The Literature on Taxes and Economic Growth

Many readers of the Oregon Catalyst believe that higher taxes curtail economic growth, and lower taxes stimulate economic growth. Progressives believe the opposite. Progressives fancy themselves as folks that follow the science, but the social science doesn’t back their deeply held faith about tax policy. The idea that raising taxes to fund higher spending is inherently better for economic growth has long been evidence-starved.

The peer-reviewed economic literature supports the basic premise that keeping public sector costs down enables more economic opportunity.

• Jay Helms, The effect of state and local taxes on economic growth: a time series-cross section approach, Review of Economics and Statistics (1985) found that revenue used to fund transfer payments retards growth.
• Reinhard Koester & Roger Kormendi, Taxation, Aggregate Activity and Economic Growth: Cross-Country Evidence on Some Supply-Side Hypotheses, Economic Inquiry (1989) found that increases in marginal tax rates reduce economic activity. Progressivity reduces growth.
• John Mullen & Martin Williams, Marginal tax rates and state economic growth, Regional Science and Urban Economics (1994) found that higher marginal tax rates reduce GDP growth.
• Howard Chernick, Tax progressivity and state economic performance, Economic Development Quarterly (1997) found that progressivity of income taxes negatively affects GDP growth.
• R. Kneller, M. Bleaney & N. Gemmell, Fiscal Policy and Growth: Evidence from OECD Countries, Journal of Public Economics 171-190 (1999) found that distortionary taxes reduce GDP growth.
• M. Bleaney, N. Gemmell & R. Kneller, Testing the endogenous growth model: public expenditure, taxation, and growth over the long run, Canadian Journal of Economics (2001) Distortionary taxes reduce GDP growth. Consumption taxes are not distortionary.
• Stefan Folster & Magnus Henrekson, Growth effects of government expenditure and taxation in rich countries, European Economic Review (2001) found that tax revenue as a share of GDP is negatively correlated with GDP growth.
• F. Padovano & E. Galli, E., Tax rates and economic growth in the OECD countries (1950-1990), Economic Inquiry (2001) found that effective marginal income tax rates are negatively correlated with GDP growth.
• Olivier Blanchard & Robert Perotti, An Empirical Characterization Of The Dynamic Effects Of Changes In Government Spending And Taxes On Output, Quarterly Journal of Economics (2002) found that positive tax shocks, or unexpected increases in total revenue, negatively affect private investment and GDP.
• Randall Holcombe & Donald Lacombe, The effect of state income taxation on per capita income growth, Public Finance Review (2004) found that states that raised income taxes averaged a 3.4% reduction in per capita income.
• Young Lee & Roger Gordon, Tax Structure and Economic Growth, Journal of Public Economics (2005) found that reducing corporate income tax 1 percentage point raises annual growth by 0.1 to 0.2 points.
• International Monetary Fund, Will it hurt? Macroeconomic effects of fiscal consolidation, in World Economic Outlook: Recovery, Risk, and Rebalancing (2010) found that 1% tax increase reduces GDP by 1.3% after two years.
• Alberto Alesina & Silvia Ardagna, Large changes in fiscal policy: taxes versus spending, in Tax Policy and the Economy, (2010) found that fiscal stimuli based upon tax cuts more likely to increase growth than those based upon spending increases. Fiscal consolidations based upon spending cuts and no tax increases are more likely to succeed at reducing deficits and debt and less likely to create recessions.
• Christina Romer & David Romer, The macroeconomic effects of tax changes: estimates based on a new measure of fiscal shocks, American Economic Review (2010) found that Tax (federal revenue) increase of 1% of GDP leads to a fall in output of 3% after about 2 years, mostly through negative effects on investment. I wrote about this for the Oregon Catalyst nearly a decade ago here.
• Robert Barro & C.J. Redlick, Macroeconomic Effects of Government Purchases and Taxes, Quarterly Journal of Economics (2011) found that a cut in the average marginal tax rate of one percentage point raises next year’s per capita GDP by around 0.5%.
• Karel Mertens & Morten Ravn, The dynamic effects of personal and corporate income tax changes in the United States, American Economic Review (2012) found that a 1 percentage point cut in the average personal income tax rate raises real GDP per capita by 1.4 percent in the first quarter and by up to 1.8 percent after three quarters. A 1 percentage point cut in the average corporate income tax rate raises real GDP per capita by 0.4 percent in the first quarter and by 0.6 percent after one year.
• Ergete Ferede & Bev Dahlby, The Impact of Tax Cuts on Economic Growth: Evidence from the Canadian Provinces, National Tax Journal (2012) found that reducing corporate income tax 1 percentage point raises annual growth by 0.1 to 0.2 points.
• Karel Mertens & Jose Luis Montiel Olea, Marginal Tax Rates and Income: New Time Series Evidence, Quarterly Journal of Economics (2018) found that a 1 percentage-point decrease in the tax rate increases real GDP by 0.78%.
• Nguyen et al., The Macroeconomic Effects of Income and Consumption Tax Changes, American Economic Journal (2021) found that a 1 percentage-point cut in the average income tax rate raises GDP by 0.78%.

Why do progressives reject the science? Should we call them economic stagnation deniers?

Eric Shierman lives in Salem and is the author of We were winning when I was there.