Wednesday, February 09, 2005

Who Really Pays the Taxes?

It's budget time, and of course, time to pay as much attention to what comes in as goes out. Two excellent pieces came out in the past two days. This one from John Hinderaker and Scott Johnson at Powerline, and this one from Larry Kudlow.

Larry Kudlow puts in pretty plain terms the fact that the Bush tax cuts are working, by noting that just in the past 12 months, individual income tax collections have increased 15%. That's gigantic. And it's the result of a tax cut feeding economic growth.

Hinderaker and Johnson lay out the tax case for personal Social Security accounts, namely that it is a soaking of the rich, given that the middle and lower income Americans contribute very little to the nation outside of payroll taxes, which they will see returned to them in the form of a personal account. But this article, a rare one indeed, argues quite persuasively, that the top 5% of income earners are going to be yoked with an even greater tax burden than before while those below actually bear a smaller one.

The larger point between these articles, but especially the Kudlow article is that supply side economics benefits the taxing and the taxed. More importantly, it is a boon to the untaxed poor, as the rich (also known as "job creators") have more cash with which to hire them as they expand their business enterprises.

The Laffer Curve, maligned by the pro-tax crowd, has been proven in the mid 1960s, the 1980s, and again now. It's principle is simple: If you have taxes too high, you actually erode the tax base from which the economy grows. If you soak the rich (also known as "job creators"), you actually decrease the amount of jobs, and thus cash, floating about in the market. The rich will stay rich regardless, but punishing them out of spite really harms the working class.

The point made by Hinderaker and Johnson, that the diversion of payroll taxes to personal accounts will put a greater burden on the highest 5% of income earners is not to be ignored. And the notion that the federal government may have a greater need for revenue, out of the pockets of the rich of course, after such a plan is equally valid.

The greater point is that the tax system we have is fairly regressive. The highest income earners bear the heaviest tax burden by far. But they're not complaining that much, given that they are significantly more wealthy despite paying a greater share of the nation's needs. So does it make sense to make it more regressive by punishing the rich to pay for further federal outlays, or do we further release the economy to do what it was always meant to do by allowing people to seek personal financial freedom apart from the state, and thus allowing the state to passively benefit from it?

Addendum

I've been asked by a very astute reader to provide some evidence for the validity of supply-side economics. Being a believer in the various macroeconomic principles upon which that economic theory relies, I can provide a few links.

A theoretical/practical analysis by Arthur Laffer himself, a Heritage piece on the benefit of tax cuts on business investment, this from AEI, this piece by Jude Wanniski, this by Mark Skousen, and an entire page of links from Heritage. Enjoy.

I would counsel, however, that every time this policy is tried, it has done the exact same thing. It has released financial burdens on the private sector, which in turn spurred economic activity and growth. That creates jobs and greater wealth at all socio-economic levels. So, while folks end up paying significantly higher taxes in terms of dollars, they never feel it, as they are bringing in way more than they ever could under a higher tax scheme. It's a simple theory, and it's been shown to work.

And while Kudow, Hinderaker and Johnson are not fans of elevated taxes, the claim by the reader that the referenced authors favor an elimination of taxation is a bit outlandish to say the least. Under the Articles of Confederation, the government had no taxing power. It therefore could do nothing. Every reasonable individual recognizes that taxes are a necessary evil. The question remains where necessary ends and evil begins.

As far as the request for a discussion about other forces on the economy, I don't see it being productive, as such a thing would miss the forest for the trees. It could likely go on forever without addressing the major point ,which is that supply side theory works. Economics is loaded with assumptions, and I am not an economist. But I believe in supply side economics in the same way that I believe in gravity. I've seen them both work.

And to be fair to the Keynesians, or demand-side theorists--most of academia and the left love them, despite the fact that these theories have been disproved. Keynesian theory believes that if you pump cash to the poor, that they will spend it and get the economy going. It's a great idea, but it doesn't work. FDR tried it before World War II, and for a very brief time it did work, but the economy crumbled again just before the war because a regime of handouts cannot long last. It is a false propping of the economy by the state, not a self-sustaining process.

