Sunday, June 02, 2013

Sharing the Necessary Expenses of Government

Government is a necessary function of society that must be paid for, and that burden must be shared equitably. We can imagine that in a just world, the greater share of the burden of supporting the public treasury would fall to those earning or owning the greatest share of wealth. We can imagine a world in which the richest – say, the top 1% of income earners – would pay a substantial chunk of the pot, say, 40%. The top 10% could pay 71%. And contemplating the bottom half of the population ranked by income, they should get relief and only have to contribute 3% of the total.
We can stop ‘imagining’. This in fact IS the current distribution of tax revenue contribution by income earning percentiles in the US.
But can’t we make the rich pay more? We have a budget deficit and a national debt, right? The government needs more money!
When the federal government is consuming 25% percent of GDP and suppressing economic activity and growth through inappropriate policies, the problem is not that the government doesn’t have enough money. Moreover, even if it were so, there are limits to how far taxes may be raised on anyone, rich or poor.
Higher tax rates do not guarantee the result of high tax revenue. This has been illustrated by the Laffer Curve, named for Arthur Laffer, the economist who proposed it:. In one version, the X axis represents the tax rate and the Y axis represents how much revenue results from that tax rate. The graph shows a curve rising from X=0, Y=0 to some height on the Y axis before settling back to X=100, Y=0. Which is to say, there are two tax rates that are virtually guaranteed to result in zero revenue to the treasury: 0% on the one hand, but also 100% on the other. At a 100% tax rate, the activity being taxed ceases altogether or goes underground to the ‘black’ market, out of reach of the legitimate tax authorities (aside: how legitimate is the IRS these days?). Somewhere in between these two extremes is an optimal rate that results in maximum revenue. Raising rates above that level results in less revenue, not more. We may argue as to where that point is – it may be 50, it may be 90, or it may be 10 – but it can scarcely be denied that it exists.
That is why the tax rate reductions of George W Bush, Ronald Reagan and John F Kennedy were successful: not only did they liberate entrepreneurs and the market, but the lower rates resulted in increased rather than decreased revenue to the Treasury.
Of course, revenue is only one side of the fiscal ledger, and tells us nothing about the virtue or folly of what the money is being used for. Congress (or your state legislature or city council) is always capable of spending as much or more money as comes in, and not always (some might say rarely even) on just the necessary and appropriate expenses of government. But if the purpose of the tax code is to raise the maximum possible revenue to the treasury, the rates must be optimized, which is very different from being raised as high as your favored politicians can make them go.