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Archive for the ‘Supply-side economics’ Category

Three years ago, I shared two videos explaining taxation and deadweight loss (i.e., why high tax burdens are bad for prosperity).

Today, I have one video on another important principle of taxation. To set the stage for this discussion, here are two simple definitions

  • The “average tax rate” is the share of your income taken by government. If you earn $50,000 and your total tax bill is $10,000, then your average tax rate is 20 percent.
  • The “marginal tax rate” is the amount of money the government takes if you earn more income. In other words, the additional amount government would take if your income rose from $50,000 to $51,000.

These definitions are important because we want to contemplate why and how a tax cut helps an economy.

But let’s start by explaining that a tax cut doesn’t boost growth because people have more money to spend.

I want people to keep more of their earnings, to be sure, but that Keynesian-style explanation overlooks the fact that the additional “spending power” for taxpayers is offset when the government borrows more money to finance the tax cut.

Instead, when thinking about taxes and prosperity, here are the three things you need to know.

1. Economic growth occurs when we increase the quantity and/or quality of labor and capital.

2. Taxes increase the cost of whatever is being taxed, and people respond by doing less of whatever is being taxed.

3. To get more prosperity, lower tax rates on productive behaviors such as work, saving, investment, and entrepreneurship.

All this is completely correct, but there’s one additional point that needs to be stressed.

4. The tax rate that matters is the marginal tax rate, not the average tax rate.

I discussed the importance of marginal tax rates in 2016, pointing out that Cam Newton of the Carolina Panthers was going to lose the Super Bowl (from a financial perspective) because the additional tax he was going to pay was going to exceed the additional income he would earn. In other words, his marginal tax rate was more than 100 percent.

Mon Dieu!

But I also included an example that’s more relevant to the rest of us, looking at our aforementioned hypothetical taxpayer with a 20 percent average tax rate on annual earnings of $50,000. I asked about incentives for this taxpayer to earn more money if the marginal tax rate on additional income was 0 percent, 20 percent, or 100 percent.

Needless to say, as shown in this expanded illustration, the incentive to earn $51,000 will be nonexistent if all of the additional $1,000 goes to government.

That’s why “supply-side economics” is focused on marginal tax rates. If we want more productive behavior, we want the lowest-possible marginal tax rates so people have the greatest-possible incentive to generate more prosperity.

Here’s a very short video primer on this issue.

One very important implication of this insight is that not all tax cuts (or tax increases) are created equal. For instance, as I explained in a three-part series (here, here, and here), there will be very little change in incentives for productive activity if the government gives you a tax credit because you have kids.

But if the government reduces the top tax rate or lowers the tax bias against saving and investment, the incentive for additional productive behavior will be significant.

And this helps to explain why the country enjoyed such positive results from the supply-side changes to tax policy in the 1920s, 1960s, and 1980s.

Let’s close with some good news (at least relatively speaking) for American readers. Compared to other industrialized countries, top marginal tax rates in the United States are not overly punitive.

Admittedly, this is damning with faint praise. Our tax system is very unfriendly if you compare it to Monaco, Hong Kong, or Bermuda.

But at least we’re not France, where there’s a strong argument to be made that the national sport is taxation rather than soccer.

P.S. I’m not saying tax preferences for kids are wrong. But I am saying they’re not pro-growth.

P.P.S. I mentioned above that Cam Newton – based on his personal finances – lost the Super Bowl even before the opening kickoff. Well, there’s scholarly evidence that teams in high-tax states actually win fewer games.

P.P.P.S. Today’s analysis focuses on the individual income tax, but this analysis also applies to corporate taxation. A company with clever lawyers and accountants may have the ability to lower its average tax rate, but the marginal tax rate is what drives the incentive to earn more income. Which is why reducing the federal corporate rate from 35 percent to 21 percent was the best part of last year’s tax bill.

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One of the core principles of economics is that prices are determined by supply and demand. That includes the price of labor – i.e., the wages received by workers.

