Last month, Kansas ended a five-year long experiment, whereby it lowered state income taxes with the expectation that it would boost economic growth in the state. As is widely acknowledged, Kansas’ low tax experiment was a failure. However, it was also a success. Few people know how to interpret the results, however, because few people use the correct economic framework to assess this experiment.
Lower taxes do contribute to higher economic growth and for everyone. This is because income that is not spent on taxes or otherwise, but saved – especially by the rich who have most of the savings – is put into bank accounts, money markets, stocks, bonds, and private equity, etc. (i.e., what some critics call ‘hoarding’). This saved income is the source of capital that businesses use to pay workers’ wages, as well as to support factories, office buildings, and tools and equipment that workers use to produce goods and services. Most of the physical means of production that our economy employs in sustaining us with goods and services is paid for by savings that people are allowed to keep, instead of having it taxed, in which case it would be used for consumption instead of investment (thereby depleting capital). The more incomes that are saved instead of taxed, the more investment, production, and economic growth our economy experiences. Productivity-enhancing capital from savings is the only source of increased economic growth.
The Kansas Republicans were correct, therefore, in assuming that lower tax rates cause greater economic growth. However, like most economists, they assumed that economic growth would show up in the form of increased wages, business revenues, and GDP. They further believed that these additional incomes would result in increased tax revenues that would offset the reduced revenues caused by lowered tax rates.
This post was published at Ludwig von Mises Institute on August 4, 2017.
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