High Tax Rates and Real Per Capita GDP

Peter Diamond, Professor Emeritus at MIT, and Emmanuel Saez, Professor of Economics at UC Berkeley, recently published an opinion in the Wall Street Journal on 23 April that serves to back up the call of the Democratic Socialist Party for increased tax rates on the rich.  They claim that high tax rates will not slow growth.  Let us examine some of their claims.

They note that when the top tax rates in the U.S. were high, 70% and above, from 1950 to 1980, the growth of GDP averaged 2.23% a year.  Between 1980 and 2010, GDP growth averaged only 1.68% a year, though the highest tax bracket rates were relatively low.  To evaluate the implications of these facts for the effect of a high tax rate, we need to ask if this is a controlled experiment with the highest tax rates the only important variable.

The answer is no.  In 1950, most of the world owed the U.S. huge amounts of money due to WWII.  Western Europe, Japan, and China were trying to rebuild following their devastation in WWII.  American exports and our investments overseas were making Americans tons of money, especially given that we were ourselves finally leaping forward from a base that had been much lowered by the Great Depression.  American men had returned from the war eager to make a better life than they had known in the Great Depression and the war.  Americans were healthier, better fed, and better housed than any other major nation's people in the world.  What is more, while Eisenhower did not drop the top tax brackets while trying to pay down the WWII debt, he did stop much of the socialist interference with the economy that had come to dominate it under FDR and Truman.  In comparison, the United Kingdom and France had turned heavily to socialist policies that retarded their economic growth.  Germany perhaps less so, but Germany had been especially destroyed, divided, and was hurt by British and French takings as reparations.  Germany and the United Kingdom had also lost much of a generation of men.

By 1980, the many nations so damaged by WWII as Germany, Japan, and the UK had been, had managed to become more capable of competing in the world economy with the U.S., simply because they had largely rebuilt.  In some cases, because of the massive rebuilding, their plant and equipment were actually newer than that of many companies in the U.S.  A new generation of workers was also now at a productively mature age in these countries, as well.  The playing field was once again more even.  So, how did the competition compare based on the respective upper tax bracket rates in these countries?

Diamond and Saez choose to make the comparison from 1970 to 2010, instead of from 1980 to 2010, despite having noted already that the high tax rates in the U.S. were not lowered until after Reagan became President in 1981.  Actually, the lowering was a couple years later than that, but it sure was not near 1970.  The same was approximately true in the United Kingdom, since Margaret Thatcher took over in 1979 and soon after lowered the British highest tax rates.  The 1970s in the U.S. were also a mess because of Nixon's Price Freeze and the policies of Jimmy Carter and the Federal Reserve that led to investment killing high inflation rates.  Before Thatcher, Great Britain was the socialist Sick Man of Europe, with many nationalized industries and rampant labor unions.

So, Diamond and Saez point out that from 1970 to 2010, real GDP in the U.S. increased at an average rate of 1.80% a year and it increased a bit faster in the previously lethargic U.K. at 2.03% a year.  In comparison, the high tax rate in France yielded an average growth rate of 1.72% a year and in Germany a rate of 1.89% a year.  Not much difference.  Of course, they fail to point out the other extraneous factors than high tax brackets that wipe out most of any advantage that lower tax rates might have had in part of their extended period.  Throwing in the lost decade of the 1970s in the U.S. and the U.K. hides the effect of each country's lowered upper tax brackets later.  This is really of the nature of a dirty trick.  It is partisan politics on the part of Diamond and Saez.

James Pethokoukis has discussed this much more meaningful comparison of real GDP growth from 1981 to 2010.  Examine the graph of real GDP per capita for each nation below:

During the 1982 recession, the real per capita GDP in the U.S. was about $4,000 dollars greater than that in France and Germany.  It was about $7,000 more than that in the U.K.  In 2010, the U.K. had surpassed France.  From 2002 to 2008, the U.K. had been equal to Germany in per capita real GDP, but did fall back as the result of the financial failures that hit the larger financial industry in the U.K. compared to that in Germany.  The U.K. had also tried too much stimulus spending, as had the U.S. in response to the Great Socialist Recession of 2008-2012.  It seems likely on the basis of this much more valid comparison that the lower upper tax rates of the U.S. and the U.K. did have a salutary effect on real per capita GDP.  Indeed, Pethokoukis offers comparisons of the U.S., Australia, Canada, Britain, France, Germany, Italy, and Switzerland. Those countries with high upper tax brackets compared to the U.S. and the U.K. fell back in per capita GDP.  In both the U.S. and the U.K. there was also a relative decrease in regulations and an increase in privatization, so some other effects are also contributing.

Diamond and Saez also make claims that tax revenues do not take a hit unless the top tax rate is greater than the 50 to 70% range.  They believe that a man will work just as hard when 50 to 70% of his time is taken from him as he will when 35% of his time is stolen.  So they advocate a hike in the highest tax brackets and also in capital gains and dividend tax rates.  When GE employs 1600 professional workers to evade taxes set at a rate of 35%, one has to wonder how Diamond and Saez can convince themselves of such nonsense.  It may be that people work almost as many hours under high tax rates, but it is clear that many of the hours they work are then devoted to avoiding those high tax rates!  They believe the government can and will invest the money of the rich better than the rich would.

They make assertions that some public investments such as education, infrastructure, and research have high rates of return.  Yet, in fact there is no correlation of added education expenditures, either at the federal or the local levels, with knowledge in our children in the government-run school systems.  Infrastructure may be necessary, but it is common for infrastructure spending to have very long payback times, such as 50 years in many cases.  This is not a high rate of return.  Government research is a mixed bag.  Much of it is a waste and some is good.  The nearly $100 billion spent on climate research in the last couple of decades has very little to show for itself.  Research money spent by industry has a much better track record.  Before claiming that government spending constitutes a wise investment, we need to ask how wisely the private sector would have spent the same money.

I suppose we will always have to expect that Progressive Elitists will back the idea that government spends money wisely, but not many Americans really agree with that.  Admittedly, there seem to be many Americans who think government wastes their money, but would not be wasting the money of the wealthy.  I am sure they are not thinking that government actually invests the money of the wealthy better.  They are only thinking that they do not much care whether the government invests someone else' money well or not as long as they get a freebee or two out of it.  That is the unbecoming thinking of a freeloader.