As Republicans press ahead with major tax reforms, politicians and pundits are debating the effects of tax cuts on economic growth. This 2012 study by the former Tax Foundation chief economist took a detailed look at the academic literature on the issue.

Here is what Will McBride found:

So what does the academic literature say about the empirical relationship between taxes and economic growth? While there are a variety of methods and data sources, the results consistently point to significant negative effects of taxes on economic growth even after controlling for various other factors such as government spending, business cycle conditions, and monetary policy.

In this review of the literature, I find twenty-six such studies going back to 1983, and all but three of those studies, and every study in the last fifteen years, find a negative effect of taxes on growth. Of those studies that distinguish between types of taxes, corporate income taxes are found to be most harmful, followed by personal income taxes, consumption taxes and property taxes.”

These results support the neo-classical view that income and wealth must first be produced and then consumed, meaning that taxes on the factors of production, i.e., capital and labor, are particularly disruptive of wealth creation. Corporate and shareholder taxes reduce the incentive to invest and to build capital. Less investment means fewer productive workers and correspondingly lower wages. Taxes on income and wages reduce the incentive to work. Progressive income taxes, where higher income is taxed at higher rates, reduce the returns to education, since high incomes are associated with high levels of education, and so reduce the incentive to build human capital. Progressive taxation also reduces investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.”

This review of empirical studies also establishes some standards by which a tax system may be judged. If we apply these standards to our national tax system, the U.S. has probably the most inefficient tax mix in the developed world. We have the highest corporate tax rate in the industrialized world. If it came down 10 points—still higher than most of our trading partners—it would add 1 to 2 points to GDP growth and likely not lose tax revenue, because the tax base would expand from in-flows of foreign capital as well increased domestic investment, hiring, and work effort.

McBride’s study, with a nice summary table, is here.

If you have followed the tax debate, you know that the United States has one of the highest corporate tax rates in the world. Most other nations have slashed their rates to attract investment, while U.S. policymakers have been in denial about global tax competition until recently.

You may be less familiar with the cuts to top individual income tax rates around the world since the 1980s. Those reforms have been driven by international competition for skilled workers, and by growing recognition of the damage caused by penalizing the highly productive people who are top earners.

How much have top individual tax rates been cut? The Economic Freedom of the World report publishes tax rate data for more than 100 countries as far back as the 1970s, but with numerous data points missing. I found 80 countries that had data back to 1985, and below I chart the average top individual income tax rate for that group. For countries with subnational income taxation, the EFW report includes a range of rates reflecting the varying taxes in states and provinces. For the chart, I chose the highest subnational rates for those countries. For the United States, the U.S. rate for 2015 is the federal rate plus California.

The average top individual tax rate for 80 nations plunged from 60 percent in 1985 to 35 percent by 2010, and then edged up to 36 percent in 2015. The U.S. federal-state rate was slashed sharply in the 1980s, falling from 59 percent in 1985 to 42 percent in 1990.

Our top rate went back up in the 1990s, then down in the 2000s, then up again in recent years reaching 51 percent by 2015, as both the federal and California rates increased. Meanwhile, rates continued to fall around the world in the 1990s and 2000s until the tax-cutting trend tapered off in recent years. 

Note: The EFW dataset has 159 countries with individual income tax data for 2015. The overall average top rate was just 30 percent for those countries. For the subset of 80 countries, I took out countries with zero rates, such as Bahamas, and countries that did not have data for 1985.

A recent paper by David Autor of MIT, Lawrence Katz of Harvard and others, “The Fall of the Labor Share and the Rise of Superstar Firms,” begins by posing a mystery: “The fall of labor’s share of GDP in the United States and many other countries in recent decades is well documented but its causes remain uncertain.” They construct a model to blame it on U.S. businesses that are too successful with consumers. 

Five broad industries, they found, became more dominated by fewer firms between 1982 and 2012: retailing, finance, wholesaling, manufacturing and services. But those aren’t industries at all, much less relevant markets: they’re gigantic, diverse sectors. Is all manufacturing becoming monopolized? Really? Census data ignores imports, but why ruin this bad story with good facts.

