What is the "ideal" tax rate?

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What is the “ideal” tax rate?

Don Quixote on Jul 29 2008 at 5:27 pm | Filed under: Economics, Taxes

Hi, this is DQ, and I have a question that I know Bookworm’s readers will have an answer to. I read a story today that said that next year’s federal deficit will hit a new record. Now, conservatives (with Bookworm leading the charge) always say that the answer to closing the deficit is to reduce taxes because this will stimulate the economy and produce more revenues over all even at the lower rate. This is true — up to the point when the loss in tax revenue due to the lower rate is so great that it is not cancelled out by the increase in revenues from the stronger economy. Liberals always say the answer is to raise taxes because this will produce more revenue. This is also true — up to the point where the negative effect the higher tax rates have on the economy is so great that it more than cancels out the increased revenues from the higher rates.

(As an aside, everyone knows the best way to close the deficit is to lower spending, but that’s not going to happen and, anyway, it is beside the point to my question.)

So, my question is, has anyone ever done any actual studies to determine what the ideal tax rate is? I mean ”ideal” in the very limited sense of the rate that will result in the highest revenues to the government. If so, what were the results of the study?

Update: Rockdalian’s comment made me realize my question is a bit too simple. I was asking for a study that yielded a specific number — the percentage tax rate at which the maximum amount of tax revenue will be raised. But such a simple answer may not be possible. Does it matter what you tax? By that I mean do income taxes, sales taxes, inheritance taxes, etc. differ in their effect on the economy? Just to take those three, my theory would be that high income taxes discourage hard work and earnings, sales taxes discourage spending and encourage saving and that inheritance taxes have the least effect of the three but probably encourage spending. However, the question remains. Has anyone done any actual scientific studies to determine these effects?

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28 Responses to “What is the “ideal” tax rate?”

on 29 Jul 2008 at 6:04 pm 1expat

DQ,

Taxes are not my field, but I have a question for you and Bookworm.
The NYT has an article on BO’s teaching career and its blog The Caucus has some of his course readings. I’d love to hear your thoughts.
on 29 Jul 2008 at 6:36 pm 2Zhombre

Taxes, and insolvency, are my field, but only from the trenches, not the think tank, and I admit a certain inability to think outside the trench. I am not aware of any studies of the “ideal” tax rate. I doubt there would ever be any agreement on such a figure. If anybody can cite a study,I’d be interested to see it. But it is not a question that lends itself to objective reasoning because it depends on one’s attitude toward government and its function and how much envy and distrust one feels for the wealthy. In an ideal world the tax rate(s) would be high enough only to fund the treasury, perhaps with a small surplus to be set aside or returned to the taxpayers, and pay for the modest functions of a limited government. Alas, we do not live in that world, which exists only in the sentence I just wrote and has no more substance than the transitory electrical impulses in your brain upon reading it.
on 29 Jul 2008 at 6:36 pm 3Don Quixote

I’ll leave that one for Bookworm, who’s the one of us who actually reads the NYT.
on 29 Jul 2008 at 6:54 pm 4rockdalian

Not sure what you are really after, DQ. There are no limit to the articles available that discuss this topic. It seems as if opinions are all over the map.

Grading the Tax Reform Panel’s Recommendations
http://www.heritage.org/Research/Taxes/wm903.cfm

Laffer Curve Key To Ideal Tax Rate
http://tinyurl.com/69yjc

America’s Shrinking Income Tax Base Requires Higher Rates for Everyone
http://www.taxfoundation.org/publications/show/1072.html

I would pose this question, at what point do the taxes rise before open rebellion sets in?
When do a majority of people get fed up?
Or a minority that refuses to pay more?
Looking at the latest tax data, the bottom 50% of taxpayers paid 3.01%. Percent of AGI paid in income taxes ( 2006 ).
http://www.taxfoundation.org/taxdata/show/23408.html
on 29 Jul 2008 at 7:32 pm 5Ymarsakar

The ideal tax rate is where if you increase it any more, the future growth of your tax income will decrease until the next year-quarter.
on 29 Jul 2008 at 7:34 pm 6Ymarsakar

The benefits of tax increases can be counted by number of jobs created, but for the really long term, you are actually looking at the total sum of all income from taxes after a certain point in time. Because wealth is the indictator, the only purest objective indicator, of how well people are doing.

