Sunday, November 28, 2010

Increasing The Top Tax Rate Does Not Increase Tax Revenues: Lowering The Top Tax Rate Increases Tax Revenues

From The Wall Street Journal, "There's No Escaping Hauser's Law: Tax revenues as a share of GDP have averaged just under 19%, whether tax rates are cut or raised. Better to cut rates and get 19% of a larger pie" by W. Kurt Hauser:
Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."

On average, GDP has grown at a faster pace in the several quarters after taxes are lowered than the several quarters before the tax reductions. 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. 
Read the complete Hauser piece here.

Reducing the deficit and debt will not be as easy as passing legislation to increase taxes.

As Hauser describes in his article and as known from other economic research, raising the tax rate produces lower than expected tax revenues and also lowers future GDP. People shift their actions to reduce tax payments, increase tax deductions and generate more tax free income from tax free investments. Higher tax rates lower the rate of capital investment, which reduces future GDP and taxable income.

The Bowles-Simpson draft deficit reduction plan envisions tax revenue rising to 21 percent of GDP. As Hauser notes, 19 percent of GDP is the norm as tax rates rise and fall over the last six decades.

The only way to substantially increase tax revenues is through strong economic growth and strong economic growth is more likely in a low top marginal income tax environment.

The US is unlikely to solve its deficit problems through higher tax rates. The US will find itself needing to make substantial cuts to its spending programs in order to get its fiscal house in order. Simultaneously it will need to lower tax rates to spur economic growth.

Cutting government programs and government spending while lowering top tax rates will not be an easy sell for politicians, but it is the right way to eliminate the deficit and increase GDP growth.

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