Noah Smith at Bloomberg ran an audacious headline about this tenuous paper: “Monopolies drive down labor’s share of GDP.” Smith writes that, “The division of the economy into labor and capital is one place where Karl Marx has left an enduring legacy on the economics profession.” He goes on to claim that “at least since 2000 — and possibly since the 1970s — capital has been taking steadily more of the pie.” Yet, Jason Furman and Peter Orszag found “the decline in the labor share of income is not due to an increase in the share of income going to productive capital—which has largely been stable—but instead is due to the increased share of income going to housing capital.” Depreciation and government, they noted, also gained an increased share (i.e., grew faster than labor income.) 

President Obama’s Council of Economic Advisers, under Jason Furman, nonetheless worried that the 50 [!] largest firms in just 10 “industries” (if you can imagine retailing and real estate to be industries) had a larger share of sales in 2012 than in 1997 (using Census data that excludes imports). They concluded that, “many industries may be becoming more concentrated.” Noah Smith, Paul Krugman and many others have suggested that this nebulous “concentration” allowed monopoly profits to rise at the expense of the working class, supposedly explaining labor’s falling share of GDP during the high-tech boom. A quixotic search for even one actual example of monopoly soon morphed into advice about using unconstrained antitrust to constrain Amazon, which is apparently feared to have monopoly profits invisible to the rest of us. 

Research that starts with such a meaningless question as “labor’s share of GDP” was never likely to lead us to any profound answers. Workers do not receive shares of GDP – they receive shares of personal or household income. 

Contrary to popular confusion, dividing employee compensation (wages and benefits) by GDP does not measure how a capitalist private economy (e.g., “superstar firms”) divides income between labor and capital. Most obviously, the government makes up a huge share of GDP, including nonmarket goods like defense and public schools. Nonprofits also account for a lot of GDP, with no obvious payout to labor or capital. Less obviously, depreciation makes up another huge share of GDP, including wear and tear on public highways and bridges as well as private equipment, homes, and buildings. The “imputed rent on owner-occupied homes” is another large piece of GDP. Asking if labor is getting a fair share of defense, depreciation and imputed rent is a truly foolish question. Net private factor income would be a better gauge than GDP, for the purpose at hand, but still flawed. 

The ratio of compensation to GDP uses the wrong numerator as well as an untenable denominator. Labor income must add the labor of self-employed proprietors.

When people say “labor’s share is falling,” they surely mean income people receive from work has not kept up with income people (often the same people) receive from property: dividends, interest, and rent. But, that crude Piketty-Marx labor/​capital dichotomy ignores another increasingly important source of personal income: namely, government transfer payments from taxpayers to those entitled to cash and in-kind benefits. 

The first graph shows shares of income from labor, property, and transfers. The property share peaked at 21.1% in 1984–85, as the Fed kept interest rates very high, but averaged 19.3% and was 19.4% in 2016 (after dropping to 17.8% in 2009). The labor share averaged 66.5% but was 63.3% in 2016 even though property owners’ share was virtually flat. What went up? Transfer payments. Transfers rose from 11.7% of personal income in 1988 to 17.4% in 2016. Personal income that has been growing persistently faster than income from work has not been income from property (since the 1980s), but income from Social Security, Disability, Medicare, Medicaid, EITC, TANF, SNAP, SSI, UI, and so on.

Some might object that personal income leaves out retained corporate profits. But profits not paid out as dividends add to people’s income only if they are reinvested wisely enough to lift the value of the firm and thus generate capital gains. Personal income excludes capital gains because national income statistics measure flows of income from current production, not asset sales. That is also true of GDP, adding another reason to discard GDP as the basis of comparison.

However, Congressional Budget Office reports on the distribution of income do include realized capital gains when assets are sold (turning wealth into income). 

