Taxes and Economic Growth

Policy Reports | Economy | Taxes

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

What Can Be Done Now for Future Growth?

Figure IV - Potential Gross Domestic Product

"A lower tax burden would raise the rate of economic growth."

For the past 50 years taxes have consumed an average of 30 percent of the GDP in the United States. These rates have resulted in lower GDP growth and lower tax revenues for the government, compared to the lower, optimal tax rate. For both fiscal conservatives and liberals, this is bad news: conservatives have always viewed higher tax rates as stifling job creation, innovation and entrepreneurship; for fiscal liberals who support the redistribution of wealth, higher rates of taxation leave fewer revenues available for the government to redistribute. So an optimal tax rate would benefit all of society, not just a select few.

Figure IV shows projected GDP in 5, 15 and 25 years with the growth rate at the optimal rate of taxation, compared to the current average GDP growth rate, beginning in 2005.

  • By 2010, projected GDP at a growth rate of 5.8 percent would amount to $14.6 trillion, compared to about $13.1 trillion at a 3.5 percent growth rate.
  • By 2020, projected GDP at the higher growth rate would be $25.7 trillion, compared to only $18.5 trillion at the lower growth rate.
  • By 2030, GDP would be $45 trillion, almost twice as much as the $26 trillion resulting from the 3.5 percent growth rate.
Figure V - Potential Tax Revenue

"Future economic output would be higher with the optimal rate of taxation."

Furthermore, at a growth rate of 5.8 percent and an average tax rate of 23.4 percent of GDP, tax revenues would more than equal revenues at the lower growth rate of 3.5 percent and higher tax rate of 30 percent. As Figure V shows:

  • In 2020, tax revenues at the lower average tax rate would be about $6 trillion, compared to $5.5 trillion at the higher average tax rate.
  • By 2030, this difference would increase to $10.5 trillion for the lower average tax rate, compared to $7.8 trillion at the higher rate.
  • Total tax revenues from 2005 to 2030 would be $148.2 trillion at the lower average tax rate, compared to only $136.9 trillion at the higher average tax rate, a difference of more than $11 trillion!

"Future tax revenues would be higher with a lower rate of taxation."

For comparison, this difference in projected federal revenues is greater than the unfunded liability of Social Security over this period.

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