Thursday, February 3, 2011

Chained to Real: Tax Rates, Inflation-adjusted GDP Measures, and the Difference

The question:  what impact (if any) do top marginal tax rates have on GDP growth rates?

Our previous chart of top marginal tax rates versus GDP growth rates utilized "chained dollars," a measure with which not everyone is familiar. That data was drawn from the BEA's Current-dollar and "real" GDP table. While the chained dollars therein are a measure of real GDP, they're not the only measure. There's a slightly different set of data at the BEA's NIPA Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product.

To satisfy those who wonders whether the result would be different if we use another measure of inflation-adjusted GDP:

Left scale for top US marginal income tax rates. Right scale for GDP growth in inflation-adjusted "real" dollars. A 10 year moving average for each figure is also included. GDP data from the BEA. Tax rate data from
The results of using this measure of (inflation-adjusted) real GDP are almost the same as using the (inflation-adjusted) chained dollars. From 1951 through 1963 the top tax rate varied between 91 and 92%. During those years, the average rate of inflation adjusted GDP growth (using real dollars) rested at 3.72%, a rather robust growth rate. (GDP growth averaged 3.39% from 1951 through 2007.) By contrast, the GDP growth under the average 37.4% top tax rate from 1986 through 2008 was only 3.2%, 0.52% lower growth than under the much higher 1951 - 1963 tax rate.

Regardless of which inflation-adjusted measure we use, the answer is still the same: Overall, the past 80 years show us a thorough lack of clear correlation between the top marginal tax rate and GDP growth. The data's closest hint of a relationship derives from the slightly more robust average GDP growth back when the top rates were higher, but that closest hint isn't close enough to be sure of an ideal rate. The notion that lowering the top tax rates improves the economy just doesn't hold water. Indeed, these 8 most recent decades show us that increasing the top tax would not necessarily have any impact on the economy, let alone slow it at all.
original chart

Update 02/07/2011:  Replaced original chart with improved version featuring better parity of scales, better visibility of trendlines, and replacement of the poly trend with a linear. The change in scale does suggest an interesting symmetry in the past two or three decades. We'll look at that in more detail later.

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