Tax the Rich, Kill the Economy? Here's Proof It Doesn't Work That Way

Republican presidential candidate Mitt Romney wants to extend the Bush tax cuts, and cut taxes even further in order to boost economic growth. In contrast, President Barack Obama argues that in order for the government to to pay its bills, we must allow the Bush tax cuts to expire (at least on the wealthy) and add surtaxes on high-income taxpayers in order.

But would cutting taxes on "job creators," as Gov. Romney proposes, rather than raising taxes on "the rich," as the President proposes, actually boost economic growth? No -- at least not according to the Congressional Research Service.

A Storm in the Making...?

Last week, in a headline that seemed about to spark a firestorm on the Internet (until Governor Mitt Romney's "47%" video preempted the pundits' attention), the CRS took up the question of whether "reduced [tax rates on the wealthy] would increase economic growth, increase saving and investment, and boost productivity."

Their conclusion: It wouldn't.

To the contrary, after 20 pages of charts, graphs, and economic navel-gazing, the CRS came to a startling (to some) conclusion: A review of 65 years of tax and economic data running from 1945 (when top capital gains and top marginal income tax rates topped 90%) through 2010 (by which time the top income tax bracket had declined to 35%, and the capital gains rate had fallen to 15%) shows no "conclusive evidence ... to substantiate a clear relationship between the 65-year steady reduction in the top tax rates and economic growth." (Here -- see for yourself).

Rather, the "data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth." These reductions did, however, result in "increasing concentration of income at the top of the income distribution. The share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession."

To summarize: Lowering taxes on the wealthy makes the rich richer, and doesn't do anything to boost economic growth.

... Or Just a Tempest in a Teapot?

The reaction from the political right wing was just as you'd expect, with the conservative think tank The Heritage Foundation firing off a quick rebuttal: "The Congressional Research Service ... set out to make a convincing case that lower income tax rates do not strengthen the economy. It failed, but in so doing, it called into question the quality of CRS analysis and the institution's credibility as non-partisan."

Heritage proceeded to work itself up into a fine lather, declaring that no matter what the data show, it is "impossible ... to argue that lower [tax] rates do not encourage stronger economic growth." The attempt to do so is "simplistic," "flimsy," and "misleading."

Impossible why? Apparently, just because the Heritage Foundation says so: "Of course, if you tax income, investment, and savings less you'll get more of them and the stronger growth that comes with the increase in these activities."

(Oh, well. If it's "of course," then I guess there's no point in looking at evidence ....)

Can't We All Just Get Along?

Now to be fair, Heritage's argument sounds sensible -- even in the absence of evidence to back it up. Taxing anything makes it more expensive, and as we all know from Economics 101, when the price of something goes up, demand for it goes down. (It's right there in the line graph.) Logically speaking, therefore, the Heritage Foundation's argument should be right, and the CRS's data should have shown this to be the case.

Except it didn't.

Instead, the CRS research showed that lowering the rate of the top income tax bracket was "not associated with private saving" and "not necessarily associated with productivity growth." As far as growing the economy goes, the "fitted values seem to suggest that higher tax rates are associated with slightly higher real per capita GDP growth rates."

So... so much for that theory. Apparently, now we're stuck with only two options. Option 1: Dismiss the facts as "impossible." Option 2: Follow a new theory that better fits the facts.

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Motley Fool contributor Rich Smith gets a bit nervous when politicians start talking about raising taxes on the rich. His only request: "Please don't forget the definite article."