Taxes should be high enough that people pay in, but they should not be higher than the point of diminishing long term tax incomes.
on 29 Jul 2008 at 7:35 pm 7Ymarsakar

(As an aside, everyone knows the best way to close the deficit is to lower spending, but that’s not going to happen and, anyway, it is beside the point to my question.)

Line item veto is what you need if you want to lower pork barrel spending.
on 29 Jul 2008 at 7:37 pm 8Ymarsakar

I mean ”ideal” in the very limited sense of the rate that will result in the highest revenues to the government. If so, what were the results of the study?

No study will ever be able to grasp all the factors required for the Chaos Theory to produce actual predictions.

You may be able to get close, within common sense parameters. You may be able to recognize when your tax rate is “not ideal”, but you won’t be able to test what is ideal, given how long it takes for these things to spread around in the economy.
on 29 Jul 2008 at 7:39 pm 9Mike

Finally remembered where I saw this info so am pasting it in here so you can take a peek. Don’t know if it could be copied and pasted but this will work.

http://joshuapundit.blogspot.com/2008/07/that-nasty-ol-deficit.html

You might have to copy this and then paste it in your browser of choice. Not sure.
on 29 Jul 2008 at 7:52 pm 10Don Quixote

Mike, Thanks for the link, but I would disagree with the article on one point. We did not survive quite nicely. Our economy has suffered and continues to suffer the effects of both the huge overhead that is our government in all its levels and our ever increasing national debt.

Trivia question: what do Clinton and Nixon have in common? They are the last two Presidents to actually balance the budget.

Another question. How many of our tax dollars have been wasted servicing the national debt over the last 50 years? The national debt is not only shameful, it is self-destructive.
on 29 Jul 2008 at 7:56 pm 11Don Quixote

Hi Rocky, Thanks for the links, but I couldn’t get your second one to work. The others are more opinion pieces than the kind of scientific research I’m looking for, but they made interesting reading anyway and got me to thinking enough to add to the original question.
on 30 Jul 2008 at 1:56 am 12rockdalian

http://www.investopedia.com/articles/08/laffer-curve.asp?partner=rss-recentarticles

This link should work DQ.
The problem with this question seems is that it seems to be open to opinion.
on 30 Jul 2008 at 8:04 am 13suek

When it comes to the deficit, this is worth reading.

http://www.americanthinker.com/blog/2008/07/how_to_lie_with_statistics.html

We [reported] on August 24, 2007 . . . even better news, from the Congressional Budget Office:

2004: $413 billion

2005: $318 billion

2006: $248 billion

2007: $158 billion

And, as a percentage of GDP:

2004: 3.6%

2005: 2.6%

2006: 1.9%

2007: 1.2%

In other words, yes, the dollar numbers are high, but as a percentage of the GDP, the numbers are falling – at least they were until the Dems took over Congress.

