The more you tax something, the less of it you get. – Fundamental tenet of economics rejected by the Left.
George Rebane
To the above we can add another truth rejected by all leftwingers – ‘Tax rates don’t impact economic behavior’. Understanding how the Democrats ignore these fundamental aspects of economics, goes a long way to explain most, if not ALL, of the progressives’ public policies that have now reached their penultimate in the Green New Deal as reflected in the Democrats’ 2020 platform.
Taxes and regulations raise the cost of starting a business and then operating it for an acceptable profit. First, let’s cut the crap that the overarching purpose of a business is NOT to make a profit for its owners who have put their own time, talent, and/or treasure at risk into the enterprise. A for-profit enterprise can neither serve nor succor the needs of a broader klatch of so-called “stakeholders” if it is not able to do Job1 – make a profit that can be reinvested in the business and distributed to its shareholders.
There are millions of progressives, leftwingers, communists, socialists, liberals, … who neither understand nor believe the above fundamental truth about private enterprise. In this short essay I will provide a very accessible quantitative argument that explains with numbers how ever higher taxes and more restrictive regulations cripple and kill businesses. Trigger warning – if you are a member of one of the above groups who fundamentally believe that taxes don’t affect economic behavior, then this is the time to stop reading.
In this dissertation I illustrate quantitatively how higher tax rates not only stifle growth, but also markedly reduce government revenues. Those with a smidgen of numeracy should be able to follow the arguments that relate to the revelatory numbers. I invite you to examine the toy economic model shown in the graphic below.
The math model that iteratively calculates the spreadsheet values is given in the graph. I remind the reader again that this is an illustrative exercise, and no attempt has been made to use an actual curve that plots rG against rT. The general nature of this relationship is modeled by the first equation as a simple exponential decay whose shape is varied by selecting the value of k, its time constant. Other similarly behaving functions, perhaps from real data, may be substituted without changing the nature of the calculated outputs, and therefore, the points made in this dissertation.
The iterative relations for updating GDP and REV are straightforward, and depend on the tax rate rT and the GDP growth rate rGDP in the usual manner. The results are shown in the tabulated number array above.
First note the independent variable rT and its range of values in the left column. Pick any value, say, rT = 0.30, and then go across the table in that row to examine the yearly behavior of GDP and government revenues, Revs. At this high average tax rate we see GDP decreasing as government strips away profitability and investment from the economy – an oft-witnessed phenomenon in the mismanagement of centrally controlled economies. What should also be noticed is the yearly decline in government revenues. Given the current GDP growth rate curve, we see that the GDP growth will cease and start going negative somewhere between tax rate rT values of 0.15 and 0.20.
But here comes a punch line that is missed by leftwing analysts doing these calculations who are not versed in or don’t believe in the impact of tax rates on GDP growth. Looking down the Revs1 column, they see tax revenues increasing with higher tax rates, and doubly so if they don’t properly subtract the government’s previous year’s take to calculate what the economy has going forward into the next year. So, without understanding the dynamics between GDP growth rate and tax rate that impacts year-to-year GDP growth, these worthies and their political bosses are always tempted to raise taxes in order to increase the government’s short-term take with which they can buy votes for their upcoming re-election.
The yellow highlighted values indicate the maximum revenues available, had the related left column tax rate been implemented over the years. What these worthies don’t recognize or choose to ignore is how such a tax rate savages the economy and reduces the annual tax revenues. Notice that with each succeeding year, the maximum revenues for each year would have been earned with the imposition of a lower tax rate. These yellow-highlighted maximum values migrate upward until they meet the highest tax rate that still would have allowed the economy to grow (here in out-year 4 at tR = 0.15).
The green highlighted Revs in the tR = 0.15 row indicate how government revenues would continue to grow over the years, and also at what we systems people call the tR ‘operating point’ at which long-term government revenues are maximized while the economy still continues to grow. You can verify this for yourself by summing the Revs over the first five years for every value of tR. Of course, the tax rate levels (here tR = 0.20 and above) destroy the economy as the government attempts to maximize short-term revenues. This illustrates how mis-managed socialist economies (e.g. Cuba, Venezuela, NK, …) come to ruin.
Finally, were we to extend the definition of ‘long-term’ beyond the five years shown above, then we would discover that even lower tax rates would induce higher rates of economic growth leading to very high government revenues in the out-years. But a little thought instantly yields the answer that such a tax rate transition can be implemented at any time by wise administrations and legislatures. Lowering taxes (e.g. making tR smaller, say, to 0.10), at any point would reduce short-term government revenues. (And cause the predictable outcry by the know-nothing socialists, ‘See, lowering taxes didn’t work, tax revenues went down!’) But these would quickly grow year-over-year as the economy kicks into a higher gear producing more income to tax. The result again is that over a longer term both the economy and government revenues would grow faster and to higher totals than they would had the higher tax rate been maintained.
