Via PrestoPundit comes The Heritage Foundation's latest propaganda piece:
At $19,588, the average annual fiscal deficit for low-skill immigrant households was nearly twice the amount of taxes paid. In order for the average low-skill household to be fiscally solvent (taxes paid equaling immediate benefits received), it would be necessary to eliminate Social Security and Medicare, all means-tested welfare, and to cut expenditures on public education roughly in half.
I didn't try to verify their figures, so lets assume they're correct. What The Heritage Foundation has discovered is that rich people pay more taxes, and poor people benefit more from transfer payments. The net effect is a transfer from the rich to the poor. Since the U.S. has many low-skilled immigrants, this is spun as "immigrants cost us money".
What The Heritage Foundation conveniently forgets is that poor people also contribute to the economy, and to society in general. Low-wage workers clean your buildings, serve you at McDonalds, take care of your children, and so on. They also support the existence of higher-wage workers. Doctors need patients, lawyers need clients, businessmen need employees and customers. If these workers were suddenly shipped out of the country, what would happen?
There would be two effects: 1) the supply of low-skilled workers would go down, thus increasing low-skilled workers' wages. Higher skilled workers would find their real-wages decline due to inflation. 2) Higher skilled workers would find themselves in a very tough job market, and some would be driven down the socio-economic ladder and forced to take low-skilled jobs.
The bottom line is that the low-wage workers are a net benefit to society. If you're trying to find people who are a net drain on society, it would be better to look at those (mostly native born) who will collect benefits as they age, but don't raise enough children to support those benefits. Or those who were born wealthy and live off of their investments.
Illegal immigrants in particular (singled out specially by The Heritage Foundation) don't have access to unemployment insurance and most other government benefits. It's hard to imagine any circumstance under which people who contribute labour, but have no social safety net, could be a drain on society.
The real deceit in The Heritage Foundation's article isn't so much that they overlook the role of low-skilled workers in the economy, but rather that they separate out immigrants as if their contribution is worth less than low-skilled non-immigrants. Unless you also think the U.S. would be better off if the poorest native-born Americans left en masse, there's no reason to assume this is true of poor immigrants.
If you don't like immigrants then be honest about it, don't try to hide behind faulty economic analysis.
34 comments:
I don't know if you followed PrestoPundit's link to the Heritage Foundation's Executive Summary. There's a lot of costs allocated to immigrants that don't actually get spent directly on them, including highway costs, fire department costs, food safety inspections, sewerage systems and parks. They've also allocated a portion of the costs of government provided education ast all levels, including colleges and universities. Means-tested programs are incorporated in the calciulation, as are direct benefits programs such as Medicare and Social Security. Spending on the national debt, national defense, and a few other items are excluded from the calculations.
I'd guess the Heritage Foundation's "immigrant cost figures" could be reduced dramatically if someone made different assumptions about which costs to allocate to immigrants. Heck, if the government would give me $30,000 cash/year (the average benefit that HF says these immigrant housolds receive) I'd retire right now!
Hi Indy,
I read it, but didn't want to quibble too much with the numbers. The truth is that, in every country I know about, rich people pay more for government services than poor people. This is how the tax system was designed, and there are good reasons for this.
What the Heritage Foundation does is take this simple fact about the tax system, puts this together with the fact that many immigrants in the U.S. are poor, and then makes the leap that immigrants "cost" money. The dangerous leap is right there: equating the economic benefits of the poorer half of society with how much tax they pay, as if tax revenue is the only thing they offer.
But of course the figures themselves are suspect. I don't see any reason to include roads, but not defense, for example.
One item that stands out immediately as flatly wrong is education. Educated citizens do in fact pay back their educations directly in the form of taxes. Allocating the cost of education to the parents is wrong. The education is paid for by the children themselves when they get older.
... Ami.
Thinking about this a little more...
It's interesting to contrast the "poor people are only worth what they pay in taxes" view with the other right-wing position that "if people pay less tax they will contribute more to the economy".
If you can sell lower taxes by pointing to offsetting economic benefits, then you're acknowledging that people contribute to the economy even if they pay no taxes at all.
... Ami.
