Taxes

But, I hear you saying (and emailing) after my last few posts, higher taxes are bad for the economy because people don’t work as hard, making the pie smaller for everyone.

Yes, that’s what it says in the textbook. But the issue is more complicated than that. Look at this, for example:

What do you see? Nothing? That’s what I see, too. Of course, the topic is more complicated than a single picture. (For starters, I’d like to replace the top marginal tax rate with the marginal tax rate for people making, say, 3x the national average and see what that looks like–anyone know where I can find that data?) I’m sure that people have done sophisticated analyses of this question controlling for this, that, and the other thing, and I’m also sure you can find studies on both sides of the question.

Then there’s the idea that high taxes and the nanny state cause people to work less hard, preferring unemployment to an honest day’s work. If you believe that, I recommend this picture to you:

Again, I don’t think these pictures prove anything. Well, maybe they prove one thing: that the real world is more complicated than the first-year economics textbook. Maybe higher taxes do result in less effort and less growth when you control for everything else. On the other hand, maybe lower taxes and the resulting higher inequality result in a larger amount of what Sam Bowles calls “guard labor”–people whose job is to keep the poor part of the labor force in line, which is all basically unproductive.

If there’s one thing I’d like people to take away, it’s that any theoretical economic argument that can be stated in a sentence is as likely to be untrue as true in the real world, no matter how clever or intuitive it is.

By James Kwak

114 responses to “Taxes

  1. The “more taxes, less work” argument is infuriating simplistic. It disregards all if the things that tax revenue buys that increase productivity like infrastructure, education, national security, public safety and a functional legal system. It also fails to take into account the other effects taxation has on behavior, if we have learned nothing over the past two years, is it not that this unrestrained accumulation of wealth by individuals by whatever means possible is not good for the economy, society, or for the psyche of those who engage in it. We are not atomistic, perfectly ratioal beings, and there is no evidence Laffer was anything but wrong.

  2. James,

    Why is it that the simple freshman microeconomic inverted U-shaped curve relating compensation to performance isn’t focused on more? If this relationship holds, doesn’t it argue for perhaps flexible pay restrictions across the board in our economy? Of course, it’d help if there was some international cooperation on such restrictions.

  3. And as I have previously noted (link at signature), most recessions result in increases in top marginal tax rates for persona lincome taxes, which means thta more taxation can actually lead to economic growth.

  4. When taxes are high, much effort in the private sector goes into tax avoidance. For example, people become more willing to spend inordinate sums of money on tax shelters. Employers can bestow non-taxable benefits on employees like Cadillac health plans to offset the higher taxes on income. Usually the rich have many more options available to them than do the middle class. So don’t be fooled when a politician wants to pay for a program by raising taxes only on the rich. It’s the middle class that will end up paying for it, and the rich will still be rich.

  5. Thank you! It has always been obvious, empirically, that there is no simple relationship one way or the other between tax rates and growth. That the tax-cut argument gets made all the time, with so little pushback, is one of the clearest signs that we live in an oligarchy that has drastically distorted our thoughts and feelings.

  6. Laffer wasn’t wrong on the theory part. The problem was that Reagan and his cronies were successful in convincing everyone that we were on the wrong side of the inverted “U” curve and that it was obvious that if taxes were lowered we’d get more taxes and more growth.

    The success of the Reagan arguement has left us with a society that views ALL government and ALL taxes as bad. When in reality what we have is a government that serves only those wealthy enough to buy its influence.

  7. Why do people assume that tax dollars will be spent wisely and efficiently? Obama’s definition, via results, of Operational Excellence is appalling and embarrassing.

    We are living in the age of idiocy.

  8. What’s intuitive about the idea that people would prefer getting unemployment to a paycheck because they don’t like high taxes? First, since Reagan, UC benefits ARE taxed. Second, have any of those who put forth this idea ever BEEN on UC? The weekly benefit is a mere fraction of one’s pay. This reminds me of the old argument that people would prefer to collect welfare than work. I suppose that was because everyone knows those checks and benefits are so enormous, it’s a wonder every denizen in every gated community across the country isn’t divesting themselves of assets so they can line up and collect.

  9. This is a well-evidenced, rational post. I hope there are still people who listen to evidence and reason.

    The problem is that trickle-down has been empirically disproved a thousand times by now. So wherever anyone who’s not rich still “believes” in it, we’re talking about flat earther fundamentalist faith, deranged irrationalism.

    To that extent it would be inaccessible to rational argument.

    I guess the place of reason is to battle the media and government lies for the minds of the not-yet-convinced.

    But reason itself isn’t enough. There has to be a real narrative to battle a lying narrative.

    This fight is pivotal, since somehow, alomst insensibly, what used to be called voodoo economics became the law of the land, univerally acclaimed by everyone in the power structure.

    And it’s the same gutter lie, the same dressed-up excuse for crime, it always was.

  10. I came across a study that failed to show a correlation between average taxes and long-run GDP growth. And another that failed to show a correlation between public sector expenditure as a proportion of GDP, and long-run GDP growth. I will have to see if I can dig them up.

    Of course it’s hard to interpret such failures. Often if they change the specification of the econometric model they can find an effect. And there are other things that econmetricians have tried to link with economic growth, and failed (at least in some studies): e.g. level of investment, quality of economic policies, openness to trade. So for both these reasons you have to be careful not to put too much weight on a study that fails to find a result.

    Still, I have some thoughts on this… government is usually better at providing public goods than the private sector, and often better at providing merit goods (like education). But the private sector is pretty much always better at providing private goods (or non-merit private goods, rather). Now I find it plausible that at any one time, different countries might need a very different balance between merit, public and private goods in order to maximize both welfare and economic growth (simplistically, one country might really need roads, and another might really need consumer goods). I also find it very plausible that the balance that they need changes over time both as a result of development and as a result of other factors. In that case, you wouldn’t necessarily expect there to be a simple recipe the optimal level of taxes or the public sector, or a simple relationship between size of the public sector and economic growth.

    Just the thoughts of a simple Talking Cat…

  11. They do collect, but it’s in low capital gains taxes and regulatory capture for their investments.

  12. “higher taxes are bad for the economy because people don’t work as hard”

    Is there any empirical evidence for that statement?

