Thanks to George Bush's amazing deficit reduction plan, the budget deficit is now only 1.2% of GDP. If this trend continues, by the time George Bush leaves office, the budget will be within a hair's breath of being balanced. I can only hope that Democrats don't squander this precious legacy of fiscal responsibility.
Just kidding! Not about the budget deficit, I mean, but about the reason for it. The reason the budget deficit has closed is a combination of economic growth and increasing inequality, which has allowed the government to collect more revenue on a smaller base. The rich really are different--they pay higher tax rates.
These are the perils of attributing economic activity to presidential will. Democrats who got angry when they read the first paragraph should note that the budget deficit is closing whether or not George Bush wants it to; broad trends in the economy dominate even large changes in tax rates. Likewise, the fact that Bill Clinton wanted to close the budget deficit doesn't mean he did; in fact, broad changes in the economy were a much more important driver of change.
Yes, one could argue (and Bob Rubin has) that closing the budget deficit a little made for amazing economic growth, thus raising tax revenues and allowing for even more deficit reduction. But the behavior of tax revenues under George W. severely undercuts this story. For reasons we still don't understand, though inequality clearly plays a large part, tax revenues started rising faster than the rate of economic growth under Clinton. This trend has continued under Bush. That--and neither Rubinomics, nor supply side magic--is why tax revenues in both administrations keep delivering huge upside surprises, regardless of whether the administration cut taxes or raised them.
How much does inflation play into this story? Or do you know?
It doesn't. That's why we present it as a percentage of GDP.
If you mean tax brackets, small. Normal tax brackets are indexed, and the AMT is constantly being tinkered with to keep it from scooping up everyone. There are second and third order effects from other taxes, but overall, they'd be minor. More importantly, they haven't changed much since the 1980s . . . and inflation under George Bush has been at (recent) historical lows.
Oh, please. Increasing budget deficits are George Bush's fault. Decreasing budget deficits have nothing to do with any Republican President (although in the 90s they were certainly the result of President Clinton's economic policies). Everybody who accepts reality knows this; aren't you a member of the Reality Based Community?
"That's why we present it as a percentage of GDP."
You're a really bad fake economist, you know that? While that will confirm the whole "inequality" part of your argument, you can't measure "economic growth" as a percentage of GDP.
" inflation under George Bush has been at (recent) historical lows"
No it hasn't. Not cross-border inflation, in any event. Or have you missed the reports about the Euro and the Canadian Dollar kicking the American dollar's ass?
Hell, they just gave bigfirm lawyers a massive pay raise after only a few years because of inflation.
""That's why we present it as a percentage of GDP."
You're a really bad fake economist, you know that? While that will confirm the whole "inequality" part of your argument, you can't measure "economic growth" as a percentage of GDP."
Being a real economist, I can assure you sir that we do measure growth as a percentage of GDP. Sometimes we take out inflation, sometimes we don't. There really is no other way to measure it.
""That's why we present it as a percentage of GDP."
You're a really bad fake economist, you know that? While that will confirm the whole "inequality" part of your argument, you can't measure "economic growth" as a percentage of GDP."
Being a real economist, I can assure you sir that we do measure growth as a percentage of GDP. Sometimes we take out inflation, sometimes we don't. There really is no other way to measure it.
Gosh. I guess the increased rate of growth that the tax cuts produced has nothing to do with all this.
When we first had the tax cuts in 2001, all the chin-pullers gloomed about how they would inexorably produce gigantic deficits and undo all the serious work of the wonderful (Greatest Economy Of All Time! [tm]) Clinton Administration. Of course there has also been vast amounts of increased spending, on the war and other, perhaps less desirable things. And of course there was the post-dot-com, post-9/11 recession to contend with.
Yet despite all this, the deficit has been lower than predicted every year since then. But that has nothing to do with tax cuts: nope, nuthin' ta see here, move along!
Why is it that tax cuts are blamed when revenues go down, but not praised when (as--inevitably--they presently do) go up?
I guess I must be one of those "supply-side absolutists" who are "the teachers' unions of the right".
'Tis easy to dismiss someone when you demonize them first, of course.
Megan McArdle: candidate for the "Strange New Respect" award, 2007 edition.
"Yes, one could argue (and Bob Rubin has) that closing the budget deficit a little made for amazing economic growth,"
Rubin is a clown. Clinton success is an artifact of 2yk and the tech bubble. His 'surplus' was a short term loan from investors paying taxes on profits that soon disappeared. Taxes that had to be paid back after Clinton left office.
Actually Rubin is quite a smart guy but, his refusal to see that the economy had little to do with Rubinomics make him a clown.
Megan: What would you predict for Y if I said in 2000 that the Bush administration will boost G, slash T, and lower R? Just wondering. Because it doesn't look too good for the longterm to me.
"Being a real economist, I can assure you sir that we do measure growth as a percentage of GDP. Sometimes we take out inflation, sometimes we don't. There really is no other way to measure it."
Stan, while this is obviously true, it does not fit her conclusion that "and this therefore obliviates the need to consider the effect of inflation."
I realize in retrospect that I didn't make that point clear - you obviously can measure economic growth as a percentage of GDP, but doing so does not automatically control for inflation. For that I apologize - but I think you understood what I was trying to get to, by your caveat.
So, Milton Friedman and Robert Eisner were wrong in their accounting methods?
Counting interest payments on debt as a federal outlay while not counting the amount by which the outstanding debt has been reduced by increasing the money supply is falacious?
Could it be that the George Bush tax cuts have just reduced the "REAL SURPLUSES" from what they would otherwise be?
I have a question for Ms. McArdle: if the decrease in the budget deficit is, as you say, partly the result of rising inequality, what effect did the upper bracket tax cuts enacted in 2001 have on this?
If these tax cuts do expire on schedule, will this lead to an increase in revenue, or an increase in tax sheltering? What's the historical record on this? Further, if the expiration of the cuts would lead to closing the budget deficit, wouldn't that create cover for congress to let them expire?
heh, just in time for the next prez to take credit for balalncing the budget eh? what a gift...
On second thought, I withdraw my question. Lazy, lazy, lazy.
Justin, stating tax revenues as a percentage of GDP is what controls for inflation. When inflation grows, tax revenues grow, but GDP also grows; the effects cancel each other out. 1.3/130=1/100
There are some second order effects from bracket creep, but they'd be small, and more to the point, they would make Bush look better compared to earlier administrations, not worse.
"The rich really are different--they pay higher tax rates"
Their income tax rates may be higher but the percent of income they pay to taxes are lower.
This tax debate is so false. It hides the real truth. I've been rich and I've been poor and I paid a lot less taxes when I was rich. The name of the game when your wealthy is write-off, write-off, write-off.
The payroll taxes, utility taxes, sales taxes, property taxes and income taxes make up a very large percent of the income of the poor and middle class. A much larger percent of income than the rich pay. I would love to hear the real truth someday from those who are in power.
Justin,
I think you've misread Megan's argument.
She is pointing out the relatively small size of the deficit in relation to GDP (Economic growth may be a cause, but we are not referring to it directly.)
The budget deficit is 1.6% of GDP. If we convert this to year 2000 dollars, then the budget deficit miraculously becomes... 1.6% of GDP.
Inflation doesn't matter for this calculation because both GDP and the budget deficit are always calculated in dollars (or yen, or whatever) from the same year. While you are correct that inflation is an important consideration when comparing economic data from different time points, you need to remember that it is as important to know when not to apply a rule, as to know when to apply it.
Also, double check your work before rushing out the insults. You'll look a lot less foolish.
Or just read Megan's response. It says the same thing, only faster and shorter.
Why is it that tax cuts are blamed when revenues go down, but not praised when (as--inevitably--they presently do) go up? - Hecht
Because the tax cuts made the revenues go down, and revenues would be higher without the tax cuts. No serious economist disputes this.
In the last year of the Clinton presidency, the deficit was not 1.2% of GDP. It was not even 0% of GDP. There was a surplus. Had there been no Bush tax cuts, we would currently be running a perfectly vast budget surplus, which might enable us to do things like, oh, I don't know, pay for the future deficits in Social Security and Medicare; or we could spend it down by investing tens of billions of dollars a year in non-carbon energy sources.
As you see, Megan, you can't give the slavering Laffer Curve element of the GOP even a centimeter of leash. They take it and start running into economic fantasyland.
I've been rich and I've been poor and I paid a lot less taxes when I had three kids and a house.
That's just me, though.
"She is pointing out the relatively small size of the deficit in relation to GDP (Economic growth may be a cause, but we are not referring to it directly.)"
