Which tax cuts stimulate the economy?

David Cay Johnston of Reuters covered my research today:

Tax cuts are the key to job creation, or so Mitt Romney, running mate Paul Ryan and the 2012 Republican platform all say. But what does the empirical evidence show? Is the rhetoric in line with the known facts?

Studies examining the impact of cutting personal income tax rates on job growth or economic activity generally have been inconclusive, said Will McBride, chief economist for the Tax Foundation.

Owen M. Zidar, a graduate economics student at the University of California at Berkeley, and a former staff economist on the White House Council of Economic Advisers for President Obama, has taken another crack at it, sifting through the data, using the National Bureau of Economic Research’s tax simulation model. Zidar looked at state level income and economic data.

He reasoned that “if tax cuts for high income earners generate substantial economic activity, then states with a large share of high income taxpayers should grow faster following a tax cut for high income earners.” The data show that tax cuts at the top, though, do not not result in faster growth in states with more more high-earners.

“Almost all of the stimulative effect of tax cuts,” Zidar found, “results from tax cuts for the bottom 90%. A one percent of GDP tax cut for the bottom 90% results in 2.7 percentage points of GDP growth over a two-year period. The corresponding estimate for the top 10% is 0.13 percentage points and is insignificant statistically.”

Asked about the new research, Romney campaign spokeswoman Andrea Saul urged against publishing a story about Zidar’s work because it is preliminary and because of Zidar’s connection to the Obama Administration. Zidar has also worked for an arm of Bain Capital, the firm where Romney made a fortune in private equity.

That fits with the argument made over the last century by a variety of business leaders — carmaker Henry Ford and retailer Edward Filene among them — that the path to economic growth lies in workers making enough (and having enough after taxes) to buy goods and services.

Readers may view Zidar’s paper online at SSRN after signing up for a free account.

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About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
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