TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Sunday, November 29, 2009

Taxes and Private Sector GDP Growth

Taxes and Private Sector (Angry Bear):

[I]t’s easy to cheat on GDP. GDP includes Government Spending, so an irresponsible administration can artificially goose GDP simply by borrowing a fortune (thus making the national debt explode) and spending the money. ...  We can pull the government consumption and expenditures ... out of GDP ..., giving us something we can describe as the “private sector component of GDP.” Next, we can divide the amount the government collects in taxes ... at all levels – federal, state and local – by the private sector component of GDP. ...  That gives us the percentage that the private sector (at all levels, from the lowliest panhandler to the most magnificent maharajah in the business world) pays in taxes in each year. If it isn’t obvious, there’s no point in including the government portion of GDP there since the government doesn’t pay taxes.


[See data here.]  [S]ince Ike took office, only three administrations (JFK, LBJ and Clinton) increased the percentage of the private sector GDP that goes to taxes; they make up three out of the four administrations with the fastest increases in the annualized real private GDP. ... The annual average increase in real private GDP is about 2.4% for administrations that cut share of private sector GDP going to taxes, and 4.2% to the administrations that increased it.

Go figure. Now, I dislike paying taxes as much as a Glenn Beck does, but the story line about big bad taxes choking off the private sector doesn’t add up. The “biggest government” president in our sample was LBJ with his Great Society and War on Poverty, and he’s the guy under whom the private sector grew the fastest. JFK was second on both counts. The reason is, without the government, and the taxes that fund it, there is nobody to build roads, provide a decent legal system or combat epidemics, and without things like this, the private sector grinds to a halt, the efforts of Anthony Mozillo and Paris Hilton notwithstanding.

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There are a lot more factors than tax rates that determine growth in the economy, and policies from an administration often have a long-term carryover impact, which may give credit to the wrong party. And, a huge issue with government spending, at least with me, isn't as much about how much is spent but how it is spent...or, wasted.

Posted by: Woody | Nov 29, 2009 3:19:36 PM

Thanks for the reminder that, war policy aside, LBJ was a pretty fair president, at least to those of us who remember those days. But imagine, were LBJ to return in a White House seance, what he might have to say about the political ineptitude of the current administration. Even better, imagine Lyndon resurrected for 15 minutes to chat with his successor, Pelosi, over coffer.

Such wonderful fictions to entertain the mind!

Posted by: Anonymous | Nov 29, 2009 5:53:53 PM

It appears the administrations (JFK, LBJ, and Clinton) that increased the percent of the private sector GDP that goes to taxes also presided over periods in which the federal budget deficit was small or in the case of Clinton going from a deficit to a surplus. It may be that deficit spending is a bigger culprit than taxes in reducing private sector growth. Robert Barro's "Macroeconomics - A Modern Approach" states the government spending multiplier is zero. If true, there would be no long-term benefit from government spending.

The Japanese increased taxes in 1997 to get a handle on their ballooning deficit. They fell back into recession soon after.

Robert Barro and Charles Redlick wrote a paper entitled "Macroeconomic Effects from Goverment Purchases and Taxes." NBER Working Paper No. 15369 issued in September 2009. They found "increases in taxes seem to reduce real GDP with mainly a one-year lag due to income effects and mostly a two-year lag due to substitution effects."

Increasing taxes and goverment spending concurrently probably won't lead to sustainable economic growth.

Posted by: Rick | Nov 29, 2009 10:40:28 PM