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.

Reaganomics
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. Insurance

    Understanding Taxes on Life Insurance Premiums

    Learn about the tax implications of life insurance premiums, including when they might be taxable and whether they are tax deductible.
  2. Taxes

    What IRS Form 990 Tells About a Nonprofit

    Want a picture of an organization's activities? This annual form, open to the public, sums up everything from salaries paid to missions accomplished.
  3. Retirement

    The 3 Most Common 401k Rollover Mistakes

    No one is born knowing the tax rules for 401(k)s and IRAs, but only dummies, scaredy cats and suckers don't buckle down to learn them.
  4. Taxes

    Top Reasons to File Separately When Married

    Most of the time, it makes sense for couples to file their taxes jointly. Except for these possible exceptions...
  5. Taxes

    What IRS Form 1023 Is Used For

    To be treated as a tax-exempt organization, start by filling out this form.
  6. Taxes

    Late with Your Taxes? Grab IRS Form 4868

    Fill out this form to get a few more months to file your tax return. But remember, April 15 is still the payment due date if you owe taxes.
  7. Taxes

    What IRS Form 8949 Is For

    Selling a painting or that lake property? Disposing of your fossil fuel stocks? You need to know about this IRS form.
  8. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  9. Economics

    Will North and South Korea Ever Reunite?

    North and South Korea have been divided for over six decades. Some analysts think the two countries could reunify within the next 10 years.
  10. Economics

    The Top 9 Things to Know About Hillary Clinton's Economic View

    Find out where former secretary of state and Democratic presidential candidate Hillary Clinton stands on the economy, jobs, trade and education.
RELATED TERMS
  1. Section 1231 Property

    A tax term relating to depreciable business property that has ...
  2. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  3. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
  4. Duty Free

    Goods that international travelers can purchase without paying ...
  5. Wealth Management

    A high-level professional service that combines financial/investment ...
  6. The New Deal

    A series of domestic programs designed to help the United States ...
RELATED FAQS
  1. Can I use my IRA savings to start my own savings?

    While there is no legal reason why you cannot withdraw funds from your IRA to start a traditional savings account, it is ... Read Full Answer >>
  2. Are spousal Social Security benefits taxable?

    Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third ... Read Full Answer >>
  3. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  4. Are credit card rewards taxable?

    Credit card rewards are taxable in the United States some of the time. The Internal Revenue Service (IRS) classifies credit ... Read Full Answer >>
  5. Where are the Social Security administration headquarters?

    The U.S. Social Security Administration, or SSA, is headquartered in Woodlawn, Maryland, a suburb just outside of Baltimore. ... Read Full Answer >>
  6. What is the Social Security tax rate?

    The Social Security tax rate is 12.4% as of 2015. Of that amount, the employee is responsible for half, or 6.2%, and the ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!