Four Graphs Looking at Real Economic Growth
by Mike Kimel
Four Graphs Looking at Real Economic Growth
This post contains four graphs looking at real economic growth, three of which also contain some tax information.
The first graph shows the five year annualized growth in real GDP for every five year period beginning the one ending in 1934. (I begin then simply because data on real GDP is only available from the BEA beginning in 1929.)
Figure 1.
I took the liberty of adding in two lines free-style. The first is my attempt to trace the high points over time, leaving out WW2. The second traces the low points, assuming the collapse from 1929 to 1932 and the post-WW2 drop are special cases. (That huge dip from 1945 to 1950, economic shrinkage and all, is what libertarian professors like David R. Henderson keep referring to inexplicably as a post-war miracle.) Those ad hoc lines seem to indicate that any “Great Moderation” in the economy – whether it began in the 1980s or earlier – is more due to a slowing down of the rapid periods of growth than to a reduction in the severity of downturns. Put another way… the Great Moderation = the Great Suckening (for readers who aren’t economists, that’s a technical term like “sterilizing monetary policy” or heteroscedasticity).
Figure 2 is similar to Figure 1, but it strips out the two ad hoc lines and adds in the five year average top marginal individual income tax rate.
Figure 2.
As Figure 2 shows, there doesn’t seem to be much of a relationship between the average top marginal tax rate in any five year period and the annualized growth in real GDP over that same period, and certainly there’s no sign from this graph that higher tax rates discourage economic growth. The fact that the correlation between the two series is positive indicates that if anything, in general real economic growth rates have tended to be higher when tax rates were higher.
Figure 3 is a scatter-plot version of the data in Figure 2.
Figure 3.
Notice that it kind of looks like you can put a quadratic curve to these points – at “low” tax rates, increasing tax rates are associated with faster economic growth. Only at very “high” tax rates – somewhere north of 70% or 80% – does it appear that reducing tax rates are associated with faster economic growth. Reminiscent of this graph, dontcha think? Another thing that’s noticeable… the greater variability in growth that accompanies higher tax rates, which was also visible from Figure 2.
Finally, Figure 4 is the same as Figure 3, but rescaled to leave out 1942-1945, which only makes the lack of a lower taxes = faster economic growth relationship more obvious.
Figure 4.
As always, if you want a copy of the spreadsheet where these graphs were produced, drop me a line. I’m at mike period my last name (that is “kimel” – one m only!) at gmail period com.
Cross posted at the Presimetrics blog.
Mike
I think you’ve got something here. But I wish you’d spend some time reading the history of these times and see if you can’t come up with a more convincing “explanation” of what happens. May be more than one “cause” operating here.
My own thought is that “investment” does not automatically translate into “growth.” Consider that most countries do not favor investment in Cocaine factories, though those would certainly be profitable at least for a time.
So it seems to me that at some point “excess” money is not invested in growth producing enterprises, but in “money making schemes.” Imperfect as it is, government “investment” is almost always directed toward activities that favor growth… even if it’s only keeping the labor supply alive while the business cycle turns around.Today, 8:35:33 AM PDT– Reply – Delete
Mike,
You’ve seen this?
http://econ.tulane.edu/RePEc/pdf/tul1107.pdf
It’s very much like some of the work you have done, but at a state level.
coberly,
You’re right about schemes, but those are always there.
Here’s an alternative that you’ve got me thinking about… you may recall from earlier posts that higher taxes lead to more investment (I think that’s to avoid paying the taxes when you take the money out of the business) until a certain point (somewhere in the 80% plus range if I recall). I think maybe at some reason that changes because at some point people have run out of good places to invest in the business, and all that’s left is pulling money out.
kharris,
Yeah… Thoma links to Florida at the Atlantic (of all places – once again, the question is – when will McArdle attack someone at the Atlantic for the things she attacked me for doing) who links to the paper. But remember… I’ve done this at the state level a lot of times. My first ever post at Angry Bear back in 2006 was a look at state taxes and growth rates.
