Wednesday, December 19, 2012

Taxpayers Aren't Stationary Targets

By Sheldon Richman

Actor Gérard Depardieu's decision to flee France for Belgium to avoid a 75 percent marginal tax rate on incomes above $1.3 million sends a message we here in America should heed: Those who are singled out for tax increases are not stationary targets. The means of avoiding and evading the taxman are legion.
U.S. government agencies routinely issue estimates of how changes in the tax code will affect the flow of revenues to the treasury. President Obama says the tax changes he has been seeking will bring in $1.6 trillion over a decade. But such estimates assume taxpayers are something other than human beings who engage in purposive action. People like to keep the money they make—why shouldn't they?—and they typically avail themselves of every legal (and not-so-legal) strategy to do so. Change the tax environment by raising rates or adversely modifying the rules, and taxpayers, especially those in the upper echelons of earners, can be counted on to modify their conduct accordingly; there's no reason to think their wish to hold on to their money has diminished just because the tax code has changed.
Economists as far back at J. B. Say and Gustave de Molinari in the 19th century understood this. As Molinari wrote in his 1899 book, The Society of To-morrow, "The laws of fiscal equilibrium set a strict limit to the degree within which it is possible to impose new taxes, or to increase the rates of those already in force. The relative productivity of taxes soon shows when this point has been overstepped, for then returns not only cease to rise, but immediately begin to fall." 
Things can work in the other direction too. Other things being equal, cutting tax rates can prompt revenues to rise. This is not to say rising revenue is a good thing. As Milton Friedman once said, if a tax-rate cut brings in more revenue, the rates weren't cut enough. Hear, hear! 
Nevertheless, revenues can increase after a rate cut. Case in point: the rate cuts of 2001 and 2003, the so-called Bush tax cuts, which President Obama (until yesterday) had been hoping would expire for the top 2 percent of earners. According to the Congressional Budget Office, revenues increased from $1.9 billion in 2003—when all the cuts kicked in—to $2.3 billion in 2008 (in constant 2005 dollars). At that point the Great Recession hit and of course revenues then fell. Tax revenues always fall in a recession because when people lose their jobs they stop paying the income tax. Companies also pay less as economic activity slows down. When would-be tax raisers today complain that revenues are a smaller percentage of GDP than in previous years, that is the reason. It's not that the tax rates are too low.
Leaving recessions out of the account, for the past 60 years federal tax revenues have been rather steady at just under 19 percent GDP regardless of the tax rates. The top income-tax rate has ranged from a low of 28 percent in 1988-90 to a high of 92 percent in 1952-53, yet the flow of money has been a fairly constant proportion of the economy. This would seem to confirm the apparently controversial hypothesis that taxpayers are purposive human beings who can be counted to modify their behavior according to the incentives and disincentives that government places in their paths.
Yet most politicians don't get it. In the Wall Street Journal a few years ago, W. Kurt Hauser, formerly of the Hoover Institution, wrote:  
Even amoebas learn by trial and error, but some economists and politicians do not. The Obama administration's budget projections claim that raising taxes on the top 2% of taxpayers, those individuals earning more than $200,000 and couples earning $250,000 or more, will increase revenues to the U.S. Treasury. The empirical evidence suggests otherwise. None of the personal income tax or capital gains tax increases enacted in the post-World War II period has raised the projected tax revenues.
"Hauser's Law" seems quite robust. Over 60 years, "there have been more than 30 major changes in the tax code including personal income tax rates, corporate tax rates, capital gains taxes, dividend taxes, investment tax credits, depreciation schedules, Social Security taxes, and the number of tax brackets among others. Yet during this period, federal government tax collections as a share of GDP have moved within a narrow band of just under 19% of GDP." 
The explanation is simple enough for a child to understand, though politicians have difficulty with it: 
When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income. Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments. This behavior tends to dampen economic growth and job creation. Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs. Taxpayers have less incentive to shelter and shift income.
Hauser shows that GDP grows faster when taxes are lower. "In the six quarters prior to the May 2003 Bush tax cuts, GDP grew at an average annual quarterly rate of 1.8%. In the six quarters following the tax cuts, GDP grew at an average annual quarterly rate of 3.8%. Yet taxes as a share of GDP have remained within a relatively narrow range as a percent of GDP in the entire post-World War II period." 
So where does that leave us as we head for the "fiscal cliff"? Obama has backed away from his intention to raise the top 33 and 35 percent tax rates to 36 and 39.6, respectively, on people making over $200,000. Now he says he is willing to have only the top rate raised to 39.6 percent on people making more than $400,000. This, he adds, would raise $1.2 trillion over a decade—again assuming those people are stationary targets.  
Republican House Speaker John Boehner has also been seized with the spirit of compromise. From his earlier no-tax-increase position, he is now willing to see the top rate raised on people making over a million dollars. He expects $1 trillion to be raised. 
But in light of the information above, this all appears to be Washington's standard ritual dance. When—or if—the economy recovers from the recession, revenues will rise to their historic level whether or not Congress tampers with the rates. One need not leave the country, à la Depardieu, to escape taxes. But raising the rates in a struggling economy will help assure that the economy keeps struggling.  
The tax raisers like to point out that the economy boomed during the Clinton years even though top tax rates went up. But this is a simplistic claim. Many other things were going on at the same time—such as the productivity boom ignited by the desktop computer and information revolution—that offset the higher rates. Economic growth likely would have been even greater had the burden of government been lighter.
Alas, the new bipartisan climate in Washington is turning uniformly pro-tax hike. This is sad news, indeed. If taxes can't be cut, at least they shouldn't be raised. First, do no harm! Meanwhile, spending of all kinds must be slashed deeply.

