Tax Cuts and the Unemployment Rate

In my previous post, I tried to find correlations between the top marginal tax rate and the economic growth rate and suggested that the growth rate is largely independent of tax rates. However, it is interesting to note that the candidates rarely mention the growth rate. Instead, they mostly mention creating jobs, strengthening the middle class, etc. Why? Perhaps, because they have learned that issues like the unemployment rate, household income, and poverty rate, are the economic indicators that really matter to the electorate. So I examined how the unemployment rate has behaved over the last 50 years or so. I obtained this graph from an article in the Washington Post:

In this graph, the blue line shows the unemployment rate over time, and the vertical yellow lines indicate recessions – the thicker the line, the more severe the recession. The dark horizontal line in the middle indicates the 5% mark, a traditional threshold for “full employment” (i.e. If the unemployment rate falls below this mark, the economy has achieved “full employment”).

Some trends are easy to notice in this chart. For instance, the unemployment rate ticks up in every recession. In addition, relative to the duration of the recession itself, it takes much longer for the unemployment rate to reach its pre-recession levels. Note that the most recent recession is perhaps the most severe one we’ve had over the last 60 years (only the one in the early 1970s comes close). Now looking at how unemployment rates have reversed following recessions historically, what would we estimate to be the duration of our recovery from this recession? And how much control do we think the president of the Unites States have over this timeline? These are obviously questions to consider before voting. However, my reason for putting up this chart is to now see if there are correlations between the tax rates and trends in the unemployment rate over the same time. For this, I plotted the top marginal tax rates since 1948 based on information from Tax Policy Center:

Here too, some trends are really easy to notice. For instance, we have some of the lowest tax rates today since world war II. Also, since 1980, US tax policy has been heavily biased towards tax cuts, except for the Clinton years (1993-2000).

Now let’s compare the two charts. Going back to the first chart, between 1948 and 1975, the economy went into recession 6 times. And it witnessed 5 more recessions between 1975 and now. Yet, the behavior of the unemployment rate has been very different during these periods. Between 1948-75, despite those recessions, the unemployment rate remained quite low and there were long periods during which the economy maintained “full employment”. On the other hand, unemployment rates have risen more dramatically in the recessions since 1975 and the recovery from these recessions have been slower, resulting in prolonged periods with high unemployment. How do these trends correlate with the top tax rates in the second chart? Interestingly, the top tax rates were much higher between 1948-1975 than they were between 1975-2012. More importantly, for all the emphasis on tax cuts over the last 30 years, tax cuts have made it neither more difficult for the economy to enter into recessions, nor have they made it easier to recover from them.

Together, based on what I have found and described over the last two posts, it is hard to see how yet another round of tax cuts, which seems to be the cornerstone of Gov. Romney’s plan, are a solution to the country’s current economic problems.

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