Mike
i don’t seem to be making myself very clear.
the point about the schemes was that there is not enough real investment opportunity to absorb all the cash available when the rich have more money than they know what to do with. this is not 1830 when capital was scarce and investments were obvious. so more and more money goes into pure “gambling.” the sort of investments that produce bubbles.
and, similarly, it’s not that people avoid paying themselves and reinvest in their business to avoid paying taxes, [though they well may for all i know] but merely that taxes take money that would otherwise be spent or poorly invested from a growth standpoint and the government invests in stuff that does underwrite growth.
of course i don’t know any of this, so it may not be so important that you understand what i am saying.
still… i think its worth looking into by those who are a little smarter than someone who thinks that technical innovation came to an end in 1970… thus explaining low growth in the face of low taxes.
i just can’t imagine that people invest or don’t invest in response to marginal changes in taxes. i can believe that people “invest” to play tax games, but there we’re not talking about real investment in productive enterprise. that is just another move in the great unproductive money gaming that an over-rich class not particularly concerned with growing real wealth entertains itself with.
So, you are saying that the government spends it’s tax dollars in better growth investments than individuals. Sounds like a good reason to tax the rich more during a recession.
coberly,
I understood. I didn’t answer properly. My bad. I think you’re partly right but wrong to use it as a mechanism.
I don’t think the use of schemes goes away just because taxes are low or just because there are plenty of investment opportunities. Madoff was running his scheme through good times and bad. Enron and WorldCom started their thing when the economy was booming. It was just that things became untenable when the doo doo hit the fan.
Jerry Critter,
I wrote that post a few times already. Here’s one of them:
http://www.angrybearblog.com/2010/05/effect-of-tax-cuts-and-tax-hikes-on.html
Mike
i wasn’t thinking that the schemes go away in good times. only that when the rich have more money than can be absorbed in real investments, the excess money goes into “schemes” which do not add to future productivity. i am by no means sure i have thought this through well enough so that it adds up.
the point would then be… the “mechanism” as it were… that when taxes are “too low” money is going into “schemes” that could be better spent “invested” by the government in infrastructure or even “jobs” for the unemployed that give them money to spend that creates real investment opportunities for real businesses.
the only way i can think of to “resolve” this would be to look at where the money is actually spent, either by “the rich” or by the government. shouldn’t be completely impossible, but might be more work than coming up with a “theory.”
not your theory i am thinking of, but all those others… the ones we live by.
heck, jerry
i thought I was the one saying that.
taxing during a recession is a big no no according to the conventional wisdom. my feeling has been that sometimes its a bad idea, and sometimes it’s not. today seems to me to be one of those times when it would be a good idea.
I agree!
coberly,
taxing during a recession is a big no no according to the conventional wisdom. my feeling has been that sometimes its a bad idea, and sometimes it’s not. today seems to me to be one of those times when it would be a good idea.
You make a very compelling presentation here. I think you should forward your analysis to the Council of Economic Advisors, and to the Nobel committee.
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Jerry you and FDR agree. Actually plenty of economists and politicians agree but they don’t rule the roost. It’s more popular with voters to say that we over-tax productive people and over-fund unproductive people. To think otherwise must be a socialist soak-the-rich philosophy. At least until you are categorized as unproductive.
Mike I appreciate your occasional link to an oldie-but-goodie posting. May I ask if you’ve previously looked at tax law changes involving investment credits and depreciation rules, as affecting aggregate investment/growth rates? I’ve read that such changes explain 1960s growth more than the cut in the top marginal personal income tax rate. I wonder if there are some interactive effects involving top marginal tax rates on wages and dividends and tax incentives for investment, and maybe you’ve looked at that.
sammy
what i have presented here is a speculation. i am not qualified to do the work that would support the idea. i keep hoping to interest an honest economist.
i would imagine that one would begin by “rating” investments according to their potential to increase productivity.
i suppose that economists are “value neutral” in the sense that if a casino will generate profits, that is a measure of “what the market demands” and is as good an investment as railroads.
but i think most people know better. and until recently the laws that communities imposed on themselves reflected a bias against “un-productive” or anti-productive investments. no casinos, thank you. no cocaine factories.
