American Gerontocracy

Generational Warfare In Our Time

The Bottom Line on Tax Policy

As I’ve pointed out before on this blog, there’s a gap between economic interest and voting patterns of younger Americans. I believe that much of this gap is explained by the fact that many younger Americans haven’t been taught the basics of economics. Obviously, this comes into play as we consider tax policy.

This recent article in the Wall Street Journal presents some pretty revolutionary and indisputable facts about tax policy in this country:

The interactions among the myriad participants in a tax system are as impossible to unravel as are those of the molecules in a gas, and the effects of tax policies are speculative and highly contentious. Will increasing tax rates on the rich increase revenues, as Barack Obama hopes, or hold back the economy, as John McCain fears? Or both?

Mr. 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.

 

Hauser's Law

 

The chart nearby, updating the evidence to 2007, confirms Hauser’s Law. 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% 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.

An amazing truth has been revealed by a simple analysis of the data. Raising taxes on the rich will not reduce our deficit or fund more social programs, because it’s revenue impact is negligible.

The only tax poicy that makes sense is one that encourages economic growth.

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May 24, 2008 - Posted by | Uncategorized

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