Another core principle is that taxes create distortions by reducing demand and supply. Which is why it’s not a good idea to impose high tax rates on behaviors that contribute to prosperity, such as work, saving, investment, and entrepreneurship.

That’s the theory. Now let’s consider some real-world implications of taxes on work.

Here are some excerpts from new research by the European Central Bank.

Several reforms can be enacted to reduce the unemployment rate in the euro area. Among them is a permanent reduction in the labour tax. Typically, a decrease in labour taxes reduces labour costs to employers and increases the net take-home pay of employees, positively impacting both labour demand and labour supply. Reducing taxes on labour can contribute to increase employment and activity rates in the EA, by increasing incentives to hire, to look for, and take up, work. …In this paper we contribute to the debate on those issues by evaluating the macroeconomic effects of a fiscal reform in the EA countries.

The study look at what happens with employment-related taxes are lowered at either the employer level or the employee level.

Permanently reducing labour tax rates paid by Home firms would have stimulating effects on economic activity and employment, and would permanently reduce the unemployment rate. The same is true when tax rates paid by Home households are reduced.

Here are some of the specific estimates of the positive impact of lower labor taxes at the firm level.

The tax rate is reduced by almost 2 p.p. (trough level). The reduction of labour taxes paid by firms reduces the gross wage bill of firms and hence increases the value of having a worker. Workers are able to obtain part of the increase in firms’ surplus in the bargaining process, which results in a real wage increase. Nevertheless, the wage increase is not sufficient to undo the increase in the value of having a worker for firms, which leads to an increase in labour demand through vacancy posting. The number of matches increases as well and, consistently, the probability of finding a job and that of filling a vacancy increases and decreases, respectively. Employment increases (and unemployment rate decreases) by roughly 0.3 p.p. after two years and 0.4 p.p. in the medium and in the long run, respectively. …Home GDP increases by 0.5% after two years. Both consumption and investment increase. Consumption increases because of households’ larger permanent income, associated with the increase in employment, hours and production. Investment increases because firms augment physical capital to accompany the rising employment.

I’ve combined some of the key results from Figures 3 and 4, all of which show the benefits over time of lower tax rates on work (the horizontal axis is quarters, so 20 quarters equals five years).

And here are the specific estimates of the good outcomes when labor tax are reduced at the household level.

Qualitatively, results are similarly expansionary as those obtained when reducing labour taxes paid by firms. Hours worked, employment, matches, and the probability of finding a job increase, while the probability of filling a vacancy decreases. …hours worked now increase by 0.4% (0.3% in the previous simulation), employment by almost 0.5% (0.35% in the previous simulation), while the unemployment rate falls by almost 0.5 p.p. (0.4 p.p. in the previous simulation). …Home GDP increases by around 0.7% after two years.

Once again, let’s look at some charts showing the benefits over time of lower tax rates on workers.

Interestingly, it appears that there are slightly better outcomes if labor taxes are reduced for workers rather than employers, but the wage numbers are better if the tax cuts take place at the business level.

I’ll take either approach, for what it’s worth.

Let’s close with one additional excerpt. The study incorporated the impact of government employment, which can have a very distorting effect on private employment given the excessive size of the bureaucracy and above-market compensation for bureaucrats.

…we allow for public sector employment and for the possibility of directed search between the private and public sector labour market… In fact, a proper assessment of the impact of the labour market reforms on private-sector employment should take into account that a common characteristic of the EA labour market is the important share of the public employment in total employment, which is, according to OECD (2015), around 20% in France, 15% in Spain, Italy and Portugal, and 13% in Germany. Thus, this component is important to understand the labour market dynamics in the EA, given also that, during a crisis period, public and private labour markets tend to be more inter-related (when the unemployment rate is high, the number of applicants to the public sector is larger).