No, she is referring to it directly. And that what makes the inflation question a question. She cited "economic growth" as a reason for a smaller deficit - I queried how much of that economic growth is due to inflation relative to other periods of time.
I understand Megan's point - its not relevant. As Megan correctly notes, the effective tax rate will be some percentage of GDP for the most part, once you deal with the bracket situation (whose main driver is inequality, as I agree). Spending, however, remains relatively static. So you end up with a formula of GDP*x - k = Y for the absolute size of the budget deficit and Y/GDP for the relation. But D(GDP) has two components - actual gains in the GDP, which create value, and inflationary gains, which do not create value. That's where the heart of my query lies.
What Megan and you forgot was the "- k" part of the equation (bad fake economists!). We aren't MEASURING tax revenue, we're measuring DEFICITS.
Justin, I'm a liberal. You need to read an economics textbook. You're not making sense here.
Oh, wait. Just read your explanation. Maybe you are.
Brooksfoe, let me put it in really simple terms.
We could eliminate the deficit by increasing inflation to infinity, even with 0 economic growth and no tax rate changes? Why? Because although GDP and tax revenue will grow at the same pace, our exenditures - our obligations - will not. And so while inflation-adjusted GDP will stay static, our budget deficit will go to 0 (indeed, turn to a surplus).
And note that the same thing would occur if inequality also stayed static. So inflation can effect Y/GDP (when GDP is not adjusted for inflation) even absent any changes in the 2 drivers that Megan identifies. So to claim that it is statistically irrelevant, to put it mildly, is nonsense.
Justin, that doesn't make any sense. When the price level goes up, the things we buy go up too; and benefits are indexed to the same inflation measure we use to deflate GDP. Obviously, the increases will not match 100% perfectly, but it could as easily go the other way, with the increase in the prices of things the government buys exceeding the growth in tax revenues. Percentage of GDP is the standard, bipartisan agreed on way to consider deficits.
If all your (sub)argument is based on is your assertion that budget expenditures are closely tied to inflation and will go up or down by the inflatiary amount, we're just going to have to agree to disagree - what you are saying is an empirical claim that I think is obviously wrong but have neither the time nor the ability to prove.
Inflation doesn't matter for this calculation because both GDP and the budget deficit are always calculated in dollars (or yen, or whatever) from the same year.
No, inflation does matter. If inflation were Zero the nominal interest payments on Government debt would be real interest payments.
Yet, the GDP would not have grown by the rate of inflation.
Therefore, the deficit would be larger as percentage of GDP. This implies that people who lent the government money would actually get something for doing so. You may even interpret this hypothetical situation as a government program to reward people for having lent the government money.
Keep in mind that if inflation remained at Zero, the Government would be issuing T-Bills with Zero interest rates. Over time this will reduce what it calls outlays for debt expense for budget purposes.
As Megan correctly notes, the effective tax rate will be some percentage of GDP for the most part, once you deal with the bracket situation (whose main driver is inequality, as I agree). Spending, however, remains relatively static.
Spending remains "relatively static"? What does "relatively" mean? Spending always goes up, often by much more than the rate of inflation.
The payroll taxes, utility taxes, sales taxes, property taxes and income taxes make up a very large percent of the income of the poor and middle class. A much larger percent of income than the rich pay.
The Rich have a habit of paying property taxes and utility taxes on larger and more numerous properties, though. The fact that this is still a smaller portion of their income as compared to Middle-Class Man is a function of being, y'know, rich.
OTOH, I have access to an apartment rental, regular payroll, and public roads largely on account of people richer than me, so it's kind of hard to dislike them -- even if the mutual fund that owns the apartment complex somewhere up the chain, is probably controlled by some of the same people who have nearly turned Aspen into one large gated community.
Al,
The delta here isn't over time, but over change in the inflation rate.
While trends in growth and inequality surely affect budget deficits, let us not pretend that tax rates do not matter. I am worried about Megan adopting a sort of nihilistic attitude, as if tax rates and spending rates do not matter at all.
I am not sure if that is any better than supply side fantasies that tax cuts raise revenue.
If tax rates don't matter, why not have them as low as possible? How about an income tax rate of 1% After all, "broad trends in the economy dominate even large changes in tax rates."
The delta here isn't over time, but over change in the inflation rate.
So, is your question "does federal government spending track the inflation rate"? The answer is no - increases in federal government spending regularly exceeds the inflation rate, often by a good margin; only rarely does it increase by less than inflation.
No, Al. Nevermind.
Thts is nonsense. Everyone knows that we are about to go into another Depression thanks to Bush, that soup kitchens, bread lines, and food banks are overwhelmed with the poor who are going hungry due to Bush's tax cuts for the rich. We almost Zimbabwe here.
Well, at least that's would I think if I believed what I read in the NY Times.
We were hit hard on September 11th, the War on Terror has cost a trillion dollars, yet President Bush's sound economic management and tax cuts have brought the economy nearly back to surplus.
Congratulations, Mr. President!
Contrary to what Bob Rubin thinks, the faster economic growth during the 1990's was the result of two one-time events: the initial build-out of the Internet, and businesses and gov't's re-engineering their computer systems for Y2K. Remember Amazon.com stock going to $400/share? These were one-time events that spawned a capital spending boom.
We are now trying to recover from that.
Consider this interesting prospect :
Hillary may tarnish the Clinton 'reputation' of having created the best economy ever.
Clinton created 22m jobs in 8 years, vs. about 8 million for Bush. Of course, this is because of the factors that propelled Clinton's numbers - Baby boomers and the last women that had not yet entered the WF, not entering, have subsided. Hillary, in her first 4-year term, will create Bush-like numbers, not Clinton-like numbers.
Hillary will have a recession in her term unless she extends the Bush tax cuts that will expire at the end of 2010. She has no choice but the extend them. She absolutely cannot raise the cap-gains tax rate.
Bill, through claiming credit for things outside of his control, has inadvertantly set the bar far higher than Hillary can ever hope to achieve. Think about it.
What role do capital gains play. With capital gains rates reduced, I wonder if investors are more likely to sell stock than they might when capital gains are at higher rates. This would increase velocity (is that the right term) of money. Each time there is a transaction, a tax is collected (assuming gains of course).
Mark,
You are right, of course, that inflation would matter if we were accounting for the government's debt as a whole. And I should have been clearer in my definition of terms.
Here the budget deficit is simply the difference between government revenue and government outlays in a given year. In this simplified view, the interest on existing debt is considered an expense just the same as road construction or sinecures for Senators' idiot nephews. We can get away with this sleight of hand because the government pays off the interest each year, so we never get into a situation of compound interest.
As far as Justin's claims go, it's pretty clear that he's misunderstood 1) what was meant by "budget deficit" and also 2) economics. I was trying (and failing, apparently) to make my argument more convincing by keeping things simple.
Now, as you pointed out, inflation will raise the amount of interest the government needs to offer on the bonds it issues this year (compared to your hypothetical 0% inflation), but that will only begin to effect outlays next year, and the effect is, all else equal, negligible: (Math ahead)
2% inflation will adjust the nominal interest rate up by 2% (Actually 2.04%, but 2% is close enough). On a 1.6% budget gap, that amounts to an extra .032% of (this year's) GDP spent on interest over the next year.
This is already quite small, but that added cost is in the next year's dollars. If we adjust for inflation to this year's dollars, that .032% disappears, leaving "real" outlays the same as if inflation were 0%. (Hence the definition of real interest rates) The inflation has, meanwhile, REDUCED the value of government held debt by 2%.
This is grossly simplified, particularly in assuming stable inflation and ignoring secondary effects, but I think it is close enough to our current situation to be illustrative.
I hope that makes sense, and please point out any errors you spot.
Cheers
I'm not a Laffer curve person or, unlike every other commenter, a Nobel prize-winning economist, but it seems strange to say WE KNOW IT'S NOT LAFFER and then say WE DON'T KNOW WHAT ON EARTH IT IS.
My ignorant question: is the difference between the Laffer curve people and Prof Mankiw et al that Laffer says "cut taxes, you'll get it back right away because of powerful effects of those marginal dollars in investors' pockets going back into hugely productive investments!" while Mankiw says "cut taxes, over the long term it will keep people properly incentivized to keep investing and working"?
"Because the tax cuts made the revenues go down, and revenues would be higher without the tax cuts. No serious economist disputes this."
