The Democrats’ analysis of tax policy has become incoherent. They want to increase tax rates during a recession. More precisely, they want to raise serious revenue, to use the president’s well chosen words, during the Great Recession.
Let’s take a look at a couple of examples of tax analysis that doesn’t stand up. You’ve heard the first one batted about the blogs and on the radio. Commentators like arguments that don’t garner a quick put-down, or even better, that don’t require much thought to state, but that require a fair amount of thought to rebut. I myself felt a little flummoxed by this one at first.
Here’s how this argument goes. Federal income tax rates in the 1990s exceeded income tax rates in the following decade, yet federal tax revenues were greater in the earlier period. So how can the Republicans say now that raising tax rates would reduce revenue, and lowering tax rates would eventually increase revenue? How can the Republicans claim that an increase in the federal income tax would ruin the economy? If we compare 2011 with the 1990s, we see a time of prosperity and higher taxes then, discouragement and even desperation now. And now, the policy argument goes, is a period of lower income tax rates.
How do you answer an argument like that, when the people who make it sound so self-confident? If we posit some connection between tax rates and gross revenues, the Democrats say we don’t have to look any further for our case in point. Accordingly Arthur Laffer does not have the last laugh. The Democrats do.
When you want to stick a gotcha to your friends on the Republican side, who cares about basic rules of logic? One rule specifies a critical condition that governs how to draw conclusions from comparisons: all things being equal. You isolate an independent variable that changes across the two cases, and you look for changes in a dependent variable. Other factors have to stay constant for the analysis to work.
The second half of the 1990s saw one of the greatest booms in U. S. economic history. The second half of the 2000s saw the greatest bust of modern times. Only two things make the Great Depression worse than the Great Recession: nominal unemployment was higher then, and, so far, it lasted longer. By all policy measures under our control, the country has ravaged itself this time around, worse than if it had reenacted the Smoot-Hawley tariff.
To compare the prosperity of the 1990s with the next decade’s destitution, to make the comparison in order to claim that we would benefit from higher tax rates right now, is just economic blindness. You might almost ask whether Democrats think low taxes cause high unemployment, or higher taxes bring prosperity. I don’t think they believe that, though. They just want to prove Laffer wrong, and leave it at that.
The fact is, gross tax revenues on the federal government’s ledger during the 1990s boom would have exceeded revenues during the bust ten years later, no matter what federal income tax rates were during the two periods. Revenues will be healthy during a time of great prosperity; they’ll suffer during a time of acute contraction. If you want to find a connection between tax rates and tax revenues, you’d better not pick a comparison where the country’s boom and bust cycle has such an impact on your dependent variable, tax revenues.
We do know this much. People in good times are usually generous and like to share their wealth. People in bad times become distrustful and angry when they see their tax payments misspent. The Democrats’ argument for higher tax rates overlooks that psychological difference entirely. People don’t want to pay higher taxes – or any taxes at all – if they don’t trust the government that receives their money.
Let’s take a look at a second instance where Democrats show incoherence in their grasp of tax policy. President Obama drew a so-called line in the sand with his pronouncement that we would veto any deficit reduction bill that cut Medicare benefits without raising serious revenue by taxing the rich. “Did you hear that, John Boehner? I said a veto.”
After the government’s high-wire bargaining over the debt ceiling this summer, I can’t say a veto threat is exactly where people wanted their representatives to come down. After all, didn’t they form a bipartisan deficit reduction committee, that would work together to bring our fiscal policies into some kind of balance? The deficit reduction committee comes from the same representatives who claim they don’t want to play kick the can anymore.
The incoherent part of Obama’s tax analysis is his belief that you can raise serious revenue by raising tax rates for wealthy individuals, or by making corporations pay their fair share, as the Democrats put it. Who does he have advising him, anyway? Ronald Reagan knew more about taxes than Barack Obama does, and Ronald Reagan, the Democrats say, is the dumb one. Does President Obama think he can resolve our revenue problems with new taxes on the rich, or does he just want to scratch around for votes?
Here’s the problem with Obama’s premise. When you apply a tax to an asset, wealthy taxpayers can respond in three ways: pay the tax, shield the asset from the tax, constrain or cease the activity that produces the asset. Wealthy people have good accountants. Good accountants can determine what combination of these three responses is most advantageous to protect their clients’ wealth.
Even if wealthy individuals choose to pay the entire tax, they don’t hold enough assets to solve our government’s budget problems. I don’t even know how large our annual deficit is, but I know we don’t measure it in billions anymore. You can’t make up a trillion dollar annual deficit with tax hikes on rich people. Suppose rich people decided to deliver all their assets to their friends in Washington. You would still have some serious budget problems.
Of course you would, Democrats say. You would still have to reduce spending. That’s not the point in a tax argument, though. You want a tax that raises sufficient revenue without causing people to alter their wealth producing activities. Manifestly, taxes on the wealthy of the sort Obama advocates would cause wealth producing individuals to alter their activities. Whether in Europe, South America or elsewhere, you see the same result when you lay heavy taxes on wealthy people. They find ways to stop paying taxes. When a nation tries to extract a large proportion of its tax revenue from the wealthy, you know it’s in financial trouble.
The Democrats typically include corporations in their roster of economic entities that pay too little tax. Here incoherence, usually compared to a fog of illogic, reaches supernova intensity. How can you claim that your top priority is to create jobs, and argue as well that corporations ought to pay more tax? Corporations with global operations already hold their earned income overseas to shelter it from high tax rates in the United States. The government lays so many obligations on companies for every new worker they hire, many business firms do all they can to avoid new hires. No coherent economic policy that emphasizes job creation would entertain the idea that corporations ought to pay more tax. We know that to increase employment, government has to decrease taxes on employment. That means decreasing taxes on corporations.
I wish I could give some good advice to President Obama. Theodore Roosevelt said several times during his first term that he would rather be a one-term president, than cave to his conservative opponents in the Republican party in order to win more votes at election time. As it was, he stuck with his progressive principles, which were out of step with the old-line Republican party, and won big at election time in 2004. Voters liked his fighting spirit.
President Obama shows a fighting spirit from time to time, but he doesn’t show much inclination to take on progressive leaders in his own party. Perhaps he simply agrees with them. As it is, he tries to appeal to progressives in his own party while he works to compromise with conservatives in the rival party. It hasn’t worked, and I’m not sure why we would expect it to. As for taxes and fiscal policy more generally, his political efforts on the left and right have left him with no direction, no target or vision for his considerable leadership skills.
We are left with tax analysis from Democrats that is so disappointing. We have an opportunity to reform the tax code here. The deficit reduction committee has signaled its desire to focus a great deal of effort on that opportunity. Democrats, Republicans, and independents all recognize that an improved tax code could be the factor that contributes most to renewed job growth. Yet we can’t seem to grasp this immense task. It involves too much change, still more uncertainty. Draw a line in the sand. Issue a veto threat. Stand pat. That’s the most our government can muster. That’s the most our aging institutions can manage.