NBER: Tax Increases Reduce GDP (Christina and David Romer)

[dkf]

"Tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent."

How do changes in the level of taxation affect the level of economic activity? The simple correlation between taxation and economic activity shows that, on average, when economic activity rises more rapidly, tax revenues also are rising more rapidly. But this correlation almost surely does not reflect a positive effect of tax increases on output. Rather, under our tax system, any positive shock to output raises tax revenues by increasing income.

In The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks (NBER Working Paper No. 13264), authors Christina Romer and David Romer observe that this difficulty is just one manifestation of a more general problem. Changes in taxes occur for many reasons. And, because the factors that give rise to tax changes often are correlated with other developments in the economy, disentangling the effects of the tax changes from the effects of these underlying factors is inherently difficult.

To address this problem, Romer and Romer use the narrative record -- Presidential speeches, executive-branch documents, Congressional reports, and so on -- to identify the size, timing, and principal motivation for all major tax policy actions in the post-World War II United States. This narrative analysis allows them to separate revenue changes resulting from legislation from changes occurring for other reasons. It also allows them to classify legislated changes according to their primary motivation.

Romer and Romer find that despite the complexity of the legislative process, most significant tax changes have been motivated by one of four factors: counteracting other influences on the economy; paying for increases in government spending (or lowering taxes in conjunction with reductions in spending); addressing an inherited budget deficit; and promoting long-run growth. They observe that legislated tax changes taken to counteract other influences on the economy, or to pay for increases in government spending, are very likely to be correlated with other factors affecting the economy. As a result, these observations are likely to lead to biased estimates of the effect of tax changes.

Tax changes that are made to promote long-run growth, or to reduce an inherited budget deficit, in contrast, are undertaken for reasons essentially unrelated to other factors influencing output. Thus, examining the behavior of output following these relatively exogenous tax changes is likely to provide more reliable estimates of the output effects of tax changes. The results of this more reliable test indicate that tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent.

http://www.nber.org/digest/mar08/w13264.html

[Dawson Leery]

1. As for the top 1%, they need to pay their fair share.

[dkf]

2. This is probably more relevant to the idea that we can raise taxes to pay for increasing spending.

People have been arguing that we can't cut spending as that would have a negative impact on GDP, but apparently raising taxes also has a negative effect on GDP. It's a rock and a hard place.

The amount the top 1% pay can be relevant to overall taxes or to the way the tax burden is spread. I'm sure there is an optimum way to handle taxes and spending. I wouldn't mind if someone could explain how it should work.

[Dawson Leery]

3. They paid much more during the 50's and 60's.

Yet the economy prospered. Bill Clinton raised taxes on the top 1% and the economy as well as the markets responded positively.

I would like to see the data behind this study too.

[dkf]

6. So the middle class tax rates were there pre-Clinton?

This is what is the big deal to me as the middle class tax cuts are 3x the top 2%.

I'm not sure I can support raising taxes just for the top 2% as the budget would still be in a mess.

I want to know what combination of taxes and spending would produce the least pain to the economy and then work from there.

[Hannah Bell]

17. Talk about cherry-picking.....

Romer and Romer also examine the behavior of output following changes in other measures of taxes. Using broader measures of tax changes, such as the change in cyclically adjusted revenues or all legislated tax changes, the estimated output effects are substantially smaller than those obtained using the new measure of exogenous tax changes. This leads the researchers to conclude that failing to account for the reasons for tax changes can lead to substantially biased estimates of the macroeconomic effects of fiscal actions.

When they consider the two types of exogenous tax changes separately, Romer and Romer find suggestive evidence that tax increases to reduce an inherited budget deficit have much smaller output costs than other tax increases. This is consistent with the idea that deficit-driven tax increases may have important expansionary effects through expectations and long-term interest rates, or through confidence.

http://www.nber.org/digest/mar08/w13264.html

[dkf]

19. My concern is how we pay for increasing Medicare costs, so beyond the deficit

What are our options when entitlements plus interest increase to 30% or 40% of GDP. Some seem to think you can keep increasing taxes on the top 1% in perpetuity and that taxes on the middle class can stay the same.

