It is common practice for liberal democrats to suggest increasing taxes
on the rich in order to reduce the deficit. It is said that the ‘rich’ need to
pay their ‘fair share’ and contribute more in tax revenue. President Obama himself
said in the beginning of the year,
“I will ask for more tax increases on the rich later[1].”
On the other hand, conservatives typically want to reduce taxes and cut
spending. Also, conservative economists typically point to times in history
where reduced tax rates led to increased tax revenue[2].
Recently, there has been more talk from conservative and libertarian political
pundits that spending cuts coupled with decreased tax rates are the solution
for putting America on a sound economic path. Economists, such as Paul Krugman,
disagree with these suggestions and warn that ‘austerity’ measures will only
hurt the US economy and more deficit spending is needed[3].
At the core of US tax policy is the debate is between the Keynesian and
the Austrian view of economics. Krugman sides with the Keynesians, while
economists like Friedrich Hayek are in the Austrian camp. The debate has been
raging between the two since their inception. Each camp will point to specific studies
or periods in history to prove their theories.
In my opinion, the Keynesian view doesn’t make logical sense. Keynesians (Krugman) argue for additional
government spending to boost economic activity. This part makes sense; money in
the hands of consumers is good for economic growth and encourages economic activity.
The problem is the way in which money is given to the consumer. Under the
Keynesian view, money is typically distributed by government ‘stimulus’
programs; however, in order for the government to be able to distribute this
money it needs tax revenue. This is the major flaw in the theory. Typically,
Keynesian economics are employed during an economic recession or depression.
Aggregate demand needs to be increased, so the government decides to flood the
economy with stimulus. However, in times of economic depressions, money becomes
scarce among the middle and lower classes, so where are they supposed to find
the tax revenue to fund the stimulus? High income earners are tapped for their
wealth and are told they need to ‘pay their fair share’ to help out the rest of
the country. The issue here is, do increased tax rates on the rich actually
produce additional tax revenue? By just looking at the theory, simple math makes
it easy to assume that increased rates will produce more revenue – more money
being taken by the government means the government has more money, right? But, the problem is, it doesn’t.
Conservative economists have found that when you increase taxes on the
rich, they tend to either find additional loopholes to avoid paying taxes or
shelter their money in other countries. This then reduces government revenue
and leads to an increased deficit. It strains families who are trying to get by
because the tax increase shifts costs to middle-class consumers. The
conservative/Austrian view advocates for across the board reduction in tax rates
as the means with which to put money in the pockets of Americans.
Given the constant debate between the two economic camps, I decided to
find some data on my own and do some analyses.
In my search, I used married-filing-jointly tax rates from 1970-2012
from the Tax Foundation[4].
For government revenue, outlays, and surplus/deficit information, I used information
from the Office of Management and Budget (OMB)[5].
I decided to run a correlation analysis, which provides a numerical
representation of the relationship between two items, to see if there was a
correlation between tax increases and overall government revenue, and also to
see if tax increases reduces the overall budget deficit. The first analysis I
ran was between tax revenue and the top income tax bracket. I did this in order
to see if higher taxes on the rich did actually generate higher tax revenue. In
a correlation analyses, the closer the correlation value is to 1 or -1, the
stronger the relationship; the value for my first correlation analysis was R = -.763.
In other words, those who pay the highest taxes under the married-filing–jointly
status is significantly (p=.00)
negatively correlated with tax revenue.
So, as tax rates increase on the wealthy earners, tax revenue decreases.
This fits within the conservative view of economics and is also at odds with
the President’s current insistence that we need to increase taxes on the
wealthy in order to increase government revenue. At least in this instance,
married-filing-jointly tax rates should be reduced to increase revenue
(counterintuitive, I know).
Now, let’s continue and see how tax rates on the rich affect the
overall deficit. When I ran the correlation analysis between the overall
deficit and highest tax rates, the results were a little different than
expected, with a correlation value of R =
.387.
The results of this analysis show that as tax rates on the rich are
increased, the surplus also goes up. There is a statistically significant (p=.01) relationship between increased
tax rates and deficit reduction, although it is weak. This doesn’t exactly make
sense given the first test. If it is true that increased taxes reduce
government revenue, how can increased taxes reduce the government deficit? In
order to figure this out we need to adjust the correlation test. For the first
test I ran a bivariate correlation because tax rates have a direct link to
government revenue. Because the deficit depends on both tax revenue and
spending, I decided to control for spending (outlays).
When we control for government spending, the correlation returns to
negative (R=-.334) and is
statistically significant (p=.03). This
result makes sense given the results of the first test. Since government
revenue is reduced from tax increases, the overall surplus of the government is
reduced as taxes are increased.
The results of the tax rates and revenue test are important. Due to the high correlation value (p=-.763) of the initial analysis looking
at tax rates and government revenue it is clear that increasing tax rates on
the rich reduces government revenue. The results from the tax rates and deficit
test are not as important; the correlation is there, but it isn’t strong enough
to be conclusive. The issue with making the case that taxes on the rich will
reduce the deficit is that it’s overly simplistic. There are many factors that
come into play when looking at the budget deficit. New government entitlements,
as well as wars, have a much greater influence on budget reduction than
increased tax rates.
What can be learned from this information is that low tax rates do
actually increase government revenue. When you start to increase tax rates on
wealthy Americans, the job creators, their investments are taken elsewhere[6].
All of the political rhetoric in Washington about taxes and revenue has nothing
to do with actual numbers. It’s all a game – a way to win votes. If only our
politicians stopped the partisan bickering and looked at some hard numbers,
they would come to an agreement on tax policy. Keep taxes low, and in a time of
crisis, drop them even lower and promote growth.
I vote for a flat tax for all. No exceptions and no conditions. The current tax code is so complex, we had a Secretary of the Treasury Timothy Geithner, unable to properly fill out his returns and had amended them when it was reported that the President wanted to nominate him to the position.
ReplyDeleteWhat is truly incredible is when someone, like the Secretary of the Treasury, doesn't file his taxes properly people don't make a big deal out of it and the government doesn't investigate. But when a business, like Apple, uses tax loopholes legally they are blasted in the news and politicians cry for more regulation.
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