P.S. I’m periodically asked whether I’m exaggerating when I assert that something (such as taxes distorting the supply and demand for labor) is a “core principle” in economics. But I don’t think left-leaning economists (and there are plenty) would disagree about taxes impacting supply and demand. But they presumably would quibble about the “elasticity” of supply and demand curves (in other words, how sensitive are people to changes in tax rates). Moreover, they surely would claim in some instances that any “deadweight loss” would be offset by supposed economic benefits of government spending (and pro-market people acknowledge that’s possible, at least when government is small). And, when push comes to shove, some folks on the left would openly argue that it’s okay to have less prosperity if there’s more equality.

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I’ve written dozens of columns about the Laffer Curve and its implications.

My favorite may be the one that pointed out why it generally is misguided to raise tax rates even if the government would collect more revenue (i.e., don’t give politicians $1 if it means reducing the private economy by $5).

And I’m always reminding people that the goal is to maximize growth rather than revenue.

I’ve even written about how the Laffer Curve relates to issues as diverse as sex and ISIS.

But I haven’t paid much attention to the history of the issue. Now, thanks to some great research from Nima Sanandaji, we can investigate that topic.

…the Laffer Curve has been used by supporters of low taxes around the world to reinforce their ideas. …it has helped to inspire a downward shift in taxation. Ronald Reagan’s administration introduced massive changes, which dropped the marginal tax rate to 28 percent. …even the proponents of high tax policy are aware of Laffer’s warnings: there is a limit to how high taxes can be raised.

All that’s true.

Reagan’s lower tax rates did produce a windfall of tax revenue from the rich.

And even folks on the left admit that the revenue-maximizing tax rate is below 100 percent, so they acknowledge the Laffer Curve is real.

But what many people don’t know is that the concept of the Laffer Curve existed long before Art drew his famous curve on a napkin.

Nima points to the example of Ibn Khaldun.

…Laffer’s theory was far from new. …Laffer has himself explained that he didn’t invent the curve, but took it from Ibn Khaldun, a 14th-century Muslim, North African philosopher. …Born in 14th-century Tunisia, Khaldun was a prominent scholar and one of the founders of economics and social sciences. Khaldun believed that a just government should only, in accordance with Islamic law, impose low taxes. …However, rulers tend to increase the tax to benefit themselves. High taxes hurt commerce and trade. When tax rates are raised to pay for a bloated government, it will finally cause the tax base to shrink so much that the government cannot meet its obligations. …at this point the state would often implode under its own weight, leading to a period of chaos and the rise of a new state.

Here’s Khaldun’s most famous statement on tax rates and tax revenue.

By the way, there were plenty of people between Khaldun and Laffer who understood why punitive tax rates are foolish, including Alexander Hamilton and John Maynard Keynes(!).

P.S. Perhaps because they’re exposed to the real-world impact, America’s CPAs also understand the Laffer Curve is very real.

P.P.S. Nima has just written a fascinating new book, The Birthplace of Capitalism – The Middle East, which can be ordered here.

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Last November, I wrote about the lessons we should learn from tax policy in the 1950s and concluded that very high tax rates impose a very high price.

About six months before that, I shared lessons about tax policy in the 1980s and pointed out that Reaganomics was a recipe for prosperity.

Now let’s take a look at another decade.

Amity Shlaes, writing for the City Journal, discusses the battle between advocates of growth and the equality-über-alles crowd.

…progressives have their metrics wrong and their story backward. The geeky Gini metric fails to capture the American economic dynamic: in our country, innovative bursts lead to great wealth, which then moves to the rest of the population. Equality campaigns don’t lead automatically to prosperity; instead, prosperity leads to a higher standard of living and, eventually, in democracies, to greater equality. The late Simon Kuznets, who posited that societies that grow economically eventually become more equal, was right: growth cannot be assumed. Prioritizing equality over markets and growth hurts markets and growth and, most important, the low earners for whom social-justice advocates claim to fight.

Amity analyzes four important decades in the 20th century, including the 1930s, 1960s, and 1970s.

