Michael Solon latches on to a point I’ve made around here from time to time either directly or implicitly:
By consistently pushing for higher tax rates on top earners, and tax credits and lower rates for lower- and middle-income earners, Democratic tax policies have unintentionally left the government dependent on the prosperity of upper-income taxpayers. Since the current recovery is so dismal, revenues have tanked.
The country’s fiscal condition thus poses a choice for Democrats. They can harvest a great deal of revenue by making peace with a profitable and growing economy and with those productive individuals who create such an economy. Or they can embrace new taxes on both upper- and middle-income earners that will restrain economic growth. The latter course will make it harder and harder to raise the revenue that Democrats demand to fund the government they love.
There’s a basic problem with how the federal government is operating. The Congress appropriates, i.e. authorizes the spending, of a certain amount of money. Obtaining that amount of money in revenues is beyond its ability or, at least, beyond its political will.
The federal government obtains revenue from a limited number of sources: mostly from fees, from payroll taxes, and from personal and corporate income taxes. The personal and corporate income tax codes are burdened with an enormous cloud of special cases, exceptions, deductions, and so on. Gaming that system is, expectedly, a multi-billion dollar industry. As long as the Congress insists on using the tax code as a tool for rewarding friends, punishing enemies, and manipulating the behavior of the citizenry rather than as a mechanism for funding the government, that will continue to be the case. As long as it insists on wielding that tool, Congress will relinquish its control over how much money it takes in. I think that should have at least some impact on what the Congress appropriates but, obviously, the Congress doesn’t agree with me.
That’s why payroll taxes (FICA) have risen so much as a percentage of total federal revenues over the years. It’s much more dependable than the income tax. It more closely approximates the politically impossible head tax (“capitation”) on which the federal government once relied than taxes on income do.
The perverse thing about our entire system is that as a general principle if you tax something you get less of it than you otherwise would. The federal government is taxing income and jobs. Do we really want less of either of those?
Finally, there’s a well known result in economics: the optimal (in the sense of producing the most economic growth) tax rate on capital, real property, and estates is zero. Among economists there are a few dissenters from that but it’s pretty generally accepted. Our present system is just about as far from that as you can get. When people wonder why the economy isn’t growing faster, they might want to keep that in mind.
The perverse thing about our entire system is that as a general principle if you tax something you get less of it than you otherwise would
Playing Devil’s advocate though, people will always seek income regardless of taxation…especially with rates being pegged to marginal increases. Of course the higher those rates go, the greater the propensity for seeking loopholes and alternatives to taxable wages for income.
But what is the alternative to taxing income anyway? Would consumption taxes not be subject to the same axiom, with potential negative consequence for aggregate demand (or if my posited assertion holds true for consumption as well as earnings, then higher rates would lead to black market consumption and/or legal loopholes for consumption taxes.) Seems to me that the key is finding the sweet spot, regardless of what activity is being taxed. And that has to do with the limits of progressivity, before human nature takes over and finds an end run around paying one’s “fair share”.
We absolutely do, look at our tax code.
Or they can embrace new taxes on both upper- and middle-income earners that will restrain economic growth.
Higher taxation schemes always seem to work their way down the socio-economic ladder. IMO, the most vulnerable are the upper, middle and lower middle classes, as they don’t have easy access to creative tax shelters like the uber rich do, and yet are the reliable work horses and revenue sources of any economy.
Seems to me that the key is finding the sweet spot, regardless of what activity is being taxed. And that has to do with the limits of progressivity, before human nature takes over and finds an end run around paying one’s “fair shareâ€.
I agree. However, that ‘sweet pot’ is defined differently by the two main ideological groups, as related to one’s fair share.
I am one who thinks that taxation should be broad based and across the board — with higher income people paying more in because they are earning more. Lower income people pay lower amounts, but, nevertheless, do have an interest in taxation considerations by their participating in the game of paying something for their government.