Wow, so many things to comment on just in this one post!
First, I agree with you concerning the low-skill immigrant vs low-skill native. No real difference in the two, so if you go after one, you go after the other.
Second, I think you're misstating the "right-wing" position (at least my understanding of it, anyway) concerning taxes. The theory is lowering tax rates increases tax revenues by expanding the economy. Of course, there's a balance point to consider, and also what level of gov't spending you want.
I'll leave the rest alone, but there's plenty more I don't agree with on your analysis. Incidentally, have you been keeping up with the Zimbabwe economic crisis?
Hi Richard,
The notion that decreasing tax rates increases revenue isn't really the right wing position. There aren't any serious economists, even on the right, who believe that. It would be unfair of me to pretend that's the right-wing view, as it's too easy to tear down as a straw-man argument.
My comment was based on the idea that decreasing taxes helps the economy (which is sort of true, if you ignore the second-order effects). If you believe that, then presumably the contribution of an individual to nation's economy goes beyond the taxes they pay.
In fact, those on the right have a tendency to see taxes paid as a total loss to the economy and untaxed earnings as a total gain.
(I'm exaggerating a bit - really only the extreme libertarians take that view, but the more right-wing people tend to lean in that direction.)
I don't follow Zimbabwe very closely, although I do read the news. Mugabe is systematically turning the country into a failed state. He's a nut, and I'm afraid a lot of innocent people will die before he's finally gotten rid of.
... Ami.
"It would be unfair of me to pretend that's the right-wing view, as it's too easy to tear down as a straw-man argument."
I seem to remember discussing this with you before (perhaps just in discussion of the 1980's), and you used factors I didn't think made sense (as well as inflation) (I seem to remember something about population increases/migration) to claim there was a net loss in revenues, even when the total $s nearly doubled in 8 years. I think we'll have to agree to disagree on that one. As Indy said earlier, it's all about the assumptions of what is and isn't part of the equation.
As for contributions to the economy being beyond the taxes you pay, I agree. However, I don't think that's their point (maybe it is, but I didn't read the report). I think it's more on the lines of "our taxes are paying for those not paying taxes to get services, so they're costing us money." Again, I'd agree that the distinction of immigrant is irrelevant, as we can't just send our poor people to a much richer nation and have them send us money back in order to prop up a corrupt gov't.
As for what low-skill people contribute to the economy, you're right. They certainly keep the economy going doing unskilled labor, but the same could be said of everyone in the economic chain at every level. Without them, it doesn't work.
Zimbabwe is in an awful situation, agreed. I think it likely to hit a humanitarian crisis level soon, if it isn't already considered one.
Hi Richard,
If you can show me any evidence that tax revenue was higher with tax cuts than without, please post it. If it holds up you could become famous. I might be able to share in some of the glory for discovering you.
But remember you have to compare actual revenue with expected revenue using some sort of plausible assumptions. You can't just assume that revenue would have been static without tax cuts. If my assumptions don't work for you, then suggest something better.
I think you're correct about the article. All they're saying is that the rich pay more taxes than the poor. We all know that, but if they wanted to debate the merits of the tax structure then that would at least be an honest debate. They could present reasons why they think this is unjust, and their critics could give counterarguments.
But instead of an honest debate, they try to twist this into being about immigration rather than tax structure. I think it's quite slimey.
... Ami.
My idea (not being an economist) would be to calculate a range of growth for the economy (by some consistent compilation method) based on the past 5 years and adjusting based on the estimated point in the economic cycle. Then, compare the range of expected revenue to actual revenue the year after the new rate goes into effect (as that's when the effects would first start to appear).
Now, in the US, this isn't nearly as simple as that sounds for a variety of reasons. The number of taxes, the rates for each type, the myriad adjustments made every year to them, and so on. I imagine the problem is similar to just about any other tax structure.
In short, I can't say that, as a rule, tax revenues increase whenever income taxes are cut, as at 0%, you don't collect any. The converse is true, because if income taxes hit 100%, there will be no taxes collected the following year. Logically, there has to be a balance point, and as economic growth and tax revenues seem to grow whenever taxes are cut here in the US, I believe we're still above the balance point.