So my question is even if the rich cover all of the increase, what is the impact to GDP.

And you've seen the graphs. You know how Medicare is the driver of spending increases.

Some Democrats actually think we can keep entitlements as is even as they see the projected growth. I wonder what they are smoking.

[Hannah Bell]

20. which has fuck-all to do with the point made in your op.

and decreasing spending on medicare would also lower the gdp.

the op is incoherent in my opinion.

[dkf]

21. Expecting constantly increasing spending to be covered by constantly increasing taxes

Isn't good for GDP.

[Hannah Bell]

22. gdp = spending. what do you think gdp is?

"GDP is equal to the sum of consumption, investment, government spending and net exports."

[eridani]

27. I'm concerned too, because pro-corporate whores refuse to regulate the health care industry.

Other countries take care of everyone for half of what we pay. My husband had an emergency root canal in the Netherlands in 1996 that cost $25.00. (Yes, the decimal point is in the right place.)

[JDPriestly]

4. The problem is that GDP is a very misleading and overrated

measurement.

In a country in which a majority of mothers stay home with their children, grow vegetables in a garden, tend a couple of chickens and don't work outside the home, the standard of living might be quite agreeable, especially for the children and the husband who comes home to a clean house and homecooked meal every night but the GDP will be lower than in a country in which a majority of mothers work outside the home (drawing paychecks that count toward the GDP), place their children in day-care (for which they pay) all day and buy carry-out food or eat in restaurants. But the second country -- where women work outside the home -- is not necessarily more prosperous really. People may not enjoy as high a quality of life in the second country as in the first. So, when you talk about GDP, you really aren't talking about a measurement that has much to do with the quality of life.

[dkf]

5. But as a measure of economic activity and levels of taxation isn't it appropriate?

How can you tax enjoyment in life?

[JDPriestly]

11. Countries in which families

grow much of their own food -- agrarian style countries -- are considered to be poor because they have low GDP. But often they really aren't. They just have wealth that can't be measured or taxed.

I doubt that taxation can be "fair." Tax revenue has to come from people and businesses who have it -- those who have more money than is needed to survive and corporations or businesses that are profitable. Can't come from anyplace else.

[Cresent City Kid]

7. Taxing the rich does lower GDP

Greedy Douchebag Pay that is.

I think more data is needed. Let's tax the ever lovin' fuck out of the rich for a few decades and see how it goes. It will give me time to look up "exogenous".

[dkf]

8. I posted this because Christina Romer was/is one of Obama's advisors.

It helps to know where the advisors are.

[Oasis_]

9. It's simple, really

In the 1950's and 60's, the US had no trade or economic rivals, as much of Europe was still rebuilding from WWII, and China (actually all of Asia) and India were still in the nascent stages of economic development. High and confiscatory rates had a negligible effect on domestic growth--as again--there were no trade alternatives.

We should look to reduce tax rates for corporations, small businesses and individuals to make America as globally competitive as possible. We enjoy the the luxury of possessing the most attractive and affluent market in the world. We should be looking for ways to harness the tremendous wealth and opportunity said wealth presents, as opposed to confiscating it.

Obviously, there's budget constraints which pose major problems, but the military budget must be trimmed (significantly), national health care would go a long way in eliminating the redundancy in the myriad of state and federal health care programs--- as would further tightening welfare and various other social program guidelines which have proven to be failures. Subsidizing poverty via so-called poverty fighting and elimination programs only increases it, as we've witnessed since their inception many decades ago.