    I am serious. Show me the citations, please.

  13. I think I would be more up for investment than wealth transfers. If the government was building real assets with all this money I wouldn’t have a problem with it. Things like the Hoover Dam or a nuclear power plant last generations. A new energy grid or other infrastructure could also be useful.

    My problem is we don’t tend to invest and people are more interested with wealth redistribution.

  14. The Age of Anxiety preceded the Age of Idiocy. People had a premonition of what was to come. ;)

  15. TalkingCat, is the government really better at providing education?

  16. A few days ago, CNBC’s Kudlow proclaimed that an increase in taxes would cause people to work less, stop investing in equities and only invest in bonds. Did the equities market begin with GWB? What bunk, the market has always been there. Work less, not bad maybe Kudlow will show us by example and retire from the TV.

    Did people work less in the 50′s with high tax rates?

    More scare tactics, just like the Death Panels. It never ends with these people.

    Want a tax plan, here is one. All income regardless of the source is taxed at the same rate, no tax benefits for off shoring or hiring H1B’s. No tax exemptions, itemization or credits. The first $50,000.00 is tax free for all tax filers, the percentage tax rate rises in increments after the first 50,000.00 up to the highest rates of over 50%.
    All businesses that do business in the US or with the US government even if registered off shore pay a business and occupation tax on their gross. Wa State is an example.

    Take a look at the national debt, deficits, job creation under the different administrations since Reagan. Tax cuts on the top do not trickle down or stimulate the general economy. Bush’s tax cuts in part brought us to this point.

  17. Turned on Fox the other day, first time in months. (Sick and bored.) Swear to god, the ‘anchor’ was interviewing two women, and one said, “Trickle down economics works.” The other woman and the host both nodded in agreement.

    If it works, it’s based on the notion that folks down at the bottom of the economic scale need to pissed on.

  18. “this unrestrained accumulation of wealth by individuals by whatever means possible is not good for the economy, society, or for the psyche of those who engage in it”

    Right, but you do not cure that with taxes, which only makes government a partner in crime, but by making sure you eliminate the market and regulatory failures that allow for “unrestrained accumulation of wealth”…

    Can´t you hear the taxman? “let me give you a patent… so you can exploit monopolistically so I can share more in your profits”…

    Taxes in a society should not be paid by corporation they should be paid by the citizens… since that is the only way you get governments to be really accountable to the citizens.

  19. In the first chart, there does seem (upon unrigorous visual inspection) to be a short-term reaction to changes in the tax regime visible in the GDP trace. So it may be true that economies respond favorably in the short-term to tax cuts (to the economy, it looks like fiscal stimulus). However, as Prof. Kwak points out, long-term correlations are going to be hard to find.

    Interestingly, there does not seem to be much of a consistent response (short OR long term) to tax increases. That suggests a high tax regime might be better as a long term policy choice, so that economic stimulus can be easily delivered when needed.

  20. It does seem like the bigger issue, when it comes to economic health and revenue stream, should be income distribution instead of tax rate.

    Not being an economist, I have no idea how to show the impact of concentrated wealth vs the distributed wealth. But I’d guess that higher income gaps, not higher taxes, are bad for the economy. Like putting too many eggs in too few baskets.

  21. Why should we raise taxes to pay for infrastructure. That what bonds and usage fees are for.

    The problem I see with higher taxes is the transfer of funds from a large number of economic actors to a single very large actor whose actions are not motivated by normal incentives.

    State and Federal governments don’t exactly have a great track record of spending money wisely or efficiently.

  22. Trickle down and the theory of lower taxes creating employment works in a “closed” economy – where investment choices are limited to what is available in the local economy.

    When a free flow of capital is allowed, investments will always seek the highest,yet low-risk investments available globally.

    Is there a study out there illustrating this?

  23. I challenge to provide a single example of any good, public or private, that the government is better at providing than the private sector.

    I concede that local and national security requires government spend.

  24. Daniel Habtemariam

    Wow. Very well stated.

    Be careful, James. You’re becoming Adlai Stevenson…thinking reason and evidence are appropriate substitutes for simple arguments with mass appeal.

  25. That first graph is pretty simple.
    The US was the sole manufacturer for the entire world after WWII.
    If we made it, they had to buy it.

  26. No, the challenge is for you to provide a single example of a large corporation which exists in “the private sector” rather than the rigged corporatist state sector.

    Banks, nope. Health insurers, nope. Big Drug, nope. Big Energy, nope. Industrial agriculture, nope. Big box stores, nope. Real estate, nope. Construction, nope….(not an exhaustive list).

    And of course any sector involved in “free” trade depends completely on the empire and the reserve currency. For that matter, everyone who uses the dollar relies on those..

    The point being, if you have a mass society, you automatically have a big government which is an aggressive market player.

    So the only decision is whether the government’s market actions will be on behalf of the people or on behalf of worthless gangster parasites.

  27. That’s similar to the “free” trade lie of “comparative advantage”, when of course no strong market player ever seeks comparative advantage, he seeks absolute advantage.

    Just like no one in business really wants to be a capitalist, but rather acts to rig the market as soon as he has the muscle to do so.

  28. Mark Longridge

    Been interested in this for a long time – What was the tax rate in the ‘good old days’? You spurred me to find the data (or at least some of it)
    The Tax Foundation has data for every bracket, every year: http://www.taxfoundation.org/publications/show/151.html (look for the excel sheet link at the bottom)
    will also look for average income data and run the numbers/graph if I can.
    Thanks for a great blog!

  29. Yeah but private industry always allocates money in to efficient, productive avenues, like the finance industry. You know, the same industry that brought the entire global economy to its knees and put millions out of work.

    Government is always inefficient and evil. Private business is the unerring crusader and paragon of efficiency and good. Riiiiiight.

  30. Yes – if we require teachers to actually be certified in the field that they teach.
    http://www.sciencedaily.com/releases/2009/02/090226093423.htm

    If you compare income brackets, public schools do as well as private schools in everything except SAT scores which are a result of offering advanced classes. Most urban and suburban high schools offer advanced classes, but rural schools often do not. The most important factor in education and test scores is family involvement which is NOT usually considered in the public vs. private debate.
    http://education-portal.com/articles/Public_Schools_vs._Private_Schools:_New_Study_Says_There_is_No_Difference.html

    CEP study:
    http://www.cep-dc.org/index.cfm?fuseaction=document.showDocumentByID&nodeID=1&DocumentID=226

    In the interest of full disclosure, I received all of my education in public schools.