BS - Arthur Laffer sure does dispute it. Simple logic would tell you that if the tax rate was 100% you would have no incentive to work (at least in the above ground economy). Put it another way, to believe you, you have to ignore the fact that supply curves slope upward. Where the bejesus did you "learn" your economics? Cut tax rates and workers take home more pay, and are therefore incentivised to work more, which in the mid to long run grows the economy and raises tax revenues. I realize that dynamic effects are generally covered in upper division and graduate levels, but this one is a no-brainer. How about this for a fact - the percentage of GDP taken in by the Feds is near its all time high. And suggest we need to tax Americans MORE? Yep we need to spend what we take in differently, that's a fact, but no we don't need more money.
One of the reasons that we "don't understand yet" is that tax compliance is much, much better than it was 10 years ago. Congress and the Department of Treasury have aggresively responded to the tax shelters of the 1990s. The result is that fewer people are playing the audit lottery, and instead are computing and paying a more realistic assessment of their taxable income. Of course, plenty of people still cheat today, but far fewer business today than even a few years ago.
The whole Laffer question--which t maximizes tY--is irrelevant. I do not want the government to maximize tY. I would rather have the government maximize Y. Can't everyone agree that maximizing Y requires a lower t? I would prefer still more that the government treat people as ends in themselves, not as sources of revenue.
Cut tax rates and workers take home more pay, and are therefore incentivised to work more, which in the mid to long run grows the economy and raises tax revenues. -- RKV
The sheer number of right-wingers who are willing -- eager, desperate even -- to incant the mantra that you can get something for nothing is really pretty terrifying.
RKV: how many extra hours did you work this year because your top marginal tax rate was 33% rather than 37%? How much extra value-creation would you have foregone if you'd had to give away an extra 4 cents on each of those top-end dollars? How many businessmen at the top end of the salary scale look at a deal and say, "You know, I'd only make $63,000 on that after taxes, so forget it. If it were $67,000, I'd be all over it, but for $63,000 I'd rather go play catch with my daughter." In other words: how much harder are you working, how much more productive are you, now than you were in 2000?
The effects of marginal tax rate cuts at thet curren level on economic growth are insignificant, as every serious economist on either side of the aisle agrees. Every serious economist agrees that federal revenue this year would have been much higher without the Bush tax cuts.
I would rather have the government maximize Y.
First, the government's ability to maximize Y is limited, as one would think any laissez-faire conservative would agree.
Second, no, I do not agree that the government aim should be to maximize Y under all circumstances; there needs to be a reasonable level of equitable distribution of Y. Under the current system, the top 10% of earners have taken the entirety of the US's GDP growth for lo these many years; none has accrued to the bottom 40% of households. I would prefer 5% less growth in total if 5% of that GDP growth had gone to the bottom 40% of Americans.
Third, your line about the government "treating people as people, not as sources of revenue" is hilarious. Next time I'm at the DMV I'll be sure to vent my outrage at the government for daring to issue me a driver's license. "Can't you treat me as a person? Not just as this thing that drives a car???"
"Every serious economist agrees that federal revenue this year would have been much higher without the Bush tax cuts."
What about over the last several years? Don't we owe some credit to the Bush tax cuts for keeping us out of a long and deep recession in the wake of the dot-com bust, the Nasdaq crash, the Enron, Worldcom and other corporate accounting scandals that happened on Clinton's watch but that Bush's Justice Department cleaned up, and 9/11?
Brooksfoe, are you suggesting that incentives don't matter? Does that really make sense to you? How else do you explain why people get so excited about "free sales-tax days"? How much do people save on such days, 8%? Is that a big deal? I hardly pay any attention at all when I see an ad announcing a "10% off sale"....and yet, when we have a "free sales-tax" day, people go nuts! Yes, incentives DO matter. To deny this is to deny a cornerstone of Economics, to say nothing of human nature.
All things being equal, slightly higher tax rates will equal higher tax revenues, but this assumes economic growth. The economy doesn't always grow, sometimes it slides into recessions where it shrinks. Bush's tax policy deserves credit for keeping the economy growing after the series of shocks it experienced in 2000-2001.
Brooksfoe- its fairly obvious that your are defining 'serious economist' as those that agree with you. Your argument is circular. There are plently of highly regarded economists that disagree with you. Whether they are serious or not I leave to you.
This isn't a something for nothing argument. Its a very simple argument- tax rates influence behavior PARTICULARLY for the very wealthy who pay the vast majority of tax revenues. If you don't think the capital gains rate (to pick a subject) enters the decision making process of 'serious' business owners when they contemplate projects, you don't know how things work in the boardroom (actually forget the boardroom the accountants would have this distilled down to a number long before anyone else). On a smaller scale would you sell your house if you lived in it for less than a year and were gonna get stuck with a capital gains hit? Now who is talking about rational decision making and who isnt?
The effects of marginal tax rate cuts at thet curren level on economic growth are insignificant, as every serious economist on either side of the aisle agrees. Every serious economist agrees that federal revenue this year would have been much higher without the Bush tax cuts.
That's a nifty trick, drawing the circle of intellectual respectability so narrowly as to preclude counterargument.
"Such-and-such economist disagrees."
"Well, he's not a serious economist. Just a crank."
I'm going to have to try this out sometime.
Adding to BC's comment, there are an awful lot of people taxed in the highest bracket who are not particularly rich, esepecially in large urban areas where even $200,000 incomes will put you solidly in the upper middle class at best. For folks like that, an increase of even 2-3% will have a real impact on their spending as they will be forced to tighten belts to pay for the increased taxes. Say such a family normally saves $10k from salary to invest in property or stocks. They now know thay will have only $7,000. Multiply this effect by the number of people subject to the higher tax rate who's primary source of income is salary. Although the top marginal rate probably has less effect on the truly super-rich, there is no question that increases in tax rates decrease the funds available for investing. Your hypothetical ignores this reality.
I never can understand how people can believe that marginal incentives (and tax-rates) don't matter. Every decision taken at work looks at IRR and particularly post-tax IRR.
On an individual level. Anyone who makes serious money is involved in every type of tax management and tax-defferal plan available. You have to ask yourself why people use deferral schemes when that leaves them exposed to firm liability; obviously the tax benefits are strong enough to make people take that kind of risk.
Also, even if you were to pretend that people do not respond to incentives and continue to work at the same rate, you are then replacing the spending of individuals by the spending of government.
I hope most people would bet that government spending is very efficient.
But lastly, I don't think we ever had an administration that tried a pure Laffer approach of cutting taxes and spending concurrently. It would be interesting to see what happens...
Excellent post. I wonder how much of the rising inequality in gross income is due to the realization of capital gains and other postponable income because of lower tax rates. If the Democrats succeed in reversing the Bush tax cuts much of this reported income and the apparent inequality it causes simply disappears. Result: less tax revenue, less flexible capital markets, less prosperity.
"Result: less tax revenue, less flexible capital markets, less prosperity."
When it comes to the gold standard of populism- income redistribution, those are features not bugs.
Supply side in essence says that above a certain tax rate there are enough disincentives to work that the State loses tax revenues it otherwise might have collected. It also acknowleges that a tax rate "too low" does lose revenues. Historically this "sweet spot" has been around an 18% tax rate. This is an observed constant: There is no particular reason it shouldn't be 19% or 15% but it works out on average to be around 18% - 18.5% for the total US economy.
Since supply side sprang on the scene in the early 1980s we've never really lowered taxes to this rate. Reagan at one point got down to ~19.5 but it crept steadily back up to as high as ~23.5% under Clinton. The "horrific" Bush tax cuts only trimmed this modestly to ~21.5%. Please note that revenues increased *despite* the lack of a dot-com cash-cow to lean on. Democrats predicted we'd all be living in Hoovervilles by now and the government would be broke. Instead we've had steady if not spectacular growth and ever increasing revenues. Even if you argue that we can't afford an 18.5% tax rate it ain't broke now so why are we trying to "fix" it by raising taxes?
"Inequality"?
You keep using that term like it means something. Going by what O'Neal says just ahead of me, you mean "inequality in gross income."
There has never, going back to troglodytes, been equality in income. Do you mean perhaps "disparity"? And if so, what's the point?
Don't we owe some credit to the Bush tax cuts for keeping us out of a long and deep recession in the wake of the dot-com bust, the Nasdaq crash, the Enron, Worldcom and other corporate accounting scandals that happened on Clinton's watch but that Bush's Justice Department cleaned up, and 9/11? - Juan
No. And your characterization of the Enron and Worldcom scandals is absurd.
How else do you explain why people get so excited about "free sales-tax days"?
For big-ticket durable items which you plan to buy anyway, it makes sense to look for no-tax days. But for the most part, such initiatives are just advertising gimmicks.
