GDP Growth Rate And What It Means For The Election

The 3rd Quarter Gross Domestic Product (GDP) growth rate (2.0%) was announced today and as expected, the “growth” is anemic and completely in line with what we would expect from Obamanomics.  Keep in mind that the economy should be booming by now after coming out of such a deep recession and we see that countries who adopt Free Market/Small Government approaches have actually seen GDP growth rates in the 4-6% range.   Red State gives a great summary of the latest GDP report and shows that some of this GDP growth came from increases in government spending (which came from the Military):

“Real federal government consumption expenditures and gross investment increased 9.6 percent in the third quarter, in contrast to a decrease of 0.2 percent in the second.”

It should also be noted that GDP figures are constantly updated and adjusted as this WSJ article reminds us:

“Beware of revisions. Today’s release is based on incomplete data, and will likely be revised in the months ahead. Those revisions can be substantial. For the first quarter of 2011, for example, the Commerce Department initially estimated a 1.8% growth rate. After revisions, that rate now stands at just 0.1%.”

What it means for the Election

One of the major policy differences between Mitt Romney and Barrack Obama is their stance on tax rates for the wealthy and what those tax rates mean for the economy and GDP.  Obama thinks that having the rich ‘pay a little more’ will stimulate the economy and reduce the deficit while Romney is in favor of stimulating the economy by reducing corporate tax rates and promoting a pro business agenda that will benefit all socioeconomic groups.

I’ve shown before how raising taxes on the wealthy will not reduce the debt because we have a spending problem, not a tax revenue problem but I’ve not seen data to address the effects on GDP from higher/lower marginal tax rates on the wealthy.

Until now.

Here is the opening paragraph of the blog post that summarizes the question.

“What is the impact of taxation on growth? In theory, a country without taxation will have difficulty providing basic public goods such as roads and research that are fundamental for economic growth. However, many politicians and some economists argue that once basic public goods are provided for, increases in taxation have a negative impact on growth. According to this argument, this is especially true for taxes on the very wealthy, who are likely to save their income and channel that savings into entrepreneurship or other investment. Much of the argument over tax policy in the United States is focused on whether the rich should be taxed at a higher or lower rate than they are today. The argument in favor of higher rates is that income inequality is at extremely high levels and the government should focus more on redistribution and also that the rising national debt is also potentially harmful to growth. The argument against higher rates is that raising taxes on wealthy would disincentivize the people most likely to create economic growth and thus jobs. In a climate where jobs are scarce, the argument goes, this is a particularly bad economic idea.”

So that is the question – Do higher tax rates on the wealthy affect the GDP?  Anyone with even a superficial knowledge of Economics knows that proving this with data is fraught with error because inputs to a Macro Economic model are much more complex that just income tax rates.  Other influences such as financial crises, foreign economies, bubbles, commodities, government policy (i.e. Obamacare), etc. all play into the overall health of an economy and the author recognizes this as well.

“This debate, however, is largely based on ideology rather than evidence. Unfortunately, it is quite difficult to figure out the impact of taxation on growth.”

But it’s still worth looking at the data to see if there is a strong statistical correlation between income tax rates on the wealthy and GDP and here is where the blog post continues.

“Nevertheless, looking at the raw correlation between top marginal tax rates and growth can be helpful for getting a rough sense of the likely impacts of higher taxation on growth. One recent paper by Pikkety, Saez, and Stantcheva looks at the correlation between top marginal tax rates and growth and finds the growth is higher when top marginal tax rates are higher.”

And here is the graph:

You can visually infer from the graph above that there appears to be zero correlation between tax rates on the wealthy and GDP.  If you imagine the trend line isn’t there, you can see that GDP growth rate averages about 5% no matter what the top marginal tax rate is.  The author goes through the statistical calculations from various time periods that shows there is not enough correlation (P-values are too high) to make a scientific statement and from the data on this graph I have to agree with him.  Here is the quote from the blog post:

“While we cannot say that there is a robust significant positive relationship between tax rates and growth”

I agree with this statement and from this data I would conclude that higher marginal tax rates on the wealthy have zero effect on overall GDP.  And if you remove the data points during World War II (1941, 1942 and 1943) where higher income tax rates yielded a higher GDP, then the correlation is even weaker.  During that period of time our GDP was humming due to war spending and this had nothing to do with the higher tax rates on the wealthy because we were borrowing all that money to spend on the war.

But that doesn’t stop the blog author from making this odd conclusion:

“What does this mean for public policy? Given the large rise in inequality in the United States over the past 40 years, if the historical evidence tells us that it is unlikely that taxing the wealthy has a large negative impact on growth (and it might even have a positive impact), shouldn’t we increase rates on the wealthy from their current top rates of 35%?”

That seems highly illogical.  If there is no statistical correlation between higher income tax rates on the wealthy and GDP then why raise taxes on them?  I’ve already shown where the extra tax revenue will not decrease the debt so that must mean the only reason to raise tax rates on the wealthy is to redistribute the wealth to others.  In other words, let’s steal money from a group of US citizens and give it to another group of US citizens even though it will have no effect on the overall US economy.

The goal of Economic theory is to prevent recessions/depressions and have positive GDP growth so if you determine that manipulating an input variable has no effect on the output then you should look for other input variables.  The US economy is in trouble and the field of inputs that need to be manipulated is target rich so why waste resources on inputs that data proves will not affect the output?

Even without this data, the notion that a higher income tax rate on the wealthy has zero correlation with GDP makes sense.  Ultra wealthy people will spend money on the things they want to spend their money on regardless if their income tax rate is 35% or 70%.  They are very wealthy and have enough money to spend in the economy to live the way they want to live.  The only ‘cutting back’ they’ll do is with their investments and they’ll restructure those to pay less taxes (capital gains vs. income) and this will have little effect on the economy.

All this talk from Team Obama about having the wealthy pay a little more is nonsense and meant to tug at the heart strings of the base of the Democrats.  Let’s hope enough of the US voting public sees through this lie on November 6th.

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4 Responses to GDP Growth Rate And What It Means For The Election

  1. Pingback: Facebook's first report: Numbers, or chatter? | Wall Street Stocks

  2. Operative word when discussing the “have-the-wealthy-pay-a-little-more” scheme as any sort of serious approach:

    Excellent job, Cosmo.

  3. Bazmac says:

    Of course, while attempting to undercut the argument that raising taxes on the wealthy will have a positive effect on the deficit, you simultaneously demolish the entire premise of supply-side economics: that high rates discourage economic growth and low rates stimulate it.

    • cosmoscon says:

      On the top marginal rate, yes. The data appears to show that the tax rate on the uber wealthy has no effect on GDP. And since raising taxes on this top marginal rate will not reduce the deficit, then we shouldn’t do it. Why turn a knob that has no effect on the output? Unless you are just trying to score political points with your base….

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