Examining 'trickle down' economics

The top marginal tax rate and the capital gains rate do not correlate with economic growth.
October 25, 2012

Much of the presidential campaign has focused on the economy. In part, this discussion has focused on how to grow the economy and create jobs. Conservative economic policy advocates for reducing taxes — claiming that the investments will increase due to increased returns. At the same time, the reduced rates would lead to increased revenues overall by taking a smaller percentage of the larger economy. In contrast to this proposal, others argue that the top tax rates must be increased in order to increase revenues and decrease the federal deficit.

There are two key elements that must hold true for either solution to solve the problems with the economy that the candidates have framed the election around. First, any decrease in the tax rate must actually grow the economy in order to generate the additional revenues necessary to reduce the deficit. Conversely, an increase in the tax rates must not cause a recession, which would reduce the size of the economy and lower revenues — despite the increase in rates. The function that predicts tax revenues as a function of the tax rate is commonly called the Laffer curve, named for Arthur Laffer whose writings on the matter were published by the conservative Heritage Foundation. Second, in order to benefit an average income earner, any growth in the economy must correlate to increasing median income.

In September, the Congressional Research Service published an economic analysis of the top marginal tax bracket and the capital gains tax rate — two specific policies in question this fall — and their influence on economic growth and income distribution since 1945. CRS is a nonpartisan organization that provides policy and legal analysis exclusively to members of Congress and their staff. The reports they publish are not generally available directly to the public unless members or their staff choose to make them available to their constituents. The New York Times recently reproduced the report, allowing the public to see the nonpartisan analysis of one of the issues at the heart of the debate this election cycle.

CRS’s findings first show that the top marginal tax rate has decreased from 90 percent after World War II to 35 percent today. The capital gains tax rate fluctuated from 25 percent in the 1950s to 35 percent in the 1970s to today’s rate of 15 percent. In total, the average tax rate paid by the very wealthy has dropped from above 40 percent to under 25 percent today — the lowest since World War II. However, the correlation between these reductions and economic growth per capita, although positive, is not statistically significant. They also fail to correlate with savings, investment or productivity growth — indicating that a reduction in the tax rate will not in fact pay for itself as claimed by conservatives. However, CRS did find that decreasing top tax rates did correlate to a statistically significant degree with increasing income disparity. Note that although the disparity correlates, it does not necessarily indicate that low incomes fall — just that top income growth outpaces growth in the median income.

CRS is nonpartisan, but the report presents significant evidence that raises questions about conservative claims on fiscal policy. Yes, cutting taxes sounds good in a 15-second sound bite, but voters deserve the statistical analysis as well, free of class-based rhetoric.

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