Her entire article is worth reading, but I want to focus on what she wrote about the 1920s. Especially the part about tax policy.

She starts with a description of the grim situation that President Harding and Vice President Coolidge inherited.

…the early 1920s experienced a significant recession. At the end of World War I, the top income-tax rate stood at 77 percent. …in autumn 1920, two years after the armistice, the top rate was still high, at 73 percent. …The high tax rates, designed to corral the resources of the rich, failed to achieve their purpose. In 1916, 206 families or individuals filed returns reporting income of $1 million or more; the next year, 1917, when Wilson’s higher rates applied, only 141 families reported income of $1 million. By 1921, just 21 families reported to the Treasury that they had earned more than a million.

Wow. Sort of the opposite of what happened in the 1980s, when lower rates resulted in more rich people and lots more taxable income.

But I’m digressing. Let’s look at what happened starting in 1921.

Against this tide, Harding and Coolidge made their choice: markets first. Harding tapped the toughest free marketeer on the public landscape, Mellon himself, to head the Treasury. …The Treasury secretary suggested…a lower rate, perhaps 25 percent, might foster more business activity, and so generate more revenue for federal coffers. …Harding and Mellon got the top rate down to 58 percent. When Harding died suddenly in 1923, Coolidge promised to “bend all my energies” to pushing taxes down further. …After winning election in his own right in 1924, Coolidge joined Mellon, and Congress, in yet another tax fight, eventually prevailing and cutting the top rate to the target 25 percent.

And how did this work?

…the tax cuts worked—the government did draw more revenue than predicted, as business, relieved, revived. The rich earned more than the rest—the Gini coefficient rose—but when it came to tax payments, something interesting happened. The Statistics of Income, the Treasury’s database, showed that the rich now paid a greater share of all taxes. Tax cuts for the rich made the rich pay taxes.

To elaborate, let’s cite one of my favorite people. Here are a couple of charts from a study I wrote for the Heritage Foundation back in 1996.

The first one shows that the rich sent more money to Washington when tax rates were reduced and also paid a larger share of the tax burden.

And here’s a look at the second chart, which illustrates how overall revenues increased (red line) as the top tax rate fell (blue).

So why did revenues climb after tax rates were reduced?

Because the private economy prospered. Here are some excerpts about economic performance in the 1920s from a very thorough 1982 report from the Joint Economic Committee.

Economic conditions rapidly improved after the act became law, lifting the United States out of the severe 1920-21 recession. Between 1921 and 1922, real GNP (measured in 1958 dollars) jumped 15.8 percent, from $127.8 billion to $148 billion, while personal savings rose from $1.59 billion to $5.40 -billion (from 2.6 percent to 8.9 percent of disposable personal income). Unemployment declined significantly, commerce and the construction industry boomed, and railroad traffic recovered. Stock prices and new issues increased, with prices up over 20 percent by year-end 1922.8 The Federal Reserve Board’s index of manufacturing production (series P-13-17) expanded 25 percent. …This trend was sustained through much of 1923, with a 12.1 percent boost in GNP to $165.9 billion. Personal savings increased to $7.7 billion (11 percent of disposable income)… Between 1924 ‘and 1925 real GNP grew 8.4 percent, from $165.5 billion to $179.4 billion. In this same period the amount of personal savings rose from an already impressive $6.77 billion to about $8.11 billion (from 9.5 percent to 11 percent of personal disposable income). The unemployment rated dropped 27.3 percents interest rates fell, and railroad traffic moved at near record levels. From June 1924 when the act became law to the end of that year the stock price index jumped almost 19 percent. This index increased another 23 percent between year-end 1924 and year-end 1925, while the amount of non-financial stock issues leapt 100 percent in the same period. …From 1925 to 1926 real GNP grew from $179.4 billion to $190 billion. The index of output per man-hour increased and the unemployment rate fell over 50 percent, from 4.0 percent to 1.9 percent. The Federal Reserve Board’s index of manufacturing production again rose, and stock prices of nonfinancial issues increased about 5 percent.

