The Corner

Economy & Business

Tax Rates and Growth

Some conservatives make overblown claims about the impact of tax rates on economic growth. Too many conservatives, for example, wrongly predicted that the Clinton tax hike of 1993 would cripple the economy. Instead, of course, we went through a boom. I wouldn’t conclude from that fact that tax rates don’t matter at all. The boom of the 1990s is compatible with the view that all else equal, an economy will do better when taxes leave people with strong incentives to work, save, and invest. But it does suggest that we should have some perspective on how strong this effect is likely to be.

When Reagan took the top tax rate from 70 to 50 percent in his first term, it increased the after-tax return on a dollar earned by 67 percent. (I’m leaving out state and local taxes for convenience.) When he cut it again to 28 percent in his second-term tax reform, that return increased by another 44 percent. But when Clinton took the top rate from 31 to 39.6, it lowered that return by only 12 percent. It should not have been expected to have terrible effects. And it shouldn’t have been surprising that any negative effects it had were overwhelmed by other trends, such as favorable demographics, falling energy prices, and technological change, among others.

Writing about Jeb Bush’s tax plan, the Wall Street Journal’s editors expressed a different view:

Liberal economists argue that marginal rates don’t matter now that they are no longer above 50%. But the Reagan reform of 1986–which Mr. Bush cites as a precedent–cut the top rate to 28% from 50%. That reform helped to sustain the 1980s economic boom and set the stage for growth through the 1990s.

So we had fast growth when the top rate was 39.6 percent from 1993 through 2000, but that’s really a reason to go back to the 28 percent top rate of 1988-1990, when growth was slower, because the high growth of the 1990s was really a delayed reaction to those low-tax years. This does not seem to me like a successful argument.

The conclusion that the Journal attributes to “liberal economists” doesn’t seem right either. Cutting the top marginal rate would be helpful, but probably not so much that we need to be single-minded about it. We might, for example, want to reduce the top tax rate to 35 percent instead of 28: giving high earners a nice tax cut and boosting incentives, but also leaving us able either to keep deficits lower or provide more middle-class tax relief, and making for a tax cut that is not quite as easy to dismiss as a Republican favor to the rich.


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