I never can understand how people can believe that marginal incentives (and tax-rates) don't matter. - JoshK
Obviously incentives matter. The difference between 33% taxation and 37% taxation on additional income at a high rate of compensation is not a significant (dis)incentive. I defy you to show me one deal that has gone down in the US in the last 6 years that would not have gone down under the income tax rules of 2000, or one extra hour you or anyone else would not have worked if the income tax rules had remained the same, or one item of value you or anyone else would not have created.
Your line about the relative efficiency of individual vs. government spending is ideological cant and cannot be responded to meaningfully in a blog post. Basically, individuals are incapable of purchasing many kinds of public goods. The US suffers from a deficit of these public goods. The government is infinitely more efficient than individuals at purchasing national parks, inspection of imported food and childrens' toys, and so forth.
brooksfoe,
Under the current system, the top 10% of earners have taken the entirety of the US's GDP growth for lo these many years; none has accrued to the bottom 40% of households.
Utter nonsense.
When it comes to the gold standard of populism- income redistribution, those are features not bugs.
Income redistribution, aka, "soaking the rich" is and will always be a futile exercise so long as the "rich" don't print their own money. There are only two ways for this to work:
- Some adventurer finds a mountain of gold under an Incan Pyramid in the Andes and the government taxes it all away from him
- Send out the black helicopters to arrest and imprison all the rich people and seize their property.
The former is only slightly less ridiculous a scenario than the latter. So long as the "rich" earn their money by selling goods and aervices to the other economic classes in a competitive environment, they'll pass along any tax hike plus the cost of accounting to the people who buy from them, ie. you and me. Worse, they'll find ways to milk the system for their own benefit - give a congresscritter $1500, he "earmarks" $50,000 for your company in the next budget. We call those "earmarks" now; in the Good Olde Dayes we called them "bribes"...
brooksfoe, I can tell you from personal experience that I used to be very careful to offset capital gains with capital losses, due to the high tax rates. Today, I just recognize a long-term gain when I think the time is right to sell. I don't worry about the 15% rate, which I consider reasonable.
As to ordinary income, I know older professionals whose decisions to retire or to work fewer hours were affected by Clinton's tax increases. Also, the decision of whether it is worthwhile for the spouse of a high earner to work outside the home is often influenced by tax rates.
These types of decisions occur at the margins affecting a relatively small number of people or transactions, but enough to have a significant economic impact.
OK Brooksfoe, how about this: If the federal and state tax increases (for my home state anyway) currently being discussed are passed, it is highly likely that my wife stops working because the marginal increase in taxes will make a meaningful dent in her net pay, such that her take home pay would no longer justify the cost of child-care, commuting, etc. This results in our having slightly less disposable income, the loss of production for my wife's employer, and a loss of employment for our child-care provider. While not a "deal" that is a real world example of higher taxes having a negative effect on the economy.
_"The difference between 33% taxation and 37% taxation on additional income at a high rate of compensation is not a significant (dis)incentive."_
That is absurd. People live and die every single day on fractions of a percent on their returns. Companies rise and fall. In a multi-trillion dollar economy where millions of decisions are made every day based on FAR less of a swing, how can it not add up to a significant effect?
Let me ask you this- if Pinch Salzburg went to his board of directors one day and said, 'hey, minor issue with last years numbers- but dont worry its only 4 percent' you think no big deal?! The kinds of business we are talking about, 4 percent of billions of dollars turns into real money pretty fast- and that means real jobs for real people.
"if Pinch Salzburg went to his board of directors one day and said, 'hey, minor issue with last years numbers- but dont worry its only 4 percent' you think no big deal?! The kinds of business we are talking about, 4 percent of billions of dollars turns into real money pretty fast- and that means real jobs for real people."
You are conflating a small and large things. 4% of a penny certainly isn't the same thing as a company adding 4% to the bottom line. The point is that increase from 33% to 37% in the top rate will have almost no real impact on economic behaviour other than increasing tax revenue. In terms of practical changes in economic behavour there isn't any - citing anecdotal is less than meaningful.
Brian Despain, do you have any evidence that increasing tax rates results in a proportionate increase in tax revenues, or is that just an assertion? Conversely, there are four past instances when presidents significantly cut marginal tax rates, and all four resulted in booming economies and strong tax receipts: the Coolidge, Kennedy, Reagan and G.W. Bush administrations.
The world is a laboratory, but some prefer ideology to observation.
"You are conflating a small and large things. 4% of a penny certainly isn't the same thing as a company adding 4% to the bottom line. The point is that increase from 33% to 37% in the top rate will have almost no real impact on economic behaviour other than increasing tax revenue. In terms of practical changes in economic behavour there isn't any - citing anecdotal is less than meaningful."
I'm pretty sure that the only people in a 33% to 37% rate are the people making a lot of money, yes? So we aren't talking about 4% of a penny. We're talking about 4% of six figures and up. Isn't the whole argument about whether the rich should be paying more?
So let's hear why 4% of quite a lot of money going to Uncle Sugar instead of your own pocket is something you'd just go "eh" over. Why you wouldn't make different decisions, spend differently, etc. No, really. I'd like to know. And no anecdotes, now...
Just imagine what President Bush could have done with the U.S. economy if he hadn't been forced to spend $460 billion on Iraq.
Yeah but Bush has only been able to reduce the deficit because he's raiding the Social Security Trust Fund.
(OK, I realize that is a lie and in fact a completely nonsensical statement when you know how Social Security works, but you better get used to hearing it because Hillary has started saying it.)
Just imagine what President Bush could have done with the U.S. economy if he hadn't been forced to spend $460 billion on Iraq.
Not much. That's less than 1% of U.S. GDP over the same period.
Ken, I agree. If you take into account the dot.com and telecom busts, the early 2001 recession, 9/11, the wars in Afghanistan and Iraq, Hurricane Katrina, and now the housing bust, the strong performance of the economy and the budget deficit at only half its historic percentage of GDP are really impressive.
None of this seems to take into account the incipient recession and dimunation of "animal spirits' the near simultaneous bursting of the tech bubble and 9/11 could have caused. Bush's tax cuts came, it seems to me, at exactly the right time. There was no recession. Recessions throw deficits out that enter the stratosphere.
I also think that some serious economists believe that a low tax environment over time generates more revenue than a high tax one. The reason is whether people choose to make the next marginal dollar or not.
Forget Iraq, if GWB had determined to veto a few bills and hold spending increases down 1% a year from what they were we'd be in surplus already regardless of Iraq.
If the federal and state tax increases (for my home state anyway) currently being discussed are passed, it is highly likely that my wife stops working because the marginal increase in taxes will make a meaningful dent in her net pay, such that her take home pay would no longer justify the cost of child-care, commuting, etc.
GC, we are clearly not talking about the 4% difference between the 33% and former 37% marginal rates, since that kicks in at $150,000 and I don't think your wife would be giving up a job that pays more than $150,000 because it doesn't pay for the childcare. I'm not sure what increases you are talking about. The 28% rate kicks in at $77,000. How expensive is your childcare and your wife's transportation? I don't think anyone is discussing raising that rate, but assuming for argument's sake that it went up to 30%, that might mean a loss of 2% of your wife's income over $77,000. If she makes $100,000, that would mean a loss of $460 in income. This is going to make the difference for her between working and not working? And I really don't think anyone is discussing hikes in tax brackets under $77,000 a year.
In 2007, the top marginal rate of 35% kicks in at $350,000. Nobody at that rate is about to give up work because it doesn't pay for transit costs.
The whole Laffer question--which t maximizes tY--is irrelevant. I do not want the government to maximize tY. I would rather have the government maximize Y. Can't everyone agree that maximizing Y requires a lower t? I would prefer still more that the government treat people as ends in themselves, not as sources of revenue.
I suspect that I agree with you given the last sentence, and I can sort of understand your desire to write in technical terms to shut us lay-people out of the discussion. But please try and look at this exchange of comments as an educational opportunity and not simply a "gotcha" for other economists.
What the heck is tY?
Please spare me. Bush doesn't get credit for reducing the deficit unless he first takes the blame for creating it. Or did you forget that there was a SURPLUS when he came into office?
t = (average) tax rate
Y = gross national income, or something like that
tY = t times Y = tax collections
I agree, any public official who looks at the people as just a source of revenue for his spending of our money ought to be tarred, feathered, and run out of the country on a rail. And that's just about all of them...
And I think any citizen who refuses to accept that he needs to pay his fair share of taxes in order to safeguard the security and prosperity of the Republic should be tarred, feathered, and run out of the country on a rail. That appears to include you, markm.
brooksfoe, the U.S. has an extremely progressive tax system. In 2005, the top 1% of taxpayers paid almost 40% of individual income taxes, the top 10% paid 70%, and the top 50% paid 97%. So, who do you think may not be paying "his fair share of taxes in order to safeguard the security and prosperity of the Republic"? Are you referring to the bottom half of taxpayers or the top half?
