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The Graph That All Tax Hike Mystics Need to Grapple With

Posted By Romina Boccia On May 25, 2011 @ 3:08 pm In Economics | Comments Disabled

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People often remember the entire decade of the ’90s as a period of robust economic growth. Economic growth was so impressive in the latter half of the ’90s, in fact, that some claim the Clinton-era tax hikes spurred the economy to prosper. But was that actually the case? Did tax hikes really lead to a stronger economy?

The data tell a different story. Growth in the first half of the decade following the Clinton tax hike was clearly subpar, and real wages actually fell. The economy didn’t take off until later in the decade, and not coincidentally after a 1997 Republican-sponsored tax cut.

Ezra Klein featured a graph by the Center on Budget and Policy Priorities (CBPP) [2] in The Washington Post last week that purports to show, according to CBPP’s Chad Stone [3], that:

Job creation and economic growth were significantly stronger in the recovery following the Clinton tax increase than they were following the 2001 Bush tax cut. And the Clinton policies produced a balanced budget.

By implying that higher taxes caused faster economic and job growth, the CBPP conveniently glosses over critical details, including the circumstances of the tax hike and especially the timing of the economic boom.

In reality, many factors affect economic and job growth—tax policy is only one of them. Proponents of higher taxes may blithely assert that Clinton-era tax hikes demonstrate how higher taxes can improve growth, but Heritage’s J.D. Foster explains in “Tax Cuts, Not the Clinton Tax Hike, Produced the 1990s Boom [4] that many events converged in the ’90s to drive growth. For example, the economy was poised for strong recovery coming out of the 1992 recession. The Clinton tax hike did not cause the recovery—which was already underway as President Clinton took office—in fact, the tax hike dampened the recovery.

Indeed, many factors were at work that would suggest a robust recovery early in the decade. The end of the Cold War led to greater economic confidence globally. At the time the economy also enjoyed very low energy prices, stable and low inflation, and a revolution in computing technology and the Internet. Vice President Al Gore may continue to argue that he created the internet, but even so, the invention occurred many years before the Clinton tax hike.

As the Heritage chart shows, a closer examination of the economic growth data during the Clinton era reveals a very different story than the one Ezra Klein and the CBPP told. Despite the unusually favorable economic environment during the period, the Clinton tax hikes likely dampened real output and real wage growth. Economic growth, measured as real Gross Domestic Product (GDP), was a moderate 3.3 percent in the period from 1993 through 1996, and real wages actually fell for the entire period. In contrast, the 1997 tax cuts, which significantly lowered the capital gains tax rate [5], coincided with a period of strong business investment, strong real GDP growth at 4.4 percent, and strong real wage growth of 1.7 percent.

As J.D. Foster explains [4],

The evidence is fairly clear: The tax cuts, especially the reduction in the capital gains tax rate, made a major contribution to a strong economy. Given this observation, it seems likely, though admittedly less certain, that the tax increases in 1993, while not derailing the economy as many had forecast at the time, did indeed slow the recovery compared to what the economy could have achieved.

The principles of economics still hold: If you make something more expensive, you get less of it. Taxes on capital and labor, ignoring all other factors, reduce economic and real wage growth. The real story of the Clinton-era tax changes is that the 1993 tax hikes resulted in slower economic growth than expected, while the 1997 tax relief unleashed economic and real wage growth—and a cottage industry of liberal history re-writes.

Co-authored by Curtis Dubay.


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2011/05/25/the-graph-that-all-tax-hike-mystics-need-to-grapple-with/

URLs in this post:

[1] Image: http://www.foundry.org/wp-content/uploads/SPECIAL-tax-cuts-1990s-economy-chart-1.jpg

[2] a graph by the Center on Budget and Policy Priorities (CBPP): http://www.washingtonpost.com/blogs/ezra-klein/post/taxes-are-not-incompatible-with-growth-in-one-graph/2011/05/09/AFSlNW6G_blog.html

[3] CBPP’s Chad Stone: http://www.offthechartsblog.org/bad-economics-and-distortions-of-1990-budget-agreement-hold-deficit-reduction-hostage/

[4] Tax Cuts, Not the Clinton Tax Hike, Produced the 1990s Boom: http://www.heritage.org/Research/Reports/2008/03/Tax-Cuts-Not-the-Clinton-Tax-Hike-Produced-the-1990s-Boom

[5] capital gains tax rate: http://www.heritage.org/issues/taxes/capital-gains-tax

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