Taxes and Economic Growth

Policy Reports | Economy | Taxes

No. 292
Tuesday, November 21, 2006
by Gerald W. Scully

Estimating the Tax Rate That Maximizes Growth

This study uses a simple but reliable econometric model.11 The parameters of the model (which are described in the Appendix) were estimated using data from standard statistical sources. The equations of the model were then solved to calculate the growth-maximizing rate of taxation - the rate at which increased taxes and spending cease to raise the rate of economic growth and begin to reduce it.

The optimal (growth-maximizing) average rate for federal, state and local taxes combined is between 23 percent and 23.5 percent of GDP. Taxes as a share of GDP were at the optimal rate in 1950 and have not been there since.

The optimal tax rate derived from this model are consistent with previous studies that conclude that the optimal size of government is 19 percent of GDP and that government spending of 20 percent of GDP maximizes productivity.12 The numbers will vary, depending on the model used and the period of years analyzed, but all of these estimates imply that the economic growth rate, and hence the level of GDP, is far below what would have been achieved had the nation's total tax rate been kept at its 1950 level.

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