The Effect of Tax Cuts and Tax Hikes on Economic Expansions

Angry Bear:

Notice… the expansions that follow tax cuts (either during the recession itself or at the start of the recovery) have tended to be the shortest ones in our sample. And short expansions are definitely not a good thing; we’re all better off with expansions that go on for a while.
What about the speed of the expansion? The annualized growth (i.e., the speed per month) of real GDP per capita for each expansion since 1929 is shown below.

This graph also does not appear to mesh with popular wisdom (not to mention accepted economic theory) in America today. In general, when tax cuts occurred during or just after a recession, the resulting expansion has been slower than when the tax rates are kept unchanged. Expansions associated with early tax hikes are the fastest of all.
Which leads us to the overall growth of the economy during the entire length of each expansion, which is shown in the next graph.

Once again, the theoretical benefits of a tax cut do not seem to match what the data shows, which is that least impressive expansions are those that follow decreases in marginal income tax rates (either during the recession itself or at the start of the recession).

So where does this leave us? Well, simply put, the data and the theory/popular wisdom do not agree. Going as far back as there is official data on economic growth, what we find is that expansions associated with reductions in the top marginal income tax rate have been shorter and slower than expansions that did not involve tax cuts. Which means, simply put, that the theory is probably wrong, and we as a nation continue to buy into it at our detriment.

Graph 1

Notice… the expansions that follow tax cuts (either during the recession itself or at the start of the recovery) have tended to be the shortest ones in our sample. And short expansions are definitely not a good thing; we’re all better off with expansions that go on for a while.

What about the speed of the expansion? The annualized growth (i.e., the speed per month) of real GDP per capita for each expansion since 1929 is shown below.

Graph 2

This graph also does not appear to mesh with popular wisdom (not to mention accepted economic theory) in America today. In general, when tax cuts occurred during or just after a recession, the resulting expansion has been slower than when the tax rates are kept unchanged. Expansions associated with early tax hikes are the fastest of all.

Which leads us to the overall growth of the economy during the entire length of each expansion, which is shown in the next graph.

Graph 3

Once again, the theoretical benefits of a tax cut do not seem to match what the data shows, which is that least impressive expansions are those that follow decreases in marginal income tax rates (either during the recession itself or at the start of the recession).

So where does this leave us? Well, simply put, the data and the theory/popular wisdom do not agree. Going as far back as there is official data on economic growth, what we find is that expansions associated with reductions in the top marginal income tax rate have been shorter and slower than expansions that did not involve tax cuts. Which means, simply put, that the theory is probably wrong, and we as a nation continue to buy into it at our detriment.

Posted via email from Jim Nichols