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Archive for the ‘Higher Taxes’ Category

There were several good features of the 2017 tax bill, including limitations on the state and local tax deduction.

But the 21 percent corporate tax rate was the unquestioned crown jewel of the Tax Cut and Jobs Act. The U.S. system had become extremely anti-competitive thanks to a 35 percent rate that was far above the world average, so reform was desperately needed.

That’s the good news.

The bad news is that Democrats in the House of Representatives already are pushing for a big increase in the corporate rate.

Rep. John Yarmuth, the new House Budget chairman, said his chamber’s budget blueprint will aim to claw back lost revenue by boosting the corporate tax rate from its current 21 percent to as high as 28 percent… he anticipates the budget resolution will envision changes to the 2017 GOP tax overhaul, including raising the corporate tax rate above its current 21 percent. “…We’ll see how much revenue we can get out of it.” The rate was 35 percent before it was cut in the GOP tax bill.

Since Republicans control the Senate and Trump is in the White House, there’s probably no short-term risk of a higher corporate tax rate.

But such an initiative could be a major threat after the 2020 election, so let’s augment our collection of evidence showing why a higher rate would be a very bad idea.

We’ll start with some analysis from the number crunchers at the Tax Foundation.

A corporate tax rate that is more in line with our competitors reduces the incentives for firms to realize their profits in lower-tax jurisdictions and encourages companies to invest in the United States. Raising the corporate income tax rate would dismantle the most significant pro-growth provision in the Tax Cuts and Jobs Act, and carry significant economic consequences. …Raising the corporate income tax rate would reduce economic growth, and lead to a smaller capital stock, lower wage growth, and reduced employment. …Raising the rate to 25 percent would reduce GDP by more than $220 billion and result in 175,700 fewer jobs.

Here’s the table showing the negative effect of a 22 percent rate and a 25 percent rate, so a bit of extrapolation will give you an idea of how the economy will suffer with a 28 percent rate.

By the way, since the adverse impact on wages is one of the main reasons to be against a higher corporate tax rate, I’ll also share this helpful flowchart from the article.

Now let’s look at some research from China, which underscores the importance of low rates if we want more innovation.

Here’s the unique set of data that created an opportunity for the research.

In November 2001, China implemented a tax collection reform on all manufacturing firms established on or after January 2002, which switched the collection of corporate income taxes from the local tax bureau to the state tax bureau. After the reform, similar firms established before or after 2002 could pay very different effective tax rates because of the differences in the management and incentives of those two types of tax bureaus…, resulting in a reduction of effective corporate income tax rates by almost 10% among newly established firms. …the policy change created exogenous variations in the effective tax rate among similar firms established before versus after 2002. We can thus apply a regression discontinuity design (RD) and use the generated variation in the effective tax rate to identify the impact of taxes on firm innovation.

And here are the findings.

Our analysis yields several interesting results. First, we show a strong and robust causal relationship between tax rate and firm innovation. Decreasing the effective tax rate by one standard deviation (0.01) increases the average number of patent application by a significant 5.7% (see Figure 2 for the graphical evidence). The reform also stimulated R&D expenditures and increased the skilled-labour ratio by 14%. Second, a lower tax rate also improves the quality of patents. The impact of tax reform on patent applications mainly comes from its effect on invention and utility patents – decreasing the effective tax rate by one standard deviation improves the probability of having an invention patent application by 4.4% and increases the number of utility patent applications by 4.7%.

Don’t forget that high personal tax rates also discourage innovation, so it’s a pick-your-poison menu.

Here’s a chart from the study, showing the difference in patents between higher-taxed firms and lower-taxed firms.

Last but not least, let’s review some of the findings from a study published by the National Bureau of Economic Research.

We present new data on effective corporate income tax rates in 85 countries in 2004. …In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy. The results are robust to the inclusion of controls for other tax rates, quality of tax administration, security of property rights, level of economic development, regulation, inflation, and openness to trade

And here’s one of the many charts and tables in the study.

The bottom line is that a higher corporate tax rate will be bad for workers for the simple reason that less investment means lower productivity and lower productivity means lower wages.

P.S. It’s also likely that House Democrats will try to increase the top personal tax rate, though hopefully they’re not so crazy as to push for Ocasio-Cortez’s 70 percent rate.

