The Tax Deception Exposed

Written by Dan Lieberman, Alternativeinsight

“A good catchword can obscure analysis for fifty years.”
 – Oliver Wendell Holmes

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Without proof, the Republican Party and Grover Norquist’s Americans for Tax Reform have pushed catchy expressions into our lexicon, casually and with absolute conviction. Two of the most prominent are:

•  Lowering income tax rates benefits the economy.
• Raising income tax rates harms the economy.

These beliefs, which derive from the assumption that if income tax rates are decreased then total spending in the economy will increase, are shibboleths and not supported by analysis or facts. Being based upon subjective statements and unproven expressions, such as private spending is more efficient (how is efficiency defined?), and its spending has a greater multiplier (can a multiplier be greater than unity?), rather than objective assessments and proven theory, the beliefs are reduced to conjecture. 

A simple analysis exposes the fallacies of both expressions. Taxes transfer money between the government and the taxpayers; neither method adds or subtracts new money nor allows more or less available spending to the economy; the purchasing power stays the same. This transaction assumes no compensating transaction, such as additional budget deficit or consumer borrowing, all tax revenue is spent, and the government budget does not have a surplus. Essentially, if the income tax is lowered, the employer credits the employee bank account with additional funds and the government receives an equivalent less dollars in its account. The GDP formula: 

GDP = C + I + G + (Ex – Im)

  where “C” equals spending by consumers, “I” equals investment by businesses, “G” equals government spending and “(Ex – Im)” is the trade balance, shows that the tax transfer between government and consumer does not change the GDP; available spending remains constant.  

 The total purchases of goods and services stay the same; the goods and services are different. Can the total economy fall or grow without a change in the money supply and a change in purchasing power? There might be factors, such as buying imports, differences in velocity of money, savings, or investing that influence the outcome in the newly established path of the money flow, but these are unknowns and not easily characterized. Actually, lowering taxes can be detrimental to the economy, while raising taxes may provide definite benefits.

 Raising taxes transfer funds from the consumer to the government.  

The government buys a product, such as airplanes from Lockheed. The manufacturer hires workers to produce the aircraft. The total wages paid the workers almost matches the raised taxes. Spending by the new wage earners ripples through the economy, and, in its final appearance, will almost match the reduced consumer spending of the taxed individuals. Consumer spending stays the same, but money circulates through other channels. Employment, production, and GDP increase – give one advantage to tax increases.

 Lowering taxes does the opposite; forces the government to purchase less goods and services and therefore does not help to increase employment. The money and spending remains with the already employed and does not allow new employment with equal spending. Because lowering taxes lowers government revenue, budget considerations might demand an increase in budget deficits.

 Lowering taxes mainly assists the already employed, and that is not the major priority. Who pays taxes – the employed. Who receives tax breaks – those who pay taxes. In effect, lowering taxes redistributes federal assistance from needy persons to the employed. Which is preferable, redistributing income so the employed have more to spend or redistributing the income so the underemployed have something to spend?

Stimulating the economy by tax breaks is a psychological phenomenon. The talk, exaggerations, promises, and general optimism of tax breaks fashion a more optimistic public, which supposedly stimulates spending, investment, and courage to carry more debt. Creeping in to the debate is another assumption – those who have excess funds will invest and stimulate growth. Not considered is they might invest in speculative ventures that only churn money or might purchase imports, which decreases purchasing power in the domestic economy.

 The taxpayer does not have the tools that are available to the government to stem a downturn and spur growth. 

Well-directed government spending creates jobs, lowers unemployment, and raises the GDP to higher levels than randomly directed spending. Can consumers supply the funds for new industries in the energy field? Can consumers implement infrastructure projects that employ workers? Another often-quoted and spurious shibboleth – The government cannot create jobs, only private industry creates jobs.

 In the past, U.S. government agencies have originated, developed, and financed the transportation industry, electronics industry, interstate highway system, medical advances, communications, space industry, and the defense industry. Defense agency’s DARPA infrastructure initiated the omnipresent Internet. Add the rescue of companies from bankruptcy and promotion of gigantic job and educational programs. 

