Thursday, September 18, 2008

More thoughts on Marginal Tax Rates

Alan Greenspan recently alluded to the fact that he doesn't support keeping tax rates low if it means increased debt. I couldn't agree more: It's called classic fiscal conservatism, not this low-tax rhetoric of today's Grand Old (really old) Party.

There are plenty of sophisticated studies that show that there is virtually no impact on investment from higher marginal tax rates on individual income. Other studies (equally (sophisticated) say that high levels of debt are damaging to economic performance, investment, and growth. But, as my graduate econometrics professor once told me, "if you torture the data enough, it will confess." In other words, maybe these studies are doing something high-falootin that is getting the data to tell us something that really isn't there. So, take these scatterplots (pictures) on for size (longitudinal data from World Development Indicators, 1998-2006):

Investment v. Government Debt:

Negative relationship. Classic fiscal-conservative result.

Investment v. Highest marginal corporate tax rate:

Negative relationship, not so bad, but now...

Investment v. Highest individual marginal tax rate:

Nothing!!! Even if there were, it's a positive trendline! Maybe some fancy-pants regressions will help:

Coefficients Standard Error t Stat
Intercept 27.33017 1.984217 13.77378
Government Debt -0.0221 0.010433 -2.11784
Highest Marginal Individual Tax -0.0238 0.031682 -0.75128
Highest Marginal Corporate Tax -0.0927 0.059525 -1.55728

Whew! At least that straightens out the signs to be as expected: Lower taxes (especially on individual incomes) are only useful for stimulating investment all else equal, i.e. if they don't lead to higher debt levels (exactly what Greenspan said!). Even then the impact of the debt is significant; the effect of taxation is not significant (in a statistical sense - significance roughly requires column 3 (t-stats) greater than 2 or less than -2).

Here's the punchline: anyone who tries to sell lower individual income taxes as a boon to investment is full of hooey (technical term).


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