Taxes, Big Government, and Economic Growth

It’s often taken as a truism that lower taxes lead to higher levels of economic growth. The National Center for Policy Analysis, an anti-tax think tank, goes so far as to assert that if the United States had lowered its marginal tax rate to the “optimal tax rate,” growth in the United States would have increased from 3.4 percent per year to 4.6 percent per year between 1950 and 1995. They argue that lowering taxes will encourage people to work more, thus increasing the total revenue collected by the government through taxes. It’s a restatement of the Laffer Curve. It’s also the argument advanced in every introductory economics textbook. And according to most studies, it’s also wrong.

Baseline Scenario has a great analysis of the relationship between tax rates and growth in gross domestic product in the United States since the end of World War II. Their finding? There is no relationship. An analysis of the data comparing unemployment rates and tax rates in OECD countries suggests that there is no direct relationship there either. Baseline Scenario’s conclusion is a good one:

I don’t think these pictures prove anything. Well, maybe they prove one thing: that the real world is more complicated than the first-year economics textbook…If there’s one thing I’d like people to take away, it’s that any theoretical economic argument that can be stated in a sentence is as likely to be untrue as true in the real world, no matter how clever or intuitive it is.

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