Taxes and Economic Growth

Studies | Economy | Taxes

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

How Americans Could Have Been Three Times as Wealthy

In 1929, federal, state and local taxes combined consumed about 10 percent of GDP. In 1950, they were 23.4 percent of GDP - roughly the optimal tax rate calculated from the econometric model. By 1969, the tax share broke the 30 percent barrier and has been rising slowly since then. Real GDP was $1.8 trillion in 1950 (in 2000 dollars). By 2004, real GDP was nearly $11 trillion, reflecting a compound growth rate of 3.5 percent per year. Figure III shows the path of real GDP. It also shows that, at the optimal rate of 23.4 percent of GDP, the corresponding real compound economic growth rate would have been 5.8 percent instead of the actual 3.5 percent. As Figure III shows:

  • Had the optimal tax rate been in effect throughout the 54-year period, real GDP (in 2000 dollars) would have been $37 trillion rather than $10.7 trillion in 2004.
  • As a result, the average American family would have had more than three times as much real income as it has today.
Figure III - Path of Real Gross Domestic Product

"Americans lost $350 trillion of output from 50 years of toohigh taxes."

Cumulative Loss of Income. From the time the rate of taxation exceeded the optimal point, more and more American resources have been devoted to less and less productive uses. The annual loss of income accumulates over time. Because taxes have been too high since 1950, the resulting lower economic growth and failure to maximize wealth have robbed the nation of $350 trillion worth of output . Specifically:

  • The accumulated real GDP from 1950 to 2004 was $287 trillion.
  • At the 1950 tax rate, however, accumulated real GDP over the same period would have been $647 trillion - $359 trillion more actual output.
  • On the average, this represents roughly $1.2 million in lost income over the lifetime of every individual.

In general, the U.S. economy has sacrificed $4 worth of income for every $1 of tax paid beyond the level of optimal taxation. The implications of this finding are staggering.

"The economy would be three times larger had the United States maintained the 1950 level of taxes."

Government Tax Revenues Lost. Exceeding optimal rates has been costly to government at all levels, too. In the short run, the revenue-maximizing tax rate is higher than the growth-maximizing rate, as the model shows. However, over the long run, revenues at the lower tax rate beat revenues at the higher tax rate due to the faster expansion of the income or production to which the tax is applied. Over the period from 1950 to 2004, federal, state and local governments collected a total of $89.5 trillion in taxes, adjusted for inflation. But if total taxes had been limited to 23.4 percent of GDP, government would have been collecting taxes on a far larger tax base, thanks to a higher growth rate. As a result, the combined governments would have collected $151 trillion . This implies:

  • Had the nation's total tax burden been limited to 23.4 percent of GDP, government would have collected $61.9 trillion more in taxes.
  • This additional revenue would equal the total of all deficits in real terms since 1949.
  • Not only would government have had enough revenue to fund all spending programs enacted, but had the total rate been held at the optimal level, there would have been no public debt!

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