Tax Revenues

[Annie]

Released today:

http://taxprof.typepad.com/taxprof_blog/2005/12/growth_in_feder.html

 

[KarlMarx]

Well.... we shouldn't be surprised, should we? The same thing happened during the 1980s as a result of Reagan's tax cuts, too.

First, it wasn't a "tax cut", it was a tax RATE cut. Second, you don't tax people, you tax economic activity.

Now apply the law of supply and demand. If the price of something goes down, usually the demand for it goes up (more accurately, if you go down the price axis on the demand curve, it tends in an upward direction).

I like to compare tax cuts to a sale at your favorite department store. When do people shop the most? When everything goes on sale. Why would stores do that? The answer is usually to increase revenue. The sale doesn't cost the store anything, it actually has the reverse effect.

Well, if you think of the government as being Target or Wal-Mart and economic activity as being the goods within it, doesn't it stand to reason that making the economic activities cheaper will increase the demand and therefore, increase revenue?

Politicians who state that a tax cut will cost the government N Billion dollars (I believe that the Bush Tax Cuts were pegged at $300B) either don't understand this or are simply misleading the public. Tax cuts in recent history have actually increased government revenue and didn't cost the government any money at all! In fact, one can argue that raising taxes costs the government. Increased taxes discourage economic activity which is what the government taxes.

 

[Mr. P]

Released today:

http://taxprof.typepad.com/taxprof_blog/2005/12/growth_in_feder.html

Well gee, wadda ya know, tax cuts DO increase revenue, PROVEN again.

 

[Hobbit]

People who like to estimate how much a tax cut will cost assume that everybody will take the extra money they get from the tax cut and burn it.

 

[BaronVonBigmeat]

Tax cuts are always a good thing, but keep a few things in mind:

* Not all tax cuts are going to have a supply-side effect. It depends on what's being taxed, and what the rate was. The capital gains tax is the most sensitive in this regard; according to supply-side guru Jude Waninski, the correct cap gains tax rate should be zero, and the overall burden that the electorate collectively "wants" is around 15% of the economy, he estimates.

* Reagan pushed for tax cuts. But then he went along with a tax hike later on (I think it was the SS payroll tax). Also you have to figure the effect of the federal reserve printing up money--a quick inflationary boom is easy, but it's always followed by recession. A lot of presidents are getting blame/credit for being in the right place at the right time during the business cycle, but the fed is what causes the business cycle in the first place.

Having said that, the laffer curve is a real phenomenon, and there IS some point where tax rate hikes do nothing. Even the most hardcore socialist will admit that revenues drop to zero when the rate is 99%. So really the only question is, where is the peak of the curve.

 

[Toro]

What is the academic literature on The Laffer Curve? I am highly skeptical of this argument as it is applied to the general US economy. It certainly does apply in some situations, and I believe it increases the marginal tax generated per unit GDP, but at what rate are we on the the left-handed slope? 30%? 20%? 10%? 0%? Surely the government doesn't collect the most revenue when the tax rate is 0%! Or 1%! Or 2%! So what rate is it? I don't think there is any academic research on this topic at all. (If there is, please direct me to it. I'd love to know.)

Certainly the tax cuts have helped the economy the past few years. And (most of the time) its better to stimulate demand through deficit financing by allowing consumers to spend (ie tax cuts) as opposed to increased government spending. But to point to the tax cuts in isolation as the primary reason why the US economy is coming out of the recession, or that government revenues are rising mainly because of the tax cuts, is false.

We must also look at the imbalances created in the economy by the tax cuts, and what the long-term effects of the tax cuts will be in the future. Almost certainly, the tax cuts exacerbated the imbalances in the global economy, which has contributed to the housing bubble, and we do not know whether the tax cuts essentially robbed growth from the future since interest rates should rise as capacity tightens in the economy and the demand for capital increases, in part due to fiscal deficits.

For the record, the Wall Street Journal noted that the NBER published a paper saying the dividend and capital gains tax cuts did NOT help the stock market. I couldn't find the study on the NBER web site. However, I could post the article here, but I'm not sure what the rules are for posting subscription content on this forum.

 

[Said1]

What is the academic literature on The Laffer Curve?

I think Canada is suffering from the extreme right side of the curve, eh?

 

[Toro]

Further

December 12, 2005
Tax Cuts, Output Cycles, and Growth

There is a lot of confusion about the effects of tax cuts, and much of the confusion is due to a failure to distinguish between two types of macroeconomic policy, stabilization policy and growth policy. To start, here's a graph of a hypothetical economy. The natural rate of output, Y*, follows an upward trend over time, and the trend has some variability in it (the degree of variability in Y* is a source of debate). The Y* line is the underlying trend of full employment output, not actual output. Actual output cycles around trend and is show as Y in the diagram (this line will be blue in the second graph to help distinguish it from other lines):

Now, let there be a tax cut at the point in time indicated in the following two graphs. Tax cuts have the potential to do two things. First, as shown in this diagram, a tax cut can stimulate a lagging economy helping it to recover faster:

In this diagram, after the tax cut, which stimulates the economy due to the deficit spending it causes, output rises faster. Thus, the data would show increasing output growth and rising tax collections. But these tax cuts do not "pay for themselves" in the sense that there is no change in the long-run growth rate of output, i.e. the underlying rate of growth in tax collections is unchanged. For that to happen, the trend rate of growth must change as shown in the next diagram:

Here, the tax cut has changed the rate of economic growth and thus will cause tax collections to grow faster as well. Most of the pro-growth people have this in mind when they think about tax cuts.

Which does the evidence suggests occurs after a tax cut? We're pretty sure tax cuts have the first type of effect of attenuating cycles, but the evidence that tax cuts affect the underlying growth rate is much more tenuous. And when you go further and ask if growth changes enough to pay for the tax cuts, the evidence is even thinner.

Anyone who says based upon a few months of data that they know which of the two scenarios is unfolding, an attenuation of cycles or a change in growth, is not telling you a straight story. Just because growth is higher and tax collections go up does not mean the second story is true. We don't know yet, and we won't know until a lot more data are available. Historically, there is reason to favor the first scenario - typically the effects are through deficit spending and the attenuation of cycles, not a change in the underlying trend rate of growth, but it is a possibility so it cannot be ruled out as implausible, and the two effects are not necessarily mutually exclusive.

If you remain unconvinced, think of it this way. Suppose the last month or two, or even the last few years, have been warmer than normal. Is this a change in the trend temperature (T*), i.e. is it global warming? Or is it just abnormally warm for other reasons, just a cycle producing higher than normal temperatures? There's really no way to tell - it takes a long series of temperatures to sort it out. The effects of tax cuts are no different. But what we do know from the data we have favors the first scenario.

http://economistsview.typepad.com/

 

[SpidermanTuba]

Released today:

http://taxprof.typepad.com/taxprof_blog/2005/12/growth_in_feder.html

Highest level of tax revenue in history - yet we're running the larest deficit in history, too.



Bush ought cut the tax rate to .0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001%

Then we'll have the highest revenues possible.