Some things to point out to all the supply-siders arguing with brooksfoe (and please note, while not a supply-sider I consider myself a fiscal conservative):
a) Way back near the beginning of this thread, the argument wasn't about Laffer economics, it was about the falling budget deficit. Megan's central point is that the falling deficit (both now and in the 90's) has much more to do with mammoth trends in the economy than any policy tweaks in spending and taxation. This whole Laffer debate is an aside, and it's kinda sad that the discussion has totally left Megan's point, which was worth a fuller discussion.
b) I don't think even brooksfoe would deny that in some theoretical sense, higher taxation lowers incentive to produce. But he's absolutely right to point out that real economies don't always work the way theoretical supply-and-demand curves would have it.
An anecdotal example: I work on salary. This year I got a promotion, and just barely jumped a tax bracket. Will I go to my bosses and ask for a pay cut or a demotion, so I can make just under the bracket threshold and take home more money? No. That might give me more money now, but if I take a demotion I'm falling behind in the rat race, and if I take a pay cut and the tax brackets slide around again, I'm stuck holding the bag. Will I work less, or less hard? No. Again, I'm on salary, and I work hard not for current compensation, but to impress my bosses so I can get the next promotion. That reality doesn't change with the tax rate. I'd have less money to spend, but the government has more money to spend, so in terms of overall spending it's a wash.
Same logic applies to Laffer curves and sliding around the tax brackets. Theoretical supply-and-demand curves would dictate that production goes down as taxes go up, yes, and Laffer curves dictate that at some point an increase in taxation leads to decreased revenue, yes (but at what level of taxation? despite Orion's assertion that the number is magically 18.5%, no one is remotely close to agreement on the actual number). But in the real world the effect of changes in tax rates is much less than theory would predict, and notably so. Just look at recent history. In the most steady period of American economic growth ever - 1945-1965 - most of that period the top tax rate was at 91% (the rest of the time, 70%), yet annual productivity growth averaged about 4%, a really high number. That implies a pretty serious disconnect between the two statistics. And since 1981, every time a supply-side-inspired tax cut takes place, deficits immediately soar and take years to start coming back down let alone grow into surplus. The burden of proof is on the supply-siders to show that this history is somehow a mirage.
My understanding is that income tax rates most often play a role in decision-making when it comes to big-money allocations, when 4% is still a big chunk of money. In terms of raw dollars, the vast majority of those allocations are performed by a small number of people who use most of their income not for consumption but for personal investments, and when it comes to productivity growth most of those investments ultimately amount to little more than rich people trading little slips of paper amongst themselves, which despite the label "investment" does not contribute nearly as much to real economic growth as, say, a direct investment in business capital or labor or R&D.
The vast majority of Americans aren't big-time investors but primarily producers of goods and services, and we're only going to pay attention to tweaks in the tax rate on rare and momentous occasions, like deciding when to retire or how large a house to buy. It won't often change how much we actually produce at work on a daily basis - and if anything, in the short term a tax increase may be just as likely to make us work harder, so we can still have the money left over after taxes to pay bills. And since the people whose behavior is only marginally affected by changes in the tax rate are also primarily responsible for the production of all our goods and services, and since the production of goods and services drives tax revenue much more than personal investment, the increase in overall economic productivity from a general cut in income taxes would be limited and should not typically make up for the direct loss of tax revenue despite possible Laffer effects. And the more a tax cut benefits top earners relative to everyone else, the more true that is.
Granted, the only support I've presented so far is a personal anecdote and some simple logic. But you don't have to take it from me. Take it from Greg Mankiw, once a top Dubya economic advisor and one of the most highly-regarded conservative economists alive today. A few years ago he was given the opportunity to promote the Dubya tax cuts as revenue-increasing, but declined. Instead he stressed that the tax cuts would only increase revenue in combination with a large number of spending cuts. Those spending cuts never happened, and sure enough, the deficit went through the roof for half a decade. And as Megan indicates, the current fall in the deficit is due to reasons (unequal income growth, the falling dollar, etc.) which loom much larger than any conceivable productivity increase fielded by a 4% drop in the top tax bracket.
And besides, there are many other good reasons to support tax cuts beyond the oddball argument that they increase government revenue. Arguments that invoke the kind of society we want to live in, and how large a percentage of GDP we trust the government to control. Stick to those.
James Tanner, good post. The extreme supply side argument that tax cuts don't lose any revenue at all is obviously false, especially in the short run. However, over the long run an extra half percent or so of annual economic growth compounds into great significance. 22% of 1.0, for example. is less than 20% of 1.11 Also, even if the lost revenue is not entirely made up, the citizens are freer and more prosperous.
I agree with the earlier posters who say the government shouldn't look upon the citizens as just a source of revenue (and votes). I also think that marginal tax rates are extremely important to investment decisions at the margin. This is something I know from personal experience.
DID ANY OF YOU PEOPLE LIVE THROUGH THE SEVENTIES? TAX RATES AS INCENTIVES FOR WORK DO MATTER.
_"You are conflating a small and large things. 4% of a penny certainly isn't the same thing as a company adding 4% to the bottom line. The point is that increase from 33% to 37% in the top rate will have almost no real impact on economic behaviour other than increasing tax revenue."_
If i'm not mistaken, its the bottom line that gets taxed by the federal government. The last sentence is purely insane- didnt someone earlier mention something for nothing?
There is a really insidious attempt in this argument to think like the rich, badly I might add. The rich are not LESS likely to make their decisions based on tax law. They are FAR MORE LIKELY. One of the reasons many of them are rich is because they take such details very seriously. This idea that 'hey, you're rich. You dont care about a 10 grand here, 90 grand there' shows zero insight into how business movers and shakers in particular think. Look at it this way- if the mega-super rich Buffets and Ellisons of America really didnt care much about their bottom lines (even to 4%)... why would they still be working at all?! Its not about the money, except as an indicator of success, a mark to measure themselves against. At some point if Michael Bloomberg is debating spending the next 5 years shoehorning expanding his empire or running for mayor- what exactly do you think influences his decision? The bottom line. And believe me, 4% is a BIG DEAL to these people. Which is why they are who they are and people like us that scoff arent.
E. O'Neal - I agree wholeheartedly with the main thrust of your post, and that's why I take a skeptical baseline stance toward government expenditures in general.
But I'd like to add that any long-term gains in economic growth from tax cuts will only be felt if the cuts are paid for appropriately through corresponding spending cuts. Currently we're not paying for tax cuts by cutting back spending - instead our government's borrowing the money and paying interest, which can only lead to larger tax increases (or some other form of economic pain) down the road. It's essentially and fundamentally stupid if one cares about the long term.
And if the government does choose to engage in spending cuts, it should take care to cut back on expenditures in which government has ingrained disadvantages (e.g. price controls, subsidies, any second-best solutions to intractable problems requiring a huge bureaucracy, etc.) rather than ingrained advantages (e.g. physical and economic infrastructure, regulating failure-prone markets whose products are essential to economic health). Poor decisions about what expenses to cut can overwhelm the beneficial effects of the tax cut, especially in the long term.
Give me a candidate that promises to limit taxes to expenses that are appropriately in government hands on one hand, and to fully (and judiciously) fund those needed expenses on the other, and I'm on board. But everyone in politics these days wants too much from government or too little, understanding policy only through the lens of ideological non-economic goals and easy economic assumptions.
And the conservative argument against taxation is, at its root, fundamentally a political concern and not so much an economic one. As I said in my last comment, it has much more to do with how you see things like fairness, equality, what an ideal America would look like. It's the same with the liberals and their willingness to trust the government to protect them against the marauding private market. Underlying these differences is not so much a difference in economic theory but rather a difference in worldview, which then fuels a difference in theory.
Not to say that conservative economic theories are bereft of good ideas, that it's all relative, etc. Far from it - again, I generally think conservative economic ideas are fundamentally more sound than the liberal ones. But in the messy real world every good idea is conditional - especially fundamental economic positions like whether tax cuts are good or bad. Not enough people stress the conditionals, so I do.
Mark Buehner - playing devil's advocate for brooksfoe again...but it should be noted that the corporate bottom line he's talking about (what Warren Buffett pays) is mostly unaffected by changes in the income tax rate, at least directly. It's subject to corporate and capital gains taxes mostly, and changing the rate of the top income tax bracket isn't going to affect the company's bottom line unless Warren Buffett's personal annual income guides his business decisions more than long-term business strategy (which I guarantee you, it does not). A four-percent-drop in executive take-home pay wouldn't have nearly the same effect on company behavior as a four-percent-drop in company revenue.