P.P.S. it’s quite possible that an increase in the corporate tax rate would reduce revenues, especially in the long run.

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Bernie Sanders is yesterday’s news.

Yes, he’s still lovable ol’ Crazy Bernie, but he’s now being overshadowed by Congresswoman Alexandria Ocasio-Cortez, another out-of-the-closet socialist who somehow thinks America should be more like Greece or Venezuela.

Brian Riedl of the Manhattan Institute opines in National Review about AOC’s proposed tax hike on the rich. He starts with a very appropriate economic observation.

A 70 percent tax bracket would raise very little (if any) revenue, while damaging the economy and sending income and jobs overseas.

He then points out that we should look at both sides of the fiscal ledger.

And the spending side of the left’s ledger is very crowded and very heavy.

…when assessing the needed tax revenues, a green-energy initiative costing $7–$10 trillion over the decade should be examined in the context of $42 trillion in additional Democratic-socialist proposals that include single-payer health care ($32 trillion), a federal jobs guarantee ($6.8 trillion), student-loan forgiveness ($1.4 trillion), free public college ($800 billion), infrastructure ($1 trillion), family leave ($270 billion), and Social Security expansion ($188 billion). …These spending promises are so stratospheric as to be incomprehensible — except to the far Left, which clings to the myth that simply taxing millionaires can finance a level of socialism that would make the Swedes start a tea-party movement.

Here’s the key part of Brian’s column.

He points out that there’s no way to finance the agenda of Democratic Socialists with class-warfare taxes. Even if the AOC tax plan is dramatically expanded.

…a 100 percent tax rate on all income over $1 million…would raise 3.8 percent of GDP — not even enough to balance the current budget, much less finance a Green New Deal. And even that figure implausibly assumes that people continue working and investing. Slightly more realistically, doubling the top 35 percent and 37 percent tax brackets, to 70 percent and 74 percent for singles earning more than $200,000 and couples earning at least $400,000, would raise roughly 1.6 percent of GDP. That figure also ignores all revenues lost to the economic effects of 85 percent marginal tax rates (when including state and payroll taxes) as well as tax avoidance and evasion. …limiting the 70 percent tax bracket to incomes over $10 million…would raise only 0.25 percent of GDP — about $50 billion annually. …$50 billion is surely too high of an estimate, because the kind of people with incomes over $10 million also have teams of accountants and tax lawyers finding every conceivable tax loophole and overseas income shift.

Everything we know about the real-world impact of tax policy tells us that these soak-the-rich taxes won’t raise much – if any – revenue for the simple reason that upper-income taxpayers will alter the timing, level, and composition of their income.

But, as Brian noted, these taxes wouldn’t come close to financing the leftist wish list even if one makes absurd assumptions that behavior doesn’t change and the economy is unaffected.

So how do European nations finance their large welfare states?

Europe finances its generous welfare states through steep value-added taxes that hit the entire population. …Increasing federal spending by 21 percent of GDP to fund Democratic socialism — even after slashing defense — would require either a 55 percent payroll tax increase, or 115 percent value-added tax, according to CBO data. Acknowledging this brutal middle-class burden would immediately end any public flirtation with “free-lunch socialism.”

This is the most important takeaway from the column.

And it’s something that I’ve noted as well. On more than one occasion.

If you want European-type handouts, you better be prepared to cough up a lot of money.

  • Onerous value-added taxes.
  • Punitive payroll taxes.
  • And income taxes that impose high rates on modest incomes.

Simply stated, there is no way to finance a European-sized welfare state without pillaging middle-class and lower-income taxpayers.

Which helps to explain why European living standards are significantly below American levels.

By the way, there one final point from Brian’s column that is worth sharing.

He explains that high tax rates in the 1950s, 1960s, and 1970s didn’t generate much revenue. Even from the rich.

A common liberal retort is that the economy survived 91 percent income-tax rates under President Eisenhower and 70 percent tax rates through the 1970s. That does not mean those policies raised much revenue. Tax exclusions and high income thresholds shielded nearly everyone from these tax rates — to the degree that the richest 1 percent of earners paid lower effective income-tax rates in the 1950s than today. In 1960, only eight taxpayers paid the 91 percent rate. Overall, today’s 8.2 percent of GDP in federal income-tax revenues exceeds that of the 1950s (7.2 percent), 1960s (7.6 percent), and 1970s (7.9 percent). Those earlier decades were not a tax-the-rich utopia.