As for ideal tax levels…

If you think of tax as “overhead” in a business, then the ideal is 0 (zero). That would maximize profits. But obviously, that isn’t possible, so the overhead has to be commeasurate with the profits. Or another way is to think of it as a progression from youth to maturity… the standard rule when I got married was that housing should be equal to approximately 25% of income. If you were looking for a house, the maximum value should be approximately 6x your income. When you’re 25, this rule of thumb produces one number, when you’re 45, it produces another number. You either “move up” or anticipate pay iincreases, or live in a less ostentatious house than you can afford. The preferred choice is living below your means. Lots of people prefer not to live this way…unfortunately, lots of people don’t like to live this way even when they can’t afford not to.
When you buy the house at 25 that you think you’ll be able to afford at 45, either you’re going to eat a lot of beans and franks, or you face a high probability of losing everything. Sometimes it works. Sometimes it doesn’t.
That’s kind of where we are now. Our economy has grown so that we can afford the debt we took on, but the Congress now wants to saddle us with a debt we probably cannot grow into. The rental of the money to afford the goodies we enjoy is costing us more than increasing income can pay for. We risk losing it all. If you win the lottery and are suddenly deluged with relatives you never knew you had and who want you to finance every scheme they ever had, you’re soon going to be back where you started.
This also reminds me of rich people or rather rich people’s children. If you’re a Rockafeller, how do you assign your kids chores? How do you tell them they have to take out the trash, make their beds or clean up their rooms if you have servants? And if you don’t, how do you teach children responsibilities? How do you tell them they can’t have a car for graduation unless they are willing to pay for insurance themselves with their own earnings? How do you tell them they have to get a job? We’re kind of like that. The majority of Americans are doing fine. We’re well above the poverty level. But obviously, some are not. Helen wants to just give them money – but we all know the old “give a man a fish” proverb. What should the ideal society look like? is it possible that at some point everybody will be successful? what obligation do those have who are successful when those who are not are self destructive?

I know – this doesn’t say anything about the ideal tax level, but the ideal tax level is going to have a lot to do with the perception people have of what an ideal society looks like.
on 30 Jul 2008 at 8:07 am 14suek

By the way…Clinton balanced the budget by cutting the military. Not a decision I think is a good one, but he did know that _something_ had to be cut.
on 30 Jul 2008 at 9:21 am 15Danny Lemieux

Excellent discourse, SueK. I guess that you could add that the U.S. HAD to absorb a greater deficit after the Clinton years due to a) the bursting tech bubble and recession, b) Sept 11th and the War on terror, c) Bush’s need to rebuild the military.

So, what I do credit GW for (and NOT the Republican Congress) was bringing the deficit as percent to GDP down IN SPITE of all that happened. The Bush economy was one of the longest ever periods of uninterrupted economic growth in our history, MSM headlines notwithstanding. He deserves a lot of credit for that.

That being said, I really, really fault the Bush Administration for saddling additional entitlement programs on society, such as Big Pharmacare, and NOT vetoing Republican and Democrat earmarked pork-barrel projects.
on 30 Jul 2008 at 9:45 am 16suek

My “discourse” above should also be considered in light of this blog:

http://the-gathering-storm.blogspot.com/2008/07/winds-of-war-thinking-about-unthinkable_30.html

Think of it as in business, a hostile takeover. In the personal life growth process, as a particularly nasty divorce.

In my opinion, we need to get back on a solid financial footing because there’s just nothing like destroying someone or some country by just letting them fritter away all of their assets. We’re in danger of doing that.

I don’t care for McCain. I think Obama’s worse. I’ll vote for McCain, but I won’t contribute to his campaign. I’m looking at the down ticket options. We need conservatives in Congress. The only way to get them there is to either vote for them locally, or if for some reason that isn’t possible, then donate to a solid conservative in some other location. I don’t think there’s a website available yet – or at least I haven’t found one – but there should be. If I knew how to do a website, I would…the “Conservative Downticket.com” site…to give info to people who feel like I do. Someone probably already has….if you know of one, I’d like a link!
on 30 Jul 2008 at 10:17 am 17Skull

Never mind relating “ideal” tax rates to how much government “needs”. How about how much a person can tolerate? A total tax burden per individual of 10% max seems plenty. Shrink Gov to fit, not vice versa.
on 30 Jul 2008 at 10:18 am 18BrianE

I don’t know of any such studies since you would have to go to some pinko-commie website to find people thinking about how much can be taken from people before the economy collapses and I don’t go to those websites. (Smiley face here)