  31. Better or worse often isn’t the issue. Will or won’t is more to the point. Many government endeavors have been of great benefit. To name a few: space exploration, scientific research and development, public universities, the judicial system, and as is apparent of late regulation of industries.

  32. Why do people assume that private money will be spent wisely and efficiently? Banking’s definition, via results, of “innovation” is appalling and embarrassing.

    We are living in the age of idiocy.

  33. Coupon clipping is hard work – if taxes are too high, folks will just stop doing it…

  34. But it’s rich piss. I thought every middle and lower class schlub could only dream of being pissed on by the rich!

  35. This argument has been circulating for a while. Concentration of decision power (whether through wealth, political power, or other) in the hands of a few results in large effects of bad decisions, and fewer chances of good but novel decisions. (Sorry, but I can’t find any links at the moment.)

  36. Alluded to here : http://www.econtalk.org/archives/2009/12/kling_on_prospe.html (at 4:30)
    Trial and error, and no apriori way to select winners and losers. Concentrate capital in few hands, and this process can’t happen.

  37. I can only assume the folks who say people will not work as hard if taxes are higher are speaking of themselves. I would like to hear their explanation of the ever-growing open source, collaborative computing movements where folks work hard for free. Or how about the hard work done free by volunteers across the country. Only the folks who are solely motivated by money make the high tax low productivity argument.

  38. Public schools have to take all students and try to educate them. Private schools can control their enrollments on the front end, and get rid of difficult students on the back.

    (This is something many parents are surprised to discover when they’re child is shown the door.)

    In a public school, a child has rights to an education; in a private school, no such rights exist.

    (I’m discussing k-12 ed. only.)

  39. James, it’s not me. I say the higher the income, the higher the taxes. If it’s so much easier working for a lower income because the taxes are easier, then let the bankers go work at Wal-mart. I will gladly do their jobs for a 1950s style tax rate.

  40. I live in CA and my wife has started a small art/design company. Because my taxable income in 2009 will be over $65,101 (is that high?), her STARTING marginal taxrate for her business is 48.55% (15.3% FICA (both sides), 8.25% CA, 25% Fed)…meaning the government will take away nearly half her profits. Who out there thinks this is not a disincentive to start a business? The unemployment rate does not include all those who are not looking for work … so James’ analysis excludes all those people who are discouraged from looking for work due to the high marginal rates.

  41. Kcar1 writes: The “more taxes, less work” argument … disregards all if the things that tax revenue buys that increase productivity like infrastructure, education, national security, public safety and a functional legal system.

    Well said !

  42. First of all, nobody is talking about raising the top tax bracket back to 90%. All the socialist Obama wants to do is bring the tax rate back to where it was in the 1990′s when GDP growth, and real job creation were taking place.

    Secondly, we’re running a gigantic deficit. Of course in a surplus environment there are arguments to be had about using the surplus money to purchase more public goods and services vs. pay down debt, vs. give a tax cut. That argument is long past. There is absolutley no way to get future deficits under control without raising taxes. There is no way to cut the budget deep enough – even with major restructuring (increasing ages, lowering benefits) of Social Security and Medicare, cutting discretionary spending in half and cutting the defense budget by 20% or so, we’re still running a deficit.

    The reason the US is still an AAA rated sovereign currency is because we have always had more untapped wealth than other countries. We could always raise taxes very slightly and yet bring in huge dollars compared to other economies where the taxes were already higher and the earnings of the average citizen that could be taxed were lower. What’s going to lose that rating is not the economic reality of what our country is capable of paying back, but a clear rejection of the political will necessary to do so.

    I personally would like to eliminate the income tax and replace it with a VAT tax. It would be more fair, it would generate more revenue, and it would spread out the pain across industries and different special interests so greatly that lobbying would be more diffuse. (not by any means eliminated) But since that’s on nobody’s radar screen (except Bruce Bartlett) I’ll settle more a partial revocation of the Bush Tax cuts. Forget the political philosophies involved, if we don’t show that we can raise taxes even a little, the bond markets are going to pull our AAA rating, and the new rates we’ll have to pay on our bonds will consume and even greater percentage of the budget, compounding the problem we already face.

  43. The road to “Too Big To Fail” is paved with gold.

  44. So you don’t need the 51.18% of the income she earned? She doesn’t have the business set up as a sub-chapter S Corp or an LLC so some of her earnings can be considered profit vs. salary and she doesn’t have to pay FICA on them? There are no deductions like business use of home, car mileage etc. that she can deduct even though they’re not “real” expenses.

    Her business earned money the first year out as well? Most small businesses show losses the first few years, which could lower your taxes below that $65K figure.

    Also, why did she start the business? Why isn’t she working for someone else? Because perhaps there are reasons to work for yourself beyond money? She wants to be her own boss, have her own vision for a company, watch something she “birthed” grow and thrive.

    Your question back to James is also misleading. Looking for work and starting your own business are not the same thing. Also, if you can’t afford to pay your bills, 50% of the money you earned is still more than 0%. Last two points, if you’re going to own a business not just get W-2′s from an employer, you really need to have an accountant and with a good accountant you can take advantage of all the tax incentives that small business owners have access to. Including putting up to $46,000 of earnings into a retirement plan and not paying taxes on those earnings. Second, sy $65K of taxable income you’re still in the 15% Federal Tax bracket.

  45. So, why did she start a business? And why do the big boys pay a much lower rate… Did you know that over 50% of all the corps in the US pay no corporate taxes.

  46. Bonds are just loans, which are paid back out of taxes…

  47. Did the finance industry really make a lot of bad investment choices? I would argue that the act of providing bail-outs shifts the balance towards dumb on the government side. The counterparties of Bear Sterns (private mostly) made out pretty well while the NY Fed is looking to take it in the shorts big time. Did GMAC bondholders really screw up? They are getting paid effectively from the US Treasury. If the government lacks the discipline to let private losses remain private losses, then I guess they convert to bad investments on the part of our government. In fact, you could easily argue that in a world where it is reasonable to expect governments to cover bad investments, then, for private parties, having a too “accurate” evaluation of risk is counterproductive. Had the government listened to Bear, Fannie, Freddie, Citi, AIG, GMAC and the like and then wished them better luck as they got shown the door I would think that public decision makers had done well. But if in the end the private parties end up with the dough, as ugly as the process may have been, I would say they performed better than the public did.