Now for some caveats.

I’ve pointed out many times that taxes are just one of many policies that impact economic performance.

It’s quite likely that some of the good news in the 1920s was the result of other factors, such as spending discipline under both Harding and Coolidge.

And it’s also possible that some of the growth was illusory since there was a bubble in the latter part of the decade. And everything went to hell in a hand basket, of course, once Hoover took over and radically expanded the size and scope of government.

But all the caveats in the world don’t change the fact that Americans – both rich and poor – immensely benefited when punitive tax rates were slashed.

P.S. Since Ms. Shlaes is Chairman of the Calvin Coolidge Presidential Foundation, I suggest you click here and here to learn more about the 20th century’s best or second-best President.

P.P.S. I assume I don’t need to identify Coolidge’s rival for the top spot.

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Adopting tax reform (even a watered-down version of tax reform) is not easy.

  • Some critics say it will deprive the federal government of too much money (a strange argument since it will be a net tax increase starting in 2027).
  • Some critics say it will make it more difficult for state and local governments to raise tax rates (they’re right, but that’s a selling point for reform).
  • Some critics say it will make debt less attractive for companies compared to equity (they’re right, though that’s another selling point for reform).
  • Some critics say it will cause capital to shift from residential real estate to business investment (they’re right, but that’s a good thing for the economy).

Now there’s a new obstacle to tax reform. Senator Marco Rubio says he wants some additional tax relief for working families. And he’s willing to impose a higher corporate tax rate to make the numbers work.

That proposal was not warmly received by his GOP colleagues since the 20-percent corporate rate was perceived as their biggest achievement.

But now Republicans are contemplating a 21-percent corporate rate so they have wiggle room to lower the top personal tax rate to 37 percent. Which prompted Senator Rubio to issue a sarcastic tweet about the priorities of his colleagues.

Since tax reform is partly a political exercise, with politicians allocating benefits to various groups of supporters, there’s nothing inherently accurate or inaccurate about Senator Rubio’s observation.

But since I inhabit the wonky world of public finance economics, I want to explain today that there are some adverse consequences to Rubio’s preferred approach.

Simply stated, not all tax cuts are created equal. If the goal is faster economic growth, lawmakers should concentrate on “supply-side” reforms, such as reducing marginal tax rates on work, saving, investment, and entrepreneurship (in which case, it’s a judgement call on whether it’s best to lower the corporate tax rate or the personal tax rate).

By contrast, family-oriented tax relief (a $500 lower burden for each child in a household, for instance) is much less likely to impact incentives to engage in productive behavior.

Most supporters of family tax relief would agree with this economic analysis. But they would say economic growth is not the only goal of tax reform. They would say that it’s also important to make sure various groups get something from the process. So if big businesses are getting a lower corporate rate, small businesses are getting tax relief, and investors are getting less double taxation, isn’t it reasonable to give families a tax cut as well?

As a political matter, the answer is yes.

But here’s my modest contribution to this debate. And I’m going to cite one of my favorite people, myself! Here’s an excerpt from a Wall Street Journal column back in 2014.

The most commonly cited reason for family-based tax relief is to raise take-home pay. That’s a noble goal, but it overlooks the fact that there are two ways to raise after-tax incomes. Child-based tax cuts are an effective way of giving targeted relief to families with children… The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income. … long-run growth will average only 2.3% over the next 75 years. If good tax policy simply raised annual growth to 2.5%, it would mean about $4,500 of additional income for the average household within 25 years. This is why the right kind of tax policy is so important.

Now let’s put this in visual form.

Let’s imagine a working family with a modest income. What’s best for them, a $1,000 tax cut because they have a couple of kids or some supply-side tax policy that produces faster growth?

In the short run, compared to the option of doing nothing (silver line), both types of tax reform benefit this hypothetical family with $25,000 of income in 2017.

