Top Marginal Taxation and Economic Growth

Abstract

The paper explores the relationship between statutory top marginal tax rates on personal income and long‐run economic growth. While theoretical models of endogenous growth explicitly allow for nonlinear effects of taxation on economic growth, the majority of existing empirical studies assume a linear association. By contrast, this paper investigates both a linear and a non‐monotonic relationship between top tax rates and GDP growth. Using a panel of 18 OECD countries over the period 1960‐2009, this paper finds support in favor of a quadratic top tax‐growth relationship. Results are robust to different model specifications and estimation techniques. The point estimates of the regressions suggest that the marginal effect of higher top tax rates becomes negative above a growth maximizing tax rate on the order of 60 percent. The quadratic relationship found for the whole sample period does not hold over the period 1975‐2009. Instead, the link between top tax rates and GDP growth after 1975 is well summarized by a linear and positive top tax‐growth relationship. Since, top marginal tax rates after 1975 are often below the estimated growth maximizing level, such a result suggest that the top tax‐growth relationship after 1975 might be placed on the upward‐sloping side of the “growth‐hill”. There is an even stronger positive top tax‐growth relationship after 1985, when average top tax rates across OECD are lower than 50%.