Your question implies that the reason for taxes is to raise revenue for government operation, but that’s not the case. Taxes are designed to coerce us to taken certain actions, which has the consequences of raising revenue for the government.
Ideally we should establish a tax policy that maximizes capital formation and utilization. But I think that’s called corporate welfare.
Deficits are not always a bad thing—what’s bad is what the borrowed money is used to buy. We are using the money to buy a good time. (Think tax rebates)

Notwithstanding President Bush’s many economic sins, revenue from capital transactions has surged in light of the 2003 reforms that reduced the maximum rate on long-term capital gains to 15%. The explanation is simple enough. Capital gains taxes apply only when the owner of a capital asset chooses to sell. The lower the tax burden on the sale, the more the owner retains for either reinvestment or consumption. The increased velocity of transactions more than offsets the loss in taxes per transaction. The public treasury and the private investor both win.

However successful the 2003 reform, it is still unwise to view tax policy chiefly in terms of revenue generation. The goal of tax policy is not to maximize tax revenue as such, but to maximize the level of overall social welfare.

Short article here:

http://www.law.uchicago.edu/news/epstein-cap-gains/index.html
on 30 Jul 2008 at 1:46 pm 19Ymarsakar

By the way…Clinton balanced the budget by cutting the military. Not a decision I think is a good one, but he did know that _something_ had to be cut.

The deficit warriors in the Republican part of Congress helped him to do it. Let us not forget that. Joe Scarborough of MSNBC, was one of those Congress critters, and he’s against the Iraqi War. Why? Maybe because spending money on foreign wars is a waste to him. Maybe spending it here at home and balancing the budget is what’s important, not improving America’s defenses.
on 30 Jul 2008 at 1:47 pm 20Ymarsakar

Your question implies that the reason for taxes is to raise revenue for government operation, but that’s not the case. Taxes are designed to coerce us to taken certain actions, which has the consequences of raising revenue for the government.

In that case, the Democrats and fake liberals should have a 90% income tax for stupidity, foolishness, and pure malicious intent.

But they don’t.
on 30 Jul 2008 at 3:07 pm 21BrianE

A few weeks ago, the Internal Revenue Service released data on tax year 2003. The data show that the top 1 percent of taxpayers, ranked by adjusted gross income, paid 34.3 percent of all federal income taxes that year. The top 5 percent paid 54.4 percent, the top 10 percent paid 65.8 percent, and the top 25 percent paid 83.9 percent.

Your question might be better restated- how high can we raise taxes on the wealthy before they move their assets out of the US?
A follow-up question might be, what is a fair rate to tax the wealthy?

If I remember correctly, Barack would classify the wealthy as those making more than $250,000 a year. Living where I do, that kind of change would make me feel pretty flush, but I suppose someone living in say, San Francisco, might object to that status.

If the top rate is moving up to 39%, and then add the increases in SS payments that the wealthy will never recoup– you are moving the rate closer to 50%. Now let’s say you make a $1 million a year– you still have $500,000 a year to play with– so what’s the beef?
Maybe you can’t afford Harvard for your kids, but there are plenty of good California colleges to choose from.

So, I guess your question is, why settle for 39%. Forget about fair– how much can they pay before they turn into turnips.
If I’m sounding a little snarky here, it’s because I have a philosophical problem with the concept of legal stealing.

If at the end of the day we want to turn the tax code into revenue generation, instead of social engineering– I think a flat tax would fit the bill and would be about 20%– and that includes a wee bit of social engineering, since those at the bottom still wouldn’t pay the income tax.

Here’s an article on revenues.
http://www.nationalreview.com/nrof_bartlett/bartlett200512070900.asp

Federal spending has been growing at a pace that outpaces inflation and population growth. While some of this growth can be justified as necessary to fund the war effort and national security activities, non-defense discretionary spending grew by more than a third in real terms since 1999.
Discussions of spending restraint often focus on eliminating government waste and frivolous earmarks—important goals to be sure. Yet the most important budgetary problem facing the government is the growing cost of entitlement programs. Already more than half of the federal budget is on autopilot. Social Security and Medicare alone consume 40 percent of the federal budget. As the baby boomers retire, the costs of these programs will swell. If nothing is done to address their costs, spending on other programs (including defense) will be crowded out, taxes will have to rise dramatically, or we will incur massive new debt.

