Historical Tax Rates: Rhetoric vs. Reality

Nov 14 2012

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A recent report by the Congressional Research Service (CRS) claims that changing the top statutory individual income tax rate has little or no effect on economic growth. To support this claim, the CRS report compares the top rates from 1945 through 2010 with various economic indicators, such as private saving, investment, productivity, and per capita GDP; and it finds no statistically significant relationship. This result should not be surprising. The top rate is only one feature of our tax system. By itself, the top rate tells us nothing about the overall tax burden.

When it comes to economic growth, what matters most are the effective marginal tax rates on labor and capital. Effective rates reflect the interaction between statutory rates, credits, and deductions for individuals and businesses, as well as the distribution of income. Marginal rates measure the additional taxes paid on additional income earned. Thus, the effective marginal tax rate determines the after-tax return to labor and capital, which affects the incentive to work, save, and invest. The top rate affects the economy only to the extent that it affects the effective marginal tax rate.

Historical Rates and Economic Growth

Between the mid-1940s and the early-2000s, the top statutory individual income tax rate declined from 94 percent to 35 percent. Despite this dramatic decline, the average annual rate of growth in real per capita Gross Domestic Product (GDP) has exhibited no discernible trend. See the chart at the top of page 2.

A recent CRS report says historical evidence supports the claim that “the top tax rates appear to have little or no relation to the size of the economic pie.” Many pundits and policy advocates have actively publicized the CRS report and proclaimed that it proves raising taxes on the richest Americans won’t adversely affect the economy. In fact, the CRS report merely proves historical changes in the top rate provide a misleading indicator of how the overall tax burden has changed over time.

 

See the full JEC Republican commentary attached below in pdf format:

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