G12 Top Marginal Rate vs GDP Residual Growth1920-2010

The two scatter plots show the curvilinear relationship between the top rate and residual growth for the data when the top bracket was above and below 80 times per-capita GDP. The charts use the same two year lead time as previous charts showing the relationship between the top rate and growth.

The red curvilinear fit line from the left scatter plot is the basis for the growth estimate shown in red on the time-series plot. The violet curvilinear fit line in the right scatter plot is the basis for the growth estimate shown in violet on the time-series plot.

The violet and red lines together show the influence of the top marginal tax rate on growth for the last 90 years. This influence combined with the influence of the top bracket and capital gains rate make the model in Figure G14.

The residual growth is the actual growth less the influence of the top bracket; its construction is shown in Figure G11. The fastest year of residual growth was 1923 which grew 9% faster than the estimate based on the top bracket. This year corresponds to the 73% top rate in 1921.

Having the top rate estimate residual growth makes for a more natural combination of the two data ranges with different brackets. The different ranges for the top bracket are shown in Figure T3.

G11 GDP Growth estimated by Top Bracket with Residual 1920-2010

This chart shows actual GDP growth from 1920, the growth estimated by the top bracket as shown in Figure G9 and the residual of the growth minus the estimate.

Figures G12 and G13 show the relationships of the Top tax rate and the capital gains tax rate with residual growth.  Letting the tax rates estimate residual growth makes for smoother construction of the model in Figure G14 that uses the top bracket, the top rate and the capital gains rate to predict growth.

T3 High and Low range for Top Bracket

The top tax bracket affects how the top tax rate and capital gains tax rate correlate with growth. As the top bracket moves higher the growth maximizing marginal tax rate also moves higher.

The top tax rate appears to have a growth maximizing rate of 54% when the top bracket is below 80 times per-capita GDP and a maximizing rate of 66% when the top bracket is above 80. The scatter plots showing these correlations are in Figure G12. Eighty times 2010 per-capita GDP was about $3.8 million.

The capital gains tax rate appears to have a growth maximizing rate of 28.7% when the top bracket is below 900 times per-capita GDP and a growth maximizing rate of 91% when it is above 900. The scatter plots showing these correlations are in Figure G13. Nine hundred times 2010 per-capita GDP is about $42.6 million.

G9 Top Tax Bracket vs GDP Growth 1920-2010

The scatter plot shows that over the last 90 years the top tax bracket has had a positive relationship with growth. This is demonstrated by the upward sloping best fit line in the scatter plot. The strongest year of growth, represented by the highest point in the plot was 1942 which grew 18.5%. This growth corresponds to the top bracket in 1939 of $5 million or 7106 times per-capita GDP.

There have been three distinct multi year periods where GDP annualized growing more than 7%: the early 1920s, the mid 1930s and the early 1940s. All three of these periods correspond with a top bracket of at least $1 million or over 1000 times per-capita GDP. The best growth came with the $5 million bracket.

On the other hand, cutting the top bracket from $5 million to $200,000 corresponds with the weakest year of growth outside The Great Depression.

The significant correlation of the top bracket’s influence on growth in recent years is somewhat hidden by the large variation in the top bracket prior to W.W.II. The post war period is shown separately in Figure G10.

The linear correlation of the top bracket to growth shown here is the first of 3 variables making up the GDP growth model shown in Figure G14. The other two are the influence of the top tax rate and the capital gains rate.

T2 Top Tax Bracket 1913-2010

The top tax bracket is the income level above which the top marginal tax rate applies. In 2010 the top bracket for married filing jointly couples was $373,650. The portion of ordinary family income above this level was taxed at the top rate of 35%. The first $373,650 of family income was taxed at the lower marginal rates.

The top bracket has ranged from $29,000 to $5 million or from 1.4 times per-capita GDP to 7648 times. Currently the bracket is about 7.9 times per-capita GDP. The top bracket as a multiple of per-capita GDP has a stronger correlation with growth and job creation than as a dollar amount or an inflation adjusted dollar amount.