  48. Agreed that we have to show political will to make hard changes and we are now showing exactly the opposite.
    But VAT is a glorious tax for the governments that impose it as well because it is so diffuse. It’s difficult to pin down just what the total burden is on the economy because it is levied incrementally. This removes much of the power of the lobbyists, yes, but also the transparency and controlability whose desirability is so much at issue in this country. What do we really want?

  49. In general it appears a strongly progressive tax table doesn’t negatively impact income growth or job creation.

    I believe our strongest periods of job and income growth (since Truman) came during periods where progressive tax tables were used.

    Progressive taxes, however, would provide strong government revenues. Which would be less likely to produce greater deficits.

    Also, high tax rates on the upper end could encourage capital gains type of investments and/or municipal tax free investments which are normally productive enhancing investments in government infrastructure (including mass transit).

    And this leaves out entirely the fairness issue of income disparity.

  50. Bruce Bartlett defined the VAT perfectly. He said that Republicans hate it because it’s a money machine and Democrats hate it because it disproportionatly affects the working class – it will get passed as soon as the Democrats realize it is a money machine and the Republicans discover that it disproportionately affects the working class.

  51. D. Christopher Leonard

    I hadn’t noticed that most Western Europeans were ceasing to innovate, to work, fleeing their countries in vast numbers because of higher tax rates. French workers are as productive as U.S. workers – but work fewer hours (poor things also have adequate pensions, excellent healthcare, longer vacations, even a two hour closing at midday for lunch). The fact of the matter is that European social democracies are more civilized than we are (in Italian: vita civile). People live in less space, have smaller incomes, eat better food, live longer.
    Our vaunted gdp growth figures disappear in armaments and into the maw of Goldman Sachs, et al. while millions look forward to no healthcare, no jobs, declining family formation (as incomes decline) lower literacy rates. What more do you want?

  52. Agoraphobic Kleptomaniac

    If a first year small business is paying 50% of their profit in taxes, it sounds like you need an accountant. Otherwise, if she does have an accountant and her tax rate is effectively double than most multinationals pay… (The average U.S. effective tax rate on the domestic income of large corporations with positive domestic income in 2004 was an estimated 25.2 percent.)[1] then something really is wrong. I have a feeling that you’re either leaving out important information or exaggerating for effect.

    Also, if you have problems paying taxes, tell her to go work for Coke designing labels or something. She might take home more pay in the short run, and she won’t have this burden of running her own business, that seems to be such a problem.

    [1]http://www.gao.gov/products/GAO-08-950

  53. Disaster Relief.

    I live in Canada. I’m a small-business (corporation) owner, with employees. I’d add health care insurance to the list of goods that the public sector does far better than the private. That’s purely based on observed outcomes, both statistical and anecdotal. We (canadians) live longer, have lower morbidity, lower child mortality, pay WAY less, and everyone is covered.

    We live in the same media-drenched, junk-food, couch-potato, bread-and-circuses, superstitious culture as you do. We get about the same rate of immigration per capita from around the world (excluding Mexico). And yet the outcome is vastly different. Why is that?

    The doctors (especially GPs) grumble a lot about the system, but we’ve been doing it this way long enough that they can’t be going into medical school for the money anymore. Besides, the ones that really wanted to get rich went south during our ‘brain drain’ in the ’80s and ’90s (you’d have to have lived thru that bit of corporate group-think to understand its idiocy).

    So there are two off the top of my head.

  54. yes to this one too — if your country wasn’t so susceptible to capture by special interests.

    What you don’t get at a public school is access to the power/influence/money network as part of your birthright.

    I went to a private prep school in the ’70s and a top Canadian University (Hons. Commerce) in the ’80s.

    I don’t think it was the method of paying for out education that made the difference where we all ended up. I think it was mostly the starting point (I and my friends got parents in the higher-earning layers). We also got parents for whom education was a priority. They were all pretty involved with making sure their kids did the schoolwork.

  55. More work on getting decision power into more hands — from Vincent Ostrom (spouse of Nobel Prize Winner Elinor)
    http://localgov.fsu.edu/readings_papers/Service%20Delivery/Ostrom_Tiebout_Warren_The_Organization_of_Government.pdf

  56. That the government is not good at providing education is one of the more irritating logical fallacies about government ineptitude…

    Because SOME public education is done poorly and there is apparent waste and mismanagement in the opinion of SOME (one person’s waste is another’s investment), all public education is bad.

    The expansion of public primary and secondary education to universal in the nineteenth and early twentieth centuries was an important driver of economic growth. The the focus on math and science education in the post-Sputnik era is lauded for its economic impact and its impact on the productivity of who graduated from that system.

    The fact that the systematic de-funding of education and the balkanized system of local control over curriculum and budgets has lead to poor outcomes is not an indictment of government provision of education, it is an indictment of a certain way of government providing public education.

    No developed country now lacks for universal primary and secondary education… and many developing countries do, this is recognized as being a drag on their ability to develop because, what do you know, those countries high rates of illiteracy, innumeracy, etc. And it is really hard to get anything but agricultural jobs and very low-tech industry into a place where the workers can’t read or do math.

    The countries that outrank us on math and science do not depend on private education to do the bulk of it. In fact, in many of those countries, private schools are second-rate… where you end up when you can’t hack it in public schools.

  57. But trickle down economics do work, the only problem is that the benefits have trickled down to China, India and several other third world countries.

  58. Do you really believe that the finance sector would have created all the CDOs and sub-prime based assets if there was no buyer of last (and sometimes first) resort.

    The housing bubble was created by fannie and freddie taking garbage and turning it into AAA bonds using the implicit federal backing.

    When the the government gets involved in markets, the markets skew and cannot self correct. Every time.

  59. Thats just a good argument to privatize infrastructure development. The new deal approach built alot of highways, sure, but much of the system is poorly allocated with 6 lane highways in Jackson MI and 2 lane higways in New York City.

