A budget solution that isn't very taxing

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Here's a fascinating fact that ought to be guiding budget negotiations:

Since the end of World War II, federal tax revenues from all sources have averaged 19.6 percent of the gross domestic product, according to a study by the American Institute for Economic Research.

In the 63 years AIER studied (1947-2010), revenues exceeded 20 percent of GDP only once (20.6 percent in 2000), but have fallen below 19 percent 55 times.

Since 1947, federal personal income tax rates have ranged from 28 to 92 percent; corporate income tax rates from 35 to 53 percent; deductions and exemptions have been added and eliminated; FICA (payroll) taxes have been raised and cut, and the inheritance tax has ranged from 77 percent to zero.

Who gets taxed how, and by how much, are important questions which have moral implications, and can have profound economic consequences. But however high tax rates rose, revenues rarely -- and barely -- exceeded 19 percent of GDP.

If no matter how tax laws are changed, tax revenues will fall somewhere between 19 percent and 20 percent of GDP. Then the only way to increase tax revenue significantly is to grow the economy. So changes in tax policy should be judged by how the change would affect economic growth, because only this will make a significant difference in revenue.

We must have government, so we must have taxes to fund government. But we should remember, always, that taxes -- all taxes -- inhibit growth. As Jack Kemp said: "You get more of what you subsidize; less of what you tax." The higher tax rates go, the heavier is the government's foot on the brakes.

There are always two tax rates that produce the same amount of revenue, said economist Arthur Laffer. A low rate can generate significant revenue because there will be so much economic activity to tax. As rates rise, economic activity declines. When rates get too high, cutting them can produce more revenue. Presidents Harding, Kennedy, Reagan and George W. Bush each made major reductions in income tax rates. Each time, revenues rose substantially.

Although all taxes hurt, some harm growth more than others. Our individual income tax rates are low, both by our own post-WWII historical standards and by comparison with our chief international competitors. Our corporate income tax, on the other hand, is among the highest in the world.

It isn't just the effective tax rate that inhibits growth. A tax that is simple and clear, stable and perceived to be fair is better for the economy than a complex, constantly changing tax, even if it has a somewhat lower rate.

Tax rates aren't the only -- or these days the most important -- government policies that affect economic growth. It's stifled more by our mammoth budget deficits and an orgy of new federal regulations.

Bad things happen to an economy when debt exceeds 77 percent of GDP. When debt exceeds 90 percent, growth rates are cut by half. Our $16 trillion debt exceeds 100 percent of GDP.

The cost to business of complying with federal regulations was $1.7 trillion, the Congressional Research Service estimated in 2008. That burden has increased significantly during the Obama administration. When all Obamacare rules go into effect, it'll grow to at least $1.8 trillion, according to the Competitive Enterprise Institute. That's 74 percent more than all the revenue from the personal income tax last year ($1.034 trillion).

What should these facts tell budget negotiators?

• Because it's the effective ceiling on revenue, no matter how we manipulate the tax code, spending must be held below 20 percent of GDP. If the government keeps adding to our mammoth debt, it won't just exert more drag on the economy. It'll crash it entirely.

• Cutting corporate income tax rates could partly offset returning personal income tax rates to what they were before the Bush tax cuts.

• Making the tax code more simple and clear -- and then keeping it stable -- could partially offset the harm done by raising rates.

• Regulatory reform could boost the economy more than tax hikes or spending cuts would slow it down.

So Republicans should compromise on taxes if Democrats agree to real, substantial, and immediate restraints on spending, because, as the AIER study makes clear, that's the only way to reduce deficits.

Jack Kelly is a columnist for the Post-Gazette (jkelly@post-gazette.com, 412-263-1476.


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