The Tax Foundation has debunked an influential report by the Congressional Research Service which claimed that economic growth is not harmed by high tax rates. The September 2012 report, “Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945,” claimed to establish that there is no connection between increasing marginal tax rates on income and capital gains and the level of economic growth. The report fueled intense debate during the 2012 campaign, with proponents representing it as a scholarly and unbiased examination of the issue. According to a new analysis by Tax Foundation Senior Fellow Stephen Entin, however, the CRS study did not meet such high standards.
The first failure of the CRS report is its omission of other factors that swamp the results, and the failure to hold these “missing variables” constant. “The key to predicting what a change in the tax code does to the economy is to understand what buttons have to be pushed to affect the level of output and income,” says Entin. “One can simulate the effect of each provision in a tax bill, or for the bill as a whole, by measuring its effect on the service price and marginal tax rate on labor income without the difficulty of tracing and correcting for the innumerable conflicting influences on the GDP statistics in a given year.”
Further, the CRS was looking for the wrong result. Instead of looking at the long-term change in the capital stock and the ultimate level of output, the CRS report focused on the short-term rise in investment and the short-term change in the growth rate.