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