Investigation of the Effects of Average Tax Rate on Economic Growth Rate (2013)

Undergraduate: Rongjia (Tim) Jiang

Faculty Advisor: William Parke
Department: Economics

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Following the recent recession in the United States, some political voices have been calling for tax cuts to stimulate economic growth. Does decrease in tax rate enhance economic growth? In this paper, an OLS regression model is used to study the effect of average tax rates on economic growth using data for 25 OECD countries for 1980 to 2009 and 31 non-OECD countries for 1990 to 2009. A negative correlation is found between the average tax rate and GDP growth rate for OECD sample; however, upon controlling for other determinants of growth, this negative relationship between average tax rate and economic growth rate disappears for the OECD sample. For the non-OECD countries, a negative relationship between average tax rate and growth rate of GDP is found after controlling for other variables. For both samples, the level of physical capital accumulation has positive impact on growth, while inflation negatively affects growth. The effects of human capital accumulation and population growth are found to be insignificant. These findings suggest that continued investment in physical capital and inflation targeting policies will facilitate growth, while changing tax policies may or may not affect growth in a positive way. The notion that tax cut leads to economic growth for developed countries like the U.S. is not supported by the findings of this research.