On the subject of taxes, what are your opinions of the Fair Tax? If you aren't familiar with the legislation, you can see more about it at www.fairtax.org. Basically, it eliminates all federal taxation, places a national sales tax on all new goods, and sends a prebate of expected sales tax on all necessities to every household (In essence eliminating taxation on the poor and eliminating tax loopholes businesses exploit).
Richard,
You're describing the Laffer curve, which is perfectly reasonable in principle. The question is where the economy sits on the Laffer curve.
When Laffer's theory became popular in the early '80s there was a ton of research into this. There was some evidence that Sweden - which had an extremely high marginal tax rate - might have been on the right hand side of the curve. All other economies were found to be well to the left of the peak.
It took a while for this consensus to develop, since there are a lot of confounding factors (as you mention), but when so many people come to the same conclusion in different ways, then it ends up being pretty convincing.
Also, Bush-1 was eventually forced to increase taxes. Obviously by the time he became president it was clear even to Republicans that a tax increase would in increase revenue.
I wouldn't support the FairTax scheme as presented by the web site, although I think they're on the right track.
Under my "fantasy" tax scheme, every citizen would have a grant of enough money to eek out a subsistence living. In Finland that would be about US$10000 a year. I don't know what it would be in the U.S. nowadays. To balance this out, the minimum wage and welfare would be eliminated. So you would get this money whether you were a millionaire or unemployed.
On the revenue side, there would be a fairly high value added tax (similar to the sales tax in the FairTax scheme) and a fixed income tax on total earnings.
Inheritance would probably be taxed higher, but there's probably a Laffer-curve-like effect there as people would try to get around the inheritance tax if it was too high. That might take some experimentation.
"Also, Bush-1 was eventually forced to increase taxes. Obviously by the time he became president it was clear even to Republicans that a tax increase would in increase revenue."
How closely were you following politics in the US at the time, Ami? The first Pres Bush lost in '92 largely on that issue. I don't know what revenues did those first few years after the tax increases, but I don't expect it was terribly impressive.
To a person who doesn't know or understand economics, it's very easy to sell the idea that increasing taxes increases revenue. However, we both know it isn't universally true. It's why Dems have done so well with the idea of raising taxes, but only on the "rich." They did so well, in fact, that they managed to get taxes up to 90% on the higher levels of income (and hense changed Pres Reagan from a Dem to Rep).
If your fantasy tax scheme had any hope of actually working (not being implemented, but actually working), I'd support it. However, the inflationary effect alone would make it necessary to continually increase the handout, not to mention the economy grinding to a halt as 60-70% of the population decided they didn't need to work anymore. Darn human nature!
I wasn't following U.S. politics that closely, but I do remember the backlash against Bush Sr. As far as I remember, it had more to do with his explicitly having promised not to raise taxes during his campaign in a very outspoken way, and then going back on his word. The late night talk shows kept mocking his "read my lips, no new taxes" speech.
If anything I think it emphasizes the fact that he had no choice, the government needed the revenue.
Regarding most people not needing to work, I doubt that's true. The U.S. has some form of social support, and most industrialized nations have pretty decent social support. If you don't work, most western countries won't let you die on the street. Yet very few people in these countries choose not to work. Nobody likes to be poor, and staying at home is boring after a while. This just simplifies the scheme.
Most of the social assistance programs have an unfortunate property of discouraging part-time work. Basically you lose all of your assistance, and end up poorer than when you started. It's called the "poverty trap". This scheme simplifies things, and eliminates the poverty trap.
... Ami.
"If anything I think it emphasizes the fact that he had no choice, the government needed the revenue."
I disagree. I think it was because he desired better political relations with the "opposition," and gave them something he didn't feel that strongly about. In fact, care to guess what Pres Bush called Pres Reagan's tax cut plan in the '80 campaign for the Rep nomination? Check his Wiki bio if you're curious. Regardless, that doesn't answer what was happening with revenues at the time, and whether taxes were to the right or the left of the Laffer Curve. I'll see if I can dig something up, but it may be awhile before I can do that.