The second graph shows that labor’s share of household income is highest in deep recessions (77.5% in 1982, 76.2% in 2009) and lowest at cyclical peaks (70.6% in 2000, 68.3% in 2007). The higher labor share in recessions does not mean recessions are good for workers, of course, but that they are even worse for business and investors. Those who equate a higher labor share of income (e.g., during recessions) with higher real income for workers are making a basic and very large mistake. 

Capital income was highest in the early 1980s because the Federal Reserve kept interest rates very high, and capital income (dividends, interest, and rent) has shown no upward trend since then. Dividends and rent are up, but interest income is down.

Capital gains rose at specific times, but there has been no upward trend. There was a spike in capital gains in 1986 because the tax on gains jumped to 28% the following year. Realized gains also rose for four years after the capital gains tax was brought back down to 20% in 1997, and again after the capital gains tax was cut to 15% in mid-2003.

The white space at the top is important because it increases by four percentage points from 1990 (15.3%) to 2016 (20.3%) while labor’s share fell by 2.5 percentage points (from 75% to 72.5%). That white space is transfer payments: income from neither labor or capital. As the first graph showed, labor’s somewhat smaller share of income is not because of any sustained rise of capital income or capital gains. It is because of a sustained rise in the share of income from transfer payments and a sustained fall in the labor force participation rate.

Meanwhile, household income from owning a closely-held private business doubled since 1986: from 4% of household income in 1986 to 8% in 2013. That reflects the well-known shift of income from corporate to “pass-through” entities after 1986 as the top individual tax rate became even lower than the corporate tax rate (1988–92) or about the same dropped to the same as the corporate rate (35% 2003–2012)) or lower. That did not mean that “business” grabbed a bigger share at the expense of “labor,” but that a larger share of business income shifted from corporate to personal data.

The frequently repeated angst about “the fall of labor’s share of GDP in the United States” is based on a serious yet elementary misunderstanding of both labor income and GDP. “Labor’s share of GDP” is fundamentally nonsensical, because so much of GDP (depreciation, defense, etc.) could not possibly be paid to workers, and because the measure of labor income is too narrow (excluding the self-employed). 

Labor’s share of the CBO’s broadly-defined household income also fell (unevenly) because the share devoted to transfers rose, but also because the share moved from corporate to household accounts (and individual tax returns) also rose. Business income counted within CBO’s household income has increased its share of such income since the Tax Reform Act of 1986, but that just reflects a change in organizational form from C‑Corporation to pass-through status.

Labor’s share of personal income fell mainly because the share devoted to government transfer payments rose. Labor’s share of GDP fell for other reasons (rising shares going to housing, government, and depreciation), but it is a fundamentally misconstrued statistic used to rationalize irresponsible remedies to an illusory problem of “monopolies.”

Critics are saying that the Republican tax plan would give high earners the largest cuts. There has been a flood of news stories with that theme since the Tax Policy Center (TPC) released its analysis of the plan.

The TPC summary says, “Those with the very highest incomes would receive the biggest tax cuts,” and tables in the report encourage readers to come to that conclusion.

However, my parsing of TPC’s data reveals something different: the GOP plan would give the largest relative cuts to people in the middle. On average, middle-income earners would receive larger percentage tax cuts than higher-income earners.

The table shows data from TPC’s analysis and from its current law estimates released in March. Households are split into quintiles, or fifths, by income level. The columns titled “change” present the effects of the GOP cuts in different ways.

Columns 1 and 2. These results from TPC’s report suggest that high earners would receive the largest cuts.

Column 3. These figures from TPC in March include all federal taxes—income, payroll, estate, and excise. Note that the higher quintiles have higher tax rates, so if we cut everyone’s taxes an equal percent, then the higher quintiles would receive the largest cuts.

Column 4. These results from TPC’s study show the GOP cuts as a percent of all current taxes paid. The top and bottom quintiles get the biggest cuts, and the middle and fourth quintiles the smallest. But there is a problem with TPC’s presentation—Congress is reforming income and estate taxes, but TPC includes payroll and excise taxes in these calculations, which slants the results. (My column 4 data are slightly different from data shown in TPC’s study because of rounding issues).

