AUGUST 12, 2011 5:20PM

Decreasing tax rates=lower unemployment rate=bullshit!

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Ever since the economy almost entirely tanked three years ago, we've often heard about how increasing tax rates for individuals or families will kill the economic recovery. According to many, increasing the rates for those located in the upper bracket will be even more devastating to our country. Even taken at face value, this kind of statement is difficult to be believed.

More recently, with the debt ceiling debacle, we've also witnessed the perpetual argument that cutting down government spending, particularly the expenses related to social services, is the only way to save our finances. God forbid that increasing revenues, via various tax increases or even closing down important loopholes, should ever be considered. Again, many are stating that any minuscule increases in revenues would lead the fall of the American Empire. This may happen sooner than later, but we'll leave this for another day.

As shown in my previous posts, I'm always very skeptical when such arguments as those described above are made by various groups of people (especially the tea partiers). Thus, for your entertainment and added knowledge, I decided to examine more closely the tax and unemployment rates covering the last 30 years. I wanted to see if any kind of relationship exists between the two.

To put it more bluntly: we'll test whether lower tax rates foster economic growth, hence lowering the unemployment rate.

Using data extracted from the Internal Revenue Service (IRS) and U.S. Bureau of Labor Statistics (BLS), I plotted the tax and unemployment rates between 1980 and 2010. For taxes, I used the basic tax rate for a family that is making $50K, $100K and more than $500K per year. I assumed that the partners jointly filed their tax returns as a married couple. Obviously, the effective tax rates will be different depending on the number and type of deductions, but this won't affect the basic premise for the analysis carried out below.

The results are shown here:

Figure 1
 

Tax and Unemployment Rates (civilian noninstitutional population)

Well, well! Even without using any sophisticated statistical analysis tools, it's obvious that no clear relationship exists between the tax rates and the unemployment level. If we were to believe that millionaires (and half millionaires) will create more jobs because of lower tax rates, shouldn't we observe a direct relationship between the tax rates and employment numbers (i.e., low rate always equals high employment)? This is clearly not the case. The employment remains pretty much flat in relation to the tax rates for individuals, which varied enormously. For the curious readers, the lowest unemployment rate occurred in the late 90s before the Bush tax cuts were implemented.

We can even make the argument that if we were to increase or decrease the tax rates for every bracket, this too will have a limited impact on unemployment.

In sum, decreasing the tax rates or maintaining low rates, especially for those in the highest bracket, won't save us! In fact, it may even lead to another kind of disaster in the waiting:

Figure 2
 

Deficit and Surpluses (1980-2007)
(Note: cumulative curve from 1980 - the cumulative debt was $680 billion in 1979)

Interestingly, when the tax rates were increased in the mid-90s (under Clinton), we also observed surpluses.

Coincidence?

Sources:

Tax Rates: http://www.taxfoundation.org/publications/show/151.html (taken directly from IRS)

Unemployment Rates: http://www.bls.gov/cps/cpsaat1.pdf
(Note: BLS indicated that we should not directly compare the unemployment rates for certain years. I assume the methodology for estimating the rates changed. However, even if the methodology is different, I don't expect the differences to be very large or marginal at best.)

Federal Budget Information: http://www.cbo.gov/budget/data/historical.pdf

Information about recessions: http://www.nber.org/cycles.html

Note: All errors are mine, if any.

Update:

I added several comments below. They all include links that are related to this post.

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This shows what economists and our eyes have been telling us all along -- tax rates have little relation to economic activity, marginal rates even less. The correlation is tax rates and debt.
This won't get you a job at the Heritage Foundation.
Paul: I agree! I'm happy where I am right now. Thus, no HF for me!
In a world full of uncertainty, this seems as clear a signal as one is going to get that lowering taxes doesn't lead to an automatic economic surge, casting doubt on the rest of the bizarre and counterintuitive claims made by the Right these days. See the article in the New York Times, Voices Faulting GOP Economic Policies Growing Louder. Unfortunately, even as such voices grow louder, the corporations amass ever more money, benefiting from that sense in the populace that it's not fair to deny them money without being certain. Certainty is never 100%, yet if we got it to 99.999% we'd be hearing from them that there was still that “nagging chance” we could be wrong...
Kent, thanks for the link. Very relevant article (about the GOP misguided financial policies). I agree with your comment. Well done!
This is absolutely ridiculous.