Amen.

I made similar points back in 2017.

The bottom line is that Alexandria Ocasio-Cortez’s economic agenda cannot be justified when looking at economic data, fiscal data, and historical data.

But we can say with great confidence that ordinary people ultimately will pay the heaviest price if her proposals get enacted since her class-warfare tax hikes will be a precursor for huge tax increases on the rest of us.

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I wrote yesterday about a handful of strange legal developments in Canada.

In a display of balance, however, I noted in my conclusion that Canada in recent decades has been “very sensible” with regard to economic issues (spending restraintwelfare reformcorporate tax reform, bank bailoutsregulatory budgeting, the tax treatment of savingschool choice, and privatization of air traffic control).

But “very sensible” is not the same as “totally sensible.” Especially not if you count recent years.

The nation’s current top politician, Justin Trudeau (a.k.a., Prime Minister Zoolander), increased the top tax rate from 29 percent to 33 percent after taking office in late 2015.

It appears, though, that he wasn’t aware of a concept known as the Laffer Curve (or, like some folks on the left, maybe he simply didn’t care).

In the real world, however, it turns out that increasing tax rates is not the same as increasing tax revenue.

Here are some excerpts from a story in the Globe and Mail.

The Liberal government’s tax on Canada’s top 1 per cent failed to produce the promised billions in new revenue in its first year, as high-income earners actually paid $4.6-billion less in federal taxes. …The latest available tax records show that revenue from Canadians earning about $140,000 or more – which had previously been the fourth and highest tax bracket – dropped by $4.6-billion in 2016, the first full year that the Liberal tax changes were in effect. Further, 30,340 fewer Canadians reported incomes in that range for 2016 compared with the year before. …The new top bracket with a 33-per-cent tax rate was predicted to raise about $3-billion a year in new revenue… Critics of the Liberal plan say the CRA’s 2016 numbers justify their concern that a new top tax bracket hurts Canadian efforts to boost competitiveness and attract top talent.

It’s quite possible, as noted in the article, that some of the foregone revenue might be the result of one-time changes, such as upper-income taxpayers shifting income from 2016 to 2015 (rich people do have considerable control over the timing, level, and composition of their income).

A report from Global News reviews a report about the degree to which revenues dropped for transitory reasons.

The Liberal government’s 2016 tax hike on Canada’s top one per cent not only failed to yield the promised billions, but resulted in a net revenue loss for government coffers… After adjusting for economic changes and one-time factors, the paper estimates, based on 2016 tax data, that the Liberals’ new tax bracket for top earners creates $1.2 billion in new revenue for the federal government but a $1.3 billion loss for provincial governments. …Finance Minister Bill Morneau’s office, however, has maintained that the revenue drop for 2016 was a one-off event. …But an analysis of the data that adjusts for the impact of the dividends maneuver and economic factors still shows that the tax hike would have fallen far short of the hype… Studies have shown that top earners are more likely than lower-income taxpayers to react to tax increases by reducing their taxable income. This may be because the wealthy have access to more sophisticated tax advice, are more easily able to shift assets to lower-tax jurisdictions or can afford to simply decide to work less given that they get to keep less of their money.

Much of the data in this story came from an analysis by the C.D. Howe Institute.

Here’s the key chart from that study, which disentangles the one-off changes and permanent changes caused by the higher tax rate.

The bottom line is that the experts at the C.D. Howe Institute believe that the central government eventually will collect more revenue from the higher tax rate, but:

  1. The revenue will be less than projected by static revenue estimates because of permanently lower levels of taxable income.
  2. The added revenue for the central government is more than offset by lower tax receipts for subnational levels of government.

In other words, Trudeau’s tax hike was a big mistake. The only tangible results are that the private sector is now smaller and the country is less competitive.

For what it’s worth, I view the lack of additional tax revenue as a silver lining to an otherwise dark cloud. Maybe, just maybe, this will put a damper on some of Trudeau’s irresponsible plans for more spending.

