Over at the Center on Budget and Policy Priorities, Chye-Ching Huang has written a massive review of the evidence and literature on the relationship between taxes on high-income earners and their effects on economic growth. Her key findings are surprisingly straightforward, and important for how we approach current debates over tax reform and economic policy:
Taxable income and revenue. Opponents of raising the taxes that high-income households face often point to findings that high-income taxpayers respond to tax-rate increases by reporting less income to the Internal Revenue Service (IRS) as evidence that high marginal tax rates impose significant costs on the economy. However, an important study by tax economists Joel Slemrod and Alan Auerbach found that such reductions in reported income largely reflect timing and other tax avoidance strategies that taxpayers adopt to minimize their taxable income, not changes in real work, savings, and investment behavior. While such strategies entail some economic costs, these costs are relatively modest.
Work and labor supply. The evidence shows that changes in tax rates that fall within the ranges that policymakers are debating have little impact on high-income individuals’ decisions regarding how much to work. As Leonard Burman, former head of the Urban-Brookings Tax Policy Center (TPC), recently testified, “Overall, evidence suggests [high-income Americans’] labor supply is insensitive to tax rates. A marginal rate increase may encourage some taxpayers to work less because the after-tax return to work declines, but some will choose to work more, to maintain a level of after-tax income similar to what they had before the tax increase. The evidence suggests that these two opposing responses largely cancel each other out.
Small business. The evidence does not support the claim that raising top marginal income tax rates has a heavy impact on small business owners: a recent Treasury analysis finds that only 2.5 percent of small business owners fall into the top two income tax brackets and that these owners receive less than one-third of small business income. Moreover, even those small business owners who would be affected by tax increases on high-income households are unlikely to respond by reducing hiring or new investment.
Growth and jobs. History shows that higher taxes are compatible with economic growth and job creation: job creation and GDP growth were significantly stronger following the Clinton tax increases than following the Bush tax cuts. Further, the Congressional Budget office (CBO) concludes that letting the Bush-era tax cuts expire on schedule would strengthen long-term economic growth, on balance, if policymakers used the revenue saved to reduce deficits.
There is a lot more than this, and it all points to the same conclusion: Conservative claims notwithstanding, there’s little evidence that tax increases for high-income Americans in the range we’re considering—i.e., a bump to the Clinton-era rates—will have an adverse effect on economic growth. Instead, higher taxes are key to reducing our medium-term deficit and making investments to critical government programs.
To put this another way, the entire supply-side narrative of the Republican Party—and Mitt Romney’s campaign for the presidency—has no basis in reality. As we’ve seen through both the Ronald Reagan and George W. Bush administrations, it’s a fiction meant to justify lower tax rates on the rich, and deep cuts to social spending.
Not that this will penetrate the public consciousness; supply-side economics has been discredited for years, but conservtives refuse to give up the fantasy, and in recent years, have doubled-down on the conviction that tax cuts will pay for themselves with economic growth. The Ryan budget, for example, uses “dynamic scoring” to achieve its promise of deficit reduction. It assumes massive economic growth as a result of tax cuts, which will generate enough revenue to form the basis for a sustainable budget. In other words, magic.
My expectation is that this will be treated as a debate point—“Some people say that tax cuts don’t pay for themselves, others disagree.”—and not an observed fact of our shared reality. As is usually the case, Republicans will avoid any real scrutiny, from the political press at least, on the utter absurdity of their budget proposals.