There are many variables that can either cause unemployment or stimulate job growth. If you are looking for a statistically significant relationship between taxation and employment then you must control for these other variables. This is statistics 101. You can't just plot a graph and immediately draw conclusions on this issue.

What if taxation were zero, but, simultaneously, there is one regulation, one government rule, so onerous that it causes businesses to decide that they need to stop hiring or even lay off people? Your amateur graph study would never show this.

Or how about the Federal Reserve creating all kinds of distortions in the economy with artificially low interest rates and money creation? This leads to a temporary sugar high—a boom—that is unsustainable and inevitably leads to a bust and unemployment. This, too, would never show up on your graph. Neither would natural disasters.

Of course there is a relationship between taxation and economic destruction. You don't need econometric models to see this. All you need is deductive reasoning and praxeological insights. If tax rates have virtually no effect on economic growth and job creation, then why not raise corporate taxes, income taxes, capital gains taxes, etc., to 100%? There will be no harm to the economy, no businesses leaving for overseas, right? Ridiculous.
Larry: I also laught very hard at your comment. Based on your view point, having a tax rate equal zero should eliminate unemployment. While I'm away, you should take look at Sweden's tax and employment rates.
I'll be away for several days with limited e-mail access.
I didn't argue that a taxation rate of zero means full employment. I'm saying that many factors affect employment. Because of this, you can't just plot a graph of taxation rates and employment and immediately draw conclusions about it.

For example, minimum wage laws destroy jobs and cause unemployment. We could have zero taxation yet, combined with minimum wage laws, have lots of people who can't find work.

Frankly I'm surprised that Paul J. O'Rourke asserts that the graph "shows" anything at all. But then again he's another cheerleader to the idea that people and property exist solely to be plundered by the government for redistribution purposes.
Larry,
The statistical relationship shown is there's no causative correlation between tax rates and employment. This is why you're sending Kanuk off to vacation with a chuckle. I'll save the other reason for the end.
In your defense, you did announce your intention --"This is absolutely ridiculous" -- before saying something absolutely ridiculous.

If you would trouble yourself to read the title, you would see the premise of what followed. Kanuk debunks the claim that lower tax rates create jobs. To confirm that lower tax rates DO create jobs, one must have something to show it does. To counter his argument, you need to show it DOES, as "doesn't" or "has no effect" is Kanuk's premise. He doesn't have to allow for every possibly relevant variable to employment, as the tax rate numbers and the employment numbers are the only numbers relevant to the argument that he is debunking.
Your Fed rant, which is libertarian trite, is a separate issue, as even though the artificially low rates did create false signals and set up disequilibrium, that merely maintained employment levels (but not %). That fact supports Kanuk's premise, as the tax cuts that came along with the artificial low rates did not increase employment. Your argument, if you knew that you were making one, is that absent the low rates, employment would have fallen. "fallen" means "did not create jobs." I doubt shooting yourself in the foot is going to compel his surrender.

Your all-or-nothing arguments are, to intelligent people with logical minds, billboards of shrill ignorance. To smart people, they are Catch 22 outbursts. You're trying to prove your mental acuity by proving you're not smart enough to see such simplistic arguments dispel the notion you have any.

The funniest thing isn't that you zoom past the point, like a Emily Littella knock-off, on your way to an incoherent response. The funniest thing is you're convinced you're educating Kanuk, a major university PhD statistician, in the science of statistics.

Watching that humorous unknowing self-deprecation was entertaining and interesting...from a praxeological viewpoint.
Larry,
Just for the record, you're an indoctrinated half wit who, along with an inability to think beyond slogans, sees others who think you're a simpwit as the polar opposite of your stunted, unstudied, spoon-fed perceptions of economics and "liberty." Keep trying to take me on and I will, as the mood strikes, keep spanking your inadequate lil' ass.
@Paul, you have stated that Kanuk is a PhD statistician, so he obviously knows his stuff. But does the non-correlation between tax rates and unemployment mean that we shouldn't lower tax rates?

