An Unexpected Relationship Between Taxes and Economic Growth

Abstract This paper examines the reduced-form relationship between top marginal federal income tax rates and subsequent economic growth using annual United States data from 1929 to 2024: real gross domestic product per capita from the Bureau of Economic Analysis National Income and Product Accounts and statutory top marginal federal income tax rates from the Tax Policy Center. Contrary to the standard supply-side view, which predicts a uniformly negative tax-growth relationship, the results show a positive association over much of the observed historical range, with the relationship turning negative only at higher tax levels. A quadratic specification estimates the turning point near 64 percent, placing most historical observations on the upward-sloping portion of the relationship. The relationship is stable across institutional regimes, holding in both the post-1982 buyback era and the earlier period. To explain this pattern, the paper develops the Aston Martin mechanism, in which high marginal tax rates raise the cost of income extraction for owner-managers of closely held firms, shifting resources toward internal retention and capital formation. The findings are reduced-form and do not identify causal channels, but they challenge simple monotonic claims about taxation and growth and suggest that income allocation between extraction and retention is a central link between tax policy and economic performance. For tax policy, the results caution against the assumption that cutting top marginal rates reliably raises growth. Where financing constraints bind and extraction is costly, as in many emerging economies today, top rates also shape whether income stays inside firms to finance investment.