Professor King Banaian of the SCSU Economics Department has an interesting post on his blog, here. The Organization for Economic Cooperation and Development (OECD) has tables of value added taxes in effect in OECD countries. King’s contention is that if we go ahead with planned tax rate hikes that could possibly put our top marginal rate at 50%, we’d be near the same rates as Italy and France, which are ranked low for 1988-2007 average GDP growth rates. Do the tax rates have any bearing on OECD GDP growth rates averaged over the past 20 years? The data does not make a compelling case for this argument:

The x-axis represents the OECD rank in economic growth. If the tax rates decided the growth rate, the higher ranked countries (1, 2, 3, etc.) on the left would have the lowest tax rates, and the lower ranked countries (28, 27, 26, etc.) on the right would have the highest tax rates. That’s not the case. (Or is my analysis of the data incorrect?)

Update: And here’s the graph not made at 2 AM, with regression line. Unfortunately, I can’t get WordPress not to crop. Hmm..

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Since you asked, I’ll answer: your analysis is absolutely incorrect. If you are going to analyze what determines growth, you have other factors you need to account for. Countries that have higher tax rates might have other economic variables (more trade, better technology, etc.) that account for higher growth. Yet if they had lower tax rates, they might have even higher growth. Only graphing 2 variables (X and Y) when about a hundred other variables also influence Y will result in spurious correlation. It’s undergrad univariate regression, not sophisticated economic analysis.

What you are proposing would be akin to graphing prices and quantities of oil over time and when I find that prices increase and quantities increase, I come to the conclusion that the law of demand is dead. Wrong. Other things are changing at the same time (income, number of cars worldwide, etc.) that are shifting out the curve. A similar thing may be happening here: each country faces a downward-sloping relationship between tax rates and growth, but different factors that are unaccounted for in your simply analysis may be shifting those curves around to different places for different countries.

You might want to at least draw a best-fit line through that graph if you’re going to look at it and just conclude by guesstimating that your theory is correct.

And perhaps you should look at the levels of economic growth (in actual numerical terms) not ordinal ranking measures.

I was simply using the same criteria used by King in his post. I know that there many other factors that determine economic growth. What we both obviously conclude here is that tax rates aren’t playing a huge role in how the OECD ranks GDP growth, and any influence it does have is being mitigated by other factors (trade, technology, etc.). So, the question was whether tax rates are a good indicator for economic growth. They aren’t.

Whether they are a good indicator is one question. Whether they have a significant impact on growth is another.

But your point is valid. King is implying a negative relationship by looking at the data. You are implying a positive relationship by looking at the data. An objective economist would say that looking at one variable and making this conclusion is nonsense, and that a proper multivariate analysis must be performed.

I’m glad to see you updated this and added a best-fit line to highlight the trend. The R-squared is low, but there is a positive trend, which would indicate higher taxes are correllated with lower growth rankings. But again, any good analysis needs to look at alot of things, not just these two.

Yes, I agree completely.