August 22, 2011

A Growing Problem

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As a first order of business, welcome to Cornell, class of 2015! You’re in for a great four years, though as a senior I can now credibly say that they go by much quicker than one anticipates. To all returning students, welcome back! I hope you’ve had great summers and are as excited to be on the Hill as I am.

I finished my string of columns last semester with one that, by my own admission, was not the most riveting piece of reading material I’ve ever come up with. But the topic — tax reform — was nonetheless one worth addressing. In that column I wrote about growing political will on the right to eliminate useless tax expenditures, more colloquially known as tax loopholes. In light of the fact that many large corporations were earning record profits while high unemployment persisted and wage growth stagnated, a number of Republicans were conceding that tax loopholes needed to be addressed.

These statements seemed promising, and I expressed hope that such considerations would carry over into the negotiations for a long-term deficit reduction deal. Unfortunately, whatever hope there was in the spring quickly evaporated as budget talks began. Despite a clear trend of successful tax avoidance by a multitude of large corporations, Republicans refused to agree to revenue increases of any form.

Neither their obstinacy nor their reasoning was novel. Ostensibly, Republicans feared that the elimination of loopholes would be equivalent to tax increases, and that increasing corporate tax burdens in the midst of a sputtering recovery would be economically devastating. Revenue increases, they insisted, were necessarily “job-killers” and would destroy our nation’s growth. President Obama’s attempts to assuage Republican concerns by delaying the implementation of tax reform for at least another year were futile; the elimination of tax expenditures remained anathema to Congressional Republicans.

We all know what happened next: Congress couldn’t agree to a plan that would even approximate the goal of $4 trillion in deficit reduction over the next decade. And because of the lackluster deficit reduction deal, S&P downgraded the U.S. credit rating, reducing investor confidence further and exacerbating the recent downward trends of markets. S&P made no secret that Republican brinkmanship and refusal to compromise on tax reform were to blame; ironically, these tactics disrupted the recovery far more than the modest proposals for tax reform possibly could have.

But let’s step back for a moment and unpack the core of the Republicans’ argument. If tax increases are necessarily harmful to growth, one could reasonably expect that similarly situated countries with higher tax burdens would experience lower growth levels than those with lower tax burdens. Surprisingly for Republicans (and unsurprisingly for the rest of us), both longitudinal and cross-sectional analyses of empirical tax and gross domestic product data violate this expectation.

Consider first the cross-sectional analysis. When graphing tax burden as a percentage of G.D.P. against G.D.P. growth for countries in the Organization for Economic Cooperation and Development (a consortium of democratic countries with market economies that are considered to be high income, developed nations), no stable relationship emerges. Many countries have significantly higher tax levels than the United States, yet experience much higher growth rates. These include Austria, Finland, Norway, Belgium and the U.K. (Note: the data I’m referencing are averaged from 1970 – 2004; they therefore do not account for the recession).

Regression analysis of OECD data does show a weak negative relationship between taxes and growth, but these findings come with two caveats: First, the explanatory power of the regressions are very low, as a vast majority of the data points fall far beyond the predicted line. Second, the regressions demonstrate that certain forms of taxes impact growth more than others. So while large increases in marginal tax rates might negatively impact growth, eliminating distortion-inducing tax expenditures would have far less of a deleterious effect, and in fact my boost growth.

The longitudinal case also shows no stable relationship between taxes and growth. The United States, despite its present insistence on low taxes, has historically had much higher top marginal tax rates. Yet if one looks at GDP growth per annum versus the top marginal tax rates of the same years, again, no consistent trends emerge. In fact, in the early 1950s the United States had a top marginal tax rate of 91 percent — more than two and a half times the current top marginal tax rate — yet the country experienced record GDP growth. Similarly, during recent years of historically low tax rates, the country experienced lower growth rates.

These are simplistic analyses, to be sure, but they demonstrate that assertions of a negative causal relationship between taxes and growth don’t necessarily hold water. Obviously, a great many additional factors affect how a country grows and develops, and with this in mind, it’s worth mentioning that I’m not attempting to argue that higher tax levels necessarily lead to higher growth.

Rather, the point I’m making is that fiscal policy must be developed intelligently in light of the conditions of the current day and age. When wealth continues to be concentrated in the hands of a select few, when corporations are earning record profits yet unemployment is persistently high, when wages for an overwhelming majority of Americans are stagnating or even shrinking while earnings of wealthy Americans grow astronomically, and when the United States has a balance sheet that requires more than just spending cuts to bring it back into the black, it’s clear that leaving revenue increases off the table is more than bad politics, it’s bad policy.

To remain a vibrant, competitive nation, the United States must be able to invest in its human capital. Washington clearly needs to undergo serious belt-tightening to curb the rapid growth of the nation’s debt, but in doing so, it would be counterproductive to force cuts in areas such as education, research and certain forms of social spending, all of which produce positive externalities that greatly exceed the government’s initial investment.

Rational economists on both sides of the aisle agree that tax reform must be part and parcel of any comprehensive debt reduction strategy. It’s high time that Republicans stop jeopardizing the economy in a bet on their political future and work towards the balanced solution our country needs.

David Murdter is a senior in the College of Arts and Sciences. He may be reached at [email protected] Murphy’s Lawyer appears alternate Tuesdays this semester.

Original Author: David Murdter