Friday, June 15, 2007

Tax cuts do NOT pay for themselves (and aren't cuts at all if you don't cut spending)

The claim that "tax cuts pay for themselves" based on the infamous laffer curve is a lie that is repeated over and over by the GOP, and apparently they repeat it often enough that most of the rank-and-file seem to believe it, judging from conversations I've had with self-identified GOP supporters.

How do I know it is a lie? Well, I'll get to that in a moment, but first, I want to do a little thought experiment about this. The laffer curve idea starts out with the notion that if you tax 100%, then no one has any incentive to do anything, because they get no reward for it so there is no economic activity and tax revenues go to zero, and so if you cut taxes to 0.01%, that suddenly gives incentive for people to work so they will, and the economy is stimulated, so you'll actually collect more taxes with that 0.01% tax than a 100% tax. Seems simple enough. The problem is when tax rates aren't so extreme at either end of the scale. Where does the "hump" in the graph go in the middle?

I'll take this a step further now. Say taxes are 99% and you cut them to 90% (basically a 10% cut). On the taxpayer side of things, such a cut would change take-home from 1% to 10%. So people now would make ten times as much money for the same gross income and tax revenues would only have been reduced 10%. It again does not seem hard to suppose that increasing incentives by a factor of ten could produce sufficient increase in activity to offset an only 10% reduction in taxes. But on the other end of the scale, this starts to look rather harder to justify. If taxes are 20% and you cut them to 10%, on the taxpayer side you've only gone from take home pay of 80% to 90% - basically a 13% increase. But you've cut tax revenues in HALF. It seems rather unlikely that increasing the incentives only 13% is going to double an economy (which you would have to do to even offset the loss) much less MORE than double it.

So what's the point of my thought experiment? To show that there are diminishing returns to tax cuts. Eventually cutting taxes just plain will cut revenues. Given that our economy even in super booming years never grows more than in single digits, it seems very likely that the "hump" on the laffer curve is well to the right of our current level of taxation (which when you factor in all taxes is about 50% or so for most of the middle class). Some think it is as high as 80 or 90%. Which means that tax cuts right now can likely only lower revenues, not increase them. Which makes claims to the contrary lies.

Now, don't take my word for it. How about taking the word of George W. Bush's own economists. Brendan Nyhan has written on this quite a bit. There is also this interesting article on the subject.

Basically, regardless of where the exact point of the laffer curve lies, it is certainly to the right of where we are now. And this was made clear by the fact that not even Bush's own economists claim revenue was increased by his tax cuts and also actual budget numbers (as indicated in links above) show that a significant portion of missing revenues is from the tax cuts.

Now, libertarian that I am, I'm not exactly in favor of high taxes or keeping taxes where they are. But if you are going to advocate cutting taxes, use honest reasons, not bullshit. And further, tax cuts really aren't even tax cuts if you don't reduce spending. In fact, deficit spending is really just a stealth tax on us all. In some senses, it is a double tax. Because first, the money will have to be paid back later (and that can only come from increased taxes later), and it also can come in the form of a tax now - if you just print tons more money, you increase the money supply, thereby increasing inflation. So now all of the money you have now is reduced in value. There really is little difference between having a tax of 5% per year on your savings account and 5% inflation. So unless you cut spending, tax cuts are meaningless, irresponsible political pandering.

I'm all for lower taxes as a general rule, and lower spending as well. But I'm not for using lies and bullshit to get us there. And I'd rather pay higher taxes with a balanced budget than lower taxes while we deficit spend ourselves into oblivion. Call me crazy, but I favor responsible financial behavior (see previous post about that).


BOY IN THE PEW said...

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Mike said...


I've been saying both those things for years. A tax cut in a structural deficit environment is a lie. In a situation where the deficits are short-term, it is a little more complicated, but a deficit that you have no plan to pay down is a stealth tax.

And somebody a while back used to call Supply Side "Voodoo Economics". Sure, it makes sense in the extreme ends. Even there (short of 100%) I doubt that the incentive factor is particularly important. If you have to earn $100 to take home that extra $10, well, you do what you have to do. Same as if you have no taxes at all. But extremely high taxes mean little capital to invest in new economic projects, and lots of resources moving to underground economies. Doesn't matter, though, because we aren't anywhere near the level of taxation where cutting taxes is going to have the kind of dramatic impact on the economy that the Laffer curve requires.