But the family tax relief (blue line) is better for their household budget than supply-side tax cuts (orange line).

But what if we look at a longer period of time?

Here’s the same data, but extrapolated for 50 years. And since there’s universal agreement that the status quo is not good for our hypothetical family, let’s simply focus on the difference between family tax relief (again, blue line) and supply-side tax cuts (orange line).

And what we find is that the family actually has more income with supply-side reform starting in 2026 and the gap gets larger with each subsequent year. In the long run, the family is much better off with supply-side tax policies.

To be sure, I’ve provided an artificial example. If you assume growth only increases to 2.4 percent rather than 2.5 percent, the numbers are less impressive. Moreover, what if the additional growth only lasts for a period of time and then reverts back to 2.3 percent?

And keep in mind that money in the future is not as valuable as money today, so the net benefit of picking supply-side tax cuts would not be as large using “present value” calculations.

Last but not least, the biggest caveat is that these two charts are based on the example in my Wall Street Journal column and are not a comparison of the different growth rates that might result from a 20-percent corporate tax rate compared to a 21-percent rate (even a wild-eyed supply-side economist wouldn’t project that much additional growth from a one-percentage-point difference in tax rates).

In other words, I’m not trying to argue that a supply-side tax cut is always the answer. Heck, even supply-side reform plans such as the flat tax include very generous family-based allowances, so there’s a consensus that taxpayers should be able to protect some income from tax and that those protections should be based on family size.

Instead, the point of this column is simply to explain that there’s a tradeoff. When politicians devote more money to family tax relief and less money to supply-side tax cuts, that will reduce the pro-growth impact of a tax plan. And depending on the level of family tax relief and the amount of foregone growth, it’s quite possible that working families will be better off with supply-side reforms.

P.S. A separate problem with Senator Rubio’s approach is that he wants his family tax relief to be “refundable,” which is a technical term for a provision that gives a tax cut to people who don’t pay tax. Needless to say, it’s impossible to give a tax cut to someone who isn’t paying tax. The real story is that “refundable tax cuts” are actually government spending. But instead of having a program where people sign up for government checks, the spending is laundered through the tax code.

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As part of yesterday’s column about the comparatively tiny – and temporary – tax cut in the Republican tax reform plan, I quoted a leftist columnist for US News & World Report, who argued that there should be a big tax increase (including a big tax hike on middle-income taxpayers) and that such a tax hike would not hurt the economy.

Today, I want to address the latter argument about taxes and economic growth. When this topic arises, I normally cite both public-finance theory and empirical research to make the case that taxes do impact economic performance, and I try to always stress that not all taxes are created equal.

And if the focus is corporate taxation, I usually share my primer on the issue, and then link to research from Australia, Canada, Germany, and the United Kingdom.

But maybe it will be more persuasive to look at some new academic evidence from a study on U.S. corporate taxes by Professor Eric Ohrn (forthcoming in the American Economic Journal).

If you don’t want to dwell on the details, the paper’s abstract tells you the highlights. Simply stated, a lower corporate rate translates into more investment and less debt.

I exploit quasi-experimental variation created by the Domestic Production Activities Deduction, a corporate tax expenditure created in 2005. A one percentage point reduction in tax rates increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of sales, and decreases debt by 5.3 percent of total assets. These estimates suggest that lower corporate tax rates and faster accelerated depreciation each stimulate a similar increase in investment, per dollar in lost revenue.

But hopefully there will be interest in some of the details from the study.

Here’s the problem Professor Ohrn identified.

…relatively little empirical work has been able to directly estimate the effects of a reduction in the corporate income tax rate on business activity. This study provides new evidence on these effects.

His evidence is based on the fact lawmakers created a lower tax rate for America-based manufacturing (a.k.a., the domestic production activities deduction, or DPAD).

