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Economic Myths Debunked Debunked III

Finally we get into some real statistical meat in the third part of this series. (Part I/Part II/Original MJ Post)

Myth 3: Lower Taxes are the Best Way to Grow the Economy

No one likes paying higher taxes. But do lower taxes actually spur economic growth? Bruce Bartlett, an economist in the Reagan administration, has compared tax rates in various rich countries in 1979 to each country’s growth rate since then. His conclusion? There’s virtually no correlation. Recent US history backs this up too.

Taxation is one part of an enormously complex economic ‘equation.’ There are many factors that go into whether an economy expands or contracts. Taxation, regulation, government spending, entitlement programs, natural resources, corruption, behavior, culture, diversity, monetary policy, immigration, the list goes on. The ‘market’ is organic; three hundred million people interacting throughout an entire continent, making billions of decisions everyday. And then we must consider the global economy, which is six billion people participating in trade across borders. Finding one factor amidst all that complexity will be tough.

Beyond the complexity inherent in economic analysis, discussing taxation also presents us with a major confound. Taxation changes behavior. We all experience this. Every tax season millions of us pay money to accountants in order to pay what we owe, and not a penny more. I have to imagine the number of people who go to a tax preparer and say “find out what I owe, then we’ll give ’em an extra ten percent” is really, really low. The mortgage deduction enables and encourages homebuying. Cigarette taxes reduce the amount people smoke and reduce the total percent of the population who smoke. People will commit incredible financial and behavioral acrobatics to avoid paying taxes. Black markets, gray markets, flea markets, all are products of the drive to avoid taxes and regulation.

And thus, if people change their behavior based on taxes in order to minimize what they pay, we can assume there might be some difficulty in doing a straight-up comparison between tax rates and GDP growth.

This current liberal talking point, that taxes don’t have consequences, is based on a ridiculously simplistic attitude towards the economy. It’s nonsense. Anyone who thinks a 99% income tax won’t hurt the economy can kindly stop voting, forever. People would simply stop working and support themselves in ways not reported to the IRS.

The Mother Jones people do give us an interesting graph comparing effective income tax rates to a rolling average GDP growth:

I like the use of a rolling average for GDP growth because it eliminates a lot of the noise found in the year-to-year numbers. Captain Capitalism, a blog that should a daily read, looked at the relationship between the rolling GDP growth and another huge economic factor, government spending:

And wouldn’t you know it, the more our government has spent, the more slowly our economy has grown. Is this something we see elsewhere? Oh yes:

So yes, while trying to pin down specifics regarding tax rates and tax methods is very difficult, and economies are really complex and it’s hard to find a single big factor affecting how it grows, we do see an obvious pattern where the larger government is as a percent of the whole economy, the slower that economy grows.

Controlling the percent of the economy the government represents is thus a huge goal, if you care about economic growth.

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