Oasis

[jmowreader]

10. Oasis, I am going to have to disagree with you

Reducing tax rates for businesses and individuals (I am not going to split business into "corporations" and "small businesses" because a lot of small businesses are incorporated) does not make America as "globally competitive as possible." The American manufacturing base didn't move to China because China has low taxes, they went there because China lets you pay your workers three dollars a day and there's no occupational safety agency in China, or at least there's not one worthy of the name.

One could argue that lowering taxes actually makes the US less competitive. Notice the great exodus of American manufacturing happened under Ronald Reagan, the guy who never saw a tax he didn't want to cut.

[Oasis_]

12. Thanks for the response

jmowreader, There's many costs with respect to a company relocating its operations overseas. Sometimes it's wage competition (lack of), other times it's regulatory, and some do to simply establish markets in a foreign country.

Reptilicans, being who they are, believe we have to accept a lower wages and quality of life to compete. I don't buy into that thinking for a minute.

Reducing all tax burdens, national health care for all--providing the dual benefit of insuring every American while eliminating the tremendous cost to business-- while removing the competitive advantage foreign business enjoys as they do not incur the direct costs of employer subsidized health care for their employees. We can do the same.

It's not only morally sound--it's a great business move as well.

Oasis

[eridani]

26. Countries with higher corporate taxes are doing much better than we are

Given that we have a big market, we could be using that clout in favor of the population instead of amoral sociopathic corporations.

[eridani]

13. Bullshit. Just look at the effects of the Bush tax cuts

A whole decade of not a single net job added.

[dkf]

14. Tax decreases don't necessarily have the opposite effect of tax increases.

It's the same thing for behavior in response to a pay raise or pay cut. Think of your own behavioral reaction, you may think a raise enables you to buy a car or buy a bigger house. Whereas a pay cut probably won't prompt you to sell the car or the house but to cut out other things because you are pretty stuck with your extra expenses.

[eridani]

15. After Clinton raised taxes, millions of jobs were added, and this--

--was well after the post-war years of no competition for US industry.

[dkf]

16. This was part of the study I'm sure.

Seeking Alpha acknowledges Romers position and these findings.

http://seekingalpha.com/#article/219751-remembering-christina-romer-tax-increases-and-their-economic-impact/

[eridani]

28. Link just goes to the home page, not a specific study n/t

[Unvanguard]

25. Actually, most of the examples in the paper are of tax decreases.

The authors treat them as parallel cases.

[mmonk]

18. I have no data that supports that religion.

I've tried to find it, but it just isn't there. It's built on the premise that what business executives think what would be great for their individual circumstances would be good for the economy as a whole. Hence they came up with the idea that what is good for business is good for the economy but that does not always hold true. For example, businesses love low wages and thus, the lower the wage, the better for the business. However, it cannot be argued sanely that low wages are good for the country's economy. Can they name even one prosperous low wage country? Of course not, because they are opposite things. But Americans have bought into a lot of this religion for some reason. People from the south for example (I'm from the south) are particularly anti-union. Thus they are idiocally against higher wages for themselves. Debt can be a larger drag on the economy than taxes. Taxes are just a cost of doing business. I can produce direct evidence to the contrary on the idea there is always growth through low taxes. The most prosperous times in this country had tax rates higher than we do now, which is historically low currently. I hate this lie more than any other. I see too many dumb ass people that did not study economics at the collegiate level such as I did, walking around talking this garbage as if they knew anything about economics. But they heard it on their right wing TV shows or read in books or articles by charlatans and they have the audacity to always tell me I'm mixed up. As long as this lie remains the blind belief religion of the average American yokel, they can always be fooled into voting against their own interests.

[Dawson Leery]

23. Correct.

Consider the trillions that are being "made" off of speculation and fast trades in the market. They pay a minimal tax. Such activities are not of a positive value to the economy at large.
Such income should be taxes as regular income.

[Unvanguard]

24. Not when tied to spending increases, and sometimes not when tied to deficit reduction.

But, yes, tax cuts probably do increase economic growth, just like big spending packages.