Does Taxing The Rich Hurt Growth? A Redistributive Lesson

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Redistribution, progressive taxes, class warfare, taxing the rich. All of these you have probably heard recently, and depending on who you talk to you might have heard different things about them.

The Democrats, and President Obama wish to raise the tax rate on the top earners – the $250,000 and $1 million marker has been tossed around. Despite popular belief that these earners are the “job creators” and taxing the wealthy leads to less output – history tells a little different story.

Instead of reducing the tax burden on upper income individuals, the theme should be about the “virtuous circle” of economic growth – where a growing middle class, “the great compression,” leads to a stronger more robust economy driven by consumer demand. One problem we have is that capital accumulates at the upper strata of the income sphere and isn’t funneled into demand for products and services at the same rate as it would be for lower-income classes.

Ask many economists and social experts and they will tell you that income inequality is one of the fundamental causes of our slow economic growth, and it isn’t just liberal democrats they say this – Here is Rush Limbaugh,

The middle class is the key to greatness in this country… We had the largest middle class in the world, and it’s under assault from practically every direction… it’s being destroyed.

Here is a fact that doesn’t sit well with me, and many who read it:

Wealth has flowed so massively to the top that…the top 1 percent (3 million people), reaped two-thirds of the nation’s entire economic gains (2002-2007)… In 2010, the first full year of the economic recovery, the top 1 percent captured 93 percent of the nation’s gains. – Kendrick Smith

Concentrated wealth works against economic growth, and the income disparity between the upper and the middle classes is partially to blame for the lack of robustness seen in the American economy. Harvard economist Philippe Aghion notes “impressively unambiguous” evidence that inequality reduces growth rates. This idea has also been supported by the International Monetary Fund (IMF) who says that more equal income distributions best support conditions for long-term growth.

With this growing inequality in America, people should really be fighting for more redistributive tax structures that grow the wages of the middle and lower classes while suppressing the excessive lenience we give to those in the upper income brackets. This would mean a raising of the income and capital gains tax rate, and a progressive estate and inheritance tax for the upper income levels. At the same time decreasing the rates paid by the middle class and expanding consumer markets for the lower-income levels.

Out of curiosity, I have done a simple economic regression on GDP growth rates from the years 1930-2012 using the top income marginal tax rate for comparison. While other factors may be driving GDP growth rates, the results are still quite surprising.

The data shows that a 1% increase in the top tax rate corresponds with a .06% change in the GDP growth rate. The results are highly significant. Here is a plot of this result, with GDP growth rate on the vertical axis and tax rate on the horizontal.

 So when someone tells you that raising taxes on the wealthy is going to hurt the economy, take it with a grain of salt. On the face of it the evidence suggests that this is simply not the case. What we need to fight for is smart, sound economic policies that support the formation of a strong consumer class to drive our economy.

I will touch more on income inequality and the “virtuous circle” in future posts.

5 thoughts on “Does Taxing The Rich Hurt Growth? A Redistributive Lesson

  1. Reply Tim Miles Oct 12,2012 %I:%M %p

    Yes. The Bush tax cuts during his administration did not lead to significant job growth. What happened is that the United States actually lost tens of thousands of manufacturing jobs due to increased automation of production and offshoring.

    • Daniel McKay Reply Daniel McKay Oct 12,2012 %I:%M %p

      It goes without being said that the tax cuts were slanted heavily towards the upper-class and high income earners. It lead to an increase in income inequality and also contributed to a rocketing debt level- with what you said, limited job growth.

  2. Reply obua samuel baker Oct 21,2012 %I:%M %p

    i totally agree with this idea,taxing highly high income earners lowering taxes on low income earners (progressive tax system) and ensuring equitable distribution of income and resources in all sectors of the economy.

  3. Reply Robin Jan 30,2013 %I:%M %p

    You’re absolutely right, though there are many on the right adamantly opposed and resolute in fighting against raising taxes on the top 1%. Unfortunately, it seems some politicians are in their constituents pockets and serve as their mouthpiece.

  4. Pingback: Cutting Taxes on Millionaires DOESN’T Increase Economic Growth ← ideafart

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