Sunday, July 13, 2008

Can We Really Soak the Rich?

If you pay much attention to politics, you'll hear a lot of politicians, especially Democrats, talking about “soaking the rich” by raising tax rates for the top tax bracket. But do you know the rich already pay the lion’s share of taxes in this country?

New data from the IRS will be out in a few weeks on who pays how much in taxes. My contacts at the Treasury Department tell me that for the first time in decades, and perhaps ever, the richest 1% of tax filers will have paid more than 40% of the income tax burden. The top 50% will account for 97% of all federal income taxes, while the bottom 50% will have paid just 3%.
Further, increasing the top tax rate has a negative effect on the economy. Here’s the deal, according to the Wall Street Journal:
Will increasing tax rates on the rich increase revenues, as Barack Obama hopes, or hold back the economy, as John McCain fears? Or both?

Mr. Hauser uncovered the means to answer these questions definitively. On this page in 1993, he stated that "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." What a pity that his discovery has not been more widely disseminated.

The chart [at the link], updating the evidence to 2007, confirms Hauser's Law. The federal tax "yield" (revenues divided by GDP) has remained close to 19.5%, even as the top tax bracket was brought down from 91% to the present 35%. This is what scientists call an "independence theorem," and it cuts the Gordian Knot of tax policy debate.

The data show that the tax yield has been independent of marginal tax rates over this period, but tax revenue is directly proportional to GDP. So if we want to increase tax revenue, we need to increase GDP.

What happens if we instead raise tax rates? Economists of all persuasions accept that a tax rate hike will reduce GDP, in which case Hauser's Law says it will also lower tax revenue. That's a highly inconvenient truth for redistributive tax policy, and it flies in the face of deeply felt beliefs about social justice. It would surely be unpopular today with those presidential candidates who plan to raise tax rates on the rich – if they knew about it….

What makes Hauser's Law work? For supply-siders there is no mystery. As Mr. Hauser said: "Raising taxes encourages taxpayers to shift, hide and underreport income. . . . Higher taxes reduce the incentives to work, produce, invest and save, thereby dampening overall economic activity and job creation."
So if you’re counting on tax increases for the rich to fund your big new government programs, like Obama is, you’re most likely going to be awfully disappointed when the money doesn’t come in. Plus the whole economy will slow down at the same time. Nice.

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