P.S. For those interested in Canadian fiscal policy, I shared some research last year about the implications of provincial changes in tax policy.

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She’s not quite as bad as Matt Yglesias, who wants a top tax rate of 90 percent (a rate that Crazy Bernie also likes), but Congresswoman Alexandria Ocasio-Cortez is not bashful about wanting to use the coercive power of government to take much larger shares of what others have earned.

And she doesn’t want to take “just” half, which would be bad enough. She wants to go ever further, endorsing a top tax rate on household income of 70 percent.

Those of you with a lot of gray hair may recall that’s the type of punitive tax regime we had in the 1970s (does anybody want a return to the economic misery we suffered during the Nixon and Carter years?).

So it’s very disturbing to think we may get an encore performance.

Here are some excerpts from a Politico report.

Rep. Alexandria Ocasio-Cortez (D-N.Y.) is floating an income tax rate as high as 60 to 70 percent on the highest-earning Americans… Ocasio-Cortez said a dramatic increase in taxes could support her “Green New Deal” goal of eliminating the use of fossil fuels within 12 years… “There’s an element where yeah, people are going to have to start paying their fair share in taxes.” …When Cooper pointed out such a tax plan would be a “radical” move, Ocasio-Cortez embraced the label… “I think that it only has ever been radicals that have changed this country,” Ocasio-Cortez said. “Yeah, if that’s what radical means, call me a radical.”

There are many arguments to make against this type of class-warfare policy, but I’ll focus on two main points.

First, this approach isn’t practical, even from a left-wing perspective. Simply stated, upper-income taxpayers have considerable control over the timing, level, and composition of their income, and they can take very simple (and completely legal) steps to protect their money as tax rates increase.

This is one of the reasons why higher tax rates don’t translate into higher tax revenue.

If you don’t believe me, check out the IRS data on what happened in the 1980s when Reagan dropped the top tax rate from 70 percent to 28 percent. Revenues from those making more than $200,000 quintupled.

Ms. Ocasio-Cortez wants to run that experiment in reverse. That won’t end well (assuming, of course, that her goal is collecting more revenue, which may not be the case).

Second, higher tax rates on the rich will have negative consequences for the rest of us. This is because there is a lot of very rigorous research that tell us:

And this is just a partial list.

And I didn’t even include the potential costs of out-migration, which doubtlessly would be significant since Ms. Ocasio-Cortez would impose the developed world’s most punitive tax regime on the United States.

I’ll close by recycling this video on the harmful impact of punitive tax rates.

P.S. Today’s column focused on the adverse economic impact of a confiscatory tax rate, but let’s not forget the other side of the fiscal equation. Ms. Ocasio-Cortez wants to finance a “green new deal,” which presumably means a return to Solyndra-style scandals.

P.P.S. There is some encouraging polling data on class-warfare taxation.

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I have a series of columns where I explore tactical disagreements with folks who generally favor free markets and less government.

  • In Part I, I defended the flat tax, which had been criticized by Reihan Salam
  • In Part II, I explained why I thought a comprehensive fiscal package from the American Enterprise Institute was too timid.
  • In Part III, I disagreed with Jerry Taylor’s argument for a carbon tax.
  • In Part IV, I highlighted reasons why conservatives should reject a federal program for paid parental leave.

Today, we’re going to revisit the carbon tax because Josiah Neeley and William Murray of the R Street Institute have a column in the Hill that claims that levy would not finance bigger government.

…There have been numerous tax rate changes in the past 70 years, with the marginal income tax rate falling from a high of over 90 percent in the 1950s to as low as 28 percent in the late 1980s. Yet during this entire time period, federal tax revenue has stayed in a fairly narrow band when measured as a percentage of gross domestic product, never rising above 20 percent or falling much below 15 percent between 1950 and 2018. This phenomenon, which keeps federal revenues within a relatively narrow band, is known as Hauser’s law…the belief that any kind of new taxation introduces even greater government spending is based on very little actual evidence. Instead, Hauser’s law provides evidence that certain kinds of tax swaps, such as exchanging an income tax for a carbon tax, may actually increase the rate of economic growth without increasing the tax share of the overall economy.

They also claim that higher taxes don’t lead to more spending.