The top bracket to some degree represents the scope and progressivity of the tax system. When it was at $5 million it directly affected very few people, but represented a system with over 30 tax brackets.

The top bracket has its strongest positive correlation to GDP growth leading 3 years. So a higher bracket this year would be a positive influence on GDP growth 3 years from now. The correlation is shown in Figures G9 and G10.

G8 Tax Policy vs Long Term Growth 1968-2010

Here are the 5 year estimates of growth based on the model in Figure G7. The five years 2008-2012 is estimated to annualize growing 0.3% a year, down from the 0.9% annualized for 2006-2010. To hit the 0.3% forecast precisely, 2011 and 2012 would need to grow at a 0.8% rate.

G7 Tax Policy vs GDP Growth 1968-2010

Figure G7 shows annual growth for GDP from 1968 to 2010 and the combined influence on growth from the curvilinear relationship of the top marginal tax rate on growth shown in Figure G5 and the curvilinear relationship of the capital gains tax rate shown in Figure G6.

The curvilinear relationships of the tax rates with growth suggest the baseline growth rate for current tax policy is 0.3%.  This is weaker than the forecast of the linear correlations shown in Figure G3.

Figure G8 shows the actual growth over 5 year periods and the 5 year rate of growth estimated by the above model.

To show the influence of tax policy on growth prior to 1968 requires showing the influence of the top tax bracket on growth and how the top bracket affects the growth optimizing tax rates. These correlations are covered in Figures T2, T3 and G9 –G15.

G6 Capital gains vs GDP Growth 1968-2010

This figure shows the curvilinear relationship between economic growth from 1968 to 2010 and the capital gains tax rate. Each point in the scatter plot shows the growth rate for one year with the capital gains rate from 5 years earlier. For example the highest point on the chart show that GDP grew 7.2% in 1984 and that the capital gains rate 5 years earlier in 1979 was 28%.

The best fit curved red line in the scatter plot is used to make the model in the time series plot on the right. The data suggests that a capital gains tax rate of about 29.1% would maximize the growth rate and if the tax rate is above or below that level that growth will be weaker 5 years later.

The weakest growth on the chart, 2009, corresponds with a below optimal 15% capital gains tax rate. The next weakest year, 1982, was influenced by an above optimal 39.9% tax rate.

The influence of the capital gains tax rate on growth is combined with the effect of the top tax rate in Figure G5 to make a model that estimates growth in Figure G7.

G3 Tax Policy vs GDP Growth 1984-2010

At a given tax bracket there is a growth optimizing top tax rate and capital gains tax rate. Since 1984 both tax rates have been below the growth maximizing level. The top rate (in green) leads growth 2 years. The capital gains rate (in blue) leads growth 5 years. Every tax rate cut in the chart corresponds with weaker growth while tax increases correspond to stronger growth. The model (in red) shows the combined influence of the two tax rates on growth. It predicts a baseline growth rate of 0.8% going forward.

The strongest growth in 1984 corresponds with the highest tax rates in the period, 50% top rate and a 28% capital gains rate. The great recession corresponds to the lowest combination of tax rates. The Recession of 1990 corresponds to the next lowest combination.

Volatility in annual GDP growth may mask the significance of tax policy’s impact on growth. Figure G4 shows the growth rate over 5 year periods and the rate predicted by tax policy.

Looking back prior to 1984 requires showing the curvilinear relationships between growth and tax rates shown in Figures G5 – G8.

Looking back prior to 1968 requires examining growth’s relationship with the top tax bracket and how the top bracket influences the growth optimizing tax rates, as shown in Figure T2 and Figures G9 –G15.

G1 GDP Growth 1920-2010

The chart shows the annual growth rate of the US gross domestic product (GDP) since 1920. Since the 2001 tax cut 9 out of 10 years have grown at a rate below the 3.3% average. Shaded areas represent recessions.

(Economic Growth, average growth, chart, graph,)