In 2005, when the DPAD was implemented, firms could deduct 3 percent of manufacturing income. This rate was scaled to 6 percent in 2007 and 9 percent in 2010, where it remains today. As a result of the policy, after 2010, firms that derive all of their income from domestic manufacturing activities and face the top statutory corporate income tax rate have a 3.15 (= 0.09 × 35 percent) percentage point lower effective tax rate than firms with no domestic manufacturing activities. …I use data provided by the IRS Statistics of Income (SOI) Division. The SOI publishes the aggregate annual dollar values of the DPAD and Net Taxable Income for corporations in 75 unique industries and all businesses in 12 asset-classes (firm size bins).

And what did he find as he looked at the difference between firms with lower tax rates and higher tax rates?

It turns out that even modest differences in tax rates can have a big impact.

I find that the DPAD has a large effect on corporate behavior. A one percentage point reduction in the effective corporate income tax rate via the DPAD increases investment by 4.7 percent of installed capital, increases payouts by 0.3 percent of revenues, and decreases debt usage by 5.3 percent of total assets. …corporations respond strongly to the DPAD, and corporate income tax rate cuts more generally, by increasing investment and payouts and decreasing debt usage. The average firm does not report more taxable income per dollar of asset, suggesting that any increases in revenue generated by corporate tax rate reductions are the product of real effects such as investment but not decreased avoidance activity.

Here are a couple of charts from the study. The dark blue line represents companies with lower tax rates and the dashed line represents the ones with higher tax rates.

And since it’s good to have more investment and good to have less debt, both these findings re very positive.

Interestingly, the benefits of fixing depreciation laws (by moving in the direction of expensing) are quite similar to the benefits of lowering the corporate tax rates.

…a dollar spent by the government stimulates virtually the same amount of investment whether it is used to reduce corporate tax rates or accelerate depreciation expenses.

I hate to digress, but I can’t resist pointing out that I’m irked by the language about “a dollar spent by the government.” Professor Ohrn certainly seems to be a rigorous and capable economist, but he has a bit of a moral blind spot. If the federal government adopts a policy that allows a business to keep more of the money it earns, that is not “a dollar spent” by government.

Unless you have the bizarre mindset of some statists who think all output belongs to the state.

Anyhow, back to regularly scheduled programming.

We’re now at a critical point in the battle for tax reform. The House passed its version and now the Senate has passed its version. The good news is that there’s strong agreement on Capitol Hill to slash the corporate tax rate.

This latest study underscores why that reform will boost investment. And remember, when investment increases, that translates into higher wages for workers.

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In my decades of trying to educate policy makers about the downsides of class-warfare tax policy, I periodically get hit with the argument that high tax rates don’t matter since America enjoyed a golden period of prosperity in the 1950s and early 1960s when the top tax rate was more than 90 percent.

Here’s an example from Politico of what I’m talking about.

Well into the 1950s, the top marginal tax rate was above 90%. …both real GDP and real per capita GDP were growing more than twice as fast in the 1950s as in the 2000s.

This comparison grates on me in part because both Bush and Obama imposed bad policy, so it’s no surprise that the economy did not grow very fast when they were in office.

But I also don’t like the comparison because the 1950s were not a halcyon era, as Brian Domitrovic explains.

…you may be thinking, “But wait a minute. The 1950s, that was the greatest economic era ever. That’s when everybody had a job. Those jobs were for life. People got to live in suburbia and go on vacation and do all sorts of amazing things. It was post-war prosperity, right?” Actually, all of these things are myths. In the 1950s, the United States suffered four recessions. There was one in 1949, 1953, 1957, 1960 — four recessions in 11 years. The rate of structural unemployment kept going up, all the way up to 8% in the severe recession of 1957-58. …there wasn’t significant economic growth in the 1950s. It only averaged 2.5 percent during the presidency of Dwight D. Eisenhower.

For today’s purposes, though, I want to focus solely on tax policy. And my leftist friends are correct that the United States had a punitive top tax rate in the 1950s.

