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Progressive Taxation Increases Growth

During the Bush administration taxes have become more and more regressive: Taxes on the rich have decreased with a variety of Bush tax cuts, while taxes on the poor remained high with payroll taxes and sales taxes. This is the Republican way; they say their policies increase economic growth. Democrats, however, believe in progressive taxation where the poor pay less and the rich pay more. Democrats say, and I will show, that progressive taxation is the way to economic growth.

In his book, Ravi Batra presents some history to show that decreasing the top-bracket tax rate decreases growth:

  • 1950s Tax Rate = 91%; Average Yearly Growth = 4.1%

  • 1980s Tax Rate = 28-50%; Average Yearly Growth = 3%
In the 1980s and 1990s regressivity was emphasized with the payroll tax burden that falls on the low-end worker. The result? Decreased economic growth.

So history tells us, first, that very high tax rates on high income people - 91% in the '50s - may not be fair, but they do not hurt economic growth.

Secondly, we learn that if the top tax rate is decreased, the economic growth rate is decreased. Why is that? Because when the tax on the rich is reduced, the taxes must be paid by the poor. This is regressive taxation, which hurts economic growth. What we need is lower taxation, not for the rich, but for the poor. Batra tells us:

"Now a low tax burden for the poor and and the middle class automatically means a high burden for the rich. That is why a progressive tax system produced much higher growth in U.S. history, and a regressive system did the opposite."

Here's the logic. Let's start with economic balance:

SUPPLY = DEMAND

If we increase taxes on the rich, the economic balance is essentially unchanged. Suppose a person makes $1 million a year, and his tax rate is raised from 10% to 15%. This means his taxes rise from $100,000 to $150,000. He still has $850,000 left to buy all the stuff he would have bought before; a good portion of the $850,000 remains in savings. There is no change in demand and thus no change in supply. The tax increase has little or no effect on economic growth.

If we increase taxes for the poor, there is a change in the economic balance for the worse. Suppose a person makes $20,000 per year and his tax rate is raised from 10% to 15%. This means his taxes rise from $2,000 to $3,000. Somebody making $20,000 a year spends every penny he earns. The extra $1,000 removed from his paycheck will cause him to spend $1,000 less. This reduces demand, which means that some products will not be sold, causing problems for business. Economic growth is negative and some people may be layed off.

Evidently, what we must do to increase growth is to decrease the tax burden for the poor and increase the tax burden for the rich. In the previous example for the poor worker, if the tax rate were reduced from 10% to 5%, only $1,000 would be deducted in taxes. The extra $1,000 would not stay long in his pockets. He would buy more, thus increasing aggregate demand, which would then allow business to expand and hire more people. The extra tax burden on the rich will fall off them like water off a duck.

Progressive taxation, unlike regressive taxation, brings economic growth to benefit both business and labor. This is why Democrats promote progressive taxation.

Posted by Paul Siegel at December 7, 2005 5:48 PM