Being a thoughtful and kind person, I offered some advice last year to Barack Obama. I cited some powerful IRS data from the 1980s to demonstrate that there is not a simplistic linear relationship between tax rates and tax revenue.
In other words, just as a restaurant owner knows that a 20-percent increase in prices doesn’t translate into a 20-percent increase in revenue because of lost sales, politicians should understand that higher tax rates don’t mean an automatic and concomitant increase in tax revenue.
This is the infamous Laffer Curve, and it’s simply the common-sense recognition that you should include changes in taxable income in your calculations when trying to measure the impact of higher or lower tax rates on tax revenues.
No, it doesn’t mean lower tax rates “pay for themselves” or that higher tax rates lead to less revenue. That only happens in unusual circumstances. But it does mean that lawmakers should exercise some prudence and judgment when deciding tax policy.
Moreover, even though I’m a strong believer in the importance of good tax policy, it’s also important to understand that taxation is just one of many factors that determine economic performance. So lower tax rates, by themselves, are no guarantee of economic vitality, and higher tax rates don’t necessarily mean the world is coming to an end.
With those caveats in mind, take a look at this table from the Congressional Budget Office’s most recent Budget and Economic Outlook. Taken from page 109, it shows what will happen if the economy grows just a tiny bit less than the baseline projection. Not a recession, by any means, just a drop in the projected growth rate of just 1/10th of 1 percent.
As you can see, the 10-year impact is $314 billion, mostly due to lower tax receipts, though there is some impact on outlays because of higher interest costs and a bit of additional entitlement spending.
So why am I sharing these numbers? Because let’s now think about President Obama’s proposed class-warfare tax hike. He wants higher tax rates on investors, entrepreneurs, small business owners and other “rich” taxpayers. And he wants more double taxation of dividends and capital gains. And a higher death tax rate, even higher than the ones imposed by France and Venezuela.
I think some opponents are exaggerating when they claim that this tax hike will cause a recession and cripple the economy. But I do think that it’s reasonable to contemplate the degree to which the Obama tax hikes will slow growth. More than 1/10th of 1 percent? Less than that? Would the damage occur in the first few years? Would it be spread out over time?
Those questions are hard to answer. Ask five economists and you’ll get nine answers, but there is compelling evidence that higher tax rates do have a negative impact.
But some people assume that taxes don’t matter at all. Using models that, for all intents and purposes, naively assume a simplistic linear relationship between tax rates and tax revenue, the number-crunching bureaucrats in Washington estimate that Obama’s proposed tax hikes will generate about $800 billion over 10 years.
I’m not going to pretend I know the economic impact of those higher tax rates, but for the sake of argument, let’s assume that the impact is minor. Indeed, let’s assume that it’s only 1/10th of 1 percent. Based on the CBO sensitivity analysis above, that means that about 40 percent of the projected deficit reduction will fail to materialize.
And that’s not even considering the fact that politicians will probably increase the burden of government spending because of the expectation of additional tax revenue.
Just something to keep in mind as this debate unfolds.
P.S. I actually shared this exact same data when testifying to the Senate Budget Committee earlier this year. Needless to say, in some cases I think my testimony went in one ear and out the other.
P.P.S. The revenue-maximizing tax rate is not the ideal point on the Laffer Curve.
[…] Unsustainable Debt – An expanding burden of government spending also will mean ever-higher levels of red ink, especially once the tax burden is so high that additional levies don’t produce much – if any – revenue. […]
[…] Now let’s make the analysis more realistic by considering that tax cuts and tax reforms will generate faster growth, which will lead to more taxable income. […]
Even Milton Friedman showed that small business creating jobs is unprovable because of survival bias (J Eco Lit, Vol. 30, No. 4, pp. 2129-2132). Small business is all about sociopath atomists who want to break the law by being on their own so no one sees them, but they want their wives to work for the government just to get the benefits, like healthcare. J K Galbraith was right that the best way is big business, big labor and big government.
