09 August 2010

It Just Finally Dawned On Me

When some economist or other reasonable person says to his friends on the Left, we should lower the highest tax rates, that way we will actually take in more total tax money: they are not actually listening, or if they are, then they are thinking to themselves how can anyone take in more money by lowering the taxes on the rich? Crazy conservatives. And the conservatives point to what happened when the tax rates were lowered in the early 60s and again in the mid 80s and they say Yes, when we lowered the taxes the deficit went up, forgetting that the spending also went up.

They never hear the phrase tax rate, with emphasis on the last word. I'm pretty sure that they think all those whose tax rate went down actually paid a lesser amount in taxes, i.e. 'tax breaks for the rich.' But somebody paid more taxes, probably only a small amount from the increase of people actually working. Most of the increase in the money taken in by the IRS would come from the few people in the highest tax bracket who actually paid more money to the IRS even if the rate was lowered.

An example: $1 million income paid 50% tax= $500,000 to Uncle Sam and $500,000 to your mattress or maybe your IRA, or maybe to the business so it can expand; then rate was lowered to 40%, encouraging the guy to expand his business; and the guy made $2 million and paid in $800,000 to the IRS. Uncle Sam makes $300,000 more than the previous year and the guy makes a total of $1.2 million, some to his mattress and even more into the rest of the economy.

So lowering the tax rate or percentage actually results in more income for the payer and the payee, that is, Uncle Sam. But I suppose if you must 'spread the money around' then having someone making more money than the rest of us is anathema, even if Uncle Sam makes more money too. Is this attitude related to Aesop's fable, the one where a dog prevents the horses from eating the hay in the manger, even though he can't digest it for himself? Or is this a reversal of the old saw about My pain is someone else's gain?

But then why should we try to raise more money for the feds? They will simply spend it and more. Catch 22? At least a variation on that theme.

2 comments:

Chris Rhetts said...

It sounds good in theory. Lowering tax rates provides a business owner with more capital to expand his or her business. That expansion results in more taxable income, which in turn yields more tax revenue, even at the reduced rate of taxation. This has been the Republican mantra for many years.

But, in the real world, is this theory testable? Price Waterhouse Cooper has a graphic of overall venture capital investments from Q1-1995 to Q1-2011, available here:

https://www.pwcmoneytree.com/MTPublic/ns/nav.jsp?page=historical

Note, especially after the Bush tax cuts of 2001, investments actually went DOWN - way down - exactly the OPPOSITE of what you would expect if the lower taxes (on higher income taxpayers) would equal increased capital investment. Note also that the second round of tax cuts in 2003, also designed to spur investment, had virtually no effect on venture capital investments whatsoever.

So, where was the money going? First, real estate appreciation, which had been rising at relatively modest rates up to the year 2001, really began to take off. This indicates investors were pumping huge amounts of cash into real estate. Second, the trade deficit balooned from 376 billion in 2001 to a historic record of an incredible 753 billion in 2006(Figures available here:http://www.census.gov/foreign-trade/statistics/historical/gands.txt).

What this boils down to is that the Bush tax cuts of 2001 and 03 had pretty much the OPPOSITE effect of that which was intended.

Investors on the one hand were able to contribute more capital to the real estate bubble - which in time not only went up in smoke, but also helped bring on a severe recession. This in turn had additional negative consequences for revenue. At the same time, on the other hand, the trade deficit actually doubled in a mere 5 years.

Thus, if the Bush tax cuts had never occurred, the American economy would have actually been better off. And not only that, but there's a good chance we would have seen a budget surplus during each of the Bush years.

Ken & Carol said...

Thanks Chris for the comment. Not only in theory but in practice too. E.g. early 60s and then in the 80s. Of course, dealing with deficits you have to take into account the spending as well as the revenue.

Venture capital: would that capture the guy on main street who hires a couple extra folks? I think that is an important part of the whole deal.

I agree things didn't work out so great with Bush. I guess we need to keep those other factors equal. Hard to do in a relatively free society. Perhaps the current administration will eventually be able to fix this last problem.

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