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Why the Tax Rates of the Rich Have Little Effect on the Economy

Updated on February 1, 2013

The recent debate over whether to raise taxes on the rich was a hard fought one, for sure. The Republicans said it would harm the economy, as is part of their political dogma. The Democrats (and mainly President Obama during the campaign) said that all they wanted to do was return the top tax rate to what it was under President Clinton, or 39.6%. That would be raising it a whole four percentage points from its former 35% rate under President Bush. In the end, the Democrats prevailed and the top tax rate was returned to 39.6%, but with a few differences. Instead of being for people who make over $200,000, filing as a single person, or $250,000, filing as a family, the new bracket starts at $400,000/$450,000 for individuals and families, respectively.

So, the real question is...do tax increases on the rich really hurt the economy? And, the larger question: does the tax rate on the rich (whether it is lowered or raised) really have much effect on the overall economy? This is what I intend to find out. This will be a multi-part series, but the first part will focus on comparing annual GDP percentage growth and the unemployment rate over the years to the top tax rate.

The Unemployment Rate

First we will look at the unemployment rate from 1981-1999. During these years, Reagan cut the highest rate from 70% all the way down to 28%. With Clinton, the rate was raised to 39.6%, where it stayed for many years until President Bush passed his two tax cuts in his first term. This will give a great look at if tax cuts or increases really hurt the economy at all.

Before I break down the graph, we must detail the common mythology that surrounds the tax debate. If you cut taxes for the rich (side note: both the Reagan and Bush tax cuts largely favored the Rich), then they will have more money to invest in business and thus, hire more people. It's what is known as trickle-down economics. The only problem with that mythology is that it's just that...mythology. There's not a lot of evidence to back it up.

Looking at this chart, you can see that when the tax rate was cut in 1982, the unemployment rate rose quite sharply to 9.7%. This is hardly attributable to the rate increase, though. There are many factors at play. The rate held steady at 9.6% through 1983 and was on its way down through the 80s. It hit its lowest point at 5.3% in 1989 when the top tax rate was also at its lowest ever, 28%. Theoretically, you could make the argument that the tax rates did have a net benefit. But, then we reach the 90s where in 1990, the unemployment rate started to go up once again.

The tax rate inched up to 31% in 1991, but was eventually raised to 39.6% by President Clinton. When this happened, you would assume the unemployment rate would have to go up since the Rich had less money to invest, and thus, would hire less people, right? Wrong. Through the 90s, the unemployment rate actually went down, finally reaching 4.0% in 2000, the lowest in decades.

What does this show? Well, it shows that the top tax rate may not have a huge effect on the unemployment rate, which tends to disprove the common mythology of the Rich having more money to invest and create jobs.

Let's move to the more recent decade.

This chart actually bodes well for the notion of lower taxes on the Rich meaning less unemployment. The top rate started to slide down from 2000-2002 and finally rested at 35% until the recent fiscal cliff deal in early 2013, where it was raised back to 39.6%.

As you can see, as the tax rates for the Rich went down, the unemployment rate went down, as well. But, in 2008, we hit the Great Recession and everything was undone. It's impossible to blame the lower tax rates for this. Reckless behavior in the housing market and financial sectors were to blame for the Great Recession.

But, this chart also shows that the unemployment rate started to go down in 2011 without the aid of tax cuts for the rich. President Obama actually cut taxes for the middle class multiple times.

Annual GDP (Gross Domestic Product) Growth

Next, we will look at the annual GDP growth percentage and see if the top tax rates coincided with it. Arguably, freeing up more money for the Rich should allow them to invest more and help the economy grow, right? Let's check that out.

This one is simple to break down. I would have included statistics from the 80s if they were available. 1991 is as far back as I could go. It still gives a pretty clear picture, though. The top tax rate was increased to 39.6% in 1993 and GDP growth stayed fairly stable throughout the 90s. During that time, the economy created over 20 million jobs. So, while the Rich were paying a bit more, the economy thrived. But, wouldn't the rich lose the motivation to invest and acquire more money? If you go by the common mythology, yes. But, in the world of facts, it's simply not true. The Rich will still want to invest and form new businesses. While, they may take home less money, it doesn't mean their motivation wanes. That's a clever, fear-mongering tactic.

Now, let's look at when the top tax rate was cut to 35% by President Bush in 2003. What happened to GDP growth? Arguably, the economy was coming out of the dot com bubble burst that happened at the end of Clinton's Presidency. So, the increased GDP growth did coincide with tax cuts for the Rich, but the economy was also rebounding like it always does. But, the key point is that the GDP growth was weaker than it was in the 90s, even with lower tax rates on the Rich. If the common mythology was to be believed, the GDP growth should be higher, as they have more money to invest and stimulate the economy.

So, what's the point?

I think the result is clear. Cutting or raising taxes on the Rich have little effect on the economy overall. While sometimes cutting or raising the tax rates on the Rich does coincide with economic growth or contraction, it is by no means a clear connection. There are times that the opposite happens.

The point of this post is to say that raising taxes on the Rich is not the earth-shattering, economy-crushing thing that Republicans make it out to be. There's something more going on. The Republicans have been the defenders of the Rich for a while now. Technically, they are defenders against any tax increases, but when specifically pushed on raising the top tax rate, they fight tooth and nail. Why? Well, one major reason is who backs their campaigns. In the 2012 election, Obama received most of his donations in small amounts and from regular people. That's not to say he didn't do fundraisers, or have rich backers. He certainly did. He raised hundreds of millions of dollars that way. But, a large, large portion of it came from online fundraising, where people donated $10-25. Romney's strategy was a little different. He received most of his cash from millionaires and billionaires. Most of the conservative Super PACs were backed by the Koch brothers, who are billionaires.

It's all about money in politics. I don't think the Republicans would fight to preserve the top tax rate as much, if they didn't face backlash from benefactors and even their own party (The Tea Party). That's all beside the point, though. The point of this article was to show that cutting taxes for the rich doesn't equate to economic growth by default. There are many other factors, but it isn't the sacred cow issue that Republicans make it out to be. Long live statistics and graphs!

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      Howard Schneider 4 years ago from Parsippany, New Jersey

      The wealthy hoard most of their wealth and have great slack in their finances. Raising their taxes has no economic effect. The middle and lower classes spend all of their income. Supply side economics is bunk. Great Hub, Steven.

    • Arghness profile image

      Edward 4 years ago from O'Fallon

      Oh look! It's HSchneider!

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