Aggregate demand is more than just buying t-shirts with funny slogans, DVDs, flat screen televisions, beer and cheetohs. A consumption tax would also increase savings. Savings in turn could be used for investment purposes–i.e. capital (plants and machinery) that can result in increased production and also increased demand for labor (i.e. capital and labor as complimentary goods).
While this is undoubtedly true not all taxes are the same. For example, suppose I want to work and save so I can consume in later years. With an income tax I get the following:
[1+r*(1-t)]^T*W*(1-t)
where r is the real interest rate, W the real wage, t the tax rate, and T the number of years I’ll be saving. Nos lets posit a consumption tax, here is what I get,
(1-t)*W*(1+r)^T.
Notice that both expressions have W, (1-t) so we can get rid of those and we have,
[1+r*(1-t)]^T
and
(1+r)^T.
Note we can eliminate the T as well to get,
[1+r*(1-t)]
and,
(1+r).
The first expression can be re-written as,
(1 + r) – r*t.
So now we can get rid of the (1 + r) term in each expression.
Since the remaining term under the income tax is -r*t, it follows that the income tax discourages future consumption and current savings…i.e. we are worse off.
The other thing is that if we think of the first two expressions as relative prices (for labor) to the before tax price which is
(1+r)^T*W.
The consumption tax creates a constant deadweight loss over time. The income tax creates growing deadweight loss over time. Basically the consumption tax taxes consumption the same both now and in the future. The income tax on the other hand posses an increasing burden the longer you plan on saving.
So the income tax not only discourages working since it will negatively impact your current consumption it also discourages working to save. The consumption tax does not have the latter effect and is one of the reasons why many consider it a superior mode of taxation.
The federal government is taxing income and jobs. Do we really want less of either of those?
Obviously our lords and masters want less of those things. They also want more and more people in debt, and they want more and more people out of work. (Thus the push to give another 20 million or so Mexicans citizenship.)
And it is bi-partisan. The Republicans want this as much as the Dems, though for different reasons. Watch the as mighty tea party darlings all line up in favor of rewarding illegal immigration, and abandon any pretense of reforming the tax system.
The only question is which variety of bastard one wants to elect.
@ Steve V…very interesting…thanks for crunching the formulas.
Intuitively I tend to support consumption taxes over income taxes but I’ve had a hard time getting too interested in details because I think that outside of a small fringe there’s nearly zero political will to make the substitution, although before long there will likely be a push to add a consumption tax on top of income taxation.
I don’t think so. That’s where the byzantine character of our tax system comes into play. People seek to maximize income while minimizing taxable income.
Well I tried to address that in the next sentence…that although people still seek income, they will attempt to shield it from taxation as much as possible but will work much harder at this when tax rates surpass a certain level. Am I wrong in believing that the evidence bore this out after the Kennedy and Reagan tax cuts (tax revenues rising in the face of declining rates, in part due to more taxpayers refraining from the use of tax shelters?) I know I heard it on Rush Limbaugh’s show so it must be true…heh.
I guess what I meant by the pushback to that rule is that there is also some property of elasticity to the things that are taxed. That may not be an orthodox use of the term, but it seems apt to me.
And work/effort. If I can get the same income for half the work, awesome!
IIRC, there are significant differences in how the employer’s half of the payroll tax effect employment levels and compensation from that of the employee’s half. It would seem to make intuitive sense. Employees tend to be wage-takers and very few can do anything to avoid the tax. For employer’s the tax is a part of total labor costs, which include wages, and the employer may have some discretion in what kind of labor or hours or technology to use.
I should also have added that in some sense Social Security taxes are different. They are a vehicle for forced savings. Without SS we would hope that a certain percentage of income was set aside, and no doubt try to find some way to achieve a similar result.
PD,
There is a difference between the statutory burden of a tax and its actual incidence. Granted firms are required by law to “pay half of the tax”, but depending on the various elasticities it is entirely possible that the worker bears almost the entire burden of the tax. That is, if the payroll tax were eliminated then the worker would likely see an increase in his pay up to the entire amount of the tax.
