Thursday, January 09, 2014
Tweet[IWS] CRS: TAX RATES AND ECONOMIC GROWTH [2 January 2014]
IWS Documented News Service
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Institute for Workplace Studies----------------- Professor Samuel B. Bacharach
School of Industrial & Labor Relations-------- Director, Institute for Workplace Studies
Cornell University
16 East 34th Street, 4th floor---------------------- Stuart Basefsky
New York, NY 10016 -------------------------------Director, IWS News Bureau
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Congressional Research Service (CRS)
Tax Rates and Economic Growth
Jane G. Gravelle, Senior Specialist in Economic Policy
Donald J. Marples, Specialist in Public Finance
January 2, 2014
http://www.fas.org/sgp/crs/misc/R42111.pdf
[full-text, 12 pages]
Summary
This report summarizes the evidence on the relationship between tax rates and economic growth,
referring in a number of cases to other CRS reports providing more substance and detail.
Potentially negative effects of tax rates on economic growth have been an issue in the debates
about whether to increase taxes to reduce the deficit and whether to reform taxes by broadening
the base to lowering tax rates.
Initially, it is important to make a distinction between the effects of policies aimed at short-term
stimulation of an underemployed economy and long-run growth. In the short run, both spending
increases and tax cuts are projected to increase employment and output in an underemployed
economy. These effects operate through the demand side of the economy. In general, the largest
effects are from direct government spending and transfers to lower-income individuals, whereas
the smallest effects are from cutting taxes of high-income individuals or businesses.
Long-run growth is a supply-side phenomenon. In the long run, the availability of jobs is not an
issue as an economy naturally creates jobs. Output can grow through increases in labor
participation and hours, increases in capital, and changes such as education and technological
advances that enhance the productivity of these inputs.
Historical data on labor participation rates and average hours worked compared to tax rates
indicate little relationship with either top marginal rates or average marginal rates on labor
income. Relationships between tax rates and savings appear positively correlated (that is, lower
savings are consistent with lower, not higher, tax rates), although this relationship may not be
causal. Similarly, during historical periods, slower growth periods have generally been associated
with lower, not higher, tax rates.
A review of statistical evidence suggests that both labor supply and savings and investment are
relatively insensitive to tax rates. Small effects arise in part because of offsetting income and
substitution effects (which make the direction of effects uncertain) and in part because each of
these individual responses appears small. Institutional constraints may also have an effect.
Offsetting income and substitution effects also affect savings. Capital gains taxes are often
singled out as determinants of growth, but their effects on the cost of capital are quite small.
International capital flows also appear to have a small effect. Most expenditures that affect the
productivity of labor and capital inputs (research and development, education, or infrastructure)
are already tax favored or provided by the government. Small business taxes are also sometimes
emphasized as important to growth, but the evidence suggests a modest and uncertain effect on
entrepreneurship.
Claims that the cost of tax reductions are significantly reduced by feedback effects do not appear
to be justified by the evidence, where feedback effects are in the range of 3% to 10% and can, in
some cases, be negative. Because of the estimated realizations response, capital gains tax cuts
have in the past been estimated to have a large revenue offset (about 60%), but more recent
empirical estimates suggest one of about 20%. In general, for stand-alone rate reductions the
additions to the deficit would cause tax cuts to have a larger cost both because of debt service and
because of crowding out of investment, which would swamp most behavioral effects.
Contents
Short-Run Counter-Cyclical Effects Versus Long-Run Growth ...................................................... 1
Historical Comparisons of Tax Rates, Labor Supply, Savings, and Growth Rates .......................... 1
Labor Force Participation .......................................................................................................... 2
Savings and Investment and GDP Growth ................................................................................ 3
Review of Evidence on Factors Affecting Growth .......................................................................... 5
Labor Supply ............................................................................................................................. 6
Savings and Investment Response ............................................................................................. 6
Technological Progress, Innovation, and Small Business ......................................................... 7
Dynamic Revenue Estimating ......................................................................................................... 8
Figures
Figure 1. Tax Rates and Labor Force Participation ......................................................................... 2
Figure 2. Tax Rates and Hours Worked ........................................................................................... 3
Figure 3. Tax Rates and Net Savings ............................................................................................... 4
Tables
Table 1. Average Top Tax Rates on the Growth Rate of Real GDP and Real Net Fixed Investment, by Time Period ................... 5
Table 2. Average Top Income Tax Rate on the Growth Rate of Real GDP ..................................... 5
Contacts
Author Contact Information............................................................................................................. 9
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