The article is here:
http://www.iwf.org/files/208b234094c08b442dfd810d3b28c305.pdf
We can’t tax our way out of this problem.
on 30 Jul 2008 at 4:25 pm 22Ellie2

The ideal tax rate is one that collects a contribution from every citizen/voter.
on 30 Jul 2008 at 5:36 pm 23Earl

I’ll agree with Ellie2 to this extent — we’re in a dangerous situation where our tax policies don’t really affect 1/2 of our wage-earners. They’ll vote for tax and spend all day long because someone ELSE is paying. Does that sound familiar? Third-party payers? Always a bad idea.

I’m surprised no one has brought up the “Fair Tax”. It gets a lot of bad reviews by people who don’t really understand it (based on their own statements, by the way), but I think it would be much better than what we have now – provided that we repeal the amendment that makes an income tax legal!
on 30 Jul 2008 at 7:31 pm 24Don Quixote

Thanks for all the comments, and I agree with most of them. But my point is, as in so many areas, we are operating in a vacuum here. As Rockdalian rightly points out, most of the comments in this area, including most of the comments here, are matters of opinion, backed by personal ethical and political philosophies. The point of my post was to suggest it would be helpful if we could make these comments against a backdrop of some knowledge of what effects, both economic and psychological, various tax rates and types of taxes have.

I’m enjoying the discussion as to what we should do, and welcome you all to continue the discussion, but I also remain interested in the original topic. Has any serious scientific analysis been brought to bear on this problem at all? Or is the whole discussion opinion and philosophy with no factual basis at all?
on 30 Jul 2008 at 9:31 pm 25BrianE

I disagree we’re operating in a vacuum. To determine your ideal tax rate, you have to decide what is the lowest sustainable economic growth rate you consider acceptable.
And I think you have to factor population growth into that.
Inherent in your question is the concept that the government deserves all of our money except that which we need to live on with x amount left for investment.
OK, let’s see if we can agree on some facts.
Low personal income tax rates increase the disposable income of citizens to consume, invest, save, donate, etc.
Low corporate tax rates promotes domestic investment, increases corporate profits which are returned to the ‘owners’ in the form of dividends or increased share prices.
Low capital gains taxes promotes investment and consumption, allowing capital to flow to innovators and the next ‘big’ idea.
Low dividend tax rates encourages investment in stable, mature market sectors and saving.
High ‘sin’ taxes– well that doesn’t do anything except give society an excuse to profit off personal weaknesses.
Now the ideal rate for each of these– well that depends on whether you’re a capitalist or a socialist.

I would ask the question another way. Is a high rate of economic growth possible with high tax rates? Economic growth increases the size of the pie. How much bigger do you want the pie?

Here’s a paper that discusses some of the issues, relating to growth.
http://www.g24.org/ehc0904.pdf
on 31 Jul 2008 at 7:27 am 26BrianE

Today’s American Thinker has a good article that highlights the problem we are facing.
Here’s the link:
http://www.americanthinker.com/2008/07/the_credit_problem_1.html

A long wave of credit stimulation has been allowed to obscure the underlying problem of capital accumulation in the United States. We are paying a price, but not solving the problem.

The political class simply cannot be trusted to provide solutions. They are too interested in retaining power for the sake of power. They do not have the guts to say what needs to be said for fear of alienating some group of supporters. They do not have the integrity to stand on principle and advocate unpopular but necessary policies. They are too beholden to special interest groups to do what is right for the country rather than what is right for their campaign contributors. It is high time that politicians were held responsible for the damage done by policies intended to benefit the few at the expense of the many.

