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Accounting for Growth: the Role of Taxes

September 17, 2012 3 minute Read by Matthew Denhart

In the Sunday review pages of this week's New York Times, David Leonhardt asks the sensible question, "Do tax cuts lead to economic growth?" Leonhardt then offers a chart that plots U.S. economic growth from the late 1980s through today (using a five-year running average). The chart has annotations showing tax-rate increases in 1990 (under George H.W. Bush) and 1993 (under Bill Clinton), and tax-rate reductions in 2001 and 2003 (under George W. Bush). What is immediately obvious is that economic growth was much higher in the 1990s, following tax-rate increases, than it was in the 2000s, following tax-rate cuts. The implication from Leonhardt is that tax cuts do not lead to strong growth. But is the experience of the 1990s really a good guide to answering Leonhardt's initial question, about the relationship between tax cuts and growth? Ike Brannon — a fellow of the 4% Growth Project — wrote recently for this site on Leonhardt's very topic. Brannon points out that the IT revolution, and its accompanying productivity gains, are to thank for such impressive economic growth in the 1990s. Tackling the tax question head-on, Brannon concludes: "Lower marginal tax rates in the 1990s would have resulted in even higher growth than was actually achieved. Similarly, higher tax rates in the last decade would have resulted in lower growth." In an article for Forbes.com, Charles Kadlec points out other factors, beyond IT gains, that helped boost economic growth in the 1990s. In particular, the Clinton years were witness to a number of pro-growth policy changes like welfare reform, new free-trade agreements, a stable dollar, and a balanced federal budget. These policies, Kadlec says, helped usher-in the years of strong growth which could have possibly been even stronger with lower tax rates. Debate over the effect of tax rates on growth is not new, and the issue is certainly not resolved. Even the best economic models and equations cannot perfectly explain what "causes" growth because economies are so dynamic and have so many simultaneously moving variables. Therefore, tax-rate increases coinciding with strong growth does not necessarily mean that high taxes caused that growth. Perhaps growth in the 1990s would have been even stronger had tax rates been more amiable. Regardless, the real lesson is that growth results from many factors, and trying to explain a decade of growth using a single policy variable is an inherently limited exercise.


Author

Matthew Denhart
Matthew Denhart

Matthew Denhart is an expert on immigration policy and is the author of the Bush Institute’s America's Advantage: A Handbook of Vital Immigration and Economic Growth Statistics, now in its third edition. He currently serves as executive director of the Calvin Coolidge Presidential Foundation and is a founder of the Coolidge Scholars Program which provides full-ride merit scholarships to America's most promising college students. A summa cum laude graduate of Ohio University, Denhart has written and spoken widely on a variety of policy topics including the economics of higher education, labor, and taxes. He has contributed articles to numerous national publications including The Wall Street Journal, Forbes.com, CNN Opinion, and Bloomberg View. 

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