This chart from the Politico story shows the top tax rate beginning on that dark day in 1913 when the income tax was adopted. It started very low, then jumped dramatically during the horrible presidency of Woodrow Wilson, followed by a big reduction during the wonderful presidency of Calvin Coolidge. Then it jumped again during the awful presidencies of Herbert Hoover and Franklin Roosevelt. The rate stayed high in the 1950s before the Kennedy tax cuts and Reagan tax cuts, which were followed by some less dramatic changes under George H.W. Bush, Bill Clinton, George W. Bush, and Barack Obama.

What do we know about the impact of the high tax rates put in place by Hoover and Roosevelt? We know the 1930s were an awful period for the economy, we know the 1940s were dominated by World War II, and we know the 1950s was a period of tepid growth.

But we also know that high tax rates don’t result in high revenues. I don’t think Hauser’s Law always applies, but it’s definitely worked so far in the United States.

This is because highly productive taxpayers have three ways to minimize and/or eliminate punitive taxes. First, they can simply choose to live a more relaxed life by reducing levels of work, saving, and investment. Second, they can engage in tax evasion. Third, they can practice tax avoidance, which is remarkably simple for people who have control over the timing, level, and composition of their income.

All these factors mean that there’s not a linear relationship between tax rates and tax revenue (a.k.a., the Laffer Curve).

And if you want some evidence on how high tax rates don’t work, Lawrence Lindsey, a former governor at the Federal Reserve, noted that extortionary tax rates are generally symbolic – at least from a revenue-raising perspective – since taxpayers will arrange their financial affairs to avoid the tax.

…if you go back and look at the income tax data from 1960, as a place to start, the top rate was 91 percent. There were eight — eight Americans who paid the 91 percent tax rate.

Interestingly, David Leonhardt of the New York Times inadvertently supported my argument in a recent column that was written to celebrate the era when tax rates were confiscatory.

A half-century ago, a top automobile executive named George Romney — yes, Mitt’s father — turned down several big annual bonuses. He did so, he told his company’s board, because he believed that no executive should make more than $225,000 a year (which translates into almost $2 million today). …Romney didn’t try to make every dollar he could, or anywhere close to it. The same was true among many of his corporate peers.

I gather the author wants us to think that the CEOs of the past were somehow better people than today’s versions.

But it turns out that marginal tax rates played a big role in their decisions.

The old culture of restraint had multiple causes, but one of them was the tax code. When Romney was saying no to bonuses, the top marginal tax rate was 91 percent. Even if he had accepted the bonuses, he would have kept only a sliver of them. The high tax rates, in other words, didn’t affect only the post-tax incomes of the wealthy. The tax code also affected pretax incomes. As the economist Gabriel Zucman says, “It’s not worth it to try to earn $50 million in income when 90 cents out of an extra dollar goes to the I.R.S.”

By the way, Zucman is far from a supply-sider (indeed, he’s co-written with Piketty), yet he’s basically agreeing that marginal tax rates have a huge impact on incentives.

The only difference between the two of us is that he thinks it is a good idea to discourage highly productive people from generating more income and I think it’s a bad idea.

Meanwhile, Leonhardt also acknowledges the fundamental premise of supply-side economics.

For more than 30 years now, the United States has lived with a top tax rate less than half as high as in George Romney’s day. And during those same three-plus decades, the pay of affluent Americans has soared. That’s not a coincidence.

But he goes awry by then assuming (as is the case for many statists) the economy is a fixed pie. I’m not joking. Read for yourself.

..,the most powerful members of organizations have fought to keep more money for themselves. They have usually won that fight, which has left less money for everyone else.

A market economy, however, is not a zero-sum game. It is possible for all income groups to become richer at the same time.

That’s why lower tax rates are a good idea if we want more prosperity – keeping in mind the important caveat that taxation is just one of many policies that impact economic performance.

P.S. Unbelievably, President Franklin Roosevelt actually tried to impose a 100 percent tax rate (and that’s not even the worst thing he advocated).

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