EVIDENCE ON THE ECONOMIC
EFFECTS OF TAXES
JON BAKIJA
PROFESSOR OF ECONOMICS, WILLIAMS COLLEGE
JUNE 21, 2012
1
CROSS-COUNTRY EVIDENCE ON TAXES AND
ECONOMIC GROWTH: REASONS FOR
SKEPTICISM
• Not even close to an experiment
• Reverse causality
– Business cycle fluctuations cause tax revenue to change
– Demand for government increases with income
– Tax administration improves with higher income
• Effect of government size on growth should differ
depending on quality of government
– Scandinavian countries have:
• Large progressive governments
• Well-designed, well-administered, economically efficient policies
2
CROSS-COUNTRY EVIDENCE ON TAXES AND
ECONOMIC GROWTH: REASONS FOR
SKEPTICISM
• So many other factors affect economic growth
– We don’t have good control variables for them all
– Econometric estimates are very sensitive to reasonable changes
in the set of control variables
– Controlling for a variable that is a channel through which
government affects growth makes estimates worse instead of
better!
• Selection bias
– If you select only countries that are rich today, you leave out all
the countries with small governments that did not grow
3
AMONG ALL COUNTRIES, THERE IS A POSITIVE
CORRELATION BETWEEN INCOME PER PERSON AND
CENTRAL GOVERNMENT REVENUE AS % OF GDP
Qatar
GDP per person, 2007
70
60
50
Kuwait
Singapore
Norway
USA
Hong Kong Ireland Netherlands
Switzerland
Australia
Canada
France
Germany
Italy
Spain
Korea, Rep.
40
30
Cyprus
20
10
Lesotho
0
0
10
20
30
40
50
60
70
80
Central government revenue (excluding grants), % of GDP,
2007
Source: World Bank World Development Indicators. Includes all 98 countries with data available and population greater
than 1 million in 2007. GDP per person is in thousands of constant year 2005 dollars, adjusted for purchasing power
parity.
4
THERE IS NO CLEAR CORRELATION BETWEEN INCOME PER
PERSON AND TAXES AS A PERCENT OF GDP FOR
COUNTRIES COMPARABLE TO USA
50
GDP per person, 2009
Norway
45
USA
40
Switzerland
Netherlands
Australia
35
Ireland
Austria
Canada
UK
30
Japan
Spain
25
Greece
Germany
Belgium
Finland
France
Sweden
Denmark
Italy
NZ
Portugal
20
20
25
30
35
40
Tax revenue as a % of GDP, 2009
45
Source: author's calculations based on OECD data. GDP per person is in thousands of constant year
2005 dollars, adjusted for purchasing power parity. Includes tax revenue of both central and subnational governments. Includes all OECD countries with populations over 1 million in 2009, and GDP
per capita (in 2005 PPP dollars) over $8,000 as of 1970.
50
5
Average annual real growth rate (%) in
GDP per person, 1970-2010
THERE IS NO CORRELATION BETWEEN REAL GROWTH IN INCOME
PER PERSON AND TAXES AS A PERCENT OF GDP, 1970-2010,
FOR COUNTRIES COMPARABLE TO USA
3.5
Ireland
3.0
2.5
Norway
Portugal
Japan
Spain
USA Greece
2.0
Australia
1.5
Switzerland
1.0
UK
Germany
Canada
Italy
Finland
Belgium
Netherlands
Sweden
France
Austria
Denmark
NZ
0.5
0.0
20
25
30
35
40
45
Tax revenue as a % of GDP, 1970-2010 average
Source: author's calculations based on OECD data. GDP per capita is in thousands of constant year
2005 dollars, adjusted for purchasing power parity. Includes tax revenue of both central and subnational governments. Includes all OECD countries with populations over 1 million in 2009, and GDP
per capita (in 2005 PPP dollars) over $8,000 as of 1970. Tax revenue average is for 1970-2009 for
Australia, Japan, and Netherlands.
50
6
Change in average annual real growth rate in
GDP per person (%) from 1970-1990 to 19902010
THE RELATIONSHIP BETWEEN CHANGE IN ECONOMIC GROWTH
RATE FROM 1970-1990 TO 1990-2010 AND CHANGE IN TAXES
AS A PERCENT OF GDP FROM 1970 TO 1990 IS UNCLEAR
1.0
0.5
NZ
Australia
Ireland
0.0
Switzerland
USA
-1.0
Sweden
Netherlands
UK
-0.5
Greece
-1.5
Canada
Austria
Germany
Norway
Denmark
Spain
Belgium
France
Finland
Portugal
-2.0
Italy
-2.5
Japan
-3.0
-3.5
-2
0
2
4
6
8
10
12
14
16
18
Change in tax revenue as a % of GDP, 1970 to 1990
Source: author's calculations based on OECD data. GDP per person is in thousands of constant year
2005 dollars, adjusted for purchasing power parity. Includes tax revenue of both central and subnational governments. Includes all OECD countries with populations over 1 million in 2009, and GDP
per capita (in 2005 PPP dollars) over $8,000 as of 1970.