You, dear reader, can demonstrate this to yourself by extending the above calculations to, say, ten years. And you can do that by either replicating the above spreadsheet, or downloading mine here – Download Revs_v_taxRate-02 (recall the spreadsheet convention, blue numbers are inputs you can change, black numbers are calculated)
(Un?)fortunately, our toy model also clearly illustrates the nature of fiduciary politics in general, and specifically what happens when a leftwing government is ensconced by a dimwitted electorate. What has happened then is the start of a fiduciary death spiral as the government, desperate to increase short-term revenues, keeps increasing taxes. Again, this dynamic is illustrated clearly in the above spreadsheet.
[Addendum] In the following I will attempt to convince the reader of another major difference between our socialist Democrats and capitalist Republicans. The Democrat wants Americans to look to their government for ever greater levels of succor. That is why the progressive politician is fiercely focused on short-term government revenues that can be redistributed to constituencies whose votes are assured by such transfer payments. And if the economy is growing too slowly to provide the needed increase in revenues under current tax rates, the fastest way to get more money is to raise taxes through increased tax rates. (Yes, deficit spending is the other way, but its political optics are poor, but robbing the ‘rich’ always sells.)
The capitalist Republican argues that an economy with lower taxes and minimally regulated open markets will outperform a highly regulated and taxed economy on all counts. And economic history along with the economic model presented here clearly supports this argument and quantitatively demonstrates this fact. So what’s the problem? Why don’t voters elect politicians who would put in place such an economy with reduced regulations and lower taxes?
The answer lies in how can we get from here to there, and there’s the rub. For politicians whose prime motivations consist of power and re-election to remain in power, these must always go back to their constituents with promises of government providing ever more wealth transfers. Their supporters are always in a state where they have discounted their current government benefits, and their mantra is therefore ‘More, we want more.’ In this political environment the leftwing politician (along with some similarly motivated rightwingers) has little wiggle room or room to compromise when it comes time to bake and divide this year’s revenue pie. The last thing these scalawags can tolerate is lower tax revenues, and exactly that is the immediate short-term result when tax rates are reduced.
Simple arithmetic dictates a reduction unless some other unknown (and unrealistic) factor suddenly and concurrently kicks economic growth rate up an equivalent notch. And that ain’t gonna happen, so the politicians immediately see the lower revenues such a proposed tax reduction will deliver, and the demogauging begins – ‘Your lower taxes will just put money into the pockets of the rich and the burden on the backs of the poor.’ And this argument will carry the day unless the Republicans are willing to reduce military spending, the biggest gorilla in the discretionary part of the federal budget.
The reality, as we will see, is that while government tax revenues will necessarily go down in the short-term, in the longer-term economic growth will provide an immediate relief to the taxpayers, and in the out-years will even yield greater government revenues, both annually and cumulatively. So if we can get through the politically dangerous short-term dip, the longer-term economic prospects will swamp any pain that might have been endured when regulations and tax rates were reduced.
However, if we yield to the ‘increase taxes and regulations and government’ crowd of politicians, then exactly the opposite will happen as has been demonstrated over and over. Tax revenues will immediately increase at the expense of slowing economic growth, but those increases will outpace the old tax rate revenues, and most certainly the reduced-tax revenues for the next few years, even as economic growth slows (or even goes negative). And this immediate increase in income will allow the politicians to immediately spend it through the best thought-out vote buying programs to ‘put money in the pockets of hardworking Americans’. And as we see, that siren song works almost all the time.
Now returning to the spreadsheet you can download; it consists of three sheets. The second sheet extends the years to ten and calculates cumulative tax revenues over the years for the range of tax rates. The maximum cumulative values for each out-year are highlighted in yellow. Don’t be fooled by the early year maximums at 100% tax rates. As can be seen from the array above, high average rates above 25% quickly destroy the economy, and only rates 15% and lower show economic, and therefore tax revenue growth. Recall that this all depends on the curve relating actual GDP growth rate to the tax rate as presented on the first sheet. But the arguments here hold for any such actual curve that monotonically decreases with increasing tax rates, which is just the quantitative reality behind ‘you get less of what you tax more’.
