positive spin-off effects of the resulting economic growth.

What we are seeing today is lower taxes leading to owners extracting money rather than reinvesting it. The cash sits on the sidelines in bank accounts, or in their wallets. So let’s raise taxes, and “force” this idle cash back into businesses for reinvestment and create the jobs this country needs.