As for the "poverty trap," I agree. Any reduction in benefits should come along something like a 2/1 split (for every $2 earned, you lose $1 in benefit; the actual ratio is negotiable). It's ridiculous that you can be better off doing nothing than working a part-time job.
Yup, he coined the term "Voodoo Economics" :-). I new the origin of the expression when I chose the name for my blog. And he was right about that.
But I'm a bit confused. Are you saying that the president raised taxes knowing it would worsen the budget deficit, and did this to please the Democrats? Even though he made a huge deal of not increasing taxes during his campaign? And why would the Democrats want to reduce revenue anyway?
That seems really odd.
Honestly the whole perspective is a little odd. There are many countries with much higher taxes than the U.S., and most of them are run by fiscal conservatives at least some of the time. If there were really a lot of countries on the right side of the Laffer curve you'd think politicians around the world would jump at this free lunch.
Everybody politician dreams of being able to please everybody, and more government services with lower taxes would be incredibly popular.
There's also the small issue you need to contend with: Bush Sr's tax increases did in fact increase tax revenue.
Much the same as we disagree on whether any particular tax rate is to the right or left of the Laffer Curve, Pres Bush disagreed w/Pres Reagan's view on taxes, and hense his willingness to raise taxes. I don't consider it indicative of revenue distress that he signed a tax increase from an "opposition" Congress.
As for the campaign promise, that was blatant political pandering to the Rep base. Politicians in both parties do it all the time.
As for the tax rates, politicians derive power from higher tax rates, as higher rates necessitate more reliance on the gov't for services and increased control over businesses being taxed. Also, economics isn't a requirement for politics, and the idea of higher taxes=higher gov't revenue=more gov't services is a very simple message to sell to voters, especially if you only claim to raise taxes only on the "rich."
As for the revenue increase after Pres Bush's tax hike, do you have a source? I don't doubt there was an increase, but I seriously doubt it was any more significant than prior years
If politicians' power comes from the ability to spend, then it would make sense to have revenue as high as possible. According to you, this means reducing taxes, so they would presumably have done so already if their economic advisors had any evidence that this should work.
Historical tax revenue data is here:
www.whitehouse.gov/omb/budget/fy2004/pdf/hist.pdf
The closest applicable table starts on page 25. The third column over gives tax receipts on constant 1996 dollars. Of course you'd have to make these figures per-capita, and factor in recessions, to make a proper analysis, but these figures are a good start.
Out of curiosity, I combined the above data with the population data from here:
http://www.census.gov/popest/archives/1990s/popclockest.txt
and calculated some per-capita figures for government revenue:
1980: $4207
1981: $4378
1982: $4176
1983: $3844
1984: $4030
1985: $4253
1986: $4310
1987: $4617
1988: $4720
1989: $4915
1990: $4897
1991: $4744
1992: $4692
1993: $4790
1994: $5066
It's hard to see for sure what the effect of Bush Sr's tax increase was, especially given the impact of the early 90's recession, but it's pretty clear that Reagan's tax cuts didn't increase revenue.
I see Ami beat me to the punch on finding the actual revenue data. I'll note that on-budget revenue (excluding Soc. Sec., Medicare, etc.) actually increased in FY 1991 after the tax increase despite there being a quite nasty recession. And I'll also note that anger over that recession also played a big role in Bush's defeat in 1992.
There's a serious misconception on your part, Richard. Reagan in fact raised taxes in the early 1980's as the unsustainability of his original 1981 tax cuts became obvious. Iirc there were big tax hikes in both '82 and '83, although there may have been just one. Overall federal revenue - in real dollars - fell in FY 1983 for the only time during the 1972-2000 period. The 1986 tax reform, initially hyped as being "revenue neutral", was acknowledged as giving a slight overall boost to revenues even before its passage as well. Both men were willing to raise taxes when they saw it as necessary.
Yes, Indy, Pres Reagan did raise taxes during his term, but not even close to the amount he lowered them by. For instance, he took the top rate from 70% to 28%, and they haven't gotten close to that level since.