Of course, the economy rebounded during the war, but that's because businesses had money from government defense contracts, requiring workers to labor for the war effort. But government involvement in that economy was as a participant, not a subsidizer.

Avoid the urge to stick it to the rich with higher taxes, because the presidents who have put the greatest tax burden on the rich in terms of dollars paid were JFK/LBJ, Ronald Reagan, and George W. Bush. The job creators pay more as they make more.

Addendum II

Ok, time for a few responses. The first three paragraphs of JWB's response are right on, but I can't get past the idea that he thinks the Republicans are pointlessly cutting taxes with a goal of eliminating them. The government can't run on rhetoric alone. It's not about eliminating them, it's about cutting them to the point that the government maximizes revenue without choking off the economy that forms the tax base. A simple look at the Laffer curve indicates that elimination of taxation is not a consideration. Rather it is a means of managing the burden the government places on the private sector so that it does not hamper growth.

Granted, other forces may act on an economy, but it is a bit unrealistic to argue that in the mid-sixties, eighties, and now, that random market forces caused the sustained economic booms that were witnessed each time supply-side economics were implemented. It's just too coincidental.
But if we are to speak of other market forces, this decade provides a perfect example of the positive effects of supply side economics. In late 2000, we began a recession. Then we were attacked by terrorists on our home turf, in the financial and political centers of the nation. The markets were full of anxiety bordering on panic. It was a time for people to buy gold and huddle away in a mountain bunker. Energy prices were and remain quite high. Housing prices continued to climb.

Almost every factor worked against a strong economy, yet those who create jobs had the cash to continue hiring, to the point that the unemployment rate, denounced by Democrats in 2004 as being astronomical, was equal or below that of Bill Clinton's best rate. We are currently hovering near the rate of full employment. Most economists agree that there will always be around 5% of the total workforce which is at any time unemployed.

The only significant factor working in favor of the economy was a lower across the board rate of taxation. Yes, interest rates were low in order to encourage borrowing, but one must have the income to service their debt. They don't get loans otherwise. Those are real indicators of the financial health of consumers and their belief about their future employment prospects. There is an abundance of employment and good wages.

As far as regressiveness goes, I'm pointing out that people are paying more in terms of percentages the higher their incomes. Certainly they can afford it, but should that be the measurement? And I think that was Powerline's point. The counter question is whether it is fair to burden certain individuals more than others simply because they can afford it. Should we resort to a flat tax as advocated by Steve Forbes? One that exempts the low income earners, and which eliminates the patchwork of loopholes in the already incomprehensible tax code? Maybe. There is no right answer.

But as an attorney who has seen the unbelievable nightmare that is the Internal Revenue Code, something needs to change, which is why I support a complete abrogation and simplification of the tax code.

And that leaves us with the Keynesians. Check Kudlow's article. As spending continues to slow, as it is projected to do, the combination of a tight rein on taxes, and a GDP growing at faster than the adjusted 3.3 percent projection we have now (which it seems to be doing), the budget will fall into balance within about 5 years. This is classic supply side.

Now, the articles offered by JWB are excellent to make his point, but there is one fatal flaw. Remember what I said about the FDR recovery & Keynesian theory. It DID work for a time, but it imploded into a brand new depression when the priming of the pump could not be sustained. It is not real economic improvement, but rather a subsidy. Once spent, it's gone, and it does little for durable goods, which really makes the economy run. The tax rebate was indeed Keynesian, but it was not done in a vacuum, and it was only done as a one time deal. The pressure from above was exerted in the form of a reduction in tax rates on the job creators. Keynes is not self-sustaining. Only when the economic needs of World War Two were being addressed did the economy become self-sustaining. The people above needed to hire, the people below took jobs and received money. They spent it on all sorts of things, knowing that a new check was coming. We recovered.