…demand for government spending drives tax policy, not the other way around. This conclusion has important implications for the carbon tax debate. …The relative imperviousness of the gross domestic product tax percent equilibrium since the late 1940s suggests that spending pressures drive taxes and not the other way around.

I have two responses to this analysis.

First, I very much want Hauser’s Law to be true. It would be very comforting if politicians in Washington could never seize more than 20 percent of the private sector’s output.

Sadly, that’s simply not the case. Just look at Europe, where central governments routinely extract far more than 40 percent of economic output.

All that’s required is taxes that target lower- and middle-income taxpayers. That’s happened in Europe because of harsh value-added taxes, punitive payroll taxes, onerous energy taxes, and income taxes that impose very high rates on ordinary people.

Needless to say, a carbon tax would be a step in that direction.

Second, the authors offer zero evidence that “government spending drives tax policy, not the other way around.”

By contrast, there is some persuasive data for the “starve the beast” hypothesis, which is based on the notion that higher taxes will encourage more spending.

In other words, Milton Friedman was right when he warned that “History shows that over a long period of time government will spend whatever the tax system raises plus as much more as it can get away with.”

Though I actually don’t think this causality debate is very important. The bottom line is that higher taxes are a bad idea if they trigger higher spending, and higher taxes also are a bad idea if they merely enable higher spending.

The column in the Hill is a spin-off from a recent study published by the R Street Institute.

Let’s look at that publication to further explore this issue. It starts with the basic hypothesis that a revenue-neutral carbon tax would be desirable.

…a carbon tax…provides a source of revenue that can be put to beneficial purposes, such as funding cuts to other existing taxes. By using the revenue from a carbon tax to replace existing ones, such a revenue neutral “tax swap” would greatly reduce or eliminate the economic costs of the tax. Indeed, in some cases, even if benefits from reduced emissions are not considered, a tax swap could be a net positive for the economy. …many critics of a carbon tax are skeptical as to whether a revenue-neutral carbon tax could be enacted. Some critics go further, arguing that even if a carbon tax started out as revenue neutral, it would not remain so. …While there are no guarantees, the existing evidence suggests that a revenue-neutral carbon tax would not lead to larger government over the long term and could even shrink it.

I don’t object to the notion that a carbon tax would be theoretically desirable if it replaced a tax that did more damage per dollar collected, such as the corporate income tax.

My concern has always been such a swap is highly unlikely. Indeed, many proponents of the carbon tax are very explicit about wanting to use the revenues to create a new entitlement. That would be the worst outcome, assuming we want more growth.

And, as noted above, I don’t think Hauser’s Law would save us from higher overall taxes and a larger burden of government spending.

Interestingly, the study basically acknowledges the same thing.

…given that Hauser’s Law is not an iron law of economics, it would be imprudent to put too much weight on it when considering the effects of a tax swap.

There are a couple of other parts of the study that deserve attention, including the assertion that politicians would have a hard time using the carbon tax as a money machine.

…a carbon tax has natural limitations that preclude it from being used to generate ever-increasing amounts of tax revenue. This is because higher carbon-tax rates induce a more rapid fall in greenhouse gas emissions. This, in turn, limits the overall revenue collected from the tax. In fact, unlike revenue from income, sales or property taxes, which tends to increase over time even at a constant tax rate, revenue from a carbon tax is likely to remain stable or fall gradually as emissions decline.

Since I’m a fan of the Laffer Curve, I think this argument is very reasonable in theory.

In effect, the R Street Institute is making the same argument – excessive tax rates can reduce revenue – that Alexander Hamilton used when endorsing tariffs.

But where is the point where carbon taxes become excessive? I don’t know the answer, but I’m very worried that there would be ample leeway to collect a lot of tax revenue before getting close to the revenue-maximizing point (the Congressional Budget Office estimates that a $25-per-ton carbon tax would generate more than $1 trillion in the first ten years).

The bottom line is that I worry that a carbon tax likely would be akin to a value-added tax. Yes, there are negative feedback effects from a VAT, as I noted at the end of yesterday’s column. But that doesn’t change the fact that the revenue-generating capacity of the VAT helps to explain Europe’s bloated welfare states.

I understand how a carbon tax, in theory, might not enable bigger government. But I see no way, in reality, that politicians wouldn’t use this new levy to finance even more spending.

