The New York Times recently reported that a Congressional Research Service (CRS) report was "withdrawn from circulation" at the behest of Senate Republicans. The CRS report finds no relationship between upper-income tax rates and economic growth, undercutting Republican claims that an extension of the Bush tax cuts for the wealthy is necessary for economic growth. Senate Republicans called the report's validity into question, and CRS eventually withdrew it. However, the report's findings are only the latest in a series that suggest only a tenuous relationship between the economy and upper-income and capital gains tax cuts.
CRS Findings Undercut Conservative Approach to Tax Policy
CRS is a part of the Library of Congress and provides Congress with unbiased analyses of legislative topics to help members craft public policy. The report that was withdrawn by CRS, Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945, analyzes the connection between tax rates on upper-income taxpayers (and capital gains tax rates) and economic indicators, including saving, investment, productivity growth, and income inequality. The report concludes:
The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.
However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. The Times article quoted a spokeswoman for the Senate Finance Committee's Republicans who said that "[t]here were a lot of problems with the report from a real, legitimate economic analysis perspective." (Jared Bernstein, former Chief Economist and Economic Adviser to Vice President Joe Biden, refutes these complaints from an "economic analysis perspective.") CRS, against the advice of its economics division, withdrew the report. However, it is only one of several reports from CRS that blunt claims that a return to Clinton-era upper-income tax rates would be detrimental to the current economic recovery.
Three Percent of Small Businesses Affected by Upper-Income Tax Cuts
In October, referring to the expiration of the upper-income Bush tax cuts, House Speaker John Boehner (R-OH) wrote:
Proponents of the looming tax hike don't call it a tax increase on small business, of course; they frame it as a tax increase on 'the wealthy.' But the fact of the matter is it will dramatically impact small businesses in America.
One year prior to this statement, CRS released a report entitled Small Business and the Expiration of the 2001 Tax Rate Reductions: Economic Issues that contradicts this assertion. That report examines the available data on small businesses and how the expiration of the upper-income Bush tax cuts would impact them. It notes that "the empirical evidence suggests that tax rates have small, uncertain, and possibly unexpected effects on the formation of small business" and concludes: "…lowering the top tax rates benefits only a small share (3% or so) of businesses, and 80% or more of the tax cut's benefits do not accrue to business."
Capital Gains Tax Cuts Unlikely to Expand Economy
Thomas L. Hungerford, the author of the withdrawn report, wrote a June 2010 analysis that examines the relationship between capital gains taxes and the economy. This report, The Economic Effects of Capital Gains Taxation, did not draw similar criticism from Senate Republicans, but it has similar findings as his withdrawn report. Hungerford indicates that:
Many economists note that capital gains tax reductions appear to have little or even a negative effect on saving and investment….Consequently, capital gains tax rate reductions are unlikely to have much effect on the long-term level of output or the path to the long-run level of output (i.e., economic growth).
An effective short-term economic stimulus, however, will have to increase aggregate demand, which requires additional spending. A tax reduction on capital gains would mostly benefit very high income taxpayers who are likely to save most of any tax reduction. Economists note that a temporary capital gains tax reduction possibly could have a negative impact on short-term economic growth.
Economic Growth Factors "Insensitive" to Tax Rates
Tax Rates and Economic Growth, released in December 2011, is another CRS report that looks at the relationship between tax rates and economic growth. It finds that "[a] review of statistical evidence suggests that both labor supply and savings and investment are relatively insensitive to tax rates." That is, labor supply, savings, and investment, which are key components of economic growth, would be minimally impacted, if at all, by an expiration of the upper-income Bush tax cuts. In fact, the report notes that lower savings are associated with lower tax rates.
That report separates out the long-term and short-term effects of taxation on the economy. In terms of short-term economic-boosting activity, "the smallest effects [on employment and economic output] are from cutting taxes of high-income individuals or businesses," whereas policies that impact lower-income families have the largest impact. In the long term, the evidence "suggests that past changes in tax rates have had no large clear effect on economic growth and selected factors commonly associated with economic growth."
Tax Cuts Least Efficient Policy to Maintain Recovery
The urgency to address the expiration of the Bush tax cuts and the $1 trillion across-the-board spending cuts set to start in January comes from concern that such rapid fiscal contraction could push the nation into a recession. The Congressional Budget Office (CBO) projects that if all of the Bush tax cuts expire, the automatic cuts are fully enacted, and other fiscal policies scheduled to expire take place, the economy will shrink and unemployment will increase from today's 7.9 percent to 9.1 percent.
A CRS report issued in September, The 'Fiscal Cliff': Macroeconomic Consequences of Tax Increases and Spending Cuts, details the impacts of these fiscal policies. The report suggests that between the trade-off of allowing the national debt to grow or pushing the economy into recession from too-severe deficit reduction measures, Congress could allow the "less robust" tax provisions (e.g. upper-income Bush tax cuts) to expire and replace them with federal spending programs, like expanded unemployment insurance.
When Congress reconvenes for its lame-duck session, it will begin debating the merits of allowing the upper-income Bush tax cuts to expire. The health of the economy and the millions of families that are affected by it will be central to that debate. Despite the attacks on the most recent CRS report, a raft of other analyses supports its conclusions: raising upper-income tax rates will have little, if any, negative impact on economic growth.