Hauser's Law and the Deficit

Today's WSJ has more insight on Hauser's Law, on which I have previously posted. In summary, we have seen empirically over the last 80 years that regardless of top marginal tax rates, the federal government's tax receipts as a share of GDP always falls just short of 20%.



This evidence is important to consider when trying to reduce the deficit. It becomes clear that raising marginal tax rates will not increase federal tax revenue, so we shouldn't even try. Further, evidence from other countries is that the efficiency of the tax code matters to growth. The Tea Party should be supporting a simpler and fairer tax code, along the lines of the compromise that Reagan reached with Democrats in the 1980s.

Eliminating all manner of "tax breaks" for businesses and individuals will be part of the difficult work ahead. Special interests, and I include myself as a homeowner, enjoy these benefits. But if the structure were simpler, with lower rates, we would all be better off. Further, eliminating complexity in the tax code reduces corruption and the appearance of corruption as fewer interest groups have the ability to gain benefits through the code. A simpler tax code also directs resources based solely on economic benefit, not tax consideration. A simpler tax code also eliminates the waste of businesses time and money in trying to "game the system," freeing management time to focus on improving profits.

From Hauser's article on why higher marginal rates (which are always coupled with complexity) work against the economy:

Higher taxes discourage the "animal spirits" of entrepreneurship. 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.

Tackling the deficit means reducing spending and increasing federal tax receipts. But we can only do so by growing the real economy. A simpler tax code with lower marginal rates is consistent with Tea Party principles of a less intrusive federal government. Further, the growth in tax revenues that such policies cause help reduce the deficit.

Quote of the Week

Comes from Arthur Laffer in today's Wall Street Journal:

It has always amazed me how tax cuts don't work until they take effect.

I know that KT has talked about paying enough in taxes to cover our deficits, but there are solid arguments to be made on the limits of raising revenue through the income tax. Hauser's law is an observation that, despite a variety of tax rates imposed since World War II, the percent of federal income tax receipts as a share of GDP has held remarkably steady at 19.5%. In practice, this means that the federal government should set tax rates in a way that encourages investment and saving. Only by growing GDP does federal income tax receipts grow.


I allow that other forms of taxation bring in revenue to the feds, but that is not the point of the current discussion. The combination of tax increases set to take effect in 2011 almost guarantee Obama a one term presidency, don't take my word for it, here is what tax experts H&R Block have to say:

Beginning in 2011, tax rates in effect prior to 2001 spring back into effect. The top income tax rate returns to 39.6 percent, and the special low 10 percent bracket is eliminated. Whether this will actually happen will be at the heart of a spirited battle in Congress.

Estate Tax Revived

For individuals dying after 2011, the federal estate tax returns with a $1,000,000 exemption and a 50 percent maximum rate. This assumes that Congress allows the estate tax to disappear in 2011, which is unlikely.

Increase in Capital Gains and Dividend Tax Rates

The tax rate reductions for long-term capital gains and dividends is scheduled to expire this year.

In 2011, the maximum long-term capital gains tax rate goes back up to 20 percent from 15 percent. A lower 10 percent tax rate is used by individuals who are in the 15 percent tax bracket. Their long-term capital gains had been tax-free since 2008.
In 2011, dividend income (other than capital gain distributions from mutual funds) is taxed as ordinary income at your highest marginal tax rate.

Child Tax Credit

The credit of $1,000 per eligible child reverts to $500 after 2011. After 2011, none of the child tax credit will be refundable to taxpayers unless their earned income is more than $12,550. This is one of the many Bush tax cuts currently scheduled to expire after 2011.

Payroll Tax Credit

Starting in 2011, the partial credit for payroll taxes paid is no longer available.

Decreased Section 179 Expense Deduction

Taxpayers who purchase qualifying business property may elect to deduct the cost of the property (new or used) in the year that it is placed in service. This is referred to as a Section 179 deduction. In 2010 and 2011, the maximum amount of property that may be taken as a Section 179 deduction is $125,000, as indexed for inflation. In 2011 and future years, the maximum deduction drops to $25,000.

College Savings Plans

Beginning in 2011, 529 Plans can no longer be tapped tax-free to pay for a computer or Internet access.

Tax Credit for College Tuition

The Hope credit is again limited to the first two years of college and is capped at $1,800. None of the credit is refundable if it is more than your regular income tax liability.

Earned Income Tax Credit (EITC)

Temporary increases in the Earned Income Tax Credit for filers with three or more children and the higher income levels for the phaseout of the credit are repealed.

The blog Emptysuit has a nice summary as well. The collective weight of these marginal tax rate increases will inevitably kill any economic recovery.