Thursday, August 09, 2007

The beast eats well

Community columnist Steve Paske thinks taxes are not so bad. Of course, some level of taxation is necessary. But his suggestion that high marginal rates of the past had no impact on economic activity because there were times in the past when the economy is good begs for comment.

Steve's suggestion is that there was a time when we were more heavily taxed, but that's really not true. While top marginal rates were much higher before the Reagan-era tax cuts, they were readily avoided. The tax code was much more complex and had many more exemptions and deductions back then. Thus, as this chart shows, even though marginal rates were much higher in the 60s and 70s, income tax collections were not.

He suggests that someone will not choose to skip medical school because the highest marginal tax rate is 50%, rather than 39%. That's probably so but it misses the point about the impact of high marginal rates on economic activity. That difference may have an impact on how much a doctor works. It may have an impact on whether or not his wife goes to work. Marginal tax rates have an impact at the margin. The fact that lowering marginal rates are often followed by higher revenues demonstrates that.

Of course, this doesn't mean that there cannot be a counterproductive tax reduction. But, all things equal, high rates will tend to reduce the incentive to work and invest. Personally, high marginal rates are about to become less of a problem for me than they have benn in the past, but I have had occasion to work with business people who make and invest lots of money. You may wish they did not have tax rates in mind when they make decisions about what to do with their lives and money, but they do.

Steve suggests that we have "falling bridges" (watch out!) and failing schools because we don't pay enough in taxes. At least he didn't trot out Grover Norquist's desire to "starve the beast", i.e., shrink the size of government by denying it revenues.

News flash: Grover Norquist lost that battle. The size of government has not shrunk. It may not have grown as much as some wanted and the uses of the money it receives may have changed, but if it can no longer keep bridges standing or educate kids, the problem is not the lack of revenue.


Dad29 said...

You touch on this briefly, but the 'tax-driven' decisionmaking often used also produces waste.

Case in point: a businessman decides to build a warehouse and lease it back to his business--a good tax move.

However, when it becomes apparent (5 years later or so) that the warehouse is actually 'excess baggage' to the business' operations, the owner has a problem: the property CAN'T be vacant. Result: business suffers.

Anonymous said...

You make really good points about the marginal impact of tax rates on human behavior. In fact, you ignore one other point that bolsters your position.

The income tax receipts are measured as a percentage of GDP. This might mean, as you suggest, that income tax receipts are stable under differing marginal tax rates. But, it may also mean that, although income tax receipts grew substantially, the economy grew much more substantially. In effect, the receipts as a percentage of GDP will remain stable, though nominal increases in federal receipts occurred.

There are persuasive counterarguments, however.

It is true that when federal expenditures grow slower than the economy as a whole, tax cuts are possible or even desirable. But, tax cuts are not equally desirable in the presence of expenditure increases.

Deficit spending, an inevitable consequence of “cutting and spending,” creates a crowding out effect in the debt market, raises interest rates, and slows economic growth overall. The increases in disposable income, by most economic estimates, can only offset a small percentage of the lag caused by ongoing deficits. Further, this is extremely damaging to highly leveraged industries and investment markets.

And, as we have seen under both parties, the presence of deficits will not necessarily curb spending. For a hamburger today, Congress will gladly pay you Tuesday.

The Laffer curve argument is not well accepted by economists, who have discovered that we are probably on the left hand side of the curve (meaning increases in marginal tax rates will not decrease revenue). For example, the Congressional Budget Office published a paper in 05’ estimating that further tax reductions would ultimately slow macroeconomic growth in the United States. Further, the paper estimated that a mere 28% of revenues lost would be recouped in a decade.

In theory, an economist can solve for a greek symbol that represents the optimal level of taxation. But, empirical work is where rubber meets the road. If econometric models predict significant losses in revenue from decreasing taxes, isn’t it sensible to defer to those estimates over political calculations?

Perhaps the current administration’s reluctance to rely on the best available science explains why the council of economic advisors has been a revolving door.

Anonymous said...

Good points all. The taxation question as I see it, is as simple as could possibly be.
Liberals want higher taxes, and they want Conservatives constituents to pay them.
Then liberals want to spend the ill gotten booty on their constituents.
Liberals will see no reason NOT TO take someone else's money, even if by taxing the so-called RICH, they hurt the very coffers they lust for. Liberals need others money to satisfy the losers that they represent and pander to.

The End.

Anonymous said...

There are many positive externalities that arise from this "ill gotten booty."

In any event, conservatives like to spend their "own" money just as much as liberals do.

Reason Magazine, which has the slogan "free minds and free markets," summed up the facts nicely:

"Total real discretionary outlays increased about 35.8 percent under Bush (FY2001-06) while they increased by 25.2 percent under LBJ (FY1964-69) and 11.9 percent under Reagan (FY1981-86). By contrast, they decreased by 16.5 under Nixon (FY1969-74) and by 8.2 percent under Clinton (FY1993-98). Comparing Bush to his predecessors is instructive. Bush and Reagan both substantially increased defense spending (by 44.5 and 34.8 percent respectively). However, Reagan cut real nondefense discretionary outlays by 11.1 percent while Bush increased them by 27.9 percent. Clinton and Nixon both raised nondefense spending (by 1.9 percent and 23.1 respectively), but they both cut defense spending substantially (by 16.8 and 32.2 percent)."

Rick Esenberg said...

Joe makes some good points and the counterarguments he described correlate well with what I learned in macroeconomics in the late '70s.

I certainly agree that there is a point at which tax reductions will not increase revenue. The Laffer Curve is, after all, a curve.

I also agree that experience is the test of theory, although it seems like it is always hard to do that with economic policy because there are so many confounding factors.

Having said all that, the idea that deficits crowd out private investment and raise interest rates has taken a bit of a empirical hit lately. Like tax reductions leading to more revenue, isn't it more accurate to say that they can, but don't always?

Anonymous said...

I suppose using "can" in my assertion is better than "will."

The fact remains that massive government borrowing will eat investment dollars and drive up interest rates.

Simplistically, it is supply and demand. When demand is increased faster than supply, prices go up. And, the price of money is interest.

Anonymous said...

That is not to say that there isn't a certain amount of astrology in economic prediction.

Anonymous said...

What's interesting about Mr. Paske's opinion is that he likely does not pay very much in income taxes.

It is easy to suggest that we need to raise marginal tax rates if you know that you don't have to pay them. It is easy to suggest this when you do not have to pay for health care and you have a generous pension plan in place.

As a CPA, I can assure you that tax rates play a huge factor in the decisions business people and taxpayers make. For example, the increase in the Section 179 deduction has prompted clients to invest in capital equipment and in turn create jobs.

The reduction in the capital gains tax has caused several taxpayers to liquidate some assets and redeploy them in a way beneficial to the economy.

Anonymous said...

Generally, I would argue that the messenger is less important than the message.