Zorba, we could go a step farther in correcting usage of the term conservative. Do you recall the reaction in Wisconsin and elsewhere in early 2011 when the Republicans dared to tamper with the sacred cow of compensation of public sector employees? That reaction was basically the same reaction that occured in March, 2011, in London and that has been occurring regularly in places like Greece. No doubt you’re familiar with Hellenic children’s wide-eyed demonstrations against alleged austerity. THAT reaction is an example of reactionary conservatism at its ugliest.
It would help all conservatives to pay another visit to the World’s Smallest Political Quiz. Liberalism, generally speaking, is near the top, and the most intense statism is at the bottom. Sure enough, the bottom is also where both despotism and conservatism tend to be at their worst. That lower portion is also territory of great friendliness to tax ideologues.
Unfortunately the quiz is culture bound and nation bound. Note the question about a “National ID card”. There is also the phrase “privatize Social Security”, which indicates an ideal popular among too many crony capitalists.
Still, the quiz has its merits, and if nothing else it should corrupt the one dimensional thinking about politics that is so common among conservatives whether leftwing, rightwing, or centrist.
http://www.theadvocates.org/quiz
Now, I don’t think that any injustice would be done by identifying and embarrassing a few people who have demonstrated a longstanding commitment to helping the leftists to do their dirty work. Rush Limbaugh and the guy who runs the Future of Freedom Foundation are two such suspects. It so happens that the latter guy demonstrated that he’s obstinate, for he admitted via e-mail that he knows better than to call a leftist a liberal.
Indeed, one of the first things conservatives should do is change terminology.
One of the greatest PR successes of leftists and statists has been to convince people who value individual freedom to capitulate to the term “conservative”.
So “progressives” have been able to at least etymologically and subconsciously associate with progress (i.e. growth, change, evolution) vs. “conservative” (i.e stagnation). Yet who is typically talking about “conservation”? And, more importantly, what leads to more progress? A population under flattened effort reward curves which is guided with sticks and carrots by majority down a few mandatory growth avenues dictated by bureaucrats elected by majority (as in “this shall be your healthcare system” – “this is the village, participation is mandatory”)(i.e. un-motivated average intelligence), or the parallel multiplexing of people operating under the unadulterated effort-reward curves of free enterprise (i.e. motivated aggregate intelligence)?
Changing the terms would be a very good start indeed…
A change that may help galvanize the western world back to 5% growth rates and thus stave of its precipitous decline and absorption into the worldwide average.
juandos, nice to see you carrying water for leftists, who are pleased when their political enemies repeat the myth that they are liberals. Reality, however, cannot be altered by a childish game with words.
Leftists are radically illiberal.
Hey if liberals want government services and government interference in their lives then let liberals pay for it…
So here is my discord with liberals in a nutshell: Liberals say that we are far from flattening the motivational levels of Americans (penalizing exceptionalism to insulate the ordinary from the consequences of mediocrity) to the point where America looses its top spot in economic competitiveness. I say that we not only are not far from the threshold, but that we have actually crossed it and have thus entered the vicious cycle of decline.
Time will prove who is right.
Liberals should start working on excuses, as I enjoy life away from the rat-race during America’s decline years.
The strong invitation to indolence that ObamaCare, in itself, will unleash, will have a growth trendline impact of a lot more than 1/10th of 1% — perpetually compounding as long as the program stays in force,…i.e. forever. And that is the mid term effect only. The longer term effect will be outright less ambitious lifetime choices that permanently steer people towards a lifetime of increased mediocrity. “There’s not much urge to strive to do exceptional things. The basics are covered anyway and taxation on exceptional work rather heavy” will be the ever more prevailing advice amongst family, friends, advisors, psychiatrists, life planners etc.. Hence the 1-2% growth trendline to decline that has irreversibly taken hold in Europe, comes to America — and never leaves again. The economic distress of decline will then prompt the electorate to vote even more government “care packages” (thus entrenching the accelerating vicious cycle) in the hopes that the American middle class will maintain a standard of living six times the world average without any differentiating motivation incentives compared to the rest of the world. The naïveté of hope seems unbound. There is no perpetual motion machine of prosperity, so the middle class will inevitably be tapped upon to pay for the very “care packages” it voted for.
