The Congressional Research Service (CRS) stirred controversy last year when it released a study claiming that tax rates do not influence economic growth. Predictably, those who favor higher taxes used the flimsy report to bolster their backward argument that raising tax rates, as Congress and President Obama did with the fiscal cliff deal, would not further slow our economy.
The CRS report was not based on robust statistical analysis, but on simple correlations that reveal little about the impact of tax rates on the economy. The weakness of the CRS report brought well-deserved criticism.
CRS pulled the report after the controversy but subsequently re-released it with minor changes.
In December, in response to the controversy regarding the CRS report, William McBride of the Tax Foundation published a review of the scholarly literature on taxation and economic growth. McBride reported that the empirical work of economists agrees overwhelmingly that higher tax rates slow economic growth and he concludes that “the U.S. tax system is a drag on the economy.”
Their findings are no surprise. It has long been known that higher tax rates slow the economy because they reduce the incentives to work, invest, and take new risks. These academic studies succeed in confirming this because, unlike the CRS report, they conducted rigorous statistical analysis to isolate the impacts of tax rates on many economies during many different time periods.
Surveying 26 scholarly studies dating from 1983, McBride finds that 23 of the studies—and every study in the past fifteen years—corroborated the finding that higher taxes negatively affected growth.
For example, Young Lee of Hanyang University and Roger Gordon of the University of California at San Diego in a 2005 Journal of Public Economics paper estimate that cutting the corporate tax rate by 10 percentage points would induce one to two percentage points higher growth every year.
Moreover, in a forthcoming paper in the American Economic Review, Karel Mertens of Cornell University and Morten Ravn of University College London find that cutting the personal income tax rate by one percentage point would cause per capita gross domestic product (GDP) to increase by 1.8 percent in the first nine months.
Taxes do not all have the same economic effects: Some taxes create more distortions in markets and the economy than others. McBride notes:
[C]orporate and personal income taxes are the most damaging to economic growth, followed by consumption taxes and property taxes…. Our current economic doldrums are the result of many factors, but having the highest corporate rate in the industrialized world does not help.
The hard data and econometric analyses highlighted by McBride underscore an important policy lesson: increasing taxes, both personal and corporate income tax rates, will impede the growth of the U.S. economy.