Sunday, December 11, 2016

12/11/2016 Taxes and Revenue

Just a quick note on dynamic scoring.

The bipartisan congressional budget office calculated the so-called Bush tax cuts as a way of optimizing tax revenue over long time periods.

Nothing magical there.  If the government taxes 100% of your income it should get 0 dollars in revenue because you won’t work – or at least that’s the theory proposed by Art Laffer.  The “Laffer Curve” is a hypothetical tax revenue curve between 0% taxation and 100% taxation, with both 0% and 100% collecting 0 dollars in revenue, and the optimal point being somewhere in between.

Both Democrats and Republicans accept the basic concept, but disagree on where that optimal point would be.  On the left, Paul Krugman places the top rates at a whopping 65% before “economic distortion” sets in.  The CBO placed the top rates at 35%.

But who is right?

The answer isn’t so simple.  The maximum tax revenue collected depends on how long a time frame we are measuring.

To give a real-world example, let’s compare the United States and the Soviet Union during the cold war.  The government of the USSR was able to keep pace with us for about 70 years before it finally collapsed.  Granted, the people were impoverished, but the government was able to squeeze a theoretical 100% taxation / with redistribution into a competitive arms race that left the future of freedom in doubt for generations.

How?  If the Laffer Curve truly collects 0 revenue at 100% taxation, wouldn’t people stop working?  Well, no.  People still work for the common welfare (or to keep from going to the Gulag), but they do so with less creativity and less resources.  Nevertheless, they do indeed work, and over the course of long time frames a communist regime can sustain about 40% of the resources that the United States can with our present system.

Over shorter time frames a Communist government can collect as much revenue as a Capitalist one.  How short?

“Short” in historical terms, but a full lifetime for a typical human.  The chart above has 146 lines, each measuring how much revenue would have been collected from United States citizens at each percentage of taxation from 1871 to the present.

Obviously for the top line – measuring the full 146 years – the maximum revenue point is at an average rate of 27%.  Keep in mind that 27% is the average for total GDP for the federal, state, and local levels.  That is, all taxes of all kinds combined should be about 27% to collect the maximum amount of sustainable revenue.  Since the federal government historically collects between 15% and 20% of GDP, that leaves a little less than half for the states and local municipalities.

But what’s not so easily visible on this graph are all the lines clustered at the 100% taxation rate.  For the first 69 years maximum revenue would have been collected at the 100% rate!

And that’s why the Soviet Union was able to keep pace with us in the cold war until it was about 70 years old.  Communism works, in the extreme short term, and only for the government.  It doesn’t really work for the citizens at any point.  But the government can impoverish its citizens and maintain full revenue for about 70 years before economic distortion breaks its back.

My point is this: Republicans are right about the ideal rates, but they are wrong about the immediate gains.  Lowering taxes is better for the economy, and over the course of centuries it is better for the government too.  But that’s CENTURIES.  Immediate benefits in a single Presidential term are fantasies that only work if the demographics kick in at the right time.  Kennedy and Reagan had favorable demographics.  We don’t.

I understand that the next President plans to lower taxes to the CBO calculated rates.  He is absolutely correct to do so.

But he also has to cut spending; because if you cut taxes, in the short term you also cut revenue.

In a 4 year time frame more taxes means more revenue and less taxes means less revenue.  The Democrats are right about short time frames.

So was the Soviet Union.

But should a government only think in terms of 4 years?


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