Tax Cuts For The Rich Don't Lead To U.S. Economic Growth, But Income Inequality: Study

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A key difference between the economic agendas of President Barack Obama and his Republican opponent Mitt Romney hinges on whether tax cuts should be granted to the wealthiest Americans. Obama and the Democrats are calling for higher taxes on the wealthy to reduce the deficit and fund spending, while Romney and the GOP are advocating lower marginal tax rates for upper-income groups, saying they fuel investment and job creation.

A new study from the Congressional Research Service - a non-partisan government group that provides analysis to Congress - will likely fuel the already bitter political fight.

The report concludes that tax cuts for the rich don't seem to be associated with economic growth and instead are linked to a different outcome: greater income inequality in the U.S.

Analysis of six decades of data found that the evidence does not suggest necessarily a relationship between tax policy with regard to the top tax rates and the size of the economic pie, but there may be a relationship to how the economic pie is sliced.

The top income tax rates have changed considerable since the end of World War II. In 1945, the richest families had to pay a marginal tax rate of more than 90 percent. Today, it is 35 percent. But both real GDP and real per capita GDP were growing more than twice as fast in the 1950s as in the 2000s.

At the same time, the average tax rate paid by the top 0.1 percent of U.S. families fell from about 50 percent to 25 percent in the last 60 years, while their share of income increased from 4.2 percent in 1945 to 12.3 percent in 2007, before falling to 9.2 percent due to the recession.

Here are two graphs of the top 0.1 percent and 0.01 percent. The first shows average tax rates for the highest-income taxpayers since 1945 has been dropping. The second graph shows that during the same period, the richest American families captured a greater and greater share of total income.

Source: CRS report Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945.Source: CRS report Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945.

Those finds will likely give a lift to Democrats' calls for the Bush-era tax cuts to lapse next year on incomes above $250,000. And they don't bode well for the Romney campaign. The Republican presidential nominee has continuously argued that cutting taxes for the rich would stimulate entrepreneurship, job creation, and investment, thus breathing life into the present anemic recovery.

A recent paper by Owen Zidar, a PhD student in Economics at the University of California at Berkeley, also found that tax cuts for the top-earners are not correlated with economic growth.

Zidar reasoned that if tax cuts for high-income earners generate substantial economic activity and job creation, then we should expect to see three things in the data. First, employment growth should tend to be higher in the years following exogenous tax cuts for the rich. Second, places with a higher share of rich people should grow faster following national tax cuts for the rich (since these areas receive more tax cuts for rich people in dollar per capita terms). Similarly, growth should be lower following tax increases on the rich, especially in places where many rich people live. None of these predictions are born out in the data.

But Zidar did find that tax cuts for the bottom 90 percent of income earners can stimulate economic growth and job creation.

Almost all of the simulative effect of tax cuts, Zidar found, results from tax cuts for the bottom 90 percent. A one percent of GDP tax cut for the bottom 90 percent results in 2.7 percentage points of GDP growth over a two-year period. The corresponding estimate for the top 10 percent is 0.13 percentage points and is insignificant statistically.

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