No America will not collapse tomorrow under more taxes, more regulation, more central planning, i.e. more collective management of the economy by majority. But it will be a slow wretched and, more importantly, entrenched decline, possibly peppered with crises and even periods of modest hope, unable to make a significant dent on the overall decline trajectory. The end result will be that the relative worldwide standing of America’s next generation will be at a three times only prosperity multiple over the worldwide average, down from the current six times multiple.
As in in Europe, the upcoming crises will be attributed to many superficial causes: “Its this country’s or that state’s fault,… it’s the investors,… it’s the speculators…” etc. But they will all be manifestations/facets of the same underlying fundamental cause: Decreased motivation levels under flatter effort-reward curves. The differential motivation force that once existed in America ( and yes I do mean the unadulterated reward for exceptional work and lack of safety nets to insulate the ordinary from the consequences of relative mediocrity ) will no longer exist – or will be watered down enough that some other environment/country will take the worldwide competitiveness lead. As the American environment descends to the same motivation levels that exist in the rest of the world (and especially Europe) there will be no fundamental reason why Americans manage to continue commanding a standard if living six times the world average. Liberals/progressives should start working, thinking how to spin plausible explanations and narratives explaining away the upcoming crises, so that there are as few voices as possible attributing them to their true root cause: American Motivation levels that have declined to unexceptional levels.
At some point the threshold will be crossed – and has probably already been crossed. Silicon Valley employees (and their insulated from mediocrity co-workers) will no longer leave their families in the morning to be raised by baby sitters, to go sit in an office ten hours a day so that a government park ranger collecting snail samples (a job that any one of the three billion third world citizens can do) can have lifetime benefits and a standard of living six times the world average. Our Silicon Valley hero will of course still attempt to do it, on momentum, but not with enough aggregate enthusiasm around him to outcompete everyone else in the world. His company will fail to thrive, and soon he will no longer be able to do it, regardless of enthusiasm or even high levels of altruism (for the few who fall in that category), because his job will no longer exist. It will have moved to other places, outcompeted by environments with stronger effort-reward curves.
It is simply impossible to go against people’s desire to pad their standard of living through the work of others, redistributed at the polls. Well not entirely impossible, but I doubt that it will be Americans who do it, given the fact that Americans were serendipitously there but now seem to have converged to the mentality of the average world voter. With cultural convergence, economic convergence towards the worldwide average will be inevitable. The American voter pendulum is clearly swinging in the direction of unexceptional worldwide average mentality. Economic performance and prosperity averagedom will inevitably follow.
But as I have said, as practical advice, for some people reading these comments, declines can provide a happy less stressful existence for a few years until reality catches up – if you play your cards right. If you have been productive in the past, if you are not in the immediate need for a full time job, then sit back relax, withdraw into a quieter life away from the rat race, enjoy non-pecuniary activities in life which will greatly improve your happiness (though they offer virtually nothing to the HopNChange society surrounding you) and live a happy life in the sunset years of the once mighty American empire of motivation. Heck! You may even qualify for ObamaCare! It will take a few years for HopNChangers to exhaust their momentum and stop working for your health insurance. So enjoy!
I should have added that a tax revolt in the USA would be dangerous given the fact that most Americans are vampires, pirates, and tax idealists.
Perhaps the ideal tax rate is the one that provokes a tax revolt.
I have actually written several dozen letters to President Obama about the Laffer Curve but I don’t think it is correct. Even if he sees that it sometimes works, he does want to increase the taxes on the rich for reasons of “fairness.”
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