    BTW… The New Jersey Turnpike pays for itself through usage fees (i.e. tolls) as to the bridges and tunnels in NYC. No need for taxes there.

  60. Functional legal system… really. Have you sued or been sued lately. Do you know what % of cases in major cities go to trial.

    But I agree that we have no choice but to live with lousy justice when the force of the state is indispensable (criminal cases).

    Private arbitration is much more effective in civil cases.

  61. carping demon

    But, corporations ARE citizens; the Supremes said so.

  62. You guys are all just a bunch of communists.

  63. Bureacrats spend someone else’s money on a third person. Incentives to ECONOMIZE disappear under this scenario. Therefore government spending is NEVER as efficient as private spending.

  64. As with all economic effects, we’re talking about what happens at the margin. Of course someone who is middle class would not purposely move into the unemployment line. But if someone who is already unemployed has a meaningfully lessened incentive to look for work (i.e. extended/boosted benefits), he is in fact less likely to do so.

  65. That is really not the question. It is whether people at the TOP of the income distribution (we are talking about **marginal** tax brackets here) will be so demotivated by an few percentage points increase that they will move to the unemployment line…

    If you are comfortable both from a financial and psycho/social perspective being on unemployment, than any change in the top rate is immaterial to you.

  66. The pragmatist

    There were times in the past that what we now consider basic government services, such as police protection, fire protection and roads, were provided by the private sector. The reason that they are now provided by government is that the private sector failed in their efforts.

  67. I don’t think high taxes are the best way to correct income inequality. Recent research has proven that nations with egalitarian distribution of wealth have correspondingly good health, and lower health costs, than nations with greater income disparites. Strikingly, this bears out whether the nation is rich or poor. Japan stands at the top of the list. How do they do it? I don’t think they redistribute the wealth with extremely high taxes, as they do in some socialist countries — there is less disparity of income.

    I remember those TV images of Japanese executives humbly apologizing to their workers and fellow citizens for betraying their responsibilities. Just imagine the Wall Street banksters doing that. What basic sense of honor and responsibility is missing in North American culture? Redistributing wealth through taxes won’t fix what’s broken. Neither, on the other hand, will social Darwinism. Just dogs fighting over bones. How does Japan keep income and wealth egalitarian?

  68. First google search provided with an unconfirmed answer:

    “Japan’s individual income tax rates including local taxes are among the highest tax rates in the world. The effective top marginal tax rate is around 50%.”

  69. and the proof of this universal statement is? … I hope it doesn’t include silly notions like perfect information.

  70. and perhaps if the shareholders of all these paragons of virtue had woken up and actually worried about what the managers were doing … Oh I’m sorry that would spoil your argument. And the ‘government’ includes you and me via the ballot box. I guess you’re ready to let the market implode to impose all that ‘discipline’. Maybe some other folks aren’t. Maybe they want jobs.

  71. yes, as a matter of fact I do think the banks would have created all that stuff. They securitized it all and sold it off to dumb fools in other financial institutions like pension funds etc. They didn’t give a hoot about lender of last resort because they never intended to hold it anyway.

  72. How exactly does a higher or lower marginal tax rate affect the incentives of someone who has no income to tax?

  73. She didn’t have to start a business. She could have looked for a job and avoided some of those taxes.

  74. Marginal taxes based on tax brackets do not reflect the actual marginal tax rates paid by taxpayers, which is one of the reasons you do not see an effect. Many deductions, such as the itemized deduction, which include among others real estate and state income taxes, phase out at different income levels. Congress may lower the marginal tax bracket rate, yet simultaneously phase out a deduction based on income level, or it may raise a marginal rate but add new deductions. The actual effect on the marginal tax rate paid can be similar to or opposite to the tax code marginal income tax rate bracket change. Similarly, there is the AMT inflation creep (which is temporarily fixed), which is encompassing more taxpayers. It also distorts the marginal tax rate effect.

    Without adjustments for lost deductions, AMT and bracket inflation creep and other marginal tax effects there is too much noise in the data to prove the point about marginal tax rate effects on work, either way. What superficially looks like a marginal tax increase can be an actual decrease and vice versa in the higher income brackets due to other changes in the tax code.

    There is also the additional problem of expectations that distort the relationship. Tax laws usually take effect in the future, allowing high-income producers, but not the average salaried worker, to accelerate or delay income recognition to get the most favorable tax treatment. If tax law changes affect investment decisions, the GDP effects will not be seen until the investment starts returning income, which can be several quarters or years forward.

    Additionally, one would really have to know what future GDP would be without the tax change to compare it with the tax change. If the economy would have grown by 4 percent but instead grew by 2 percent, the tax law had an effect. The effect may not be noticed by comparisons to previous GDP, which is why some macro-economists who study tax effects develop Dynamic Stochastic General Equilibrium (DGSE) models. It allows them to fit a model to the economy and see what effect the tax rate has on future output compared to the future economy without the tax change. Most of these studies look at past changes to insure the models accurately describe the economy at the time of the tax change and have a high degree of reliability. These models have a very high degree of explanatory and analytical usefulness for past government policy changes, but are poor at forecasting into the future. The models are good for finding cause and effects of past GDP behavior, but much less so for predicting future outcomes. However, certain policy changes consistently have the same effect and therefore previous analyses are very useful for showing how policies affect future GDP.

    Simplistic analysis of comparing GDP with tax bracket marginal tax rates really proves nothing about the effect taxes have on future production and work.

  75. My mistake. Thanks. My source was wrong and I should have double checked.

  76. What a truly terrible graph, one country over time is incredibly useless in this context. Identification in variance is needed, you have none.

    Do a real post, compare American tax rates, UI benefits, and GDP growth to Europe. Then you will have something that isn’t pathetic pandering to your viewpoint.

  77. UnnaturalIntelligence

    I too admire Japanese culture in this respect. It’s a great example of the problem of looking at simplistic economic “laws” in isolation of political and sociological considerations.