GDP has steadily grown, with a few bumps, in the last 70 years, and no relation to lowering of taxes has been proven. A government report: Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945 (Thomas L. Hungerford Specialist in Public Finance, September 14, 2012)  has this conclusion:

The top income tax rates have changed considerably since the end of World War II. Throughout the late-1940s and 1950s, the top marginal tax rate was typically above 90%; today it is 35%. Additionally, the top capital gains tax rate was 25% in the 1950s and 1960s, 35% in the 1970s; today it is 15%. The average tax rate faced by the top 0.01% of taxpayers was above 40% until the mid-1980s; today it is below 25%. Tax rates affecting taxpayers at the top of the income distribution are currently at their lowest levels since the end of the Second World War The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution. As measured by IRS data, the share of income accruing to the top 0.1% of U.S. families increased from 4.2% in 1945 to 12.3% by 2007 before falling to 9.2% due to the 2007-2009 recession. At the same time, the average tax rate paid by the top 0.1% fell from over 50% in 1945 to about 25% in 2009. Tax policy could have a relation to how the economic pie is sliced-lower top tax rates may be associated with greater income disparities.

In the world of probability, all types of statements might prove correct at certain times. As one example, supporters of lowering taxes during recessions mention Herbert Hoover’s tax increase during the 1931 year of the Great Depression and Franklin Roosevelt’s 1936-tax increases in the top income brackets, as examples of destructive tax measures. In both cases, economic downturns followed the tax increases. Sounds logical, that if A occurred before B, then A must be responsible for B. However, simple relationships do not automatically constitute logical arguments. In both cases, the presidents raised taxes to balance the budgets and stop runs on the U.S. dollar. By forcing budget revenues to follow budget expenses, those administrations refused to pump the economy with deficit spending and limited the budgets from reacting to the wants of fragile economies. Besides, in 1932, the economy was already falling rapidly, and in 1936, substantial increases in union wages added to corporate uncertainties. Capital rebellion followed the labor rebellion.

Taxes should be used mainly to balance the budget and not to regulate the economy.

Ever since the demands of the United States Civil War, social and economic circumstances forced American governments to tax its citizens according to budget needs. Massive industrial growth, population expansion, and rapid change in all sectors of society prompted government intervention to maintain the national ship on even keel and prevent calamities. Budgets adapted to sharply changing and disparate conditions and forced immediate responses to wartime, peacetime, and distressed times. A responsible budget solicits taxes to obtain national benefits that exceed the benefits obtained from leaving an equal amount of revenue with the wage earners. The budget expense often promotes wage increases that far exceed the added tax assessments. One example is the interstate highway system, which escalated the automobile industry to become America’s prominent revenue maker and employer.

 Opposition to specific taxes and tax rates deserve debate, but transfer of public spending to private spending does not increase total spending, and may skew the economy. Optimizing tax programs is a challenge that proceeds from maintaining a suitable quality of life for wage earners and allowing sufficient profit margins for capital reinvestment. Taxes respond directly to the budget, and not in accord with the shibboleth that taxes can regulate the economy. Corporations, small business, and the public have operated well in all types of tax situations. Domestic and government spending enter the economy, start from different allocations, and eventually circulate at similar rates. In an economy of excessive unemployment, caring for the needs of the deprived comes before adding to the wants of those who have sufficient resources.

Media salutations, public relations, and political expediency have brightened the private sector and darkened the public sector, conditioning the citizenry to feel comfortable with private initiatives and to question public thrusts. To appease a confuse electorate, political compromise has replaced public responsibility – a route to disaster.

 It can be shown that lowering individual taxes may not benefit the economy. Time to expose the fallacy of a rash assumption and silence Grover Norquist’s Americans for Tax Reform.

This article is taken from a chapter of a new book in preparation: A New look at the Old Economics. Dan can be reached at [email protected]