By David Ranson:

Will increasing tax rates on the rich increase revenues, as Barack Obama hopes, or hold back the economy, as John McCain fears? Or both?

[Economist] Mr. [Kurt] Hauser uncovered the means to answer these questions definitively. On this page in 1993, he stated that "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." What a pity that his discovery has not been more widely disseminated.

...The federal tax "yield" (revenues divided by GDP) has remained close to 19.5%, even as the top tax bracket was brought down from 91% [during WWII] to the present 35%. This is what scientists call an "independence theorem," and it cuts the Gordian Knot of tax policy debate.

The data show that the tax yield has been independent of marginal tax rates over this period, but tax revenue is directly proportional to GDP. So if we want to increase tax revenue, we need to increase GDP.

What happens if we instead raise tax rates? Economists of all persuasions accept that a tax rate hike will reduce GDP, in which case Hauser's Law says it will also lower tax revenue. That's a highly inconvenient truth for redistributive tax policy, and it flies in the face of deeply felt beliefs about social justice. It would surely be unpopular today with those presidential candidates who plan to raise tax rates on the rich – if they knew about it.

...What makes Hauser's Law work? For supply-siders there is no mystery. As Mr. Hauser said: "Raising taxes encourages taxpayers to shift, hide and underreport income. . . . Higher taxes reduce the incentives to work, produce, invest and save, thereby dampening overall economic activity and job creation."

Labels: Economics, laffer curve, tax cuts, taxes

Coolidge, JFK, Reagan, and Bush... how many times does it have to be proven? Tax cuts increase tax revenues.

[WSJ] The Bush Administration's midsession budget review, released yesterday, estimates that the deficit will have shrunk by more than 50% in three years: to $205 billion in the fiscal year ending this September from $413 billion in 2004. As a share of the economy, the budget deficit is expected to fall to 1.5%, well below the 40-year average of 2.4%.

Buoyant tax revenues are the major reason for this deficit reduction. So far this year tax receipts are up 7.5%, and that follows two years of double-digit increases. Federal tax receipts since 2004 are up by nearly $700 billion -- the largest ever revenue gain over a similar period. Tax collections have been so resilient that many private forecasters and the Congressional Budget Office are predicting a budget deficit well under $200 billion by year's end.

After the fiscal blowout of Mr. Bush's first term, federal spending is finally starting to slow, with this year's increase estimated to be a more sustainable 4.7%. Medicare is still the entitlement that ate the taxpayer -- up $42 billion, or 13%. Congress is set to expand federal health-care expenditures by another $25 billion or so next year with more funding for the states to pay for health programs in the name of children that increasingly cover adults. Because the states have built record budget reserves over the past two years, it's not clear why the indebted feds should be giving states more money.

The bright fiscal picture is especially impressive given that we have the fiscal burden of spending $173 billion this year to fight the war against terror in Afghanistan and Iraq. The biggest threat to continued deficit reduction is not war spending, which as a share of the economy is still below what it was in 1992. The main risk is from a potential economic slowdown -- which would mean less worker income and corporate profits to tax.

In 2003, Mr. Bush and Congress cut taxes on investment and high earners, and the happy result has been revenues aplenty. As a hedge against the economy cooling down, it might be time to cut tax rates further on the economy's most productive assets and workers.

Labels: Economics, laffer curve, supply-side, tax cuts, taxes