The Soak-the-Rich Catch-22

[chefdennis]

Fom a Democrat

AUGUST 2, 2010

The Soak-the-Rich Catch-22

By ARTHUR LAFFER
Arthur Laffer: The Soak-the-Rich Catch-22 - WSJ.com

Tax reduction thus sets off a process that can bring gains for everyone, gains won by marshalling resources that would otherwise stand idle—workers without jobs and farm and factory capacity without markets. Yet many taxpayers seemed prepared to deny the nation the fruits of tax reduction because they question the financial soundness of reducing taxes when the federal budget is already in deficit. Let me make clear why, in today's economy, fiscal prudence and responsibility call for tax reduction even if it temporarily enlarged the federal deficit—why reducing taxes is the best way open to us to increase revenues.

—President John F. Kennedy,
Economic Report of the President,

January 1963

If only more of today's leaders thought like JFK. Sadly, in the debate over whether to extend the 2001 and 2003 tax cuts, and if so whether the cuts should be extended to those people who are in the highest tax bracket, there is a false presumption that higher tax rates on the top 1% of income earners will raise tax revenues.

Anyone who is familiar with the historical data available from the IRS knows full well that raising income tax rates on the top 1% of income earners will most likely reduce the direct tax receipts from the now higher taxed income—even without considering the secondary tax revenue effects, all of which will be negative. And who on Earth wants higher tax rates on anyone if it means larger deficits?

Since 1978, the U.S. has cut the highest marginal earned-income tax rate to 35% from 50%, the highest capital gains tax rate to 15% from about 50%, and the highest dividend tax rate to 15% from 70%. President Clinton cut the highest marginal tax rate on long-term capital gains from the sale of owner-occupied homes to 0% for almost all home owners. We've also cut just about every other income tax rate as well.

During this era of ubiquitous tax cuts, income tax receipts from the top 1% of income earners rose to 3.3% of GDP in 2007 (the latest year for which we have data) from 1.5% of GDP in 1978. Income tax receipts from the bottom 95% of income earners fell to 3.2% of GDP from 5.4% of GDP over the same time period. (See the nearby chart).

use link above to see the chart
These results shouldn't be surprising. The highest tax bracket income earners, when compared with those people in lower tax brackets, are far more capable of changing their taxable income by hiring lawyers, accountants, deferred income specialists and the like. They can change the location, timing, composition and volume of income to avoid taxation.

Just look at Sen. John Kerry's recent yacht brouhaha if you don't believe me. He bought and housed his $7 million yacht in Rhode Island instead of Massachusetts, where he is the senior senator and champion of higher taxes on the rich, avoiding some $437,500 in state sales tax and an annual excise tax of about $70,000.

Howard Metzenbaum, the former Ohio senator and liberal supporter of the death tax, chose to change his official residence to Florida just before he died because Florida does not have an estate tax while Ohio does. Goodness knows what creative devices former House Ways and Means Chairman Charlie Rangel has used to avoid paying taxes.

In short, the highest bracket income earners—even left-wing liberals—are far more sensitive to tax rates than are other income earners.

When President Kennedy cut the highest income tax rate to 70% from 91%, revenues also rose. Income tax receipts from the top 1% of income earners rose to 1.9% of GDP in 1968 from 1.3% in 1960. Even when Presidents Harding and Coolidge cut tax rates in the 1920s, tax receipts from the rich rose. Between 1921 and 1928 the highest marginal personal income tax rate was lowered to 25% from 73% and tax receipts from the top 1% of income earners went to 1.1% of GDP from 0.6% of GDP.

Or perhaps you'd like to see how the rich paid less in taxes under the bipartisan tax rate increases of Presidents Johnson, Nixon, Ford and Carter? Between 1968 and 1981 the top 1% of income earners reduced their total income tax payments to 1.5% of GDP from 1.9% of GDP.

And then there's the Hoover/Roosevelt Great Depression. The Great Depression was precipitated by President Hoover in early 1930, when he signed into law the largest ever U.S. tax increase on traded products—the Smoot-Hawley Tariff. President Hoover then thought it would be clever to try to tax America into prosperity. Using many of the same arguments that Barack Obama, Nancy Pelosi and Harry Reid are using today, President Hoover raised the highest personal income tax rate to 63% from 24% on Jan. 1, 1932. He raised many other taxes as well.

President Roosevelt then debauched the dollar with the 1933 Bank Holiday Act and his soak-the-rich tax increase on Jan. 1, 1936. He raised the highest personal income tax rate to 79% from 63% along with a whole host of other corporate and personal tax rates as well. The U.S. economy went into a double dip depression, with unemployment rates rising again to 20% in 1938. Over the course of the Great Depression, the government raised the top marginal personal income tax rate to 83% from 24%.