Also, I think you're both oversimplifying the impact of tax cuts. If tax cuts help increase the rate of economic growth, then it's very possible that the first few years of tax cuts may bring in less, but subsequent years would catch up and surpass where you would have been at some point. Conversely, the first few years after a tax increase may show more revenue comparatively, over time they will result in less. Again, there's some sort of balancing point for this, where current gains will outpace future benefits over an acceptable timeframe. I don't know what that point is, but as revenues didn't dramatically drop immediately after Pres Reagan's tax cuts, we were substantially to the right of this curve prior to that (and maybe even after, but there's no way to tell either way, considering the constant adjusting of tax rates preventing a good way to measure growth rates properly).
Ami, I still don't buy factoring in population migration, as I think that any real effect that has would alreay be present in inflation.
Richard: I'm pretty sure you don't have any hard evidence to support your hypothesis, but do you at least have some theory on how this link would work? The theories I know about about long-term economic growth all have to do with technological progress. You would have to show, for example, that lower taxes lead to better robots or something like that.
I don't see how inflation would take into account population growth (not just migration, by the way).
The inflation deflater is just a way to take into account the fact that $1 buys less today than last year.
The population adjustment takes into account that a larger population means a larger economy. If you want to compare the GDP of Canada and the U.S., for example, then it would be meaningless if you didn't take into account the difference in population.
Similarly, comparing the U.S. ten years ago with the U.S. today doesn't mean anything if you don't take into account the population change.
"I don't see how inflation would take into account population growth (not just migration, by the way).
Population growth, in and of itself, is an inflationary factor. More people in an area means more demand for goods, leading to an increase in prices as supply drops.
As for the tax cut argument growing the economy, it's very simple. Lower taxes mean an increase in available funds (for both businesses and consumers). Businesses open and expand (since they have additional capital) to try and get more of the expanding pie. Competition increases for resources, and companies put more money into R&D (among other things) to be more competitive in the new economic environment.
I think we've had this discussion before regarding increased gov't spending. I agree it has much the same effect, but as there isn't really competition in gov't services, it's a less efficient manner of growing an economy.
I also agree you can't compare economic points 10 years apart, as it's incredibly likely that those points are at different points in the economic cycle.
Population growth, in and of itself, is an inflationary factor. More people in an area means more demand for goods, leading to an increase in prices as supply drops.
Population growth also increases supply. That's the point of adjusting for population - the economy as a whole, both supply and demand, grows.
Inflation is a produced by the money supply (controlled by the fed) growing faster than the economy. It's a function of monetary policy, not population.
Competition increases for resources, and companies put more money into R&D (among other things) to be more competitive in the new economic environment.
Actually the opposite appears to be true. Companies facing intense competition tend not to have money to invest in R&D, since R&D is risky and only pays off in the long term.
On the other side, taxes support government research, education, and university research.
I agree it has much the same effect, but as there isn't really competition in gov't services, it's a less efficient manner of growing an economy.
I wouldn't argue that government spending is the right way to grow the economy. I'm pretty sure I never said that.
I do argue, however, that there some things that the government does much better and more efficiently than the private sector. Health care in particular.
Also, people on the right have a habit of speaking as if government services are worth nothing, and are therefore a complete loss to the economy. That's certainly not true.
But this discussion was about whether or not tax cuts lead to more government revenue. As far as I can tell you've now abandoned that position, except that you think there might be some long-term effect on R&D.
"But this discussion was about whether or not tax cuts lead to more government revenue. As far as I can tell you've now abandoned that position, except that you think there might be some long-term effect on R&D."
How have I abandoned it? My entire point is that, with less barriers (lower taxes, fewer regulations, etc), economies grow faster. You argued that the only way that can happen is through things like tech improvements, and I pointed to that being part of the very complex picture.
"Population growth also increases supply."
Only in the labor market. Of course, increasing populations necessitate more goods and services, so businesses will divert more resources in that direction. I digress, however, because populations move/increase for a reason (usually opportunities), and new opportunities are more plentiful where factors are more favorable for business (i.e. lower taxes, less regulation, etc.). One thing to note is that, in the US, we are seeing definite migration tendencies away from the Northeast (New England, but you probably knew that) region (where taxes and regulations are higher) to lesser-developed areas in the South and West (where they're lower). These trends might not be a primary factor, but they certainly are a part of it.