P.S. If you’re not already convinced that a carbon tax will mean bigger government, then all you need to know is that both the International Monetary Fund and the Organization for Economic Cooperation and Development support higher energy taxes for the United States.

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A couple of weeks ago, I used a story about a local tax issue in Washington, DC, to make an important point about how new tax increases cause more damage than previous tax increases because “deadweight losses” increase geometrically rather than arithmetically.

Simply stated, if a tax of X does Y amount of damage, then a tax of 2X will do a lot more damage than 2Y.

This is the core economic reason why even left-leaning international bureaucracies agree that class-warfare taxes are so destructive. When you take a high tax rate and make it even higher, the damage grows exponentially.

As such, I was very interested to see a new study on this topic from the World Bank. It starts by noting that higher tax rates are the wrong way to address fiscal shortfalls.

…studies have used the narrative approach for individual or multi-country analyses (in all cases, focusing solely on industrial economies, and mostly on industrial European countries). These studies find large negative tax multipliers, ranging between 2 and 5. This recent consensus pointing to large negative tax multipliers, especially in industrial European countries, naturally entails important policy prescriptions. For example, as part of a more comprehensive series of papers focusing on spending and tax multipliers, Alesina, Favero, and Giavazzi (2015) point that policies based upon spending cuts are much less costly in terms of short run output losses than tax based adjustments.

The four authors used data on value-added taxes to investigate whether higher tax rates did more damage or less damage in developing nations.

A natural question is whether large negative tax multipliers are a robust empirical regularity… In order to answer this highly relevant academic and policy question, one would ideally need to conduct a study using a more global sample including industrial and, particularly, developing countries. …This paper takes on this challenge by focusing on 51 countries (21 industrial and 30 developing) for the period 1970-2014. …we focus our efforts on building a new series for quarterly standard value-added tax rates (henceforth VAT rates). …We identify a total of 96 VAT rate changes in 35 countries (18 industrial and 17 developing).

The economists found that VAT increases did the most damage in developing nations.

…when splitting the sample into industrial European economies and the rest of countries, we find tax multipliers of 3:6 and 1:2, respectively. While the tax multiplier in industrial European economies is quite negative and statistically significant (in line with recent studies), it is about 3 times smaller (in absolute value) and borderline statistically significant for the rest of countries.

Here’s a chart showing the comparison.

Now here’s the part that merits close attention.

The study confirms that the deadweight loss of VAT hikes is higher in developed nations because the initial tax burden is higher.

Based on different types of macroeconomic models (which in turn rely on different mechanisms), the output effect of tax changes is expected to be small at low initial levels of taxation but exponentially larger when initial tax levels are high. Therefore, the distortions and disincentives imposed by taxation on economic activity are directly, and non-linearly, related to the level of tax rates. By the same token, for a given level of initial tax rates, larger tax rate changes have larger tax multipliers. …In line with theoretical distortionary and disincentive-based arguments, we find, using our novel worldwide narrative, that the effect of tax changes on output is indeed highly non-linear. Our empirical findings show that the tax multiplier is essentially zero under relatively low/moderate initial tax rate levels and more negative as the initial tax rate and the size of the change in the tax rate increase. …This evidence strongly supports distortionary and disincentive-based arguments regarding a nonlinear effect of tax rate changes on economic activity…the economy will inevitably suffer when taxes are increased at higher initial tax rate levels.

What makes these finding especially powerful is that value-added taxes are less destructive than income taxes on a per-dollar-raised basis.

So if taking a high VAT rate and making it even higher causes a disproportionate amount of economic damage, then imagine how destructive it is to increase top income tax rates.

P.S. The fact that a VAT is less destructive than an income tax is definitely not an argument for enacting a VAT. That would be akin to arguing that it would be fun to break your wrist because that wouldn’t hurt as much as the broken leg you already have.

I’ve even dealt with people who actually argue that a VAT isn’t economically destructive because it imposes the same tax on current consumption and future consumption. I agree with them that it is a good idea to avoid double taxation of saving and investment, but that doesn’t change the fact that a VAT increases the wedge between pre-tax income and post-tax consumption.

And that means less incentive to earn income in the first place.

Which is confirmed by the study.