Is it any wonder that the Great Depression was as long and deep as it was? Whoever heard of a country taxing itself into prosperity? Not only did taxes as a share of GDP fall, but GDP fell as well. It was a double whammy. Tax receipts from the top 1% of income earners stayed flat as a share of GDP, going to 1% in 1940 from 1.1% in 1928, but at what cost?

We all know that there are lots of factors influencing tax revenues from the rich, but the number one factor has to be the statutory tax rates government tells the rich they have to pay. Not only do the direct income tax consequences of higher tax rates on those in the highest brackets lead to higher deficits, the indirect effects magnify the tax revenue losses many fold.

As a result of higher tax rates on those people in the highest tax brackets, there will be less employment, output, sales, profits and capital gains—all leading to lower payrolls and lower total tax receipts. There will also be higher unemployment, poverty and lower incomes, all of which require more government spending. It's a Catch-22.

Higher tax rates on the rich create the very poverty and unemployment that is used to justify their presence. It is a vicious cycle that well-trained economists should know to avoid.

Mr. Laffer is the chairman of Laffer Associates and co-author of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).

 

[Turtle]

Several years ago when I was living in Nashville, back when Opryland was a theme park before it became an outlet mall, the city decided since people were coming to town in droves for vacations and conventions that they would double the motel tax to get all that increased revenue.

Instantly convention bookings all but ceased, and motels within the city limits were averaging less-than half bookings. The motels outside the city limits were full, of course, and conventions moved to places like Louisville, Birmingham, Knoxville and Memphis. The net result was an almost immediate 40% drop in overall tax revenues for the city.

That was back when Phil Bredesen was the mayor, who is the current governor of the Volunteer State. Incidentally, Phil Bredesen's very first political campaign was in 1969 when he ran for the Massachusetts State Senate, and lost. Also, as both mayor and governor, he's tried several times to get around the State's Constitutional prohibition on an income tax, by trying to do things such as levying an additional tax on businesses with a payroll larger than a certain dollar figure, which is nothing more than a payroll income tax. You'd think he'd have learned something from his motel tax extravaganza, but noooo.

Oh, yeah, he's a Democrat. Shocking, I know.

 

[Freightdawg]

When my son was about 8 (he's 24 now), we were talking about taxes. He said, "You know Dad if they cut people's taxes, people would have more money to spend. If they had more money, they would by more stuff. Companies would have to make more stuff, so they would have to hire more workers. Those people would pay taxes, so the government would get more taxes. The government would make more money."
Pretty much summed it up!

 

[muttly]

Unfortunately the crowd in the whitehouse doesn't believe in supply side economics so it will remain it a death roll spiral. The only remedy is gentle pressure on the rudders (keeping the tax cuts and reduce govt. spending) and hands off the controls.(stop spending us into unsurmountable debt and stop raising taxes and killing the private sector.)

 

[Pilgrim]

Laffer had another good article in the WSJ back in June.

Arthur Laffer: Tax Hikes and the 2011 Economic Collapse - WSJ.com

Two key points he makes:

"On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush's tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts."

"In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn't take effect until Jan. 1, 1983. Reagan's delayed tax cuts were the mirror image of President Barack Obama's delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.
But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don't work until they take effect. Mr. Obama's experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011."

I'm sure many of us have noticed the profits being declared by some major corporations, and we hear some tepid optimism about the economy being out of recession (barely) from Bernanke today. However, if these numbers are being skewed by the process Laffer describes in this article we're only seeing the beginning of the gathering storm.

It's always been common knowledge that raising taxes in a recession are counterproductive. We have only to look at what happened when Hoover tried to tax the country back into prosperity during the 1930s - he created a double dip depression with unemployment north of 20%. Don't think for a minute that Obama couldn't do the same thing in this day and age.

 

[nightshift]

A couple of things to keep in mind with all this. First very few of the politicians in DC have ever run a business, or had to meet payday deadlines, or even been a manager at a business, they are career politicians, so they have no clue of what it takes to create jobs or produce a product. None of them have an common sense, they don't seem to grasp the idea that if they raise taxes instead of bringing in more money to the coffers there will be less, people will spend less, companies will sell less, workers will be laid off, production costs will increase, producers will pass on these increases to the consumer, and on and on and on. Lastly, who's to say that the President doesn't know exactly what he's doing? He has no love for this country so he is systematically destroying it. He is destroying our economy, he is taking power away from Congress (the one place we might have a chance of throwing out the bums and halting the destruction), he is putting his cronies in powerful positions to do his bidding, he is keeping racial tensions high with the immigration issues and by not putting the NAACP, the New Black Panthers, the ACLU, La Raza and others in the same category as the KKK, the Neo-Nazi's, the Aryian Brotherhood and other pro white organizations. He told us he wanted to transform America, we just didn't ask into what.