Currently, almost all companies who used to be based out of the US are now "operating" overseas. I put operating in quotes because most companies are only opening small offices, if not just a simple mailbox, overseas to claim they operate out of a different country in order to claim a lower tax rate, which is always lower than the current US corporate tax rate of 35%.

So I guess my point is that, yes, there may be no correlation between unemployment and tax rate, but that doesn't mean that we should raise taxes, or even keep them the same. I'm not saying that immediately lowering tax rates will solve our financial crisis, but in the long run, lowering tax rates will encourage companies to start paying taxes in the US and will extremely benefit our economy. Lower tax rates is better than the current situation of companies paying 0% taxes in the US. And when you think about companies moving headquarters back to the US, this will inevitably create jobs.

I'm completely open to people who have different opinions and extremely encourage people to debate the comments above, but one thing I'd like to point out is that calling someone an "indoctrinated half wit" doesn't necessarily stimulate a healthy debate :)
Kanuk says his model demonstrates that decreasing tax rates does not mean lower unemployment, that "it's obvious that no clear relationship exists between tax rates and the employment level." Based on his model, this conclusion is a non sequitur.

Employment levels can be influenced by many things other than tax rates. This is obvious. In other words, in a test to see if there is a relationship (does taxation rates influence employment rates?), we have an independent variable and a dependent variable. Control variables need to be factored in, because, as I stated, employment (the dependent variable) is influenced by many things. This is where the above test is flawed, because there is no mention of controls; he just plugs in the two variables and takes a look.

(It is also stated that certain years should not be compared to others, but that there should not be large differences. Maybe, whatever. But we all know gov't underestimates unemployment, so even if it would be possible to control for everything, the graph still won't allow us to get a clear picture of real unemployment.)

Again, econometric models are not necessary for this question anyway. It is of course clear -- logically, intuitively -- that there is a relationship between taxation and employment: higher taxation equals lower employment. If this relationship did not exist, as Kanuk and PJO claim, then we could raise all taxes to 100 percent and not expect any jobs to be destroyed or moved overseas—an absurd expectation.

As I mentioned earlier, minimum wage laws destroy jobs and cause unemployment. We could have a taxation rate of zero combined with a minimum wage. People would be disemployed by the law. But Kanuk and PJO would point to the graph and declare, "Taxes are zero and yet we still have all this unemployment, so therefore zero taxes does not mean lower unemployment." Never would it occur to them that something else is affecting the employment level, making their claim a conjecture and a logical fallacy. Other factors could be natural disasters, Fed policy, rules and regulations, government prohibitions, government make-work, etc.—all affect free-market employment and must be controlled for.

Paul, all your petty little personal insults don't impress anyone. Instead, for entertainment purposes, let's hear another embarrassing rant from you about how we've been living under a "libertarian economy" for the last 30 years. We all get a laugh out of this totally absurd ipse dixit.
Creating employment is not the business of business. Business hires when their cost of hiring is lower than expected return. That brings us to effective tax rate on business. If you do the same research on the top marginal tax rate and effective tax rate paid by businesses, I am sure there will be no correlation.
Here is an example to show the impact of effective tax rate:
Gross profit is $100K, effective tax rate is 50%. Tax paid is $50K and Net profit is $50K
Business has to hire somebody at $50K, they know their cost is effectively $25K, the rest is tax saving. They will hire the person if the expected return is above $25K.
If the effective tax rate is 20% then the out of pocket cost of hiring the same person for the business is $40K. So they would not hire if the expected return is less than $40K.
If we let corporations exploit loopholes and pay effective tax rate close to ZERO then you can see why the business want to sit on the pile of cash and not hire anybody.
Close the loopholes and raise the effective tax rate to 50%. If they want to hire in another country then they have to find somebody really cheap. They can’t escape taxation if they sell here and make profit. By the way that reduces the national debt too.
Just super stuff. Quite elegant and succinct.
This would be very good if the stupid people could interpret graphs. Unfortunately, information like this interferes with their faith-based beliefs in government. Rick Perry has a direct line to Jesus, so it must be Truth.
Paul: Thanks! Always appreciate your comments (and posts).

