Taxes and Economic Growth
The term â€œAustrian economistsâ€ usually refers to the likes of Hayek, Menger and von Mises. But I recently met some rather different economists from the Austrian Chamber of Labour.
Austrian law requires that union members pay dues to the Chamber of Labour, so it is very well-funded for a progressive think tank. Similarly, all Austrian businesses are members of the Economic Chamber and farmers are members of the Chamber of Agriculture. The Austrian government must consult these Chambers on all legislative proposals.
The Chambers are based in Vienna but also have offices at the Austrian representation (embassy) in Brussels. In fact, the Austrian Chamber of Labour has more staff in Brussels than the International Trade Union Confederationâ€™s policy department.
I encountered the Austrians presenting an excellent paper, â€œDo higher taxes result in lower economic growth?â€ Click here for a link toÂ an English translation of the paper and synopsis of a panel discussion. (I circulated this link a week ago on Facebook and my pal, The Jurist, has already blogged about it.)
Europe is currently in the midst of a debate about the extent to which â€œfiscal consolidationâ€ (i.e. deficit reduction) should be achieved through spending cuts versus tax increases. The Austrian paper contributes to this debate by debunking the notion that higher taxes impair economic growth. However, the analysis is equally applicable to policy debates outside of Europe.
The first section notes that personal income taxes reduce earnings from each hour worked. While that might prompt people to choose more leisure time rather than working, it might instead prompt people to work more to achieve a given level of after-tax income. In any case, many people have little control over their work hours.
While corporate income taxes reduce the earnings from investment, they also increase the value of amortization and depreciation from investment. In any case, investment decisions are often motivated by capacity limits, depreciation and technological change rather than by precise, after-tax estimates of uncertain future earnings.
Of course, income tax rates approaching 100% would severely reduce labour and capital supply. But the effect of tax rates is unclear over the range actually implemented by various OECD countries.
Some empirical studies find a negative relationship between taxes and labour or capital supply, but others do not. So, there are theocratical and empirical reasons to doubt that taxes reduce economic growth. The paper even cites our very own Marc Lee for expressing such doubt.
The second section examines the â€œtax ratioâ€: total tax revenue divided by GDP. The OECD and others count public pension contributions as taxes. However, compulsory contributions to private pension plans presumably entail the same financial burden for citizens and the same (dis)incentives for labour supply.
Simply adding private pension and health-insurance contributions to taxes dramatically narrows the supposed differences in tax ratios between countries. For example, different financing arrangements for similar pension benefits account for most of alleged gap between â€œhigh-taxâ€ Austria and â€œlow-taxâ€ Switzerland.
The third section runs simple regressions with the conventional or adjusted tax ratio as the explanatory variable and GDP growth as the dependent variable. The relationship between the conventional tax ratio and growth was negative since 1970, but positive since 1990. The relationship between the adjusted tax ratio and growth was always positive.
The fourth section runs multivariate regressions, including other variables selected by the OECD that influence growth. These regressions indicate a negative relationship between taxes and growth. But this relationship loses all statistical significance if one removes the emerging economies of Eastern Europe and Asia, and replaces the conventional tax ratio with the adjusted one.
The upshot is that picking different data, time periods and methodologies produces different results. So, right-wing economists can easily construct â€œempiricalâ€ studies to suggest that tax cuts spur growth. But such results are far from definitive.