Sheldon Richman is the vice president of The Future of Freedom Foundation (FFF) and editor of its monthly, Future of Freedom. He is the author of three books published by FFF:Separating School & State: How to Liberate America's Families (1994); Your Money or Your Life: Why We Must Abolish the Income Tax (1999); and Tethered Citizens: Time to Repeal the Welfare State (2001). Previously, Richman was the editor of The Freeman (Foundation for Economic Education), 1997-2012.

The above originally appeared at The Project to Restore America and is reprinted with permission.


  1. There's another thing to consider here. While FED money pumping artificially decreases risk aversion, tax increases increase risk aversion. When your risk is guaranteed to bring you fewer profits, you are less likely to take the risk.

  2. This is all well and good, except for the fact that the end game for the statists is a one world government. Where are you going to go, then? Mars? The Moon.

    1. For US citizens that is already the case since simply leaving the US is not enough to avoid the taxman as it is everywhere else in the world. You have to give up your citizenship and pay an exit tax (I guess they did that to stop people from leaving before they die to avoid estate taxes). My view is that as rates go higher, I will try to work less. Right now I'm planning to increase my income and cut expenses to deal with the tax increases coming my way. At some point, as in the case with France, that makes no sense.

  3. The typical Washington politician defines spending cuts as "spending less than I'd like" rather than "spending less next year than this year." Sure, it's deceitful, but what do you expect from the political class?

  4. I think Hauser's Law is generally true, but I am curious as to why it differs by country. If you look at some countries, they are able to expropriate 30% of GDP in taxes. How are they doing it (other than by destroying incentives, etc)? I don't think Hauser's Law is absolute. There could be a time when they figure out a way to extract MORE from the taxpayers. Therefore, the moral argument will always be stronger, IMO...

    1. Hauser's law crosses borders when you consider the whole picture: the US is much less centralized than other OECD nations. While Federal taxes grab 20% of the nation's output, state and local govt grabs 8-12% depending on region. When you exclude the Europeans' health ministries and the tax revenues that pay for them, we are sadly not under a lesser burden than Western Europe.