So, economic theory is not perfect, but supply-side theory remains about managing tax rates not eliminating them. It's also about recognizing that the government exists for the benefit of the market, not the reverse.

Thanks for the debate.

2 Comments:

Blogger jwb said...

First, where is the correlation between the tax cuts and the tax revenues? Oh, wait know one has been able to demonstrate, that's right demonstrate a correlation, let alone a causation between the two. Alls that there has been is supposition. But why bother with the facts or rigorous statistical analysis, when a bald assertion will do.

That's not to say that I'm not for the tax cuts. But the republicans are being irresponsible on this front. Based upon your arguments (as well as those asserted in the Powerline and by Kudlow), we shouldn't have any taxes.

Second, the Laffer Curve? I bet you can't even find an economic analysis that shows where the Laffer Curve is on the current income tax structure. That's because, while in theory it is correct, too many factors exist in the U.S. economic structure to actually show where it is in real-time. As for the assertion the Reagan's tax cuts had the Laffer Curve affect see

http://www.ncpa.org/iss/bud/2002/pd020402a.html

http://www.ncpa.org/edo/bb/2002/bb020402.html

http://en.wikipedia.org/wiki/Laffer_curve

Another problem with the Laffer Curve rhetoric is that the analysis never holds constant or addresses the effect that other factors/forces have on tax revenue. When you find such an analysis, would you be so kind as to post it to support your hypothesis.

3:29 PM  
Blogger jwb said...

The simplistic argument that we should keep on reducing taxes does not take into account the benefits that taxes generate. It is amazing how conservatives don't ever say what they think the right level of taxes is, only that taxes are bad.

I will agree that excessive taxation is bad and that many government programs are wasteful and should be eliminated. I'm not a fan of farm subsidies, for example. But frankly, I'm grateful for the roadways on which I drive every day and on which all of the goods that I purchase arrive at a store near my home. I'm glad that we have a military to defend our country. I’m glad that we have some semblance a system to pay for medical care for those individuals who can’t pay for it. I’m thankful that children in our country get an education, regardless of their parents' income. But we can't have those things without taxes.

Furthermore, many, if not most governmental programs, are essential for a healthy society/economy. For example, if we didn't have our national interstate highway system, which was paid for by tax dollars, I would speculate (I admit, I'm speculating) that our economy would not be as strong as it is today, even with all the additional monies that went directly into the economy instead of into the government coffers to pay for the highways.

Regarding the Laffer Curve reference. None of the posts actually demonstrate/prove the Laffer Curve proposition (i.e. that taxes have ever been on the right side/downward side of the curve). The sites only note that when the tax rate went down, tax revenues increased, BUT THOSE EXAMPLES DON’T HOLD CONSTANT OTHER FACTORS/FORCES!!! (such as natural upswings in the economy that would have occurred even if the tax cuts had not been instituted).

Your "regressive" tax analysis, left me scratching my head. I’ve never heard “regressive” tax described that way. See
http://www.psnw.com/~bashford/taxation.html
http://en.wikipedia.org/wiki/Tax#Progressive_and_regressive_taxation
http://ase.tufts.edu/gdae/Pubs/wp/03-10-Tax_Incidence.pdf#search='regressive%20taxation'

Finally, your assault on Keynesian theory also left me scratching my head. Are you aware that President Bush is a big Keynes proponent. In fact, the justification of the current budget deficits is based upon Keynesian theory.

http://www.jsonline.com/bym/your/nov03/183481.asp
http://www.washingtonpost.com/ac2/wp-dyn?pagename=article&node=digest&contentId=A59814-2001Aug24
http://www.bepress.com/cgi/viewcontent.cgi?article=1001&context=ev

1:03 PM  

Post a Comment

Links to this post:

Create a Link

<< Home