Fundamental philosophical differences in the role of government and taxes plague both political and pundit discussions alike. Some see tax hikes on wealthy citizens as the fundamental method for raising funds for federal, state and social programs. Moreover, central planning, including large-scale projects, can certainly help to spur economic growth, create jobs and grow the middle class. Alternatively, some argue tax reductions across the board will produce such growth by spurring private sector investment and job additions. Regardless of which side of the spectrum you find yourself, there is helpful historical data to help provide answers to some of the complex questions we face.
Between 1970 and 2011 the Bureau of Economic Statistics and Tax Policy Center have produced interesting data on what GDP has done when the marginal tax rate has seen increases and decreases. Statistical significant effects on GDP growth from tax policy are always dependent on a second variable: the growth of the economy. Historical economic data suggests tax policy can be effectively used as a short term fix to cyclical changes in GDP. Here are a few take-aways.
Tax hikes can further exacerbate a weak economy. In 1990, during a time of weak GDP growth, marginal tax rates were increased from 28% to 31%. Subsequently, GDP went from positive to negative territory(3.6% in 1989 to -0.2% in 1991).
Tax cuts work to spur economic growth. Perhaps the most notable tax reductions which helped to spur economic growth occurred during the Reagan tax cuts of the early 80’s. Reagan helped to decrease marginal tax rates from 70% to 50%. The subsequent growth attributed to these cuts was palpable: -1.9% GDP in 1982 to 7.2% in 1984. This reversal of sluggish GDP was also felt (1.1% to 3.5%) from 2000 to 2003 when marginal rates were again decreased from 36.9% to 35%.
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Good economies remain unaffected by tax increases. Marginal tax increases in the 1990s from 31% to 36% had little effect on the nation’s expanding GDP.
Long term GDP growth cannot be predicted by tax policy. Tax policy, and in this particular case, increases and decreases in the marginal rates cannot be used to predict outcome in long term GDP. This is true in both bear and bull markets.
It is important to note this information only considers marginal tax rates (taking it as the most important factor of tax policy for growth), does not include other rates (capital gains, payroll taxes, etc.), and does not include shifts in monetary or fiscal policy which may have been implemented to help spur growth.
The political debate will progress, but what occurs with the nation’s GDP and how it may alter your investment strategy could be helpful when you take a look at marginal tax policy, current GDP growth strength and what policies may be put in place shortly. One may not be able to predict long-term effects, but the short-run implications, at least based on historical outcomes, will be pretty clear.
Nathan Nead is a marketing and tax writer for Small Business Taxes.