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WebMemo #162 on Taxes

October 25, 2002

Issues 2002: Tax Reform for Economic Growth

By

Taxes, as a share of gross domestic product (GDP -- the output of goods and services produced by labor and property located in the United States), have remained fairly constant over time, hovering around 18% to 21% of GDP.



 

Q: Why then has Washington, D.C., gone from talk of surpluses to deficits, with federal revenue charts looking like mountain ranges, with erratic peaks and valleys?

A: Because the economy drives the budget, not the other way around.

 

Picture GDP as a pie. Eighteen percent of a huge pie is considerably more than 18 percent of a small pie. Therefore a larger and more robust economy will result in more federal revenue.

 

Q: What policies would create a more robust economy?

A: Lower tax rates create better economic conditions. It's simple: lower tax rates = more robust economy = more federal revenue.



 

Tax relief will boost the economy's performance. To energize a soft economy, lawmakers should seek far larger reductions in the tax penalties that are imposed on productive behavior. The higher the rate, the steeper the penalty.

 

Q: Wouldn't higher tax rates raise more revenue?

A: No. Higher tax rates don't raise more revenue, as  this chart shows.

 



Consulting the Federal Revenue and Spending Book of Charts, reveals the facts:

This chart, Top Federal Individual Income Tax Rates, 1960-2002, shows that the income tax rates have dropped during the last nine administrations, with the greatest relief to taxpayers coming from Ronald Reagan.

 

During that same time, as chart Total Federal Tax Revenue per Taxpayer, 1960-2002 shows, revenue has continued to grow.

Long Term Tax Reform

Of course, simplifying the tax code is the long-term goal, and lowering taxes will help control federal spending. Every dollar the government spends is a dollar removed from the private sector.



 

Lower tax rates and other long-overdue tax reforms will help to promote a vibrant economy. This, in turn, will help to generate at least some additional revenue and thereby create a virtuous cycle that will allow for further tax reductions.

 

If Russia can have a 13 percent flat tax, U.S. lawmakers should be able to reduce America's tax rates.

 

In the States

Many states are facing budget deficits, but as examined above, raising taxes will not reverse their situations.



 

Many states have encountered budgetary shortfalls because of excessive spending. Indeed, 47 out of 50 states increased their spending by over 4 percent a year, as Heritage has reported in the WebMemo: How to Cut Taxes and Balance State Budgets.



 

The goal of tax policy is to maximize economic growth, not tax revenues.

 

For years, budget deficits and surpluses have played a big role in the political debate. As a result, some tax policy proposals, such as reductions in the capital gains tax, are judged primarily by their effect on tax collections.

 

Yet there is no evidence that fiscal balance has any impact on the economy. Putting revenue maximization ahead of sound tax policy is therefore a misguided approach and should be discarded.

 

Class Warfare

For class-warfare arguments, see Daniel Mitchell's Backgrounder, The Correct Way to Measure the Revenue Impact of Changes in Tax Rates, which shows how the rich paid more under the 1920s tax cuts, the Kennedy tax cuts, and the Reagan tax cuts.



 

The Joint Economic Committee of Congress released a study this week with new Internal Revenue Service (IRS) data showing that the tax share of top 1 percent has gone up; i.e. the wealthiest American's are paying more:



 

"The top one percent of tax filers paid 37.42 percent of federal personal income taxes in 2000, the latest year for which data are available. The 2000 share paid by the top one percent (ranked by adjusted gross income) reflects an increase from the 36.18 percent level posted in 1999. The 3.91 percent share paid by the bottom half of taxpayers was virtually unchanged during this period..."
 



See Issues 2002 chapters for more:

| Taxes | Budget |

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