    Even though modern and westernised, Japan still retains many aspects of its traditional culture, of which honour is a huge part (even if seppuku is not a common thing any longer). This contributes to their income distribution, among other things. You can’t simply legislate into existence centuries of cultural inheritance. But since it’s hard to put a value on it, all too often today it’s simply ignored or treated as an afterthought

  78. Looking into it . . according to Wiki, Japan’s corporate and personal tax rates are very close to those of the US. And yet — they have the most egalitarian wealth distribution in the world — so go figure.

  79. Marrty, in fact I haven’t, in part because the system of private property and intellectual property, not to mention the body of tort law, are strong enough to have reinforced norms and created a deterent to activities like blatant knock-offs through reverse engineering, taking of the copper from the lines feed electricity into my house and business, or the siphoning off of water and fuel, or the befouling of my property because in is more convenient than proper waste disposal. Is it perfect, no, does ot create the conditions for Steve Jobs to profit by being innovative, yes, keep Coca Cola from profitting by dumping nasty stuff into the water supply so it sells more Dasani, yes. That is “functioning” and when you don’t have it, it is infinitelyore difficult to conduct business.

  80. D. Christopher Leonard

    The problem with a ‘culturalist’ explanation is that other national states (e.g. in europe) share virtually none of the ‘values’ (like respect for elders, obedience, social deference) you find attractive in Japanese society – yet have more egalitarian distributions of wealth, reasonably good economic performance (especially taking into account citizen’s welfare by various measures). Japan his also been effectively, a one party state since 1948 – so perhaps gilded authoritarianism (like singapore) is what you want?

  81. UnnaturalIntelligence

    Each country has its own culture that will shape its attitudes towards income distribution. If Japan is too alien, then just compare Canada, where “Tall Poppy Syndrome” is prevalent, and the US. After the financial crisis hit, many Canadian bank executives, even though heading banks that were in good shape, voluntarily took pay cuts to levels that would make average Goldman employees feel destitute.

    The point is that you cannot find economic explanations (i.e. due to this tax level or this policy, etc.) for the behaviour of Blankfein vs Ed Clark, the CEO of Royal Bank of Canada who took a paycut.

    Similarly, income inequality in the US can never be addressed in isolation of culture. Attempts to redistribute, through taxes, will likely be resisted fiercely. A return to some level of humility and maybe some old-fashioned shame tactics for executives who loot their companies rather than reinvesting and financing projects through retained earnings will be much more successful in naturally restoring income balance.

  82. Let’s say I have to net $100,000 to survive so I have to earn $130,000. My taxes double to $60,000. I still need $100,000 so now I have to work my ass off to earn $160,000. Higher taxes should result in increased output, not less.

  83. D. Christopher, according to the people whose research correlates distribution of wealth with the health of the population, NO nation has a more egalitarian distribution of wealth than Japan.

  84. . . and I should add: what is the big difference between “a one-party government since 1948,” and a two-party government in which both parties are controlled by corporations and financiers?

  85. I’m simple minded and don’t understand a lot of this fancy economics talk about the impact of taxes on jobs and work. Let’s keep it simple: what was US private sector employment when the Bush tax cuts were adopted and what was the number when he left office?

    There are a whole lot of folks out of work who would take nearly any job, regardless of the tax rate, because to work is to contribute, i.e. to live as a productive member of a family unit and as a contributing member of society. If we need to raise taxes to achieve full employment over the next half a decade, so be it. It worked nearly 80 years ago and it can work now.

  86. Measure for Measure

    Well, my labor textbooks say that there’s an “Income effect” (higher after-tax income makes people consume more of everything, including leisure) and a “Substitution effect” (working becomes more attractive relative to leisure when it is taxed less). Which effect outweighs the other is an empirical question.

    And empirically, the relationships range from “Subtle” (affecting mostly married females, at best) to “Nonexistent”. That implies that the 2 effects are a wash, or that both of them are so small so as to be overwhelmed by more important factors.

    So it’s not the textbooks that are wrong, it’s the students!

  87. Marty S: “State and Federal governments don’t exactly have a great track record of spending money wisely or efficiently.”

    Especially in the last generation or so. But before then, despite the waste, we had people who governed effectively and well. Government effectiveness or the lack thereof is largely a self-fulfilling prophecy. Compare the government responses to Katrina and to the 1906 San Francisco earthquake.

  88. Why do people assume that any dollars will be spent wisely and efficiently?

  89. Talking Cat: “I came across a study that failed to show a correlation between average taxes and long-run GDP growth. And another that failed to show a correlation between public sector expenditure as a proportion of GDP, and long-run GDP growth. I will have to see if I can dig them up.
    “Of course it’s hard to interpret such failures. Often if they change the specification of the econometric model they can find an effect.”

    That does not mean much. One now well known problem in the social sciences is the studies done that do not show an effect and do not get published. Their existence means that the effects in published studies are more likely than otherwise to be attributable to luck. Tweaking the model to get an effect then becomes like drawing cards from a deck until you draw an Ace. The world is full of spurious correlations waiting to be found.

  90. “is the government really better at providing education?”

    You have to consider the price. Private education is generally better than public education, but it costs a lot more. If public schools got funding on par with private schools, they would provide good education, too. Public education in Mandarin China was excellent, but it was not mass education. Government bureaucrats identified promising boys and gave them a free education.

  91. @ engineer27: I crunched the numbers this morning from 1954 – 2009 and found a *positive* correlation between tax increases/decreases and GDP increases/decreases. r = 0.084. Really, not worth mentioning.

  92. “Just like no one in business really wants to be a capitalist, but rather acts to rig the market as soon as he has the muscle to do so.”

    That’s what it means to be a capitalist. Just ask Jay Gould and the Robber Barons.

  93. James,

    Come on – you know better than that. Your graph of effective tax-rate versus unemployement is very misleading. You have effective tax-rate in 2006 versus avg. unemployement rate for 2007-2009. I think in order to prove or disprove the hypothesis you would need to look at multiple graphs like this over a longer period of time. In other words, how about 2001 effective tax versus avg. unemployment 2002-2003, combined with 2003 eff. tax vs. avg. of 2004-2005 unemployement, combined with…you get the picture?