It also seems evident that the government budget deficit is a result of excessive spending rather than a lack of taxation. Tax revenue has been remarkably stable as a percentage of GDP for many years, ranging between 18% and 21% regardless of tax rates. Right now it stands at 19%. Furthermore, other countries, such as Hong Kong, are able to collect nearly the exact same percentage of revenue with much lower tax rates. Hong Kong has income tax rates, personal and corporate, of less than 20% and generates a budget surplus while spending over 15% of GDP on government services. Hong Kong also doesn’t tax capital gains or dividends. We do not need higher taxes to generate the revenue needed for essential government services. We do need to decide what is essential.

In particular, it is illogical to raise taxes on capital when the basic problem we face is a lack of capital. If anything, taxes on capital should be further reduced to encourage accumulation of the capital needed to fund our growth. As for income taxes, it is time for Americans to assess the wisdom of taxing the very thing we wish to generate. If it is logical to tax cigarettes to discourage smoking, what is the logic for taxing income? A consumption tax coupled with repeal of the income tax would realign incentives toward a more rational economy based on thrift and savings rather than conspicuous consumption.

Everyone should read the entire article.
on 31 Jul 2008 at 9:35 pm 27BrianE

Something bothered me about your question about tax rates, and your assertion that we were all operating in the dark.

I mean ”ideal” in the very limited sense of the rate that will result in the highest revenues to the government.

The question itself is not very scientific and quite subjective, since you’ve not shown why a policy of the highest revenues to the government is by any means “ideal”. So my question to you, is why would that be ideal?

There are so many variables in the question, economists build complex models to quantify questions such as that, and then argue the modality.

This is another good paper that touches on optimum tax rates.

http://www.econ.washington.edu/user/sturn/endog_growth_labor.pdf

“Fiscal Policy, Elastic Labor Supply and Endogenous Growth” by Stephen Turnovsky, University of Washington

Empirically it has been determined that the “growth-maximizing tax rate for the US is 21% of GDP (still arguable though). As of 2005, all government spending was 30% of GDP, so we may already be close to a tipping point. GDP growth for the first second quarter was 1.9% annualized (still no recession).

I’ll concede that some government spending is necessary and promotes economic growth, though that is not true of most government spending. Since government spending, in general, is a hindrance to growth, wouldn’t we want it to be as small as possible?

One of the effects I think was overlooked during the balanced budget years of the late 90’s was the reduced pressure on capital. Deficit spending competes for capital, reducing capital available for growth, even though most of the deficit funding has come from foreign governments spending our trade deficit.

Here’s another good article:

http://www.heritage.org/Research/Budget/bg1831_suppl.cfm

The OECD admitted: “Taxes and government expenditures affect growth both directly and indirectly through investment. An increase of about one percentage point in the tax pressure—e.g. two-thirds of what was observed over the past decade in the OECD sample—could be associated with a direct reduction of about 0.3 per cent in output per capita. If the investment effect is taken into account, the overall reduction would be about 0.6–0.7 per cent.”[83]
· A National Center for Policy Analysis study found: “We use data on the real rate of growth of GDP for the 46-year period from 1950 through 1995 and on federal, state and local taxes as a share of GDP for that period. The resulting calculations suggest that: The estimated growth-maximizing tax rate for the United States is 21 percent of GDP.”[133]
Looking at U.S. evidence from 1929–1986, an article in Public Choice estimated: “This analysis validates the classical supply-side paradigm and shows that maximum productivity growth occurs when government expenditures represent about 20% of GDP.”[121]

The federal budget in 2005 was $2.5 trillion, or about 20% of Gross Domestic Product (GDP). State and local government are spending an additional 11% of GDP, so the total cost of government amounts to nearly 1/3 of the economic output. 54% of current federal government spending is for “entitlements” (Social Security, Medicare, federal portion of Medicaid, etc.), 39% is discretional, and 7% goes for interest on the national debt.
on 02 Aug 2008 at 9:36 am 28BrianE

Your use of the word ideal bothered me. If tax rates rise until revenues to the government fall, lots of others things have happened to the economy—none of it good. Ideal implies ‘an honorable or worthy aim’. Taking more money from Americans pockets is not an ideal IMHO.

