Home > Main > Risk Adjusted GDP growth and taxing the rich

Risk Adjusted GDP growth and taxing the rich

May 13, 2011

Matt Y tackles a tough problem. Many economists believe that lower taxes on the rich increase economic growth by a few tenths of a percent.  We do not have much solid empirical evidence for this, but they still believe it.  So of course, these people agitate for lower taxes on the rich – its a no brainer because it makes everyone better off.

But the most cursory investigation makes it obvious they care far more about low taxes than economic growth.

First, Nearly all the benefit from this .2% comes after the current generation is dead.  The extra benefit is barely visible after 40 years.

Economic Growth after 40 years

3.5%   296%

3.7%  328%

The overall economy is 30% better off after 40 years. Thats great, but not exactly earthshaking extra growth.

Next, This is the total economic growth. It doesn’t account for distributional effects.  If the entire economy is 328% better off, but the middle class is only 200% better off, the deal is much better for the middle class to go with taxing the rich.

Over the last 40 years, the middle class is closer to 0% better off than 200% better off. No wonder why the middle class wants to tax the rich more.  They don’t get any growth otherwise.

Then, This thinking doesn’t account for increased economic volatility that results from wealth concentration.  I pound the table about this – we need to think about risk adjusted returns when looking at economic growth.

Downside volatility is horrible for long term growth, because digging out of the hole takes a long time.  Some people are waking up to the idea, but we need more focus on the risk and not just the return when thinking about long term GDP growth.

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  1. Tom Hickey
    May 13, 2011 at 12:54 pm

    “Many economists believe…” What are the assumptions? Are they empirically testable? What is being held cet. par. Is this realistic?

    • TC
      May 13, 2011 at 12:59 pm

      The meta critique in a nutshell…

  2. Clonal Antibody
    May 13, 2011 at 6:20 pm

    Interesting overlay on Saez’ income graph by The Animal Spirits Page

    The American “Golden Age” stands out clearly as the era of the least inequlity — and the highest top income tax brackets.

  3. Clonal Antibody
    May 13, 2011 at 6:21 pm
    • Clonal Antibody
      May 13, 2011 at 7:51 pm

      So adding my 2c worth – roughly 17% of annual INCOME shifted from the bottom 90% to the top 10% over 30 years. So the additional growth from the tax cuts enriched the top 10% and actually impoverished the bottom 90%. The additional growth (if it was really there — and I believe that the growth rates would have been much higher, if instead of reducing the top brackets, FICA had been abolished, and SS was to come from general funds.) It is a myth that investment comes from the savings of the rich. Investment happens when businesses see an additional demand for their products, and then they will always borrow in preference to raising new equity, because borrowing is always cheaper in the short term.

      • TC
        May 14, 2011 at 1:44 pm

        Yep. I also think the usual story of causation is a bit wrong-headed.

        “Investment happens when businesses see an additional demand for their products, and then they will always borrow in preference to raising new equity, because borrowing is always cheaper in the short term.”

        Borrowing is way cheaper than equity if you think the business will grow. Not marginally cheaper, but vastly cheaper. The value of the firm might be the same, but the value to the current owners is vastly different.

        Since banks don’t need deposits to make loans, the entire savings = investment idea is a bit suspect.

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