Taxes and Unemployment Rates

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July 3, 2011 by D Stack

Listening to the economic debate going on right now I believe it is safe to say that supporters of conservative economic policy would treat as a solid truth that lower taxes leads to lower unemployment. To quote from the 2011 Republican economic plan:

We will set the top tax rates at no more than 25% for job creating businesses. This would level the playing field with our competitors and would help to generate investments and create American jobs allowing the U.S. to be more competitive in the global marketplace and attract business.

This is not a particularly new economic strategy. Ronald Reagan certainly championed it but supply-side economics has origins are older than his use of it.

How does that theory hold up? I did a little bit of digging. First I tried to map unemployment rate with the top marginal tax rate. This is a snapshot but not one that can be taken as absolute gospel, as the way the unemployment rate is calculated has changed over the years and the number of people falling in the top marginal rate is also not a fixed number. But, I believe, it is at least useful for spotting trends.

Unemployment vs. Top Marginal Tax Rate

(Be merciful on my chart, it’s my first time trying to use the Google API to produce a chart…)

So what does that chart tell us? To be honest, it’s not, in my opinion, as conclusive as one would like regardless of what one’s views are. Some data points of interest:

  • In the 1960s the top marginal rate went down sharply. Unemployment did go down around that time but then it began a gradual climb leading to the “malaise” of the 1970s.
  • The 1980s has two large tax cuts which seem to support the theory of tax cuts being good for unemployment. But again, by the early 90s we see unemployment spiking sharply. 
  • Further in the 90s there is a spike in top marginal tax rate which is followed by a lengthy period of unemployment decline.
  • In the 2000s there are two cuts in the top marginal rate. The first one took place under increasing unemployment and unemployment continued rising after this. The second cut seems is followed by  unemployment going down for a few years, followed by a very sharp rise in unemployment (which we are still in the midst of).
Conclusions? To be honest, as a layman, the best conclusion I can make is there isn’t a particularly strong direct link between unemployment and top marginal tax rate. It certainly doesn’t seem to be a strong enough link to make the argument that lower tax rates leads to lower unemployment is self-evident. 
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