But an answer to your question may be extrapolated from government spending as a percentage of GDP.

The question itself is subjective, since you’ve not shown why a policy of the highest revenues to the government is by any means “ideal”. So my question to you, is why would that be ideal? I don’t know how old you are DQ, but if we don’t get spending under control, the consequences will be disasterous. Bush’s unwillingness to control spending has been his greatest failure as president.

Empirically it has been determined that the “growth-maximizing tax rate for the US is 21% of GDP. As of 2005, all government spending was 30% of GDP and each 10% increase in government share of GDP reduces growth by 1%, you might assume we could balance the budget easily without negative growth, but this is short sighted.

As noted in a Public Choice study, “The stakes are enormous. The difference in real GNP between a 3% yearly growth rate in productivity over a 1% growth rate is 48% after 20 years and 167% after 40 years.”[70]

I’ll concede that some government spending is necessary and promotes economic growth, though that is not true of most government spending. Since government spending is in general a hindrance to growth, wouldn’t we want it to be as small as possible?

One of the effects I think was overlooked during the balanced budget years of the late 90’s was the reduced pressure on capital. Deficit spending competes for capital, reducing capital available for growth, even though most of the deficit funding has come from foreign governments spending our trade deficit.

Here’s a good article with lots of cited research:

http://www.heritage.org/Research/Budget/bg1831_suppl.cfm

The OECD admitted: “Taxes and government expenditures affect growth both directly and indirectly through investment. An increase of about one percentage point in the tax pressure—e.g. two-thirds of what was observed over the past decade in the OECD sample—could be associated with a direct reduction of about 0.3 per cent in output per capita. If the investment effect is taken into account, the overall reduction would be about 0.6–0.7 per cent.”[83]
· A National Center for Policy Analysis study found: “We use data on the real rate of growth of GDP for the 46-year period from 1950 through 1995 and on federal, state and local taxes as a share of GDP for that period. The resulting calculations suggest that: The estimated growth-maximizing tax rate for the United States is 21 percent of GDP.”[133]
Looking at U.S. evidence from 1929–1986, an article in Public Choice estimated: “This analysis validates the classical supply-side paradigm and shows that maximum productivity growth occurs when government expenditures represent about 20% of GDP.”[121]
· An NBER paper concluded: “Our results are in contrast to many of the ‘new growth’ models…in finding that government spending, rather than tax rates, have the greatest long-term negative impact on private sector productivity,” and that “government spending and taxation both reduce the productivity of labor and capital, although the interacted taxation coefficients are not jointly significant at the 5 percent level.”[88]
· The NBER paper also found: “The effect of government expenditures and taxation on GDP growth rates is central to many debates in both developing and developed countries. This paper has developed a theoretical model that integrates the effects of government spending, and the distortionary effects of taxation, in a model of output growth. Using a sample of 107 countries during the period 1970–85, we found strong and negative effects of both government spending and taxation on output growth. A balanced-budget increase in government spending and taxation of 10 percentage points was predicted to decrease long-term growth rates by 1.4 percentage points. The implied behavioral parameters from the model suggest that the allocation of factor inputs are sensitive to intrasectoral tax distortions.”[89]

The federal budget in 2005 was $2.5 trillion, or about 20% of Gross Domestic Product (GDP). State and local government are spending an additional 11% of GDP, so the total cost of government amounts to nearly 1/3 of the economic output. 54% of current federal government spending is for “entitlements” (Social Security, Medicare, federal portion of Medicaid, etc.), 39% is discretional, and 7% goes for interest on the national debt.

Even the socialist states of the EU have reached the conclusion that lower taxes stimulates economic growth. Corporate taxes in the EU are lower than the US, since it does not serve government interests to have a large percentage of the population unemployed. They realize that low corporate rates encourages domestic corporate development.