Steve V, I don’t disagree at all with that conclusion (the employer’s half is eventually borne by the employee), I think that’s generally accepted. But I think it was also generally accepted that the economic effect of a payroll tax holiday for employers was different than that for employees. I think the elacities differ between employer and employee, at least outside of tight labor market. For one thing, the employer gets decide if wants to hire an additional employee.
If employees were assessed a 1% payroll tax increase going forward to go into SS, would employees quit their job? If employers were assessed a 1% payroll tax increase going forward, would the country find there were fewer jobs?
Of course, one is facing a demand elasticity the other a supply elasticity, they could be the same, but it would only be by coincidence.
Depends on the actual incidence of the burden. If it is predominantly on the former, then some may very well quit. Similarly for employers if they bear most of the burden. And if the burden is shared, then yes to both.
@PD
“Without SS we would hope that a certain percentage of income was set aside, and no doubt try to find some way to achieve a similar result.”
I’ve lost the link, but maybe Dave will point you to his posting on why Social Security, or something like it, is necessary. Short answer (IIRC): Folks can’t save enough to avoid poverty in old age.
@sam, I don’t know if that can be proven; Dave believes it; I believe it. This is in the background of my comments. I think people need to be forced to save, though one can argue about the means. I am troubled by the assertion that such policies would be anti-employment, not because I know whether its wrong/right, but because it makes the problem more difficult.
One difference between a physician and an economist. We have theories also. When we practice based upon those theories and patients die, we go look for new theories. Economists mostly double down. Lots of economists, maybe a large majority believe the the ideal cap gains rate is zero. When you look at the data, it really isnt clear that it has much effect. There is some evidence for income tax having a negative effect, and I support the idea of a consumption tax, but property taxes may have the least income economic distortion while being the most disliked. I dont buy it for estate taxes at all.
Over the last 30 years, we have shifted our revenue aways from corporate taxes, away from the income tax and gotten a larger share from withholding taxes. Has the economy been better? True, the wealthy pay a higher percentage of taxes, but they make a much higher (and higher) percentage of income and control larger percentages of wealth. Somehow those taxes are not stopping the wealthy from becoming even wealthier.
Steve
Effect on what?
Really, income taxes in 2012 represented 47% of federal tax revenues and the payroll tax 34%.
BTW, what is your definition of a witholding tax? For example our income tax is technically a witholding tax system.
And? This doesn’t mean taxes on income don’t reduce incomes. The problem of the wealthy getting wealthier and income income inequality could be handled much better via other means. For example, reducing rent seeking.
Are doctors always this vague, making appeals to anonymous authorities and confusing? Is something about going the medical school that doctors think they can just spout off arrogantly and people will accept what they write without question?
“Really, income taxes in 2012 represented 47% of federal tax revenues and the payroll tax 34%.”
When a payroll tax cut was in effect. Wolf ran the numbers a bit ago.
”
So here are the data on the individual income tax (as a share of GDP): 1980 – 9.0 per cent; 1984 – 7.8 per cent, 1988 – 8.0 per cent, 1992 – 7.6 per cent, 1996 – 8.5 per cent, 2000 – 10.2 per cent, 2004 – 6.9 per cent, 2008 – 7.9 per cent and 2009 – 6.4 per cent. (Except for the last year, I have shown the pre-presidential election years). The evidence is absolutely clear.”
In 2009, the payroll tax was 6.3% of GDP, almost the same as the income tax. I t has gone from below 30% pre-Reagan to about 40% when the cuts were not in effect. Corporate taxes averaged about 4% of GDP in the 50s and 60s, but have steadily dropped since then. I am much more interested in trends, rather than picking one yea to make a point.
“Effect on what?”
GDP, employment, economic output,whatever. Oops, forgot income. It appears to have increased income for some people. Has that benefitted the economy?
Steve