  94. Incorrect. Assume that supply and demand for labor are more or less being met – we wouldn’t have high unemployement if demand for goods and services was higher, right? Ok, so you probably can’t find more work to work your ass off any harder, there is simply no way for you to earn $160k. It’s also unlikely in a down market that you can insist on a higher salary from your employer. Even if you are self-employed, you may not be able to pass the costs of your business on to clients/customers. Basically, if you are lucky (because you could actually earn less) you will earn your $130k, the government will take out $60k and you are left with $70k.

    Eventually, people need to buy more stuff and the economy turns around, when it does, and companies begin hiring again to meet demand – you might be able to work additional hours or even ask your employer for higher wages, but that probably won’t help you because everyone will pass their higher labor costs on to consumers as long as the demand is there, and everything will cost more so your $160k will give you $100k after-tax, but it won’t buy the same amount of stuff as it did before.

  95. That’s the best comment of the day – 100% dead on.

  96. The discussion reminds me of James Galbraith’s two-line summary of neoclassical economics: The poor don’t work hard enough because they are paid too much, and the rich don’t work hard enough because they are paid too little.

  97. I’m not interested in income redistribution, for starters, and don’t see tax rates as appropriately used to make social statements. All I can say, is I worked my hardest when I was in a higher income tax category and had to pay a higher percentage, because I wanted a higher net income, and working harder (and smarter, if that counts) was a way to ensure that happened. I really don’t believe (and it isn’t borne out on your charts/graphs) that higher tax rates discourage hard work. And, the bigger question is, if other policy is effective, and people believe in the positive effect of those who are spending their taxes on the overall progress of the society, then there is pride in paying more taxes, for being a more substantial contibutor toward progress.

  98. Obviously, taxing is some sort of redistribution of income, but given the composition of the federal budget, increasing the top margin tax rate is not so much direct transfer payments from the rich to the poor (as all of talk of income redistribution implies), it is (1) meeting current obligations, most of which as some sort of service provision that is not dependent on personal assets (military, Medicare, various regulatory bodies, etc.) and (2) MINIMIZING the direct transfer payment from our children we have authorized ourselves.

    Interesting poll, republican voters would rather have tax cuts and run deficits than balance the budget, so the concern over the debt is really not about the debt, this is about a fundamental misunderstanding (generous interpretation) for where we are with the budget or this reveals the healthy dose of hypocrisy that backs the GOP position. http://www.rasmussenreports.com/public_content/business/taxes/february_2010/41_fine_with_budget_deficit_if_taxes_are_cut

  99. “people don’t work as hard” is entirely anecdotal. It sounds feasible, but I see no reason to believe it. It could just as easily mean people work harder to get better raises to make up for the taxes.

    Clearly the people writing textbooks are mixing science with opinion (or worse, ideology).

  100. This is certainly not a scientific interpretation of the chart showing GDP vs Tax Rate, but how is this for an explanation? Take the graphic “average” (between highs and lows) Annual Real GDP Growth 1947 to 2007 and it follows roughly the 3% Annual Real GDP Growth side. Draw a line from 1947 tax rate (say 90%) to 2007 rate (say 35%). The intersection of the two lines shows a top marginal tax rate of about 50%. Looking at top tax rate from around 1986 to 2007 the average would be about 45% with a GDP of only 2%. If the tax rate had been kept constant at 50% from 1947 to 2007 I wonder what effect this would have had on GDP. Intuitively one would think that the tax rate stability would have produced less highs and lows. Since there would have been less uncertainty it is likely that GDP would have risen at a steadier rate and been higher than the nominal 3% average. Booms and busts would have had a lesser impact on the overall economy even if black swan events came along. Of course in the post-Oil Peak world this model of unlimited growth (based on cheap petroleum and exploitation of the environment) will become irrelevant. In any event we are about as far away from a free-market system of economic checks and balances as Adam Smith ever could have imagined – to say nothing about the failed tax system that we have today.

  101. Private arbitration would not be possible without a functioning legal system. Or, to put it in another way, the outcome of private arbitration without a functioning legal system would depend on who has the bigger gun, as it often does in illegal transactions (why do you think drug dealers are usually in company of big guys with lumps under their jackets?). There are always at least three parties in every transaction, the third being the one who enforces the terms and conditions of the transaction. The enforcer in democratic societies is always the state.

  102. I ask which is more parasitic behavior:

    Working 60 hours a week to keep your business functioning properly (as many managers and small business people are doing today), or watching the calendar for your next extension of unemployment benefits?

  103. I think James fully acknowledges that the issue is not simple and the graphs are not enough to settle the questions. His point though seems to be:

    There was a huge decrease of marginal tax rated in the last 60 years without any measureable effect on GDP growth. Whatever correlation may exist between the two can’t be very strong.

    He does seem to have a point there…

  104. And the parents of that child have the RESPONSIBILITY of seeing that their child is ready to learn each day.

  105. IIRC correctly the slogan for the anti-Apec protesters in Vancouver was: Make the corporations pay up!

  106. Every study I have ever seen or heard of shows that Laffer was wrong at any marginal tax rate below 90%. The fact that Republicans, including the entire leadership team, continue to say that cutting taxes will solve the deficit is mind-boggling. The fact that most Americans believe them is just sad.

  107. brokhernowhysher

    The top marginal tax rate does mean something to the little guy. In the end all taxes are paid by the end consumer of any service or product. So if you think you are getting something for nothing by taxing the “rich”, be aware that it is being passed down to everyone who is a consumer.
    As to trickle down economics, I have always believed that they work exactly as advertised. The money trickles down. Unfortunately, most people see the term trickle down and expect gusher down.

  108. How does an individual pass on his/her individual tax increase onto the consumer? He/she might demand higher wages from his/her employer but it does not follow that that will be given, and if given, it does not follow that the company will necessarily increase prices (there is almost always a little “slack” to be cut), and if they do increase prices it does not follow that consumers will continue to purchase from that company absent monopoly or collusion. Even less likely to happen in the case of small business owners who, very generally speaking, are loath to lose customers and are even more at the mercy of competitive forces. Sometimes, you just have to eat it…

    In fact, the trickle down theory does not seem to hold at all — if it did, you would not expect to see **increasing** concentrations of wealth at the top coupled with **stagnate/declining** wealth at the bottom — both were supposed to expand, even if at different rates; rising tide lifts all boats, if I remember correctly. It was supposed to be that the rich would spend more money, invest more in productive technologies, etc., etc. but the rich can only buy so many washing machines, get their hair done so much, and thanks to all of that productive technology, automation and outsourcing, restructuring left a lot of people without jobs and no resources to transition to a new one. And, apparently a lot of that “investment” was not in production at all but in moving money around faster.