Column 5. This column shows current individual income, corporate income, and estate taxes, based on TPC’s March data. These are the taxes that Congress is reforming. Current tax payments are hugely tilted toward the top end. The bottom two quintiles do not pay any of these taxes, on average. If we cut everyone’s taxes an equal percent, then higher earners would get—and should get—the largest cuts.

Column 6. This column provides the best answer—in my view—to the question of which group gets the largest cuts under the GOP plan (at least the GOP plan as interpreted by TPC). The middle quintile gets a huge 20 percent tax cut, on average, which is much larger than the 12.0 and 12.7 percent cuts for the top two quintiles. Looked at this way, the middle-class would get the largest tax cuts under the GOP plan.

I have assumed so far that TPC’s underlying analysis is sound, but actually there are problems with it. The TPC analysis is not dynamic, and thus overstates revenue losses, particularly from corporate tax cuts. That factor combines with the TPC assumption (erroneous in my view) that the corporate tax burden mainly falls on shareholders, not workers. The result of those two factors is that TPC exaggerates the tax cuts going to the top end.

TPC has fine analysts and it produces an impressive stream of reports, but I wish they would present their results in a more even-handed way. As an example, when they publish a table showing that the top quintile would get income/​estate tax cuts of $8,470 and the middle quintile would get $660 in 2018, on average, they should show that the former group will currently pay $66,701 of those taxes and the latter group will pay just $3,300, on average.

By the way, I do not think that the middle class should receive the largest tax cuts, so I do not agree with the rhetoric of either party on that issue. High earners should receive the largest cuts because they pay the highest rates, and reducing their rates would generate the most economic growth.

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For more on the GOP tax plan, see here, here, and here. For a discussion of distribution tables, see this study by Jason Fichtner.

The media’s favorite analysis of the Big Six tax reform framework comes from the Urban-Brookings Tax Policy Center (TPC), which purports to estimate that the plan would increase individual income taxes by $471 billion over a decade (by slashing exemptions and deductions), while cutting business taxes by $2.6 trillion. Predictably, this generated a tidal wave of outraged editorials and TV ads claiming the plan would do nothing for economic growth and benefit only “big corporations and the top 1%” (which is redundant, because individual taxes aren’t cut and the TPC wrongly attributes nearly all corporate tax cuts to the top 1%).

The Wall Street Journal has offered a powerful corrective to the TPC’s concealed analysis in “Where Critics of Tax Reform Go Wrong”, by Larry Kotlikoff of Boston University. It draws on his working paper with Seth Benzell of MIT and Guillermo Lagarda of the Inter-American Development Bank, which found “The [corporate] tax reform produces enough additional revenues to permit a reduction in personal income tax rates.”

The Tax Policy Center opines there will be “little macroeconomic feedback effect on revenues,” Kotlikoff explains, because they rely on an antique closed-economy model in which (1) investment can only be financed from some domestic “pool” of savings, and (2) higher taxes are equivalent to more savings because they supposedly reduce government deficits without reducing private savings. If government borrows more, this supposedly raises interest rates and “crowds out” private investment.

In reality, U.S. interest rates do not rise and fall with budget deficits, partly because arbitrage ensures the global bond yields move in tandem. Japan ran large chronic budget deficits for decades with super-low interest rates. 

The TPC nevertheless claims that lower corporate tax rates must add to the deficit because they will not raise investment and economic growth. And the reason lower corporate tax rates will not raise economic growth is because they will add to the deficit. Run those two sentences back and forth a few times to appreciate the magnificent circularity of this rhetorical trap for the unwary.

Unfortunately, Kotlikoff’s policy advice is not quite as careful as his analysis. He and his co-authors apparently “share critics concerns that [some unspecified aspect of] the plan would disproportionately benefit the top 1%. One way to rectify the fairness problem and address the country’s long-term fiscal gap would be to add, as the framework foresees, a fourth personal tax bracket for those with very high incomes.” 