"I wouldn't argue that government spending is the right way to grow the economy. I'm pretty sure I never said that."
I'm sorry, that's not what I meant. You certainly didn't express an opinion either way in our discussion back then. We were discussing the '80's, and the growth of the US economy being due either to gov't spending or tax cuts (I'm not sure you believed either one to be true).
"I do argue, however, that there some things that the government does much better and more efficiently than the private sector. Health care in particular."
I would argue that the gov't doesn't do anything better or more efficiently than it can be done in the private sector, but there are certain functions that this isn't the primary concern. Health care, however, isn't one of those, in my opinion.
"Also, people on the right have a habit of speaking as if government services are worth nothing, and are therefore a complete loss to the economy. That's certainly not true."
I agree on that. Gov't certainly has its purposes (conflict resolutions, protection of citizens, etc.), and these things aren't just conveniences, but are essential to the maintenance of a (somewhat) free economy. It's too easy to paint with too wide a brush, and too many people do so (both right and left).
Finally, I made a point earlier about taxing being a source of political power. I wasn't limiting that to spending habits, but to the restrictions on people's lives such taxes can impose.
I find Ami's argument regarding tax rates and revenue more convincing, Richard, and not just because he's an economist. If you reduce the average tax rate by a factor of X you'd need to increase overall income by a factor of 1/X to generate equal revenue, presuming all other factors remain constant. Thus a 10% reduction in taxes (multiplying by a factor 0.9) would require an 11.1111% increase in overall income (i.e. multiply by 1/0.9 or 1.11111) to offset the revenue lost directly due to the tax cut. For any value of X less than 1 (which would correspond to a tax cut) the corresponding value of 1/X must represent a higher % increase in growth than the % decrease in taxes.
That's an extremely simple equation using average tax rates only, and doesn't reflect that some tax cuts will generate more investment than others, but it does illustrate the central "voodoo economics" issue with the initial Reagan sales pitch that a 4% cut in tax rates would create 3% growth that would eventually balance the budget. A 4% cut (X = 0.96) would require 4.166667% growth (1/X = 1.04166667) simply to offset the revenue lost by the tax cuts.
Richard:
How have I abandoned it? My entire point is that, with less barriers (lower taxes, fewer regulations, etc), economies grow faster. You argued that the only way that can happen is through things like tech improvements, and I pointed to that being part of the very complex picture.
You've moved from a very bold statement that tax cuts lead to clear revenue increases, to a much more nuanced argument that eventually (presumably over a fairly long time, since we've never been able to actually observe the effect) the increased efficiency from lower taxes would increase revenue, if only we stuck with the policy long enough.
In a sense it's impossible to disprove your theory, since you can always say that we just need to try it again and wait longer this time for things to improve.
Only in the labor market
Ok, I think I get your argument now. Presumably poor immigrants don't add as much to GDP as richer native-born workers. I'll have to concede that it's possible, although I seriously doubt that the effect is large enough to matter.
I also didn't bother to make a lot of other possible adjustments, like population aging. I imagine the effect of one might cancel out the other. It would take some careful study to figure this out - more than I can invest I'm afraid - but I'll see if I can find any articles on it.
We were discussing the '80's, and the growth of the US economy being due either to gov't spending or tax cuts (I'm not sure you believed either one to be true).
Actually both are true. Deficit spending (both through tax cuts and increased spending) pumped huge amount of money into the economy and boosted short-term growth.
I have no problem with short-term deficit spending (this is a very Keynesian, left-wing strategy :-).
But:
1. you have to realize that this is a short term boost. It doesn't do much for long-term growth. Especially since you will have to reverse the policy eventually to pay off the debt.
2. you aren't going to increase revenue this way, even if you can improve the economy.
Indy:
Good idea illustrating this with a proper example. But I think it might be clearer to think of it in absolute terms, since percentages confuse people.
I can steal your math and illustrate it differently:
So if your initial GDP is $100 and your initial tax is 40%, then you get $40 of revenue. If you cut taxes to 36%, then you need to increase GDP to $111.11 to break even on revenue.