    Instead of a rising tide, a more appropriate analogy would probably be that of a dam, one that is never at capacity; those in the upper 20% are on the upside of the dam and were their boats ever lifted, those in the bottom 80%, but particularly the bottom 20%, were left on the downside of the dam (maybe a lock system with less water at every level would be a better visual), and all that is left to them is the trickle…

    So, trickle-down economics is either (a) a failure or (b) sold very deceptively. Either way, it is not prescription or description of how taxes should or do work.

  109. How efficient it is to use tolls ? From what I’ve seen, I pay 50 cents, and waste another 50c in slowing down (time, gas etc :), plus the cost of building and manning the booths; is there any studies that calculate the overhead ?

  110. Show me how can I send a letter through a private company for 41c

  111. The interesting thing about the “taxes only get passed on to the consumer” school of thought is that it requires that one accept the cost-of-production concept of value, which is precisely the theory of value that they reject. If prices are set by the market in equilibrium of supply and demand, a cost increase cannot increase prices.

    As far as taxes competing with money for expansion, the truth is that credit does not come from savings, but from the power of banks to create credit ex nihilo.

  112. There were big trickle down effects. It is just that average income numbers reported in the media are misleading when viewed in percentiles brackets in two different time periods because the same people are not in the same percentile break in both times.

    From Wikipedia on Household Income in the US “According to the Bureau of Economic Analysis, per capita income has increased every year for the past 10 years, with an annual average of 5.2% gains for the past 4 years. The recently released US Income Mobility Study showed economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. Income mobility of individuals was considerable in the U.S. economy during the 1996 through 2005 period with roughly half of taxpayers who began in the bottom quintile moving up to a higher income group within 10 years. In addition, the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups.”

  113. jonathan hopkin

    Peter Lindert is a great source of insight on this question – in his paper ‘why the welfare state is a free lunch’ he shows that high tax rates don’t generally have the negative effects simply theory would predict, because governments aren’t completely stupid. Taxes are often designed to minimize disincentive effects, and spending can often have lots of positive effects for economic performance.

    Of course, this is not always the case. But to assume otherwise is to assume that government is always corrupt and incompetent, an ultimately silly and childish assumption.

  114. From Thom Hartmann’s piece re how the rich fool Americans about tax policy-

    “All of this money was spent — invested, really, since it’s been more than saved back in low income tax rates on millionaires and billionaires — to convince Americans that up is down and black is white when it comes to income taxes. Here’s how it works:

    Rich Person’s Tax Effect

    If a person earns so much money that he doesn’t or can’t spend it all each year, then when his taxes go down your income after taxes goes up. This is largely because there’s little to no relationship between what he “needs to live on” and what he’s “earning.”

    Somebody living on a million dollars a year but earning five million after taxes, can sock away four million in a Swiss bank. If his taxes go up enough to drop his after-tax income to only three million a year, he’s still living on a million a year, and only socks away two million in the Swiss bank. His “disposable” income goes down when his taxes go up, and vice-versa. (Technically, the word is “discretionary” income for after-tax, after-living-expenses income, but “disposable” income has become so widely used as a phrase to describe discretionary income I’ll use it here.)

    The Rich Person’s Tax Effect is the one that virtually all Americans understand — and, oddly, most working class people think applies to them, too (this is the truly amazing part of the con job referred to earlier).

    But it doesn’t.

    Working Person’s Tax Effect — Version One

    Most working people spend pretty much all of what they earn — their “disposable/discretionary” income is close to zero. Savings rates in the US among working people typically are small — one to five percent — and during the last few years of the W. Bush administration actually went negative. So the take-home pay that people have after taxes — regardless of what the taxes may be — is pretty much what they live on.

    As economist David Ricardo pointed out in 1817 in the “On Wages” chapter of his book “On the Principles of Political Economy and Taxation,” take home pay is also generally “what a person will work for.” Employers know this: Ricardo’s “Iron Law of Wages” is rooted in the notion that there is a “market” for labor, driven in part by supply and demand. So if a worker is earning, for example, a gross salary of $75,000, his 2008 federal income tax would be about $15,000 ($802.50 on first $8,025 of income; $3,687.75 on income from $8,025 to $32,550; $10,612.50 on income from $32,550 to $75,000), leaving him a take-home pay of $60,000.

    Both he and his employer know that he’ll do the job he’s doing for around $60,000 a year in take-home pay.

    So what happens if his taxes go up, cutting his take-home pay to $55,000 a year (even though his gross is still $75,000)? Over time (typically one to three years) his wages will rise enough to compensate for the lost income.

    Alan Greenspan used to be hysterical about this effect — he called it “wage inflation” — and The Wall Street Journal and other publications would often reference it, although the average working person has no idea that if his taxes go up, his wages will eventually go up. Similarly, when working-class people’s taxes go down, their gross wages will, over time, go down so their inflation-adjusted take-home pay remains the same. We’ve seen both happen over the past eighty years, over and over again.

    When I was in Denmark last year doing my radio show from the Danish Radio offices for a week and interviewing many of that nation’s leading politicians, economists, energy experts, and newspaper publishers, one of my guests made a comment that dropped the scales from my own eyes.

    We’d been discussing taxes on the air, what the Danes get for their average 52% tax rate (free college education, free health care, 4 weeks of vacation, being the world’s “happiest” country according to research reported on CBS’s “60 Minutes” TV show, etc.). I asked him why people didn’t revolt at such high tax rates, and he smiled and just pointed out to me that the average Dane is very well paid with a minimum wage that equals about $18 US (depending on the exchange rate from day to day).

    Off the air, he made the comment to me that was so enlightening. “You Americans are such suckers,” he said, as I recall. “You think that the rules for taxes that apply to rich people also apply to working people. But they don’t. When working peoples’ taxes go up, their pay goes up. When their taxes go down, their pay goes down. It may take a year or two or three to all even out, but it always works this way — look at any country in Europe. And it’s the opposite of how it works for rich people!”