The Real Problem for Republicans: Economics

There has been a lot of left wing concern trolling of Conservatives since the election. While this post will veer close to doing that, it is not my intent to ask Conservatives to jump on the bandwagon regarding some liberal issue due to demographics, cultural change, or because of fracturing coalitions.

Instead, my intent is to point out that for my generation and younger they are going to have to develop new arguments for their favored economic policies. This section of a David Frum post on health care reform brought this to my attention:

1) One of the worst things about the Democrats' plan is the method of financing: an increase in tax on high-income earners. At first that tax bites only a very small number, but the new taxes will surely be applied to larger and larger portions of the American population over time.

Republicans champion lower taxes and faster economic growth. We need to start thinking now about how to get rid of these new taxes on work, saving and investment -- if necessary by finding other sources of revenue, including carbon taxes.

I understand where this statement comes from, for anyone whose political development occurred in the 80s or 90s the link between taxes and economic growth is obvious. This is what we were taught in history and what little economics we were taught in high school, it was the mainstream view of undergraduate economics through the 90s and early 2000s, and it has become economic common wisdom.

However, for tax and national accounts economists this was by no means common wisdom for at least the past decade.* Over the past few years the field as a whole has moved away from the idea that tax cuts are strongly linked to economic growth, though economists from different fields who received their training earlier and members of certain schools of thought continue to hold out.

For younger people, or individuals that have chosen to try to do some reading on tax economics, lower taxes and faster economic growth aren't immediately linked in their minds. For the Occupy Wall Street generation lower taxes are primarily salient for increasing income inequality, economic stagnation, and a banking crash, while faster economic growth is associated with stimulus and the GM rescue. Since Obama will most likely be presiding over significant economic growth since we're finally getting to the expected years of recovery from a financial crisis, this generation is also likely to associate faster economic growth with health care expansion, bank regulation, and the consumer protection board rather than low inflation and the 86 tax reform.

If the Republicans wish to remain competitive they will need to learn to argue for lower taxes and faster economic growth as separate things. Younger people will simply not be linking these two things in their minds, if Republicans are to be the party of economic growth, which to me is the biggest single issue and the main reason I considered myself a Republican up until I observed them failing to update to the newer economic literature, they will have to actually develop an argument for why their policies will lead to faster growth rather than relying on the magic word taxes.




*While there are better economic journal articles and books on the subject, the CRS reports are readable and written for a non-specialist audience. To quote some essential pieces,

Historical data on labor participation rates and average hours worked compared to tax rates
indicates little relationship with either top marginal rates or average marginal rates on labor
income. Relationships between tax rates and savings appear positively correlated (that is, lower
savings are consistent with lower, not higher, tax rates), although this relationship may not be
causal. Similarly, during historical periods, slower growth periods have generally been associated
with higher, not lower, tax rates.
Historical data on labor participation rates and average hours worked compared to tax rates indicates little relationship with either top marginal rates or average marginal rates on labor income. Relationships between tax rates and savings appear positively correlated (that is, lower savings are consistent with lower, not higher, tax rates), although this relationship may not be causal. Similarly, during historical periods, slower growth periods have generally been associated with higher, not lower, tax rates.

and:

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. As measured by IRS data, the share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the top 0.1% fell from over 50% in 1945 to about 25% in 2009. Tax policy could have a relation to how the economic pie is sliced—lower top tax rates may be associated with greater income disparities.

My simple takeaway is that lower top tax rates and capital gains rates are not associated with higher economic growth. Average tax rates may be associated with higher economic growth, given the other evidence it is most plausible that lower taxes on lower incomes increases growth while higher taxes on higher incomes has little, if any, impact. International and comparative evidence leads to the same conclusion.

If the GOP wishes to defend lower tax rates on top earners, it will ultimately have to abandon economic arguments for philosophical and moral arguments since the economic arguments are weak, and getting weaker as evidence accumulates, and won't be convincing to younger generations anyway.