What everyone seems to miss about taxes, (or won’t admit)
Economics has increasingly become a field where maxims rule over factual analysis. This has been led by the Chicago School of Economics that asserts, “there is no free lunch” while also maintaining that “by lowering taxes we grow tax revenues.” While the former may be true, is can’t be squared with the latter. And, the principle that lower tax rates increase revenues is untrue, it is also untrue to say that lower taxes will grow GDP. There are reasons of perspective that make this question harder to analyze.
First off, macro-economists seem to conflate tax rates with tax revenues. From their perspective, a rise in tax rates is the equivalent to the taxes each person or firm would pay. This ignores steps that people take to avoid taxes, not to mention conflates different forms of taxation. Increasing the federal gasoline tax, property taxes, sales taxes would likely act as the macro-economist would predict, but income taxes, and taxes on profits work very differently. Income and profits taxes on people and firms that are in the middle to lower tier, would hit hard. These “people” both have their spending, investment behavior meted out carefully. Their tight budgets constrain their behavior, hence they have little ability to maneuver or adjust to avoid taxation. But the top rates, on the very wealthy and profitable are far less effective.
In the Cold War era, Americans had a very different tax code. Tax rates under Eisenhower exceeded 90%–but we had WW2 debt, and were fighting the Korean War and our containment policy toward the Soviets was hardening. Kennedy lowered those rates to 70% and they stayed there till Reagan lowered them in the 80’s, eventually lowering them to 28% on incomes exceeding $56,000 (adjusted for inflation http://www.taxfoundation.org/publications/show/151.html.) In Carter’s last year, 1980, the top tax rate of 70% fell on incomes exceeding $580,000 adjusted for inflation. In 1953, Ike’s rate was 92% on incomes exceeding $200,000; the equivalent of $1.68 million adjusted for inflation.
Despite the very different rates, actual tax rates paid varied very little. So, where did that money go? Well, the explanation is easy to find if we put ourselves in the shoes of the directors of these firms. Today our top tax rates claim a 1/3 of profits or income; whereas 40 years ago, that rate was 2/3. It would seem hard to justify paying out 2/3 of income to the gov’t, whereas 1/3 doesn’t seem so egregious. But, we noticed that actual tax rated paid didn’t change much. How can that be? Deductions.
Deductions have gotten a bad name, and perhaps, special deductions deserve that. First off, basically all the costs of businesses are deductible. So, if a firm is highly profitable they may choose to lower their profits by advertising more, expanding offices or facilities, increasing research and development, hiring, offering employees a raise or more benefits–all of these are deductible. Special deductions often double the benefit, where the gov’t wishes to extend incentives. We have these for those who invest in drilling, green technology, vehicles for business and many, many more. These are never simple, as they are essentially a command economic tool. But, many DO want to encourage drilling, green technology and our auto industry. So, all these deductions, whether they be conventional as the cost of business, or they are special incentives as dictated by gov’t policy. Most of these deductions drive investment, expansion and thereby GDP. As tax rates rise, the value of the deductions increases!
So, higher tax rates should stimulate business, and GDP. “But,” say many economists, “companies will flee our markets and our shores.” Will they? The United States is still number one in one category, and there ain’t no rivals; we are the crowned kings of consumption and firms will do whatever it takes to access our markets. China’s consumer base is far lower than ours, and that won’t change for over 50 years. Though China’s GDP may exceed ours, much of that is non fungible, non exportable; namely utilities, food and exclusively domestic consumption which aren’t exportable. There are several simple ways to encourage large, profitable firms to increase domestic expenditures through the tax code, most obviously by not allowing foreign investments and expenses to be deducted as domestic.
So, what is the corollary of this theory? That lower tax rates decrease investment, employee wages, and encourage high executive salaries. Executive salaries certainly were much more modest, and in-line with regular workers when tax rates were higher. Again, it would seem a hard sell to ask for pay where the gov’t absconds with 2/3 of it. Similarly, it would seem to offer less a penalty to cut retirement programs and pensions, off shore jobs, shutter factories and sell them off. And, we’ve certainly seen that since tax rates are lower. But we keep hearing that the entrepreneur, the small businessman can’t bear higher tax rates.
I’ve been a small businessman for 25 years. If I had a boon year, and faced heavy taxes for my profits, I’d simply buy a truck, perhaps a new computer, expand my advertising, up-grade my equipment and suddenly, my “profit” for the year fell. And, the higher the tax rate, the greater my incentive. The true entrepreneur isn’t hurt by high tax rates, presumably, he’s pouring his profits, his wealth into his ideas–all deductible. Rather, it’s the hoarder, those larded with large incomes that will be pinched. My proposal WILL suppress the wage earners at the top 1/2%, it will force those with great wealth sitting on the sidelines to engage that money in the economy, to invest, incur some risk, and reap it’s rewards. Higher taxes encourages investment, encourages retirement savings to the deductible limits, encourages businesses to spend money, directed by them into deductible avenues.
We need to clean out the tax code. We need to make it easier to understand, and to purge these special deductions to those we can defend in the light of day. While raising top marginal tax rates on incomes exceeding $1 million/year to levels at or above 50% may not increase direct tax costs for these firms, (if we are to believe the historical example that actual taxation has stayed at 20% regardless of the top marginal rates) but, it should drive flight into deductible avenues, that no doubt increase GDP.
Comments are closed.