Friday, November 26, 2010

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.

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