You Blew It! The Case for Higher Tax Rates?

Posted: Nov 23, 2014 12:01 AM

“The American economy grew faster in the 1950s and 1960s when the tax rates were much higher.” — Lou Dobbs, Fox Business anchor

A popular myth, perpetuated by Lou Dobbs, is that the best period of economic growth was during the 1950s when the top rate was more than 90%.

One pundit expands the argument: “There is no historical evidence that tax cuts spur economic growth. The highest period of growth in U.S. history (1933-1973) also saw its highest tax rates on the rich: 70-91 percent. During this period, the general tax rate climbed as well, but it reached a plateau in 1969, and growth slowed down five years later. Almost all rich nations have higher general taxes than the U.S., and they are growing faster as well.”

Is this true?

Remember, in economics correlation is not the same as causation. There may be factors other than the tax rate to explain the performance of the economy. For example, during the 1950s, when the top marginal rates exceeded 90%, almost nobody paid those rates because of all of the loopholes in the law — tax shelters, trusts, offshore investments, etc.

The 1950s also may have benefited from a pent-up release of entrepreneurial stimulus following the Great Depression and World War.

Checking the academic literature on the subject of taxes and economic growth, the vast majority, almost 90%, conclude that increased taxes have a negative effect on the economy. This makes practical sense. Higher taxes raise the cost of doing business.

Of those studies that distinguish between the types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.

My assessment: Economic growth could have been faster if tax rates and the burden of government had been reduced in the 20th century.

Ben Franklin said it best, “A virtuous and industrious people may be cheaply governed.” Do we have cheap government? When I make an appearance as Ben Franklin, I’ve asked this question to the audience, and no matter what their political affiliation, they all answer that government is expensive and no bargain.

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In case you missed it, I encourage you to read my e-letter column from last week about an economics expert’s forecast for markets.