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Saturday, March 17, 2012

"Wishful Thinking About Tax Rates"

Christina Romer gives some evidence (or, to be more precise, notes the lack of evidence) on the dynamic effects of tax cuts discussed in the post below this one:

That Wishful Thinking About Tax Rates, by Christina Romer, Commentary, NY Times: At least since Calvin Coolidge, politicians have trumpeted the supply-side benefits of cutting marginal income tax rates. Lower rates will unleash economic growth and the cuts will largely pay for themselves — or so it’s often said. Yet careful studies find little evidence of such effects. ...
This idea was the essence of President Ronald Reagan’s theory of supply-side economics, and his justification for large, permanent tax cuts in the early 1980s. Mitt Romney, now seeking the Republican nomination for president, cited a similar argument when he proposed cutting all income tax rates 20 percent. ...
History shows that marginal federal income tax rates have varied widely. ... If you can find a consistent relationship between these fluctuations and sustained economic performance, you’re more creative than I am. ...
Of course, many factors affect the economy, so a lack of correlation doesn’t prove that marginal-rate changes have little impact. That’s why economists have devoted thousands of pages in journals to testing the effects more scientifically.
One standard approach is to look for natural experiments in the tax code. ... But a critical review of several natural-experiment studies concluded that ... if the marginal tax rate for high earners decreased from its current level of 35 percent to 28 percent (which Mr. Romney proposes), reported income would rise by just 2 1/2 percent.
In a new study, David Romer and I found that changes in marginal rates in the 1920s and ’30s had even smaller effects. ...
Where does this leave us? I can’t say marginal rates don’t matter at all. ... But the strong conclusion from available evidence is that their effects are small. ...
[I]ncome inequality has surged in recent decades. Raising marginal rates on the wealthy is a straightforward, effective way to counter this trend, while helping to solve our looming deficit problem. Given the strong evidence that the incentive effects of marginal rates are small, opponents of such a move will need a new argument. Invoking the myth of terrible supply-side consequences just won’t cut it.

    Posted by on Saturday, March 17, 2012 at 03:52 PM in Budget Deficit, Economics, Productivity, Taxes | Permalink  Comments (57)


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