Congress might take a clue from the Clinton-Gore campaign, for example, and add a 10% surtax on taxable income above $1 million. That would leave us with a 38.5% tax rate on income reported on individual income tax returns and a 20% tax rate on income reported on corporate tax returns. Contrary to Kotlikoff, that would not raise more revenue (to “address the fiscal gap”) for reasons explained by Kotlikoff himself: “If corporate tax rates are lower than personal income tax rates, people have an incentive to shelter their self-employment income (lower their personal tax bill) by incorporating.” 

In the 1980s, as the top tax rate on individual income fell from 70% to 28%, professionals and owners of closely-held businesses shifted en masse from reporting most of their income on corporate tax forms to reporting it on individual tax returns, as pass-through partnerships, proprietorships, Subchapter S corporations and LLCs.

A 2015 study by five Treasury economists and two Chicago scholars finds, “‘Pass-through’ businesses like partnerships and S‑corporations now generate over half of U.S. business income and account for [41%] of the post-1980 rise in the top- 1% income share.” If we now slam that process into reverse – by cutting corporate tax rate to 20% while leaving top individual rates of 35–40% – that would soon result in massive income-shifting out of pass-through entities back into C‑corporations that pay no dividends and compensate owners with tax-free perks, company cars and condos, and lavish expense accounts rather than large salaries. 

In short, the wider the gap between top tax rates on individual and business income (including self-defined pass-through income on Schedule C) the more futile it would become to raise top tax rates on income reported on individual tax returns above 30% much less 38–40%. The fourth tax bracket is a really bad idea based on really bad estimates of who wins and loses from a lower corporate tax rate.

Kotlikoff, Benzell and Lagarda have no basis for evaluating the “fairness” of proposed tax changes for individuals because they explicitly “do not model” such changes – they are exclusively concerned with the corporate tax. But, their model estimates that cutting the corporate tax raises tax revenue and also raises real wages by about 8 percent.

Kotlikoff’s endorsement of a fourth individual tax rate higher than 35% is not because he believes the GOP Framework adds much to budget deficits, but because he apparently accepts the Tax Policy Commission’s static estimates that the top 1% benefits most, as shown in the Table.

TPC Estimated Static Change in Federal Taxes by Income Group from Republican Framework Tax Plan

The reason the top 1% appears to get the largest tax cut is not because of the plan’s trivial rejiggering of individual deductions and taxes (which go up rather than down), but because the Tax Policy Center arbitrarily “assumes” that owners of capital bear 80% of the corporate tax, and most capital is owned by people with high incomes.

The trouble is, the TPC assumption that labor bears only 20% of the burden of the corporate tax is totally inconsistent with Kotlikoff’s model predicting an 8% rise in real wages from cutting the corporate tax. It is also totally inconsistent with all recent empirical studies on that issue. Congressional Budget Office economist William C. Randolph, for example, estimated U.S. labor bears 70% of the corporate tax, once we drop the TPC closed-economy fiction and allow capital to gravitate to countries with lower marginal tax rates. For tax-friendly countries attracting U.S. business and investment, Randolph explains, “Foreign workers benefit because an increased foreign stock of capital raises their productivity and their wages. Domestic workers lose because their productivity falls and they cannot emigrate to take advantage of higher foreign wages.”

A Tax Policy Center survey of the evidence likewise concluded that “Recent empirical studies… all conclude that wage earners bear most of the ultimate burden of the corporate tax.” That means everything you have been reading about “Trump Plan Delivers Massive Tax Cuts to the 1%” is just made-up fiction – based on a key assumption the source (the Tax Policy Center) knows to be false.

As Republicans flesh out details of their tax plan, one target for reform should be the “required minimum distribution” (RMD) rules for retirement accounts. The rules generally require that people begin withdrawing from their 401(k)s, 403(b)s, and traditional IRAs at age 70½ whether they need the cash or not.

