Marginal, at Best

In an Economix post about the Bush tax cuts, David Leonhardt writes:

The theory for why tax cuts should create growth and jobs is a strong one. When people are allowed to keep more of each dollar they earn, they are likely to work longer and harder. The uncertainty is the magnitude of this effect. With everything else that’s happening in a $15 trillion economy, how large of an effect on growth do tax cuts have?

Every available piece of evidence seems to suggest that the Bush tax cuts did little to lift growth.

Indeed, its fairly easy to demonstrate in simple economic models that higher marginal tax rates distort the economy and might lead to less labor effort and less saving (and hence a smaller capital stock).  To be careful, though, in most models the effect of a tax reduction would be on the levels of income and output, not on the long run growth rate.

Nonetheless, there are pretty solid economic theory reasons why economists - even those of us with generally liberal (in the contemporary American sense) political inclinations - would favor tax reforms that would broaden the tax base (i.e., reduce deductions and credits) and lower marginal tax rates.  But perhaps not as fervently as Glenn Hubbard, who recently wrote:

When I left my job as the deputy assistant Treasury secretary for tax policy in 1993, I left a message on my office blackboard for my successor. I wrote, “Broaden the base, lower the rates” repeatedly until I filled the entire space. I then had it covered with wax so it could not be erased. (Yes, the government charged me for my bit of vandalism. But it was worth it.) 

I share his instinctive sympathy for this aspect of the Simpson-Bowles proposal (though I basically agree with Paul Krugman that the package is bad overall).

However, as Leonhardt points out, as an empirical matter, its not clear that tax rates make that much of a difference to overall economic performance.  The best decade for growth in the postwar period was the 1960's, when the top marginal income tax rate was over 70% (as I noted in the second-ever post here).  The economy did well after the 1993 increase in the top marginal tax rates, and not particularly well after the 2001 and 03 rate cuts.

Of course, that doesn't prove anything - the effect of any policy should to be judged relative to a counter-factual. That is, perhaps the economy would have done even better in the 1990's without the tax increase, and even worse in the 2000's without the tax cuts.  Nonetheless, I think a brief glance at historical evidence is enough to convince us that lower marginal tax rates aren't some magical economic elixir.  As an economist, I'll never say that people don't respond to incentives, but, in the case of taxes, it looks like they don't respond very much.