Panels A and B in Figure 18 show the relationship between the VAT rate a and the perceived effect of taxes on incentives to work and invest, respectively, for a sample of 123 countries for the year 2014. Supporting our previous findings, the relationship is highly non-linear. While the perceived effect of taxes on the incentives to work and invest barely changes as VAT rates increase at low/moderate levels (approximately until the VAT rate reaches 14 percent), it falls rapidly for high levels of VAT rates.

Here’s the relevant chart from the report.

The moral of the story is that all tax increases are misguided, but class-warfare taxes wreak the most economic havoc.

P.S. Not everyone understands this common-sense observation. For instance, the bureaucrats at the Congressional Budget Office basically argued back in 2010 that a 100 percent tax rate was the way to maximize growth.

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I recently wrote about the failed 1990 budget deal. My big complaint was that President George H.W. Bush compounded the mistake of higher taxes by also allowing a big increase in the burden of government spending.

However, I didn’t blame the agreement for that year’s recession for the simple reason that the downturn began in July and the tax hike was signed in November (that would make me like Paul Krugman, who wanted people to think that Estonia’s 2008 recession was caused by spending cuts in 2009).

But maybe I’m not being sufficiently critical. After all, Bush announced he would abandon his no-tax pledge in June, and that was then followed by months of tax-hike negotiations. Isn’t it reasonable to think all that talk would have a negative effect, especially on investors and business owners?

The answer may be yes, at least in part. There’s a very interesting new study by Sandra García-Uribe at Spain’s central bank. She examines how the anticipation of tax changes affects economic performance.

Prior to the approval of laws, there is often widespread information about the progress of bills. This information may be valuable for the forecasts that agents make about the economic environment in the future. …This paper provides a way to account for the economic responses to anticipation of tax shocks… In this paper I introduce a new measure of mass media anticipations of tax bill approvals by exploiting the content of news in the US television during the period 1968-2007. …this is the first paper that exploits a dynamic factor model to account for fiscal policy effects on economic activity. The factor specification considers the dynamics of the factor and the potential effects of tax changes and their anticipation on it.

She’s definitely correct about there being a process for tax legislation, so people (“agents” in economic jargon) have ample warning.

The study includes data on how tax increases harm growth once they are adopted.

Figure 3 presents the implementation effects of exogenous tax liability changes on economic activity, in the period 1948 to 2007…The figure shows the cumulative effects in terms of an increase in tax liabilities of a one percent of QGDP together with the one-standard-error bands. The maximum effects are achieved 29 months after implementation of the tax changes when monthly economic activity growth drops by 99.56%. …the maximum implementation effect of a 1% of QGDP increase of tax liabilities is a reduction of monthly economic activity growth of 0,28%. …For the period that we dispose of television data, 1968 to 2007, immediate implementation effects are -6.6% for monthly economic activity growth. Two months after implementation the effects are -10.7%. Maximum effects are a -69.1% and happen 25 months after implementation.

Here’s a chart showing the negative impact of tax increases.

But does the discussion of tax changes also impact the economy?

According to the research, the answer is yes.

Anticipating tax increases reduces economic activity by 1,36% while anticipating tax cuts stimulates it by 3,04%. …Conditional on the media release of information about a potential tax approval, it is likely that people is aware of what is the net tax liability change associated to the potential approval since media also makes reference to terms like ”increase”, ”rise” or ”cut”. There are 20 episode approvals in the sample and learning how to predict the sign joint to the approval based on 10 approvals per sign resulted in something unfeasible. I construct an indicator variable that captures the mention of ”increase” or ”rise” within the tax news to approximate the possibility of a tax rise approval. …In columns (3) and (4) I control for this indicator and its interaction with media anticipation of tax approvals …A 10% probability of tax approvals conditional on the tax news at t not mentioning tax increases significantly stimulates current monthly economic activity growth by 3.04%. In the case of the media mentioning tax increases the effect is a reduction of monthly economic activity growth by 1.36%.

For economic junkies, here’s the relevant table from the study.

By the way, none of this changes my view that monetary policy is always the first place to look when assigning blame for economic downturns and volatility.

Simply stated, taxation is just one of many factors that determine economic performance. But the fact that it’s not the only thing that matters doesn’t change the fact that it’s a very bad idea to increase the tax burden.

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