More Jobs through Lower Tax Rates? A Look at the Evidence

Do lower top marginal tax rates create more jobs? The following evidence does not support that proposition. Here’s a graph of historical top marginal tax rates (red line, scale on the right axis) and unemployment rates (blue line, scale on left axis).

Relationship Between Top Marginal Tax Rates and Unemployment
When marginal rates were relatively high, unemployment is low. When marginal rates are relatively low, unemployment is high. If the theory of high tax cuts worked to produce jobs it would be fine with me, but the evidence doesn’t support the theory.

I ran a zero-order correlation between unemployment and top marginal rates, r = -.32, suggesting an inverse relationship. That is, when marginal tax rates are high unemployment is low. Lagging the variables didn’t produce any appreciable change in interpretation.

Here’s a graph depicting the ‘line of best fit’ between unemployment rates and top marginal tax rates.

Line of best fit - tax rates and unemployment rate.Adjusted R2 is only .089 suggesting the two variables share little variance. The model is statistically significant, Prob > F =  0.0108.

So, where are the facts supporting the proposition that lowering marginal tax rates is an effective strategy for “job creation?”

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4 Responses to More Jobs through Lower Tax Rates? A Look at the Evidence

  1. Todd says:

    When you run, you get tired, so you stop running. So is being tired the result of stopping? It may not be causality but actually an affect it had over time. Therefore, lowering tax rates may in fact decrease unemployment.

    • Michael Morrison says:

      If so, why did Reagan’s economic advisor, Feldstein, find in 1989 that lower tax rates were not responsible for the economic gains observed in Reagan’s Administration? In 1989, they were surprised to read in their own data that the recovery that began in 1983 had been caused mainly by an expansionary monetary policy. (To a lesser extent, it had come from growth in business investment after changes to corporate taxes in 1981.) Feldstein and Elmendorf pointed out that the recovery had not been caused, as was popularly thought at the time, by reductions in the personal income tax rate.

      That is: As early as 1989, Reagan’s economics guy did not find any evidence that the Reagan recovery had come from the Reagan administration’s personal income tax cuts.”See: http://www.decisionsonevidence.com/2012/09/do-cuts-in-personal-income-taxes-foster-economic-growth-again-no-according-to-the-evidence/

  2. elysia says:

    I don’t know much about running tests to prove correlation, so I’m confused on one thing. Does your r=-.32 mean that it is correlation? Or does that mean that it is not correlation, therefore being causation?

    • Michael Morrison says:

      Correlation coefficients vary between plus 1 and minus 1. A positive coefficient indicates a direct relationship: As one variable increases so does the other. A negative correlation coefficient indicates an inverse relationship: As one variable increases the other decreases. Correlation by itself does not, using you words, “prove” causality. That’s an entirely longer and complicated discussion.

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