Myth of the Day: Raising Tax Rates Will Not Harm Economic Growth

A centerpiece of the progressive case for big government is the premise that high taxes don’t effect economic growth.  In Tax Myths Debunked, co-authors Dr. Pozdena and Dr. Fruits offer extensive historical and theoretical evidence which establishes that government spending is not a “free lunch.”  Instead, taxes have real effects on the choices made by the individuals and businesses that must pay them. Those decisions by citizens and firms have a ripple effect through the economy that results in broad and substantial effects to innovation, entrepreneurship, labor migration, business migration, productivity, wage growth, and employment growth.

The economic case that taxes negatively affect growth rests on the notion that taxes lower the return for productive activity like work, production, and innovation. Lowering the return to such productive activity—activity which often involves substantial difficulty and sacrifice—leads people to engage in that activity less frequently. Moreover, those businesses and highly talented individuals with the greatest ambition and will to succeed are likely to take their opportunity or talent to greener pastures—states or nations with more favorable business climates.

Ironically, many progressive groups that dismiss the case against high and inefficient taxes are happy to accept that taxes do indeed change behavior, just not productive behavior. Advocates of so-called sin taxes on cigarettes, soda, and liquor support those discriminatory taxes based on the premise that the tax will lead fewer citizens to engaging in these behaviors.

Citing studies from a range of reputable sources, including President Obama’s own former council of economic advisors, Dr. Pozdena and Dr. Fruits highlight the wealth of historical evidence in agreement with the theoretical case. This evidence establishes the proven negative effects of taxation on economic growth and investment. This includes national level studies, as well as those studies that analyze state level difference in tax policy and economic performance. Utilizing IRS taxpayer migration statistics, the research presented in Tax Myths Debunked proves that tax rates matter when decisions about where to locate one’s family or business arise.

Similar to the efforts of Dr. Pozdena and Dr. Fruits, Dr. William McBride at the Tax Foundation analyzed the evidence on how taxes affect economic growth in a study titled, “What is the Evidence on Taxes and Growth.”  Dr. McBride’s findings are substantial:

“In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth. Of those studies that distinguish between types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.”

Perhaps most staggering is the size of the effect of taxes on GDP. Christina Romer, a former chief economic advisor to President Obama, along with her husband David Romer, found that:

  • Each 1 percent increase in taxation lowers real GDP by 2 to 3 percent.
  • These damaging effects on the economy are persistent and are not diminished by offsetting changes in prices.
  • Investment falls sharply in response to tax increases. It is very likely that this strong retreat of investment is part of the reason the declines in output are so large and persistent.

To read more about the relationship between tax policy, stimulus spending, and their effects on an economy during a recession, check out Tax Myths Debunked. Co-authors Dr. Pozdena and Dr. Fruits use overwhelming evidence to confirm that the path to prosperity is in free-market, pro-growth policies. The report is available for free download at www.alec.org/tax-myths-debunked.

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One Response to Myth of the Day: Raising Tax Rates Will Not Harm Economic Growth

  1. Eric Johnson says:

    I love their contradictory notion that sin taxes reduce bad behavior while taxes on good behavior will have no impacts. Huh?

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