The Fallacy of Higher Taxes and Revenue

by Jeff Swanson

The fallacy of higher taxes as a means to increase tax revenue assumes that the trajectory of current economic activity will continue.

Interesting.

If you unpack this in the most rudimentary terms; would you continue lying to your parents even after your daddy took the leather belt to your hide. Probably not.

Why would anyone continue doing that which only gets them punished. Thus is the story of higher taxation. Punitive measures are intended to curtail unwanted behavior. Liberals don’t like the rich, even when they’re one of them. So, to show the unwashed, undertaxed (well, untaxed masses) that they care about fairness, liberals will tout a fallacious doctrine of taxation fairness.

It’s unfair that the rich are rich so lets stop those evil robber barons from their wanton exploitation. Those rich are stealing from us poor and we can’t have that. They don’t deserve that money.

…and this raises government income (i.e. – revenue) in what way? Remember that we’ve heard repeatedly with regard to the deficit that we need to raise ‘revenue’.

Well, firstly, it doesn’t.

According to Thomas Sowell in reference to the Mellon tax cuts on the 1920’s, “What actually followed the cuts in tax rates in the 1920s were rising output, rising employment to produce that output, rising incomes as a result and rising tax revenues for the government because of the rising incomes, even though the tax rates had been lowered. Another consequence was that people in higher income brackets not only paid a larger total amount of taxes, but a higher percentage of all taxes, after what have been called “tax cuts for the rich.”

We know that lowering taxes can effectively create growth and an increase in actual tax dollars collected but, what proof of revenue lost or gained on higher taxes?

As noted by Kurt Brouwer of WSJ’s Market Watch in 2010, “As you can see from the next chart produced by the conservative-leaning Heritage Foundation, we have not had tax revenues of more than 20% of GDP for any length of time since at least 1960.  This is true even though we have had much higher tax rates in earlier years, in fact, we once had a marginal rate of 91%.  Despite higher tax rates, tax revenues still tended to trend around the level of 18% of GDP.”

The real question then is; how do we raise revenue to offset the deficit? Remember that ‘raising taxes on the rich’ is the assumption of the liberal Democrats.

First, to be clear, it would be nice to spend a little less on things like the upcoming, crushing healthcare costs. That said, if we could not cut another single budgetary item, how do we raise tax revenue?

Lower taxes?

For conservatives, we think it is lower taxes that creates economic growth. Recall that no matter the tax rate, tax revenues wiggle around in the 18 to 20% range. The way to bring more actual cash revenue is is to grow GDP. If revenue percentages never really get much higher no matter the tax rate, what effective tax rate maximizes actual economic growth?

Honestly, not an historically easy question to answer.

If you look at data from the 1950’s forward, it is hard to make a clear case for lower taxes. I’d said before that it is hard to argue outliers. More to the point, taxes in and of themselves are not a clear indicator of economic growth.

Like anything in life, we must look at history with context. However (somewhat) simply put in a Colgate University study (PDF) conclusion, “For more conventional parameter values, there are weaker, but still important long-run revenue gains from some reductions in financial income tax rates. The analysis of a reduction in (tax rates) from 40% to 30% shows that expansion of the financial income tax base is moderate so only some of the tax cut is self-financing through that channel. However, general equilibrium effects are important: the extra research and development activity stimulates labor productivity and wages, increasing labor income tax revenue in the long run by more than enough to offset the initial revenue losses.”

That is to say, lower taxes can create positive long term effects on economic growth. On average, lower taxes drive economic growth and accordingly, improvements in GDP.

Since tax rate cannot exist within a pure ‘low tax bubble’, other social factors must be factored when considering the net end effect of lower taxes.

What of those outliers?

By the end of the 60’s, income tax rates were lowered by a nearly gargantuan 20% from the 1950’s high of 92%. Now the good news is, the growth rate in GDP did curve up more positively than previous. Still, anyone alive in the 1970’s United States didn’t think the economy was all that hot. With oil embargoes from OPEC nations, double digit inflation, interest rates hitting double digits and overall, so called stagflation and add in the effects of the Viet Nam war. So, really, any economic gain was lost on a poorly managed economy. I’d also assert the percentage in tax decrease was simply not enough to overcome any of these challenges. There was not enough incentive to grow past these issues. This is just my opinion

In the fifties, we grew like gangbusters. A virtual, then only imagined, rocketship. The question is why?

According to National Bureau of Economic Research Study (PDF), “At the end of World War II, the United States was the dominant industrial producer in the world. With industrial capacity destroyed in Europe—except for Scandinavia—and in Japan and crippled in the United Kingdom, the United States produced approximately 60 percent of the world output of manufactures in 1950, and its GNP was 61 percent of the total of the present (1979) OECD countries. This was obviously a transitory situation.”

We didn’t have economic growth because of high tax rates in the 50’s, we had them despite higher tax rates. Imagine what growth we could have had with a lower rate.

So, the hypothesis of lower tax rates resulting in growth in GDP (and therefor increased tax revenue), where’s that deal it in all this mess?

You need to remove the outliers. This is why they are outliers and should not be factored in to a solid data set. If you look at 1980 forward where the U.S. and the U.K. adopted more pro-growth policies of lower tax rates, less regulation and government interference in commerce, you see do not radical, stratospheric growth. This would be an economic distortion and would create a proposed future market correction. You do see sustained, steady, moderate growth from that year forward. Particularly when compared to other industrialized countries that did not adopt these policies.

Sure, this doesn’t make for much of a Presidential debate soundbite but it does make the point that to raise tax revenue, a lower tax rate will spur the kind of growth that allows revenues to increase in actual cash influx.

So, raise taxes on the rich to pay their fair share, well…the only reason to do this is to punish the rich.

The question you have to ask (anyone) is; if the only reason to raise taxes on the rich is because they need to be punished for being rich, would you?

That is effectively the question liberals ask whether they say so or not. There is no economic merit to the question otherwise.

The majority of Americans would probably say no, if the only reason was to punish.

To assume punitive taxes would allow economic trajectory to continue on the same path (as lower taxes) touches on a psychological diagnosis of insanity.

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3 thoughts on “The Fallacy of Higher Taxes and Revenue

  1. Pingback: The Liberal Mirror | The Rightward Journal

  2. Pingback: Stop Falling on the Tax Cut Sword | The Rightward Journal

  3. Pingback: Boehner’s Not The Problem | The Rightward Journal

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