Larry: Yes, I laughed very hard at your views about how high taxes and minimum wages will destroy the US or any country for that matter. Interestingly, Norway and Sweden (as an example) have lower unemployment rates than the US (below 6% on average). In fact, Norway was not even affected by the 2008 economic disaster (still at about 4%). Yet, their combined tax rates are very high: IT=40%,CT=28%, ST=25% for Norway and IT=57.77%, CT=25%, ST=25% for Sweden. Since you have difficulties understanding how taxes can be used to benefit businesses, you might want to read this comment; see also comment below. And get this, Norway, Sweden and Canada, also with higher tax rates, still have a better credit than the US. Go figure…

If you would have taken Stats “102”, you would understand that before developing any relationships, you need to explore the data. You should see how many people blindly use techniques learned in Stats 101 and get it all wrong, as you did here. Time to get back to school it looks like.

What are you talking about a model? I don’t see anything that looks like a "model". With regards to minimum wages, you might want to read the following article: "A Blunt Instrument; The Minimum Wage," The Economist, October 28, 2006.
Scotty: Thanks for your comment. The discussion point is not one of correlation, but what we call cause-effect. Does changing the tax rate directly affect employment or unemployment? The real issue is actually not the tax rate, but what you do with the taxes the government collects (such as spending it for useless wars, etc.). For instance, the overall tax rate (or burden) in Canada is much higher than in the U.S. Yet, many companies benefit from the taxes they pay with lower production costs than say the U.S. A good example can be found here (the bad ideology applies to Larry it seems):

GMs Healthcare Double Standard: Bad ideology trumps good business:

"Yet just across the Detroit River in Ontario, the company's subsidiary-like the subsidiaries of Ford, DaimlerChrysler and other U.S. firms----strongly endorses Canada's national health system.

"The Canadian plan has been a significant advantage for investing in Canada," says GM Canada spokesman David Patterson, noting that in the United States, GM spends $1,400 per car on health benefits. Indeed, with the provinces sharing 75 percent of the cost of Canadian healthcare, it's no surprise that GM, Ford and Chrysler have all been shifting car production across the border at such a rate that the name "Motor City" should belong to Windsor, not Detroit.

Just two years ago, GM Canada's CEO Michael Grimaldi sent a letter co-signed by Canadian Autoworkers Union president Buzz Hargrave to a Crown Commission considering reforms of Canada's 35-year-old national health program that said, "The public healthcare system significantly reduces total labour costs for automobile manufacturing firms, compared to their cost of equivalent private insurance services purchased by U.S.-based automakers."
"

Even the business leaders in the U.S. understand this problem:

U.S. Health Care's Competitive Disadvantage

Thinker: Thanks for the info.

Steve and OLN: As for Paul, I always appreciate your visits. Thank you!
Here's another one that is relevant to the dicussion above:

The Sheriff of Nottingham would love the Republican Party

There are more than a dozen major countries with higher corporate tax rates than the US.

Interestingly, many of the countries listed in the article that are characterized by higher corporate tax rates are still alive and well (and not on a path of economic destruction because of high taxes, as Larry told us above). Some are not doing well, but it's not tax related.
Wow! Articles related to my blog post keep on coming:

A More Progressive Tax System Makes People Happier

Upcoming paper to be published in Psychological Science.
Larry and others,

As discussed in this link:

"It is capital availability that matters, not the tax rate that you pay," said Silverman. "The difference between us paying a 35% corporate tax rate and a 25% corporate tax rate is peanuts at the end of the year compared to our ability to raise a couple million dollars when we need it. That is what is important. That is what creates jobs." (Bold characters are mine.)
From Paul Krugman's latest blog post Phony Fear Factor.

...The answer, repeated again and again, is that businesses are afraid to expand and create jobs because they fear costly regulations and higher taxes. Nor are politicians the only people saying this. Conservative economists repeat the claim in op-ed articles, and Federal Reserve officials repeat it to justify their opposition to even modest efforts to aid the economy.

The first thing you need to know, then, is that there’s no evidence supporting this claim and a lot of evidence showing that it’s false.