And if maximizing money is a critical measure of self-worth to these people - an astute observation, btw - how would changing the tax rates change that behavior? The executive class would all be affected pretty much equally by a rising tax rate, compared to one another.
None of these wealth distribution numbers factor in the changes in technology. When things become cheaper, and much more broadly distributed, it doesn't necessarily show up in the numbers. What has the Internet done for income distribution? And the technology revolution in general? I'd argue it's brought about a massive redistribution of wealth in this country, flattening the disparities, opening vast new pathways of upward mobility, and improving the quality of life.
Most of the talk of widening distributions of income is simple political demagoguery, pablum for those with idle minds.
brooksfoe "In 2007, the top marginal rate of 35% kicks in at $350,000. Nobody at that rate is about to give up work because it doesn't pay for transit costs."
Spoken like someone who earns less than 70 thousand a year. People who pay that kind of money in income taxes are very rate sensitive. You confuse revenue with income. Amazing things can happen when very bright lawyers and accountants transmute what was ordinary income into other forms of revenue that are taxed at different and lower levels. People who have real money have real options to avoid getting robbed entirely. Just ask the Kennedy's or Teresa Heinz Kerry for starters. You don't actually believe George Soros pays the top marginal income tax rate on every dollar that comes his way?
A better way to reduce the deficit is to cut spending. The thing is the really rich have a pain threshold that is lower than the upper middle class, probably because they have more options. Squeeze them too hard and the money leaves the country. And if the amount is large enough they give the finger to Uncle Sam and renounce their citizenship just like the Darts did a few years back when faced with losing 5 plus billion in inheritance taxes. So long America, hello Brazil. For the really rich it is a lot easier to do than you can imagine. That is why there will always be loopholes when the marginal rates get raised to a higher level. The benefit of avoidance is greater than the cost of paying and the politician's know that and work it to their advantage. Funny thing, I have yet to see a rich liberal, and believe me I know quite a few really wealthy democrats who rag on Bush, pass on taking every deduction on their taxes and using ever legal dodge they can. So to the next lib/marxist/progressive who takes a deduction on their taxes; it's established what you are, all we are doing now is negotiating the price.
I can do little here other than to second what James Tanner writes. If the world consisted of Ezra Kleins on one side and James Tanners on the other, we would probably have a rational debate about tax policy going on. The difficulty, which Jon Chait accurately describes in his book "The Con" and which Megan's earlier post on her axed book review initially referred to, is that the conservative side has been hijacked by an idea which, while magically delicious, is simply a lie: that cutting taxes leads to higher revenues. This idea never got much respect among economists, and every time it has been put into practice, it has failed, producing much less revenue.
Conservatives will have to renounce this Laffer Curve supply-side gibberish before they can expect to be taken seriously by liberals. While conservatives continue to insist that the sky is down and that the Bush tax cuts are the only reason why the sun rose this morning, liberals will simply ignore them, and the debate on what policies to enact under the growing Democratic majority will increasingly tune them out.
Amazing things can happen when very bright lawyers and accountants transmute what was ordinary income into other forms of revenue that are taxed at different and lower levels. - cubanbob
This is pretty vague, but I presume you're talking about turning income into capital gains, which are taxed at 15%. It will always make sense for the rich to take as much revenue as possible as capital gains, since obviously their income tax rate is not going to be lower than 15%. So an increase in top marginal rates (for earners above $150,000/year) from the current 33% and 35% back to those awful 36% and 39% rates that produced the disastrous, uh, '90s boom years, would make no difference in the incentive for rich people to shift their income to capital gains.
Your accusation that it is hypocritical for Democrats to use the same tax loopholes as Republicans is reprehensible. You appear not to understand basic civics. Taxes are an agreement which everyone makes together, through the political process, on how to pay for government. The responsibility is shared. For one person to decide that, because they think the level for everyone should have been set higher, they will voluntarily pay more, is equivalent to agreeing to be someone else's bitch. Republicans have ratted out on their responsibility to pay for the things they want to buy through government. I and other Democrats are not going to pick up the tab for Republicans' irresponsible behavior by voluntarily paying more taxes than they do.
apetra - sorry, I can't help but point out that the pot is calling the kettle black here.
You state that "talk of widening distributions of income is simple political demagoguery". While most of those spouting off about inequality may in fact be exercising liberal demagoguery, to use that as an excuse to cast the entire issue aside is foolish and misleading. We have plenty of numbers for this - according to the Census Bureau, for example, between 1979 and 2005, the top five percent of American families saw their real incomes increase 81 percent. Over the same period, the lowest-income fifth saw their real incomes decline 1 percent. Regardless of your political orientation, this quality and quantity of demographic money shift has serious consequences for policy, and the economy as a whole.
(link: http://www.census.gov/hhes/www/income/histinc/f03ar.html)
In the face of these kind of numbers, to talk about the benefits of Internet access for the bottom quintiles is misleading, to say the least. You're talking about a technology that has only recently made it to the middle-class mainstream, and then only slowly over the last ten years. Could it eventually have revolutionary effects on the economy, promising to level the playing field to some significant degree? Absolutely. Has it done it yet? Absolutely not, not on any level that could produce serious macroeconomic effects comparable to the rising inequality we're currently seeing. The economic impact of the Internet to date has been mostly in productivity increases on the part of American business - the "haves" - not some bottom-up surge of "have-not" computer literates reshaping the economy.
Believe it or not, computers and computer software are still considered expensive equipment for most of us. The Internet, while quite convenient, is not yet a necessity outside the workplace for most people. Most of us who have Internet access at home use it to watch dogs on skateboards. Large swaths of rural and poor urban America are still without high-speed access, and webpages have so much content these days that the Internet has become considerably less accessible without a high-speed connection. Just based on that, I'd argue that up to this point the Internet has mostly been serving those who can easily afford to take advantage of it, modestly widening income gaps rather than drastically closing them.
You also insist that while the Internet has "brought about a massive redistribution of wealth in this country", but somehow it "doesn't show up in the numbers". That is a mind-blowing combination, considering we're talking about income. Money is countable. It's made of numbers, so if you don't see it in the numbers, that's because it's not there (unless you think technology gains have been strictly zero-sum, impoverishing as many wealthy people as it has enriched poor people...but that would be even more absurd).
Growing economic inequality in America is an established fact beyond the scope of informed debate. Diminishing that fact just because it's convenient to your opponent's argument is yet more political demagoguery.
The "horrific" Bush tax cuts only trimmed this modestly to ~21.5%. ...Even if you argue that we can't afford an 18.5% tax rate it ain't broke now so why are we trying to "fix" it by raising taxes? - Orion
Orion, I am counting off the days until I hear you claim that Social Security or Medicare are "unaffordable".
"I can do little here other than to second what James Tanner writes. If the world consisted of Ezra Kleins on one side and James Tanners on the other, we would probably have a rational debate about tax policy going on."
If I ever write a book, I may have to use that a back-cover blurb. Though I might say it came from James Fallows or something. That'll sell more paper, natch.
James, you are right in the specifics but i am trying to illustrate a thought process.
Look at it this way: the very wealthy behave with their wealth very much like rational actors in game theory (most of us rarely do) in the mathmatical sense. The money itself isnt the point (how many yachts can you sail on, how many houses can you live in?), it could be bottle caps or pennies for all they care. Their goal is to maximize utility, because for whatever reason they have decided not to lay on a beach the rest of their lives like I would (very likely the personality requirements that got them their millions and billions precludes this).
So when one of these people sit down and decide what to do with their money, whether it be starting a new business venture or donating it to charity- the RETURN is foremost in their mind (even giving to charity, if not in a fiscal sense). These people either have very good accountants or are very good accountants. If they are deciding on starting a new business (or keeping an old one running) they decide on a number that determines the return they PERSONALLY expect versus the risk and time they will invest. If the return is equal to or above that number, they start the business (or keep the old one going). If its not, they dont (shut the doors).
Now you guys must grant that if the above is true- even sometimes- there will be times when even a 4% income tax hit will be enough to push that number below that threshold and that economic activity doesnt happen. That MUST be true. How often? Enough to make an impact on the macro-economy? Consider just how often the wealthy make those decisions every single day, week after week, year after year in this trillion dollar economy. Even if we are talking about it making a difference a small percentage of the time, the cumulative effect must be non-trivial. Because it is ALWAYS a negative effect. Nobody ever looks at their tax implications and decides to start a new business because their taxes are finally high enough. Taxation is always a drag on the economy, there is no upside (government spending of tax revenues aside). The cumulative effect of all these marginal decisions in such a huge economy that is largely fueled by the rich must be relevant- and the historical dataseems to back this up.