7
IN THE U.S., THE TOP OF THE INCOME DISTRIBUTION HAD LARGER CUTS IN
MARGINAL TAX RATES, AND LARGER INCREASES IN PRE-TAX INCOME
Marginal tax rate (%) on ordinary income,
U.S. personal income tax, at different
points in the top 10% of the income Position in
the income
distribution
distribution
100
90
Top tax
bracket
80
Percentage increase since 1960 in
share of U.S. pre-tax income
(excluding capital gains), at different
points in the top 10% of the income
distribution
300
260
220
70
Top 0.1%
60
180
50
140
40
30
20
10
0
1960
1970
1980
1990
Year
2000
2010
Top 1%
outside
top 0.1%
100
Top 5%
outside
top 1%
20
Top 10%
outside
top 5%
60
-20
1960
1970
1980
1990
2000
2010
Year
Source: author's calculations based on data from Piketty and Saez (2003, updated in 2012 at
http://elsa.berkeley.edu/~saez/TabFig2010.xls), Saez (2004), and IRS Statistics of Income Bulletin, Spring 2012.
8
IS RISING INEQUALITY EVIDENCE OF THE RICH
RESPONDING TO BETTER INCENTIVES CAUSED BY
TAX CUTS?
REASONS FOR SKEPTICISM
• Skill-biased technical change
• Globalization
• “Superstar” theory
• Executive compensation issues
• Pay (e.g. stock options) tied to booming financial market asset
prices
• Shifting of income from corporate to personal tax base
• Changes in tax avoidance and evasion
– Costly, but can be addressed by tax reform and enforcement
9
PERCENTAGE OF PRE-TAX INCOME (EXCLUDING CAPITAL GAINS) GOING TO
THE TOP 0.1 PERCENT OF THE INCOME DISTRIBUTION, BY OCCUPATION,
1979-2005.
FINANCE AND MANAGEMENT ACCOUNT FOR 60 PERCENT OF TOP 0.1 PERCENT,
AND 70 PERCENT OF THE INCREASE.
Percentage of national income
going to top 0.1 percent
8
7
6
All other professions
Executives, managers, supervisors,
entrepreneurs (non-finance)
5
4
Financial professions, including
management
3
2
1
0
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
Year
10
Source: Bakija, Cole, and Heim (2012).
PERCENTAGE GROWTH SINCE 1979 IN THE SHARE OF PRE-TAX INCOME
(EXCLUDING CAPITAL GAINS) GOING TO EACH OCCUPATION IN THE TOP 0.1
PERCENT OF THE INCOME DISTRIBUTION.
Percent growth in share of national
income since 1979
DIFFERS GREATLY BY JOB, SUGGESTING NON-TAX FACTORS ARE IMPORTANT.
500
Conultants, accountants, & other
business operations (nonfinance)
450
Real estate
400
350
Financial professions, including
management
300
Arts, media, sports
250
Computer, math, engineering,
technical (nonfinance)
200
Executives, managers, supervisors,
entrepreneurs (non-finance)
150
100
Lawyers
50
Other
0
1979
1984
1989
1994
Year
1999
2004
Medical
Source: Bakija, Cole, and Heim (2012)
11
Change in percentage of income going to top
1%, 1975-79 to 2004-08
COUNTRIES WITH LARGER
CUTS IN TOP PERSONAL INCOME TAX
RATES HAD LARGER INCREASES IN THE PERCENTAGE OF PRETAX INCOME GOING TO THE TOP 1% OF THE INCOME
DISTRIBUTION, 2004-08 COMPARED TO 1975-79
10
USA
8
UK
6
Norway
Ireland
4
Portugal
2
Australia
Canada
Finland
Italy
Sweden
Japan
NZ
Spain
France
Denmark
Germany
Netherlands
Switzerland
0
-2
-40
-35
-30
-25
-20
-15
-10
-5
0
5
Change in top personal income tax rate, 1975-79 to 2004-08
Sources: Piketty, Saez, and Stantcheva (2011), updated with data from the World Top Incomes
Database. Notes: Uses a measure of income excluding capital gains. When data from 1975-79 or
2004-08 is not available, data from the closest 5-year period within the range 1975 to 2008 is used.
12
Average annual real % growth rate in GDP
per person, 1975-2008
THERE IS NO CORRELATION ACROSS
COUNTRIES BETWEEN SIZE
OF REDUCTION IN TOP PERSONAL INCOME TAX RATE 1975-79 TO
2004-08 AND GROWTH IN REAL INCOME PER PERSON 1975-
2008
4.0
Ireland
3.5
3.0
2.5
Portugal
Japan
UK
USA
2.0
1.5
Norway
Finland
Netherlands
Australia
Italy
Sweden
Canada
Germany
Denmark
France
NZ
1.0
Spain
Switzerland
0.5
0.0
-40
-35
-30
-25
-20
-15
-10
-5
0
Change in top personal income tax rate, 1975-79 to 2004-08
5
Sources: Piketty, Saez, and Stantcheva (2011), updated with data from OECD (2012).
Notes: Real GDP per capita is measured in constant year 2005 PPP dollars.
13
IMPLICATIONS OF CROSS-COUNTRY RELATIONSHIP BETW
CHANGE IN TOP PERSONAL INCOME TAX RATE AND CHA
IN TOP 1% INCOME SHARE
If entirely a real
If mostly due to other
behavioral response to
factors (Piketty, Saez, &
incentives
Stantcheva’s position)
0.44
0.2
$0.95
$0.28
60%
79%
Percentage change in
income caused by a one
percent increase in net-of-tax
share
Deadweight loss per dollar of
additional revenue raised in
top bracket
Revenue-maximizing top
marginal tax rate
Source: author’s calculations based on Piketty, Saez, and Stantcheva (2012)
Note: “net-of-tax-share” is one minus the marginal tax rate.
14