"You've moved from a very bold statement that tax cuts lead to clear revenue increases..."
No, not exactly. I've argued that there's a balancing point where taxes yeild a maximum return(since both a 0% and a 100% tax rate will have the exact return of $0 over any length of time). I've also stated I think it's on the lower, not upper, range, but as you've said, I have no "proof" of that.
"...to a much more nuanced argument that eventually (presumably over a fairly long time, since we've never been able to actually observe the effect) the increased efficiency from lower taxes would increase revenue, if only we stuck with the policy long enough."
Again, it would solely depend on where your tax levels are at the time, which isn't defined by either of us. However, per the data you've presented, it would be logical to assume that, under Pres Carter, we were to the right of the Laffer Curve, as a 60% reduction in the upper tax bracket (among other reductions), at worst, provided a slight drop in revenues the following year (in adjusted dollars). Certainly, the tax rates moved to the left of the Laffer Curve by this reduction for the subsequent year, but did the subsequent economic boom occur because of the tax cuts, or was it a function of the business cycle reaching the rising point? If caused by the tax cuts, did economic growth get to the point where revenue was larger than if they hadn't happened?
As for my comment on "Only in the labor market," I was referring to the only thing that an increase in population increased the supply of. Certainly, as the increased population will increase demand in the area, supply will either be shipped in or businesses in the area will expand to meet the higher demand, thereby increasing supply. Maybe I'm making a distinction without a difference here. I just see the increase of population causing inflation in the area, as the near-simultaneous increases of supply and demand will increase monetary supplies in the area, hense I think inflation already takes into account population migration.
Indy, your math is certainly correct if you only consider one year out. However, try projecting a few years out. Assuming a base $100 economy, I calculated a 30% tax rate with 10% growth to a 26% tax rate at 13% growth. In year 6, the lower rate exceeded that year's returns by 54.13 to 53.15. By year 9, cumulative revenue gains for the lower rate exceed the higher rate $478.91 to $478.12. Higher initial tax rates show a faster growth of revenue for the lower rate, while the growth rate doesn't appear to impact the difference. Now, it's certainly arguable (and I'd agree) that a 4% cut isn't always going to yield 3% growth (or ever, for that matter, as I'm not an economist and don't have the data on such). However, it does show that a 10% tax cut doesn't have to yield 11.111% growth to improve revenues over the long term.
Richard, your example implies that annual growth will be 30% higher after a tax rate reduction of 13.333%. That is contrary to the "voodoo economics" creed, which holds that a growth rate which is lower than the tax rate reduction would yield higher revenues.
I have more serious issues with your example, actually. A sustained annual growth rate of 13% is not a realistic assumption, nor for that matter is the 10% rate you include in your base tax alternative. In the former case the overall economy would be doubling in size roughly every 5.5 years, while in the latter case it would double in about 7 years. China has experienced growth in the 10% range in recent years, but this has been built heavily on a manufacturing and export base and cannot be sustained indefinitely. I believe for the U.S. the sustainable growth rate is believed to be in the 4%-5% range, which means the economy doubles roughly every 14-18 years.
Another question I have is what size tax cut would actually be required to generate a sustained 3% annual growth rate in and of itself. The U.S. economy has grown at a fairly steady clip during the past 60 years, maybe 4% or 5% a year, with a few temporary downturns followed by explosive growth years, irrespective of the percentage of revenue taken in taxes. Adjusting that growth rate upwards to, say, 7% annually on a sustained basis simply based on tax policy is counterintuitive, to say nothing of whether a 7% growth rate is in fact sustainable in the long run at *any* tax rate.
The flaw is actually in the idea that the higher growth rate is "sustained". That's simply not true.
Lets try comparing the GDP to the speed of a race car. Ways to go faster are are 1) tuning the engine, 2) pressing on the gas, 3) installing a faster engine.
Reducing the size of government (both spending and taxes) is like tuning the engine (at least in classical theory - I wouldn't buy into this in all cases, but I'm willing to accept this as true in many cases.) Certainly a well tuned car will go faster than a poorly tuned car.
