Matt Yglesias notes the lack of empirical evidence for a long run tax-growth relationship.

One issue in this neighborhood that I think is interesting is simply the fact that even though it seems like tax policy ought to be an important determinant of economic growth, it’s pretty hard to find evidence for this proposition

 

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I’d only point out that the theoretical evidence is limited as well. First, as surprisingly few people note, theory is ambivalent on the relationship between taxes and work or savings. It is possible that taxes discourage both, but it is equally possible that taxes encourage both.

It depends on whether people stop working or saving because they can’t get much out of it or work and save more because the taxes made them effectively poorer.

Now, it does turn out to be true that its hard to get a model where net private savings goes up when taxes on savings go up. Leaving aside for a moment the fact that all else equal, an increase in taxes produces an increase in public savings, a decrease in private savings still doesn’t portend a long term decrease in the growth rate.

In most models the growth rate declines immediately because there is less investment. However, in time a combination of deprecation of old capital and increases in technology combine to bring the savings and investment rate back to where they were before. What we are left with is an economy that is on a lower growth path, but not a slower growth rate.

One, way to think about it is that is this: suppose we have two countries, one where taxes on savings are high and another where they are low.  The two countries will grow together but the low tax country will hit any given level of per capita income a few years earlier than the high tax country.  If we assumed that every dollar in tax results in one less dollar of savings and that the low tax country has a tax rate of 20% and the high tax country has a tax rate of 35% then the high tax county will be roughly 12 years behind the low tax country.

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The gap between the economies grows in nominal terms but is constant in year terms. That is the second economy is always 12 years behind. This is more clearly displayed on a log chart

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Whether this is a big deal or not is a matter of debate. The difference can get quite large. For example for a 50% tax on capital the high tax country is a full 27 years behind. However, in the long run it always reaches the same income per capita as the low tax country, just at a later date.

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