At the end of this year, tax cuts approved by George W. Bush are set to expire. If nothing is done, the top two income tax brackets will revert back to 36% and 39.6%, up from 33% and 35% currently. Capital gains and dividend tax rate changes also lie in the balance. Right now, politicians are fighting over whether to let the cuts expire or to maintain them. There could also be other changes, such as letting them expire for wealthy individuals, such as those who make more than $250,000 per year.
Those advocating extending the cuts believe that letting them expire will hurt economic growth. There doesn't appear to be clear-cut evidence, however, that lower personal tax rates help the economy. For starters, rates have already been low and they didn't help prevent the financial crisis or speed up the recovery from the Great Recession.

A recent study by the Congressional Budget Office showed that economic growth during tax cuts implemented by Ronald Reagan in 1981 and through the Tax Reform Act of 1986 didn't stand out from the growth that the economy experienced when Bill Clinton raised taxes in 1993. The Bush tax cuts around 2001 also took place during a weak economy and didn't do much to help it recover.

Bloomberg Businessweek cited a 1989 study entitled "Budget Deficits, Tax Incentives and Inflation: A Surprising Lesson From the 1983-1984 Recovery" that also found the Reagan tax cuts weren't the main reason for strong economic growth in the 1980s. Instead, it found that expansionary monetary policy was the primary reason for the growth. Tax changes more favorable to businesses were also seen as a reason for the strong growth.

Corporate Tax Rates
It does appear that changes to corporate tax rates have a stronger ability to influence economic growth than changes to personal income tax rates. Both presidential candidates are currently advocating lowering the corporate tax rate in the United States. It officially stands at 35%, which qualifies as one of the highest in the world, though actual rates paid by businesses are much lower due to deductions and the ability to conduct business outside of the U.S. where rates can be much lower. President Obama would like to lower it to closer to 28%, while Romney would like to be more aggressive and lower it closer to 25%.

As the 1989 study cited, lower corporate tax rates can help spur investment. It is pretty clear that a lower domestic tax rate could encourage businesses to return to the U.S. or at least start investing at home more aggressively.

A final consideration was a U.S. News study that looked at tax rates and growth among U.S. states. One of its findings detailed that, between 2001 and 2010, states with the highest tax rates experienced among the strongest economic growth in the country. It found little evidence to suggest that "low rates lead to prosperity," at least when it comes to individual state personal income tax rates and growth or income levels among the respective states' residents.

The Bottom Line
It appears rather clear that changes to personal tax rates in the United States have little impact on economic growth. Raising them may help shore up tax revenues, but the impact on federal coffers or economic growth looks to be minimal. The same goes for either extending or cutting personal tax rates. Based on the evidence, politicians may want to focus more on lowering corporate tax rates and other business-friendly reforms. The Federal Reserve is doing all it can to maintain an expansionary monetary policy, which has helped spur economic growth following past downturns.

Related Articles
  1. Fundamental Analysis

    Quantitative Easing Report Card in 2016

    Find out why quantitative easing has not worked, despite the best efforts of the Federal Reserve, and how it has fueled the national debt problem.
  2. Economics

    Economist Guide: 3 Lessons Karl Marx Teaches Us

    Read about three lessons that modern economic thinkers can learn from German philosopher Karl Marx, the founding father of communism.
  3. Economics

    How Bernie Sanders Has Avoided Big Money (Mostly)

    Bernie Sanders hasn't entirely avoided PACs with his fundraising, but he has gotten a lot of bang for the buck
  4. Taxes

    Free 2016 Tax Preparation! Top Online Services

    A place that fills out and files your taxes free of charge? It's no myth, as long as you have a simple return. Read on to find the top preparers.
  5. Investing News

    Hillary Clinton's Liberal Orthodoxy

    Clinton's economic agenda laid out in July is divided into three broad groups: strong growth, fair growth and long-term growth. And her overarching goal is to "give working families a raise."
  6. Investing News

    Bernie Sanders: Socialist or Liberal?

    Sanders' pitch centers on economic inequality in the U.S., which is both more severe than it is in other developed countries and, if current trends continue, projected to worsen.
  7. Investing News

    Obama Wants to Double Wall Street Regulation

    President Obama wants to double the budgets of the SEC and the CFTC over the next five years.
  8. Economics

    Does Big Money Hurt or Help Clinton and Rubio?

    Marco Rubio and Hillary Clinton lead their parties in raising money from Wall Street. Is that a help or a hindrance?
  9. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  10. Fundamental Analysis

    The Evolution of Obamacare Since Its Inception

    Find out whether the Patient Protection and Affordable Care Act, also known as Obamacare, has lived up to its lofty projections from 2010.
  1. When should my tax refund arrive?

    More than 90% of income-tax refunds arrive in less than three weeks, according to the Internal Revenue Service (IRS). However, ... Read Full Answer >>
  2. How do I file taxes for income from foreign sources?

    If you are a U.S. citizen or resident alien, your income (except for amounts exempt under federal law), including that which ... Read Full Answer >>
  3. Are Flexible Spending Account (FSA) items tax deductible?

    Flexible Spending Accounts (FSAs) are employer-sponsored, tax-favored savings plans expressly for the future reimbursement ... Read Full Answer >>
  4. How Long Should I Keep My Tax Records?

    The Internal Revenue Service (IRS) has some hard and fast rules regarding how long taxpayers should keep their tax records. As ... Read Full Answer >>
  5. Do tax brackets include Social Security?

    A portion of your Social Security benefits may be subject to federal taxation using tax brackets. Your tax bracket is determined ... Read Full Answer >>
  6. Are personal loans tax deductible?

    Interest paid on personal loans is not tax deductible. If you take out a loan to buy a car for personal use or to cover other ... Read Full Answer >>
Trading Center