The RMD rules are misguided, and policymakers should repeal them.

In writing this study on savings, I came across a Wall Street Journal piece arguing for liberalizing the RMD rules. Accountant Ed Slott says that the “government should raise the age for required minimum distributions to at least 80—if not eliminate it altogether.”

Here are Slott’s points:

• People are living longer today than before, so the RMD rules should be updated “to more accurately reflect today’s increased longevity.”
• Many people want to keep working, but “RMDs are particularly onerous for seniors who still have employment income and don’t need to tap savings for living expenses … No one should be forced to pull money out of an IRA while they are still working. When combined with a paycheck, these distributions can substantially increase taxable income … resulting in a higher overall tax bill that prematurely eats away at retirement balances.” The government should not discourage seniors from working, and the RMD rules can do that.
• Policymakers who resist tax cuts would likely oppose RMD repeal. But Slott argues, “Uncle Sam won’t be denied his cut, even if the funds are never withdrawn during our lifetimes. The income-tax bill never goes away since there is no step-up in tax basis at death with IRAs or 401(k)s, as there is with nonqualified retirement funds and other assets. Whoever withdraws the taxable IRA or other retirement funds will pay the income tax whenever it is withdrawn.”
• Slott notes that a round number such as 80 would make for simpler RMD rules than the current 70 ½. The half age thing is just one way that RMD rules are complex, as this WSJ article discusses. Full repeal of the RMD rules and penalties would be a great way to simplify the tax code.

Here is the most important issue: the RMD rules are anti-saving. By requiring withdrawals, they encourage consumption. Yet it is good for everyone when people save more. It increases financial security, reduces dependence on government, and generates larger pools of savings to support economic growth.

So repealing the RMD rules is a winner. Simpler tax code. Support for thrift, saving, and continued earning. Greater flexibility in retirement finances. More freedom with less government rules.

For a further discussion of the RMD rules see here and here.

For more on spurring savings with tax reform, see this report on Universal Savings Accounts.

The Republican tax reform framework envisions cutting the federal corporate tax rate from 35 to 20 percent. There may be pressure in coming weeks to scale-back some of the framework’s pro-growth provisions in order to hit revenue targets, but policymakers should stick with their corporate rate target.

Various groups have modeled the revenue effects of proposed corporate rate cuts, but they generally do not account for the full dynamic effects of reform. We can get an idea of the full effects by looking at actual reforms abroad.

Sharp corporate tax rate cuts in Canada and Britain do not seem to have lost those governments much, if any, revenue. That is likely because companies responded with a wide range of real and paper changes that increased their reported income. The same would happen in the United States, which is why dropping our rate to 20 percent would probably not lose revenue over the long term. 

Here is some evidence. For 19 OECD countries with good rate and revenue data back to the 1960s, I calculated the average corporate tax rates and average corporate tax revenues as a share of GDP. The chart illustrates the Laffer Curve effect of chopping high tax rates on a mobile tax base—rates go down, the tax base expands, and revenues remain strong.

From 1985 to 2005, corporate tax revenues as a share of GDP soared even though the average tax rate across the 19 countries fell from 45 to 29 percent. Then there is a sharp drop in revenues in 2010, presumably because of the recession or slow growth in many countries at the time. But note that even in the poor economic climate of 2010, corporate tax revenues were the same or higher than in years prior to the 2000 boom year.

By 2015, revenues were rising again even as the average tax rate continued to fall to a new low of 24 percent. The average revenue for these countries in 2015 at 2.9 percent of GDP is below 2000 and 2005, but above all prior years when rates were much higher.

Data Notes:

The 19 countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Spain, Sweden, United Kingdom, and the United States.

OECD revenue data is here and rate data is here. I used the central government rates because I have not found a source for subnational rates prior to the OECD data, which goes back to 1981. As a result, the revenues (which include subnational) and the rates (which do not) are not an exact match, but that is not a big problem for illustrating trends over time.