Caveat- someone might intentionally start a business for tax purposes, but in this case they are doing it in order to pay LESS taxes by sinking it into a nonprofitable company, and this clearly negates the premise we are discussing.
Brooksfoe,
A businessman doesn't decide to work to make $67,000, he decides to work and risk $850,000 to hopefully make $67,000.
aaron,
A 7.8 percent POSSIBLE MAXIMUM return not including the value of his time? Such a businessman would be a complete moron.
http://www.cbo.gov/ftpdocs/81xx/doc8116/05-18-TaxRevenues.pdf
On May 18th the CBO reported on the growth of tax receipts from 2003 to 2006.
As a share of gdp tax receipts rose some 1.9 percentage points.
Of this, 1.1 percentage points was from a rise in corporate profits tax receipts as
pretax profits rose from 9% to 13% of gdp or from a cyclical low to above average levels.
Another 1.1 percentage points stemed from “real bracket creep”
These two factor accounted for over 100 percent of the growth in income tax receipts.
Prior to the 1980s every budget analyst and good business reporter knew that under our system bracket creep caused tax revenues to grow faster then the economy and that every few years this gave politicians an ability to appear to lower taxes. But in a great public relations campaign the republican party managed to rename bracket creep as the "laughter curve" and make wild claims about the positive impact of tax cuts on the economy.
That is all we are seeing here.
Notice how frequently we are being told that "no serious economists" believe that cutting taxes raises more revenue? It's like these guys read that somewhere and cannot stop repeating it. Hmmm.
First of all, nobody's claiming that they will pay for themselves the next fiscal year. The idea is to promote stronger long-term growth and more receipts. I would like to go back to the same source this quote was lifted from--probably conveniently removed from context--and ask if these "serious economists" believe it is impossible for tax cuts to pay for themselves in the long term.
If they say it is, then they are not serious economists. This is a "known unknown", due to countless variables, but there is some pretty strong evidence that they can.
We'll always see that "serious economists" quote passed around like it is the Sermon From the Mount, but I'd pass on arguing with anybody ignorant enough to believe it applies unequivocally in the long term.
"simply a lie: that cutting taxes leads to higher revenues."
I'm not quite following. This seems like a lie in itself or at best a misleading statement. It seems obvious that if a tax cut does not result in a zero or negative change in GDP, it will ultimately lead to higher tax revenues.
aaron - that's one poor businessman. A good one would risk $67,000 (plus some other people's money, maybe) to make $850,000.
Mark Buehner - Good post, Mark. I wouldn't disagree that taxes affect decisions at the margins in a big way, and you defend that notion eloquently. But a couple of caveats:
a) You make the astute point that wealthy frequently behave like rational actors in game theory, but then your points seem to indicate that above a certain level of taxation, business investors would just fold up their tents and go home with their money ("shut the doors", as you put it). That's not really accurate - firstly, we're talking about an income tax margin of $150,000, and the wealthy all operate well above that level, so we're not talking about decisions at the margins here. If anyone packed up and went home because of income tax margins, they'd be taking their entire investment portfolio with them because it'd all be taxed above the top margin.
Instead I think that, as you said, they would spend their money in a way to maximize return, and in real life that means not less investment but sheltering investment through capital gains, family trusts, tax shelters, etc. Increasing marginal tax rates on income indubitably increases participation in these types of options (lowering the percentage of net income being taxed at the income rate, thus producing less tax revenue than expected by the tax hikers), but it's not altogether clear that a change in top income tax rate on the order of 4% would change the net level of domestic investment in a dramatic fashion. It certainly didn't in the 90's. Investment levels actually increased, in tandem with sheltering methods like offshore banking.
b)I would never suggest that the negative effects of raising income taxes are insignificant (that's brooksfoe's argument, and I'm leaving that one alone). I would argue, however, that the effects of lowering income taxes would not be so beneficial that the tax would pay for itself, except possibly over a very long period of time. There are too many variables at play to assume that, including (perhaps especially) how the government is funding the tax cut - whether they're cutting spending or increasing borrowing, and if the former, whether they're cutting spending in ways that negatively affect the physical and economic infrastructure that only the government provides. Even beyond that, the tax would only produce a revenue boost over very long periods of time (measured in decades, not a few years), and so many other factors come into play over time (wars, recessions, tax-crazy administrations, etc.) that there's no assurance any revenue benefit will ever materialize.
To all my fellow conservatives - I would not bother putting too much emphasis on the argument that lowering taxes at current (30%-40% top-bracket) levels raises government revenue or even makes it a wash. There's too many historical contradictions and variable problems with that theory, and it's brushing too close to wishful thinking to stake your arguments on it.
I prefer instead to say: look at our government. Do you trust this dysfunctional set of blowhards to spend our money wisely? Do you expect them to be able to put into place large government programs that are so well-directed and fine-tuned that they increase the public welfare rather than decrease it, despite taking a bigger chunk of tax dollars out of our pockets? Even if the government manages to achieve this in some area or another, do you think the next administration will not try to tinker with good results and ruin everything in the process?
Defending tax cuts on supply-side grounds is like building a fort in a swampy lowland, when there's a perfectly craggy hilltop fifty yards away. Our present government does not deserve our tax dollars because our politicians are mostly dysfunctional baboons too tied up in pandering to special interests to collectively create sound policy, and government spending without sound policy is utterly wasteful and better spent elsewhere.
I mean, our conservative party is a bunch of corrupt and profligate spenders, captive to their own political machine, on par with the Rostenkowskis of old. The other party may actually tow a better line on the budget these days, yet they're the ones who want more taxes and government programs, thinking they'd be able to navigate the ship of state seamlessly despite our current partisan malaise. They couldn't be more wrong - they're so internally conflicted, even in one-party control they'd have a difficult time accomplishing anything significant, and they'd spend a ton of tax dollars doing nothing. How sad is that? Don't take back your tax dollars out of reverence to some magical revenue formula. Take back your money because at this point, the pols don't deserve to get their grubby little hands on it.
Does the budget deficit figure include the war supplementals?
James i agree with most everything you said above, I think we are on the same page.
There is an important destinction here- whether tax cuts pay for themselves or whether they somewhat pay for themselves in repeipts but are valuable in other ways.
Brooksfoe's argument is simple to demolish- if tax rates were 100% and you lowered them to 90%, would there be an increase in tax receipts? Of course, there would have to be, because nobody would work for absolutely nothing. So there must be some point of diminishing returns in taxation, the question is where is that point, and moreover how do we even define it?
Its not a simple question at all (as we are seeing in this thread) because it will necessarilly involve counterfactuals. Did we avoid a recession because of Bush's tax cuts? There is no way to answer that question definitively. If we did the cuts probably did pay for themselves (partially from receipts, but lets not forget outlays a recession would necessitate). If not, than likely not. But the economy is such a complex system its impossible to determine that even in theory. Its akin to the weather in that sense. But to reiterate an important point- increased taxes have no economic upside, no feedback mechanism to negate or mitigate its effects. Taxes are always a net drag on the economy. So we cant say how much effect it has, but we do know for a fact that it is always bad (which is actually rare in the analysis of a complex system).
I should be getting 127% return?
What am I doing wrong. /sarcasm
Too true, on Justin.
The choice is more generally a risky 8% versus a sure 5%. Higher taxes are going to move people from the venture to the risk free, slowing growth.
It seems obvious that if a tax cut does not result in a zero or negative change in GDP, it will ultimately lead to higher tax revenues.
Tax cuts do not predictably "result in" any change in GDP. The effect of tax cuts on GDP depends on whether the budget is in balance, a slight deficit, or a severe deficit, and on many other factors. The contention that tax cuts lead to greater GDP growth relies on the observation that people will spend and invest the extra money they're allowed to keep. But the government also spends and invests the money it taxes. The contention then must be that individuals will spend and invest that money more efficiently than government would, leading to higher growth. This is sometimes true and sometimes false: government will do a better job of investing in infrastructure (bridges, ports, airports), education, health, police protection and justice than individuals will. A society suffering a deficit of such public goods will see faster growth if the government raises taxes and buys the public goods than it would if individuals were given the money and spent it on, say, cheap Chinese TV sets, which do not grow the American economy at all.
