On Taxes And Delusions

Skimming through John Cochrane's recent blog post on what qualifies as "tax reform" these days got me thinking. (Always dangerous when I start thinking, I know...)

While the whole concept of "the fiscal cliff" is a cheap rhetorical cliff, as Sonic Charmer The Crimson Reach so nicely keeps illustrating, the government's solvency problem is a real one, and an important one, and one that needs to be fixed. It is probably unnecessary to provide readers with a laundry list of the potential threats associated with not keeping the government's fiscal house in order, so instead I will simply say that using the rhetoric of a "fiscal cliff" will prove to be a major political mistake.

Why? Because when ordinary, every-day, paycheck-cashing, Breaking Bad-watching Americans watch the fiscal cliff come and go without witnessing a major catastrophe, it will be that much more difficult for any politician anywhere to convince the people of the United States to acquiesce to a major change in the way the government spends money and generates revenue. By casting the debate as a doomsday scenario, the people - assuming they actually believe worthless, lying politicians - will come to expect a doomsday. When that doomsday fails to occur, they will simply go on about their business as though the underlying issue itself is trivial. It's not.

Having said all that, I would like to highlight two delusions regarding taxation. Please note: this is a blade that cuts both ways, so pay attention. You might just learn something.

The Right And Its Delusion
For a long time now, the rightist politicians have been trying to get people to swallow the idea that cutting taxes on businesses "spurs economic growth." The logic here is that the government can create so much economic growth that the increased taxable income will more than compensate for the decreased tax rate, like thus...

( tax rate ) x ( taxable income ) = tax revenue

If tax rate = 20% and taxable income = $100, then tax revenue = $20. If tax rate = 10% and taxable income = $100, then tax revenue = $10. That's bad. But, if tax rate = 10% and taxable income rises to $500, then tax revenue = $50 > $20.

Okay, so we all understand what the rightist's claim is, right? This is not "trickle-down theory," this is simple fiscal math. Rightists aren't trying to take over the known universe, they just think that if you can "make" taxable income go up by lowering taxes, then we'll get more tax revenue and fix the debt problem. Get it?

There are two problems with this particular delusion:
  1. Problem #1: Let's assume the rightists are correct. When government expenditures are more than the total size of national income, it is extremely unlikely that futzing with the tax rate is going to produce a large enough impact to fix the debt problem.
  2. Problem #2: Let's carry the rightist's logic to its ultimate conclusion. Just reduce all tax rates to 1%. Problem solved. Not only would we be paying less taxes, but the deep cut to all tax rates would have the benefit of instigating a new, futuristic Utopian age of economic growth the likes of which society has never seen before.
That last one is important. If cutting tax rates "stimulates growth," then logically the only sane course of action is to reduce tax rates to 1% on all things and watch the economy explode. That 1% should be ample to pay off the debt completely by "growing us out of our debt," and we'd also have the benefit of hardly paying any taxes at all.

Of course, this concept violates The Laffer Curve, which implies that it really is possible to reduce the tax rate so far that you fail to optimize tax revenue. (That's the left's critique-du-jour of tax rate reductions.) But that just begs the question: Why do we want to optimize tax revenue? Why do we want the government to be rich on tax money?

This brings me to...

The Left And Its Delusion
So we all can hopefully agree that cutting taxes doesn't magically "stimulate the economy," whatever that means. You can't just reduce tax rates and expect economy to happen. That's stupid, right? Ha ha ha. Isn't it funny. Stupid rightists.

...Which means we can probably raise tax rates as high as we please, and it won't hurt the economy at all! Right? After all, Warren Buffett says he's willing to pay more taxes. And frankly, if my tax bill went up a couple hundred bucks - maybe even a thousand bucks, let's go hog wild - my life sure wouldn't be over. So hike the rates and pay off the debt. Problem solved. Aren't we smart, being the smart leftists that we are? We're smart! (Stupid rightists...) We have it all figured out.

Well, actually, no. That's not how it works.

While you can't "grow the economy" by reducing tax rates, you sure can hurt the economy by raising them. A proper explanation for this would be excessive. Just ask yourself: Do you spend more money when you have less money to spend? Do you spend the same amount of money when you have less money to spend? How about when you have to spend more money to get the same amount of stuff (because the out-of-pocket price, including taxes is higher)? Do you buy more stuff, less stuff, or the same amount of stuff when the price you have to pay is higher?

Okay? So don't tell me that tax increases don't harm the economy. Warren Buffett may not buy less milk and bread if we tax him at a steeper rate, but he will definitely buy less of whatever he buys most. For bajillionaires like him, most of what he buys consists of (a) investments and (b) charitable contributions.

So if you want the rich to invest less and contribute less money to charity, then go ahead and raise their taxes. But you are not allowed to live in a delusional world in which you get to pretend that raising taxes doesn't have a significant impact on the economy. That's stupid.

Welcome To Stationary Waves, Where We Deal In Reality
The reality of the government solvency problem is that you can't fix it by fiddling with tax rates. You can't reduce rates to the point that we "grow our way out of debt" (stupid rightists...). You also can't increase rates - not even the rates that apply to bad, evil guys like rich people - to the point that you can cover all the warring, policing, welfare-stating, and economy-commanding suddenly and magically becomes affordable.

Folks, let's not be naive. We live in a big, diverse world in which there exist sundry countries, having sundry tax regimes. There are countries that have bafflingly "progressive" tax regimes. There are countries that favor the rich above all others. There are countries that have flatter tax regimes.

What we see when we look at all the many countries and tax regimes out there is variety. That is to say, there are poor countries with progressive rates, and rich countries with progressive rates. There are poor countries with (comparatively) flat rates, and rich countries with flat rates.

So the reality is that fiddling with tax rates is not a magic bullet capable of making unaffordable things affordable. Fiddling with tax rates is not a special recipe for economic growth or low income disparity.

Fiddling with tax rates is a way to make our lives more or less expensive, depending on which way we move the rates. That's it. You can't pay for ObamaCare with a sufficiently high or low rate. ObamaCare is unaffordable at any tax rate. You can't pay for multiple, decades-long military occupations and murderous drone strikes with a sufficiently high or low rate. Imperialism is unaffordable at any rate. You can't balloon the civil service into a hideous, bureaucratic Hydra with a sufficiently high or low rate. Bureaucracy is unaffordable at any rate.

Therefore, let us not live in these silly delusions any longer. Let us not go around believing that the economy is starving to death solely because the Left has strangulated the rich with high tax rates. Let us not go around believing that the government is starving to death solely because the Right won't allow us to "make the rich pay their fair share."

Rates that seemed appropriate yesterday no longer seem appropriate today. That which was a fair share yesterday is no longer a fair share today. Ask yourself: Why? What changed?

What you find when you ask that question is that the major variable affecting both economic growth and government solvency is government expenditure. The government is spending more than it takes in. The government is spending more than our economy generates in a year. This is the real catastrophe. We citizens can no longer afford to suffer delusions about how this can all be fixed with tax reform.

We don't need tax reform. We need spending reform.