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.

G2 GDP Growth with low tax rates 1920-2010

The green triangles show the years of growth influenced by a top marginal tax rate below 37%. The top rate one year influences growth about two years later. So when the top rate was cut to 35% in 2003 it affected growth beginning about 2005. The years affected by at this low top rate averaged a negative growth rate of -0.1%.

The blue diamonds show the years influenced by a capital gain tax rate at or below 20%. The capital gains rate leads growth by about 5 years. So cutting the capital gains rate to 20% in 1997 began affecting growth about 2002. The years corresponding to a capital gain rate at or below 20% averaged growing at 1.4%.

The years affected by both a top rate below 37% and a capital gains rate at or below 20% averaged negative growth at -0.8%. The Great Depression, the recession of 1990 and the Great Recession were all influenced by such a tax policy. Only one year affected by such a tax policy, 1929, had above average growth.

Growth influenced by low tax rates compares poorly with the 3.3% average growth rate.