On the third sheet ‘Scenarios Compared’ we take a look at the dynamics of raising and lowering tax rates from a starting nominal rate, here 14%. The two policies examined are raising taxes to 15%, and lowering taxes to 13%. The upper array introduces these changes in Year 3, and the lower array introduces them immediately in Year 1. Both arrays calculate GDP and tax revenues out to Year 11.
In the top array, the tax policy is changed in Year 3. We see an immediate drop in revenues from 152 to 141 when taxes are lowered from the 14% to the 13% rate. This quantitatively illustrates the political barrier described above. But note that as a result, the annual economic growth rate jumps from 2.68% to 4.54%, and continues growth at that rate for the remaining seven years of this scenario. The light green highlighted cells contain the stats for cumulative GDP and Revenues growth in dollar amounts and percent rates. We see that it takes four years (in Year 7) for tax revenues to catch up with what they would have been with the nominal 14% tax rate scenario. But at this point, the economy is already much bigger (1293 vs 1203) than the nominal scenario, and from there on the lower taxed economy and revenues continue outpacing both the nominal and, as we shall see, the higher taxed economy and revenues.
Looking at the tax increase in Year 3 (highlighted in light red), we note the expected immediate increase in tax revenues from the nominal 152 to 162. This is the quantitative side of the tax raising politicians’ glory road. These additional funds immediately get spent on programs ballyhooed to the voters. No one is supposed to notice or care that the economic growth rate has dropped from 2.68% to 0.85% annually. And no one is supposed to notice that the marginal increase in revenues over the nominal scenario immediately begins to decline with each passing year. (To maintain the new spending programs during these out years without another tax increase will require the government to deficit spend, borrow, and go deeper into debt.) In four years (Year 7) the tax income for all three scenarios are equal at 168. The only difference, and it’s a big one, is that the higher taxed economy at this point is smaller (1120 vs the nominal 1203) while the tax revenues now begin to lag both the nominal, and most certainly the lower tax rate revenues.
Extending the three scenarios out to Year 11, we see that the high tax economy is at an anemic 1158 compared to the low tax economy at 1544. And in that year the low tax economy is paying 201 into government coffers, while the high tax economy is going deeper into debt and able to collect only 174 (the nominal revenues in Year 11 would have been 187). But what is also overlooked by the braying politicians, attempting to justify their high tax policy, is that the lower tax rate economy not only left more money in people’s pockets, but also provided them a much better economy that yielded higher profits, more jobs, and paid higher wages. It is always so in advanced economies that if the transfer-payment recipients can only comprehend the near-term revenue shortfall, they stand to benefit in the longer term which is not that far off. And, of course, the working people who pay taxes will gain immediate benefits in earnings, jobs, and lower taxes. These workers and business people will experience only a more gainful future starting with the reduction of their taxes. The opposite is true for all workers and taxpayers when taxes are raised. Most RR readers understand the myth of sparing the middle class from any financial discomfort promised by ‘raising taxes only on the rich’. The middle class has always and will continue to always pay for all tax increases, simply because they have the lion’s share of the taxable income in the land.
The lower array on Sheet 3 is essentially the same except that the tax policies are changed in Year 1 which lets us look at the effects of the changes over a greater number of out-years. All the good and bad effects described above continue compounding with the passing of more years.
George, your math is spot on, as usual.
But let's wax nostalgic - an old Kingston Trio song.
"You've got to prime the pump. You must have faith and believe. You've got to give of yourself 'fore you're worthy to receive. Drink all the water you can hold. Wash your face to your feet. Leave the bottle full for others. Thank you kindly, Desert Pete."
They can smell why your math is doomed to fail. Where are they going to find a lot of someones (218 + 51) in this country who have faith, and believe? Especially when they can't see the benefits of the budget you propose for 5, maybe 10 years, before it starts paying off. As far as leaving the bottle (budget) full for others - hell, they're taking what's due them NOW. We're on our own. They probably even have a Chinese app for that.
Posted by: The Estonian Fox | 18 September 2020 at 06:16 PM
It's easy to see that the Wuhan virus has reduced 'mandatory' federal spending. The virus has concentrated on killing older citizens. Assume all of them are social security receivers. With their death, and that of their spouses, SS spending is now reduced. So the 'mandatory' SS spending is now not so mandatory, and can now be considered discretionary spending.
Some of our problem is solved.
If only the Dems would be as focused and determined to kill us older folks, like they are with pre-born humans, they could claim credit for contributing to helping balance the budget. Why haven't their PR people been advertising this fact on Facebook, Youtube, NYT, Wash Post...? It seems that they should be proud of this. Ignore that the virus has killed proportionally more black folks than white folks. blacks won't notice that.
Posted by: The Estonian Fox | 20 September 2020 at 07:37 AM