Fiscal stimulus (increasing the government deficit) is like hitting the gas. The car will accelerate for a while, but once it gets to the speed that corresponds to the new gas pedal setting, the speed will level off.
Neither of these measures will cause the car to accelerate forever. You can floor the pedal on a 1920's era car, or tune the motor forever, but it's never going to go faster than a technologically superior vehicle. The only way to make the car accelerate forever is to keep upgrading the engine, and that's only possible through technological development.
So any growth you get through lower taxes will increase growth for a few years, but you're only getting closer to the "potential" performance of the economy. You haven't actually increased that potential. In the long-term you're still constrained by the basic level of technology development.
So, Ami, is it right to presume you're saying that the effects of lowering the tax rate would be mainly to accelerate investment which should occur eventually in any case, with a lesser effect of making certain formerly marginal investments viable and certain other formerly unviable investments either marginal or perhaps even viable? I know this completely avoids the whole question of how much tax revenue results from tax cuts that we've been discussing, but that seems to be a fair conclusion to draw from what you're saying in this latest comment.
Not quite. First it's necessary to distinguish between capital investment and R&D.
Capital investment first...
As taxes are lowered, some of that money will go into extra capital: factories, buildings, etc. The marginal return on that capital is limited by the fact that you still have the same amount of labour, and capital investments depreciate (they require maintenance).
So if you have an extra $100/year to spend on machines, you might spend the whole amount on new machines in the first year, but eventually you'll reach the point where you have to use the extra money to cover your increased maintenance costs, or to pay higher wages (since everybody in the country got the tax cut, and they need new workers to run their new machines as well - this drives up wages).
That was just a long-winded way of saying that the increase in output due to capital investment doesn't keep rising forever even if you have more money each year. Your capital stock reaches a new level, and then stays there.
If you want to increase your production further you need new technology: a new kind of machine that produces more output for a given amount of labour and maintenance. That requires R&D investment.
I'm sure Richard will make the point that the demand for new machines will surely stimulate new R&D. But in practice this mechanism doesn't work that well.
First, the chain is quite long - most of your tax cut will go into consumption, most of the rest will go towards increasing the capital stock (which requires continued investment to maintain and operate, as explained above), and only some of that investment in capital stock ends up going towards R&D.
Second, R&D investment is risky and takes a long time to pay off. These are exactly the conditions where markets tend not to function efficiently.
Businesses mostly focus their R&D effort on short-term product development. Basic research ends up being funded by government in one way or another (either directly or through targeted tax breaks).
So the path greater R&D investment through general tax cuts is there, but shaky and very indirect. In practice very little of the extra money will go to R&D.
If the consequence of your tax cut is even a small loss in government R&D or education, then you'll likely wipe out any benefit from the tax cut.
There are a lot of other complicating factors, and the bottom line is that any effect of general tax rates on long-term growth, if it exists at all, is lost in the noise.
I've started using "general tax rates" because targeted tax breaks for R&D do have an effect, and are widely used, but that's not what we're talking about here.
Ami, it seems your arguments are predicated on the assumption an economy will perform at (or at least reach) an optimal level (based on technology), regardless of tax rates (within a certain range, as a 100% tax rate will obviously (to me, anyway; you haven't said either way) destroy an economy). Further, you appear to be claiming that the rate of technological advancement is a constant. Are these your claims? I don't want to argue against a point if it isn't the point you're making.
No, the tax rate (among other things, like a good finance system, rule of law, good health care, education, etc.) helps to set the "level". So it's quite possible that an economy that's performing at 50% capacity might perform at 51% if you cut taxes (all other things being equal).
But the tax rate doesn't determine how the potential capacity (the "100%" level of output) grows.
So if you cut the tax rate then you might get a year or so of better growth as the economy moves from 50% of capacity to 51% of capacity, but that's it. After that it will continue to grow at the rate that's constrained by technological progress.
The rate of technological advancement isn't constant, but there's no indication that's in any way linked to the tax rate.
Ami, QandO has an article up on the Laffer Curve and where we are on it that you might be interested in.
Oops. Put that on the wrong thread.
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