Monday, January 14, 2013

01/14/2013 Calculating the true Rahn curve (corrected graph)

"In theory, theory and practice are the same. In practice, they are not."
-- “Yogi” Berra


One of the more telling moments in the Republican Presidential primaries was when the candidates were asked what the correct tax rate should be.

Michelle Bachman piped up with something she thought she could sell, “Zero!”

Er, no.  Government actually does serve a purpose… up to a point.  If we had no government, then someone else’s government would send their troops over here and take everything; or the gang down the street would charge us “protection money” while they took one of our daughters for a ride.  Governments do serve a purpose – even for businesses.  Governments can enforce copyright and patent law to protect a business from having its intellectual property stolen.  Governments can protect citizens from fraud.

In short, government can enhance the economy by giving a stable framework in which the public can work.

If the government is too small it cannot protect us from bandits.  If the government is too big, it BECOMES the bandit.

Hence the “efficient set” postulated by Rahn.

In my original assessment of the Rahn curve, I speculated that one should estimate the maximum aggregate potential of both public and private sectors together (peaking at a government spending rate of 15% of GNP).  And, while that may be true if there were only one government on the planet, the existence of other governments shifts the curve slightly to the right for national defense and international trade regulations.  At least, that’s my hypothesis.  The reason for my change is a bit more mundane: I reviewed the revenue data and saw that government efficiency only falls after the private sector has given up half its wealth to taxation.

That’s not a 50% rate, since we are iteratively taxed: i.e. I pay you after I’m taxed, you pay your grocer after you are taxed, and your grocer… doesn’t buy much of anything by that point.  After 20%, half of the private economy has been devoured by taxes.

I’ve updated my idealized curve, then, with a peak at 20%, at which point the government becomes more trouble than it is worth.

First the idealized sets:


The Laffer Curve shows the point of the highest progressive tax rate.

The Rahn Curve shows the point of the highest average tax rate.

As I noted the other way, in a progressive tax system, a maximum tax rate of 35% would produce an average tax rate of 19% -- very close to that 20% (easily absorbed by rounding, Corporate Taxes, Capital Gains, and Inflation).

My tax brackets are the same as the other day:

and up


You would still get the $2,000 per person in the household deduction, though, because I was rounding those brackets in favor of the government to begin with and when I re-rounded with the change the results were the same.  Essentially every bracket was rounded up to the nearest $50,000 rate to account for normal inflation and GDP growth – a good 4%.  Since I was only allowing 4% in maximum deductions, it turned out to be a wash.

Hooray for rounding…

However, two things WILL change: Capital Gains and Corporate Taxes.  But first, the actual historic U.S. Rahn Curve:

My idealized Rahn Curve now caps at 20%.

The actual historic Rahn Curve appears to cap at 20% -- rather dramatically I should add.

Here are the two on the same scale:

Capital Gains and Corporate Taxes should therefore be 20%.

Oh – and there should be a single Capital Gains rate at 20%.  The difference between long and short term is an artificial difference anyway, since the less often you trade the less you will be effectively taxed, as I showed in my post on Compounding and Taxes:

Sorry about the bump from 15% to 20%, but at least I’m willing to listen to the data (unlike some people in Washington).

We’re almost finished, and there are two items left.

First, inflation.  The current Fed target is 2% annual inflation.  This seems to be embedded into the human experience from the dawn of time.  Even the Bible has a fifty year Jubilee in which all farmland reverts back to the original owning families: effectively an economic reset every fifty years (and they should STILL do that for farmers, rather than having the death tax break up family farms each generation).

In any case, this turns into something like 100% inflation once every fifty years.

2% each year serves pretty much the same purpose in a non-agricultural economy.  Regardless of your theory, it’s a fact of existence and simply serves as a backdrop for everything else.

HOWEVER, it does play into deficits.

Yeah – deficits – the last piece of our puzzle.  Do they do any good?

Actually, they don’t do that much at all.  There is a difference between correlation and causation.  In my own analysis so far, there is NO discernible causation from deficits to per capita revenues.  The reason should be obvious: revenue drops create deficits, and those deficits are caused by the random noise of a business cycle that is more variable than the government.  But that’s the whole idea of Keynesian theory.  Whether you agree with it or not, it DOES tend to make government spending more stable than government revenues.  Granted, it’s more stable expansion, but that’s a different subject.  What we want to know is if stimulus creates economic growth.

It’s not visible in this PARTICULAR study.

But is it at least correlated?

No; not even that:


Again, the causation should be from revenues to deficits.  The size of revenues influences deficits, not the other way around.

Nevertheless, we DO see that per capita revenues correspond to a peak at a 2% government surplus.

That means that the government CAN, on average, balance its budget.  It is a reasonable target to reach over time, and over the next few decades an AVERAGE annual surplus of 2% would go a long way toward shrinking the Federal debt.

The Fed inflation rate target of 2% would shrink the value of that debt as well.

These are achievable goals, but they would require the government to reach for maximum tax revenue – to collect as much money from the governed as possible: which would require:

A maximum progressive tax rate of 35% (no less, no more).

An average tax rate of 20% (no less, no more).

A single Capital Gains rate of 20% (either that, or eliminate capital gains as a separate category and just treat it as part of normal income).

Flat tax deductions (based on a finite amount per person, regardless of income bracket).

A Corporate tax rate of 20%.

An average spending rate between 0% and 2% LESS than revenues.

Current government programs can stay in place… for now.  But the rate of growth would have to be kept 1% lower than the rate of growth in the private sector, and even then it would take decades to dig out of this hole.

But it CAN be done.

Whether it WILL be done is doubtful.

Keep in mind that there are reasons for both Democrats and Republicans to pass by these solutions.  Democrats may not be able to mathematically understand that 25% of GNP is smaller than 20% of GNP (because GNP becomes smaller).  Republicans may not like the draconian treatment of the rich in a progressive income tax system that has flat deductions.

And yes, the rich will pay more – a lot more – with flat deduction limits.

But the Republicans have ALREADY budged on the idea of flat deduction limits.  All that would be needed would be for the President and leading Democrats to understand the concept of dynamic scoring.  Reaganomics was first done by Kennedy.  It’s a Democrat idea!  Take it back!

The data is there.

It’s not THAT complicated.

It just needs to be seen – and only taxpayers can compel them to see it.

Now, where’s the “Go Viral” button on this keyboard…?



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