but now we have state run lotteries….. supposedly to generate money for real investments that the people are not willing to pay taxes for.
i imagine it would not be too difficult to find out what people are “investing” in, and rate these according to their potential to affect future productivity. then i would bet that you will find that the “supply” of high-productivity-potential investments is limited at any given time, and that if during those times, the supply of “excess money” is higher than the demand for productive investment, then the money will go into unproductive or anti productive investments. bubbles.
meanwhile there are investments with high productivity potential that are not attractive to private investors because the “profit” is dubious.
railroads were an example… without public subsidies the railroads would not have been built. ditto for highways. and internet highways. airplanes. farm research. public health. and, yes, the sort of ‘welfare’ that preserves the potential productivity of people through hard times… when “let the lazy bums get a job” doesn’t work as well as sammy expects it should.
PJR,
I don’t recall having done that analysis, nor can I off the top of my head point to somewhere where I’ve seen it done. Sorry.
Coberly:
It is cheaper to take money out of a business as an owner and pay tax than pay business taxes. Raise individul taxes and money will stay in the businesses.
The gambling you speak of has been in CDS and naked CDS where the risk was supposedly mitigated by the S&P rating mechnism of the CDO. CDS were sold to insure investments and the same people shorted the same investments with a counter CDS. What do you think brought AIG down ? and who walked away with the money?
run
unfortunately i don’t know enough to have an opinion.
generally i don’t like tax schemes that invite gaming. in the case of businesses that may be hard to avoid. it would be unreasonable not to allow businesses to deduct expenses. and i think that businesses ought to be allowed to accumulate capital for future unspecified needs. but if we are going to have taxes at all, we need to tax income… probably both “individual” income and “business or corporate” income. i would argue that the tax needs to be as simple and transparent as possible .. and NOT be designed to provide incentives or maximize efficiency or “favor” investment… all of those things are highly game-able.
i sometimes think that taxing ONLY corporations would be the best system… the corporations would pass the taxes through in the form of higher prices so it wouldn’t be “taxing the fountainhead of wealth” but instead be allowing people to pay the real cost of the things they buy… including the cost of running the country that makes the whole economy possible..
as for the CDS’s and gambling… my only point there was with respect to Mike’s finding that higher taxes sometimes seem to do a better job of promoting growth: some “investments” have a low potential for creating future productivity. under circumstances where a lot of money is chasing relatively few productive private investments, higher taxes can shift money away from speculation and into infrastructure… etc.
in principle i don’t think it’s wise to focus too much on the smell factor… as a matter of tax policy. glad to let the people regulate businesses that they see as harmful… but not by creating tax dodges that every tax lawyer and coupon clipper will try to take advantage of while crying piteous tears about how HIS scheme is the real foundation of all our wealth.
in other words i do NOT think it ought to be a matter of tax policy to favor “keeping money in the business.” hell, the reason to have a business is so you can take money out of it. there is supposed to be a tension between consumption today and investment for more consumption tomorrow. let the market sort that out. not the tax code.
on the other hand, when there is a need that private enterprise is not meeting, and the money can be got by taxes, then that’s the right way to go about it. if there were any evidence that taxing was producing worse results than private investment, that would be a reason to consider not raising taxes in general… but not a good reason for tweaking the code to “favor” keeping the money in the business. not all businesses are created equal from a public policy standpoint. we don’t really want to aid marginal businesses, or throw money at very profitable businesses, while allowing the people to starve because of some religious idea that “business” creates wealth while taxes are a “dead weight loss.”
coberly
you are on the right track but profit [not earnings] – and differentials between industrial and financial – has to be taken into account. When this is done we can see the shifting into a financialized system to have begun with the early 1980s double slump or, at the latest, 1987. CDS [whether plain, squared or cubed] merely reped an attempt to avoid risk at firm level even though adding at the level of capital as a whole…much the same for associated derivatives – with worthwhile theory and data from the BIS [and then Markit], it was very easy to see coming.
You might also want to look into long waves,,,I’d recommend Wallerstein and Mandel’s perpectives [and Cambridge? debate]. Kondratief’s work was far too mechancical.
Mo