Friday, November 25, 2011

Why Spending, Not Revenue, is the Cause of our Deficit and Debt

Since 1950, tax revenues have averaged about 18% of GDP IRRESPECTIVE of marginal tax rates. They've been as low as 14.4%, and as high as 20.9% (for one year, 2000, the only year they've topped 20%), but always for very brief periods, and they almost always correct very quickly and return to about 18%. Remember, this is true REGARDLESS of what the tax rates are, even including the 92% top rate under Eisenhower in 1953. The government's collection of revenue under Eisenhower's high upper tax rates from 1950-1959 was only 17.2% of GDP.

It is therefore statistically true that there is very little association between tax rates and tax revenues. This is largely due to the Laffer curve; when tax rates become too high, the incentive to work decreases, and certain economy-growing investments no longer become profitable or worth the effort. In such circumstances a tax cut can actually increase tax revenue. This happened in the 1980's when Reagan's tax cuts increased tax revenues much faster than inflation (contrary to common perception, it was Reagan's increase in military spending that caused his deficits, not any decrease in tax revenue). For sure, tax cuts don't always, or even usually, pay for themselves: there is an optimal rate to maximize revenue, and what that rate is depends upon economic conditions. But it is simply false to claim that tax revenues are malleable or easily increased by simply jacking up tax rates.

Meanwhile, federal government expenditures over this same period (1950-2010) have averaged 20% of GDP, 2% higher than federal revenue. In the years revenues have gone up, spending has gone up with it, rather than those revenues being used to decrease the ever-running deficits. This tells us that no matter how much money we give politicians to spend, they will always spend more than that amount. This, also, makes intuitive sense. Politicians are people, and people generally act in their self interests. If a politician has 100 dollars of tax revenues, which will help his chances of reelection more: using it to pay off a debt that most Americans don't see or understand, or using it to pay for a service or road or park or handout or favor that will make some people happy now? Voters generally view politicians with a "what have you done to help me?" attitude, and vote based on who promises to help them the most. Therefore, even if using revenue to pay off debt may be in the best interests of the country, it won't help the politicians win reelection; kicking debt down the road a bit may cause a problem for the people after him, but it won't hurt his chances in November.

It is unequivocally false, therefore, to claim that we have a debt problem because of of low taxes, for two reasons. 1. There is very little association between tax rates and tax revenues, and 2. Regardless of tax revenues, politicians will spend more than those revenues if they can get away with it. The 1990's example is one of the few times in history in which the people woke up and stopped letting them get away with it. It'd be great if we could do the same today.

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