Friday, November 19, 2010

Growth and the Bush tax cuts

David Leonhardt, the lead economics correspondent for The New York Times, has written a blog post in which he asks whether the Bush tax cuts helped to promote economic growth. The answer he arrives at is essentially "not really," relying heavily on the following chart as evidence:

But how is this evidence of the impact of the tax cuts? After all, economic growth is a function of a myriad of other factors including trade policy, monetary policy, technological innovation and -- perhaps most notably -- regulation. Tax cuts may strengthen an economy, but if the overall burden placed on it is higher due to deterioration in these other factors, performance will still be slower. Conversely, if taxes are increased but other factors improved, economic growth should quicken.

Take the time period of 1996-2000, for example, which is the second highest five year period in the chart. While personal and corporate taxes were increased in 1993, this time period also witnessed huge amounts of technological innovation as the internet came into mainstream use, a big boost to free trade through the completion of NAFTA and the Uruguay Round of GATT talks in the 1993-95 period, the 1996 Telecom Reform Act which eliminated major ownership restrictions for radio and television groups and a capital gains tax cut in 1997.

Even looking at tax rates alone doesn't tell us as much as we might think. Is a top tax rate of 30 percent which applies to those making over $250,000 preferable to a top rate of 40 percent which only applies to those making at least $1 million? The answer might not be so clear.

In addition, when considering the burden imposed by taxes it's also useful to consider the role of tax complexity. The US has a tax code which is over 16,000 pages in length, which goes a long ways towards explaining why it is ranked 62nd out of 182 countries by the World Bank in the ease of paying taxes. It stands to reason that a high flat tax rate may be more conducive to growth than a more complicated system with lower rates.

Economic growth is a complicated matter, and Leonhardt does the debate no favors by distilling it down to a simple examination of tax rates. It's a lesson that those conservatives who obsess over tax rates while giving short shrift to other factors would also do well to heed.

Related: Check out this Washington Post opinion piece from a Democrat entrepreneur who laments the strangling effect of government red tape on business.

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