Brooksfoe's argument is simple to demolish- if tax rates were 100% and you lowered them to 90%, would there be an increase in tax receipts? - Mark Buehner
You are refuting some other guy's argument; interestingly, that guy does not in fact exist. My argument is that if tax rates were 39% and you lowered them to 35%, there would be a decrease in tax receipts. This is in fact what happened under the Bush tax cuts. Your argument is equally easy to refute: if tax rates were 0% and you raised them to 10%, would there be an increase in tax receipts? Yes! So clearly, if I am willing to reduce your argument to the level of pure idiocy, I can refute it.
aaron: If the choice is between a risky 8% and a safe 5%, then a +4% change in the top marginal income tax to 39% (not sure if we're talking corporate or individual here, but let's ignore that for now) would mean that after taxes, instead of 5.2% vs. 3.25%, you'd be talking about 4.88% vs. 3.05%.
How many people are substantially less likely to take a 4.88 vs. 3.05 risk than a 5.2 vs. 3.25 risk? Not many. The effect on pushing money into safer investments would be very small. The effect on reducing the federal budget deficit would be large.
So the point of this post is: government policy isn't the only thing that affects fiscal position, hence government policy doesn't matter?
Anyway, the point isn't deficits, it's the national debt. The big additions to the national debt over the past 6 years still exist, and we're still paying interest on them. It's perfectly reasonable that we're seeing low-to-medium deficits at the top of the economic cycle (under Clinton, we were seeing big surpluses), but what happens when that cycle turns down?
"In the most steady period of American economic growth ever - 1945-1965 - most of that period the top tax rate was at 91% (the rest of the time, 70%), yet annual productivity growth averaged about 4%, a really high number. That implies a pretty serious disconnect between the two statistics."
James, we'd have to bomb most of the rest of the world's manufacturing capabilities to get back to there. I do like most of your other arguments, though.
Brooksfoe, you need to get some perspective. Some of the best work on supply side econ was by Mankiw. He suggest we'd only save between 35-50% from tax cuts, depending where the cuts are made.
50% means I get to keep $2 for every $1 of service I forgo. While it does not pay for itself, it still seems to be a good deal.
"It's perfectly reasonable that we're seeing low-to-medium deficits at the top of the economic cycle (under Clinton, we were seeing big surpluses), but what happens when that cycle turns down? "
That is probably true- but there is also a popular argument that deficits in the 3% of GDP range are indefinately sustainable. So long as spending is kept under some kind of control the National Debt becomes a smaller and smaller percentage of the GDP, and hence more manageable.
The problem isnt discretionary spending at all- its the entitlement bubble that is about to burst over us. We cant tax our way out of it, and if (probably when) we try we are going to find out all too quickly how tax policy effects economic growth.
"My argument is that if tax rates were 39% and you lowered them to 35%, there would be a decrease in tax receipts. This is in fact what happened under the Bush tax cuts. Your argument is equally easy to refute: if tax rates were 0% and you raised them to 10%, would there be an increase in tax receipts? "
Of course. Hence the word CURVE. The point is once you acknowledge that this curve exists we can have a rational discussion about what constitutes a meaningful change in economic behavior and its effect on the GDP. The incentive is mathmatically factual. Can we now toss out the disdain?
Furthermore tax receipts have increased under Bush tax cuts. You are arguing a counterfactual- that they would have increased faster without the cuts. That is only true if all things are equal, which they arent.
Brooksfoe regarding, that's a 15% increase on your return for risk. Not at all insignificant. There'll be changes. It won't be huge, but it won't be small.
So long as our interest expense isn't climbing too much realtive to GDP, what's the point of reducing the deficit?
And those beneficial spending components are a fantastically small part of the budget.
No, aaron, redo the math. It's a 6.6% increase on your return for risk. On any given investment decision, that difference would be dwarfed by whatever the actual issues were that made the risky investment riskier. It would be like looking at putting your money in a safe bonds plus blue-chip fund returning 5% versus putting it in a small-cap fund that had been returning 8% over the last few years -- as opposed to putting it a small-cap fund that had been returning 8.2%. Your decision is going to hinge on whether you think the small-cap fund is going to continue to do well, not on the difference between an 8% and an 8.2% return, when the uncertainty curve on that 8% or 8.2% return will have a standard distribution of like 5% -- in other words it really means "somewhere between 3% and 13%" or "somewhere between 3.2% and 13.2%", because that's what we mean by "risky".
Buehner, the disdain continues to be merited because no country in the world has either a 100% or a 0% tax rate. Look, say I argue the Laffer Curve looks like this:
_/TTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTTT\_
In other words, flat for every actually existing case of tax rates on Planet Earth. Do you have any actual evidence to refute this? Because you haven't produced any.
Revenues have risen in the years since the Bush tax cuts because revenues ALWAYS RISE, absent a recession or...a tax cut. To say the tax cut caused the revenues to rise is like arguing that my morning cup of coffee causes the sun to rise.
brooksfoe wrote:
Last year I quit a second job because the extra income pushed me into a higher bracket and I decided that my time was worth than the after tax return is was getting for my labor.
How applicable my situation is to the nationwide picture is certainly questionable, and in general I don't think the country is on the right side of the Laffer Curve, but I know for a fact that I am.
"In other words, flat for every actually existing case of tax rates on Planet Earth. Do you have any actual evidence to refute this? Because you haven't produced any."
None of us do either way, because, again, we are dealing in counterfactuals. We can only look at projections and how things matched up, but that isnt the same as reality. You dont want to deal with 100-90 or 0-10, how about 50-80? or 30-70? Your little quasi-graph would seem to indicate the curve only applies at the very top and bottom, but realistically that isnt going to be true- since we have established the principle now we can talk about ranges etc. What percentage of income taxation swing is liable to have a macro-economic effect? Lets be honest and admit that no-one knows.
"Revenues have risen in the years since the Bush tax cuts because revenues ALWAYS RISE, absent a recession or...a tax cut."
And the stock market always rises, except when it doesnt. Not a very useful model. The current supply side argument is that the recent tax cuts prevented a recession, so your caveats are outside the argument to begin with. Again- i assume there is some level of taxation short or 100% that would be counterproductive because of its drastic effect on the economy- so what would that level be? 95%, 90%, 80%, Or dont we know (obviously we dont). We are still distilling down exactly how nefarious an effect taxation has on economic growth as far as i'm concerned. Simply acknowledging that 100% taxation isnt ideal doesnt get us far.
Buehner, it would be somewhere above 80%. Yes, we know this.
SG, your descriptions of your economic decisions don't appear to me to make any sense. So your second job pushed you into a higher bracket. Was that from 28% to 33%? Or from 33% to 35%? In either case, I can't understand how the 5% or 2% difference in taxes you were paying above the threshold could rationally have made the difference between working and not working. Your taxes on earnings below the threshold didn't change. If you were making $10,000 above the 33% threshold with the second job, you paid an extra $500 in taxes over what you would have paid if you had stayed in the 28% tax bracket. This was what made the difference? Because you only made $6700 instead of $7200 after taxes on the income above the threshold, you decided to give it up? (Your income on the second job below the threshold didn't change.) And if you made less than $10,000 over the threshold, the difference that 5% made was correspondingly less.
It sounds to me like you dropped your second job because it didn't earn enough money to be worth the lost time. I can't understand how it can really have been affected by the small change in tax brackets. In any case, this effect can be eliminated very simply by creating more in-between tax brackets.
6.5%, right. Sorry, have no clue what I did the first time.
Still not insignificant. How well the small caps that make up that portfolio do depends on... How well small caps perform. The portfolio is an agregate of their performance which depends on... their individual return. Lower taxes, more likely to have better small cap performance. Not only higher returns, but less change of failure.
brooksfoe:
Actually, it was the child credit phaseouts that did it for me (effectively a 5% increase in the marginal rate).
And yes, you're absolutely right that I dropped the second job because it didn't earn enough money to be worth my time. But the relevant point is that it didn't earn enough money *after tax* to be worth my time. It was enough to take the job even with the expectation of taxes, but after actually doing my taxes and seeing what I netted (having forgotten about the phaseout and various other details), I changed my mind.
So in this one case, an increase in my marginal rate decreased the net tax receipts. There is at least one confirmation of the Laffer hypothesis in a real world setting.
Again, I don't claim anything stronger than this. I don't think my situation is generally applicable. I wouldn't turn down a raise to avoid higher taxes, but a second job providing supplemental income is a different (and not particularly common) story. And no doubt an alternate tax scheme could mitigate this, but that alternate tax scheme would by definition have lower rates at some margins. So that "solution" is just supply side with a different name.
"Buehner, it would be somewhere above 80%. Yes, we know this."
We could raise tax rates above 80% without any significant effects on the economy? We "know" this? How? That's a ridiculous statement.