Among the most enduring political-economic myths is the claim that tax cuts on the wealthy stimulate the economy and will benefit all of society, including the middle and lower classes. This is the central claim of supply-side economics, and this is the logic behind the Trump tax cuts. One might as well believe in the tooth fairy, big foot, and the Loch Ness monster. The truth about taxes–especially income taxes on individuals and corporations–is that there is no correlation between tax rates and economic growth. There is also no evidence that taxes serve as potent tools to encourage business relocation decisions. History has repeatedly proven both of these claims wrong, yet both ideas fails to die, enduring as a chicanery that continues to waste public money, benefiting only the rich.
Two issues place the role of taxes in the economy back on the agenda. The first is the Trump tax plan, the second is the scramble across the country to use tax incentives to lure Amazon to locate its corporate headquarters to a specific state and community, such as Minnesota.
Turning first to the Trump tax plan, there are multiple frauds and myths here. First the plan calls for an elimination of the estate and the alternative minimum tax as well as increasing the standard deduction. The three are described as helping the middle class. In reality, none of them will do anything for the middle class or poor. Right now few individuals pay estate taxes. As of 2016, there is no estate tax if it is less than $5.45 million. There are not too many poor or middle class people I know who are worth more than $5.45 million.
Second, the alternative minimum tax only applies to the likes of billionaires like Donald Trump or major corporations who are able to use creative tax formula to avoid regular incomes taxes. The alternative minimum tax was meant to impose taxes on the rich and no poor or middle class pay it. Finally, for most middle class families, the doubling of the standard deduction will not be used because either they make too much or, in the case of the poor, make too little to qualify. The trump tax cuts will do little to help most middle class. If any tax cuts would help them and the poor, it would be cutting the payroll taxes which are regressive. For example, change the Social Security taxes from a flat tax into a progressive one, or lift the income cap on the maximum taxable income for Social Security. These options will actually put more money into the hands of the poor or middle class. The same would be true by increasing the Earned Income Tax Credit.
But the bigger fraud is the believe that taxes are efficient and effective tools to stimulate the economy and encourage business investment decisions. Do high taxes really hurt the economy as much as they believe and will lowering them have much of an impact on stimulating it? Anecdotal stories and illustrations confirm the tax fallacy. High tax states such as Minnesota have generally fared better in terms of economic growth, unemployment, median family incomes and location of Fortune 500 companies, than low tax ones such as Mississippi and Alabama. If taxes were the only factor, Mississippi would be thriving, Minnesota in the tanks. At best, there is little correlation between taxes, income, and unemployment rates, but in many situations high taxes, and with that, government expenditures on education, workforce training, and infrastructure, correlate positively with income and low unemployment and business retention. One needs to look not just at one side of the equation—taxes—but the other side too—what taxes buy—to see what value businesses get out of them in terms of educated workforces and infrastructure investments. Most debates fail to do this.
Using statistics gathered by the Bureau of Economic Analysis one can also examine how economic growth is related to tax rates. One can compare annual economic growth as measured by the percent change in the gross domestic product (GDP) percent based on current dollars, comparing it to the highest federal individual marginal tax rate and the top corporate tax rate since 1930. Effectively, look at the tax on the wealthy and corporations. If taxes are a factor affecting economic growth, one should see an inverse relationship between growth of the U.S. economy and higher tax rates. The GDP should grow more quickly when top individual and corporate tax rates are lower. If taxes are a major factor deterring economic growth, lines on a graph should go in opposite directions: As tax rates go up the GDP should go down.
No such pattern emerges between high taxes and GDP growth over 80 years. During the Depression era of the 1930s corporate and individual taxes rates increased but in 1934 through 1937 the GDP grew by 17%, 11%, and 14% annually. Top corporate tax rates climbed to over 50% through the 1960s, again with no discernible pattern associated with decreased economic growth. The same is true with top tax rates on the richest which were as 91% into the 1960s. Conversely, since the 1980s after Kemp-Roth and then after 2001 with the Bush era tax cuts, there is no real indication that the economy grew more rapidly than in eras with significantly higher tax rates on the wealthy and corporations. Looking at time periods when tax rates were at their highest, GDP often grew more robustly than when taxes were cut. Visually, the graph simply fails to demonstrate that tax rates negatively impact economic growth.
Pictures are worth a thousand words, but statistics are priceless. Statistically, if a tax hurts economic growth, the correction with it is -1. If they positively facilitate growth the relationship is 1, and if they have no impact the 0. The correlation between GDP and top individual taxes is 0.29, between GDP and top corporate taxes is 0.32, and among the three it is 0.14. Statistically, there is a slight positive impact on either top individual or corporate taxes or economic growth, but overall almost no connection between tax rates on the wealthy and corporations and economic growth in the United States.
But what about taxes as job killers? Again running similar statistical tests, there is little connection. Using Bureau of Labor Statistics data on unemployment rates since 1940, the correlation among top individual and corporate taxes and the annual unemployment rate is -0.02—essentially no connection at all.
Now some will claim that the 1963 Kennedy tax cuts are an example of how changing tax rates will stimulate the economy. Contrary to the folk legends, there is little evidence they helped the economy. And even if tax cuts do stimulate the economy, presently the US economy is doing well with near 3% GDP growth. The cuts will do little to help the economy, especially if concentrated in the hands of the wealthy or corporations. If anything, targeted cuts to help those currently unemployed, or incentives to invest to increase worker productivity, will be more helpful.
Cuts in taxes without cuts in spending inflate the national debt and that may not be beneficial. Conversely, cuts in taxes along with cuts in government spending will depress the economy.
Finally, now think about the bidding war by states to lure the new Amazon headquarters to their communities. Again, there is little evidence that tax incentives are a major determinant of business location decisions. Businesses, when looking to locate, look to the quality of the workforce, access to markets and suppliers, infrastructure, and other amenities (such as the arts) are far more important factors influencing location decisions than tax cuts. Literally hundreds of studies and interviews with businesses confirm this. Businesses ask for tax cuts for one reason--because t hey can--and governments are foolish enough to oblige.
The belief that tax cuts make much of an economic difference is a lie that is hard to kill off. Trump's tax plan, along with the Amazon scam, are just the latest examples of policy ideas that do no more than enrich the wealthy at the expense of the rest of us.
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