Lower taxes result in higher growth

Democrats in Congress want to fund their proposed expansion of the children's health program through higher tobacco taxes. But knowing how tobacco smokers will respond is key in estimating how much revenue will come in from the proposed tax rate increase – if any, says Richard W. Rahn, chairman of the Institute for Global Economic Growth.

According to a new econometric study by A.J. de Bruin of Erasmus University in the Netherlands of several European countries, as well as the United States:

A decrease in marginal tax rates on productive activity in high-tax societies causes a rise in economic activity (more growth).

This increase in economic activity generates additional government revenues that, in part, compensate for the revenue loss due to the lower tax rate.

The reverse is of course also true: An increase in tax rates will lower economic activity and provide the government with less additional revenue (and higher unemployment) than would be expected without any behavioural changes.

However, many in Congress like to pretend people will not respond to increases in tax rates in negative ways (this is called static analysis). Thus, they overestimate the tax revenue and overestimate the loss in revenue from a tax rate cut, which serves the interest of those who, for ideological reasons, want to increase the size of government.

After all too many years, the Bush administration is at least trying to undertake some dynamic analysis (i.e., considering the behavioural response). However, Congress refuses to fund this modest effort. The expenditure of perhaps at most several million dollars on proper estimates would save the American taxpayer hundreds of billions of dollars – and that would be a great legacy for the President, says Rahn.

Source: Richard W. Rahn, More evidence, Washington Times, October 10, 2007.

For text: http://www.washingtontimes.com/apps/pbcs.dll/article?AID=/20071010/COMMENTARY/110100011/1012

For more on Taxes: http://www.ncpa.org/sub/dpd/index.php?Article_Category=20

FMF Policy Bulletin/ 16 October 2007