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Every election cycle, I keep hearing that tax breaks stimulate the economy.

Are there any well-known studies or scientifically-backed examples from history that shed light on whether or not this claim is true or false?

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  • Context is king. What critically matters: Type of taxes in question (consumption, earnings); timing of tax cuts; permanent vs temporary tax cuts; targets (low- vs high-income earners); whether cuts are countercyclical or not; do they support demand, reduce deficit, or somethings else? – Anton Tarasenko Nov 26 '14 at 10:25
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Taxes do affect economic growth, but not equally. From the OECD paper, Do tax structures affect aggregate economic growth? Empirical evidence from a panel of OECD countries:

The results of the analysis suggest that income taxes are generally associated with lower economic growth than taxes on consumption and property. ... Property taxes, and particularly recurrent taxes on immovable property, seem to be the most growth-friendly, followed by consumption taxes and then by personal income taxes. Corporate income taxes appear to have the most negative effect on GDP per capita. These findings suggest that a revenue-neutral growth-oriented tax reform would be to shift part of the revenue base towards recurrent property and consumption taxes and away from income taxes, especially corporate taxes.

However, upon doing a review of the economic growth literature in 2002 (15 Years of New Growth Economics: What Have We Learnt?), Xavier Sala-i-Martin concluded that:

The size of the government does not appear to matter much. What is important is the “quality of government” (governments that produce hyperinflations, distortions in foreign exchange markets, extreme deficits, inefficient bureaucracies, etc., are governments that are detrimental to an economy).

In other words, a government that focuses on the right tax mix (high consumption and property tax, low corporate income tax, and reasonable personal income tax), such as Sweden, will have a tax system that has little negative effect on the economy in spite of having a large public sector.

In summary:

  • If they're talking about reducing corporate income tax, they are usually right.
  • If they're talking about personal income tax, it depends.
  • If they're talking about consumption tax or property tax, they're usually wrong.
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    Of course, a hypothesis that "The size of the government does not appear to matter much" is fully dependent on proving that the size of the government has no effect on "extreme deficits, inefficient bureaucracies" - which is NOT a proven assumption (at least in that quote) and, for most governments, demonstrably wrong. – user5341 Apr 4 '11 at 18:43
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    there's a conviction held by many people (commonly referred to as "realists") that with rare exceptions (Cincinnattus, George Washington) a VAST majority of people who are in government are incompetent or don't care enough to be very competent. As far as "elect better ones", this ranges from systems where you don't have a choice of specific polititians to vote for (e.g. party lists in Israel or some European countries) to gerrimandered-to-extreme "incumbent wins 90% of time" USA system to "We will select who 95% of you will vote for" in Russia. In short, there ARE no better ones. – user5341 Apr 4 '11 at 23:41
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    also, unless I mis-read the paper, it does not say whether consumption tax or property tax is or is not, in absolute, growth friendly. Merely that they are less growth friendly than corporate or personal income tax, assuming being revenue neutral. Whereas in your last bullet point you seem to make the assumption that consumption tax or property tax IS in absolute terms bad for growth (e.g. the paper implies "worse than other taxes" vs. your implication of "worse than no tax"). Could you please clarify? – user5341 Apr 4 '11 at 23:56
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    @DVK-- I'd say 'cynics' not 'realists.' My parents definitely lament a time when serving the government was considered an honor, not a job of last resort. That attitude is reflected by the Germans, at least according to Vanity Fair (vanityfair.com/business/features/2011/09/europe-201109 quote about leaving government for more money: "It would be illoyal!"). Of course, then I compare the US against, say, Mexico (especially after the whole Zetas vs Anonymous thing), and think that maybe the US government isn't staffed by such incompetents after all... – mmr Nov 8 '11 at 4:27
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    This answer is incomplete. Your claim about the relative benefits of the various taxes is based on a singular study. I have research experience in financial econometrics and this field is filled with contradictory findings all of the time. A finding is only convincing if it's robust to alternative econometric methodologies To summarize; your assertions at the end of your answer are unconvincing unless you can present a large amount of studies that support them and also can't find any contradictory studies that have a sound methodology. Econometrics is very different to experimental physics. – Jase Jan 4 '13 at 6:54

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