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A Dearth of Taxes?

By John Tamny

Commenting on the 1920s income-tax cuts spearheaded by Treasury Secretary Andrew Mellon, a New York Times editorial suggested that Mellon "wants in reality to get more money out of [the rich] than they are now paying. But he proposes to do it by making their rate of taxation lower."

The Times' editorial stance of over 80 years ago is notable considering the views held by its present editorial board. In a recent editorial ("A Dearth of Taxes"), the Times decried tax cuts given the board's static view that a reduction in the rate of taxation paid by individuals is tantamount to revenue reduction. Modern history says otherwise.

In truth, tax collections in the U.S. tend to follow our nation's GDP pretty closely irrespective of the tax rate. As Discovery Institute senior fellow Bret Swanson recently wrote, there is a "remarkable tendency for Federal revenues to hover around 18% of GDP (and for personal income tax revenue to gather between 7.5 and 9% of GDP), no matter if tax rates are high or low."

What this means is that if we grow the overall economic pie, we expand the taxable base. Sure enough, the reductions in top marginal rates that began in 1981 helped U.S. GDP to grow sixfold over the last twenty-five years and as a result, federal revenues have hit record levels nearly every year since. The Times argues that, "This country's meager tax take puts its economic prospects at risk," but if revenue collections are in fact static as a percentage of GDP, it seems pretty clear that marginal rate cuts are the surest way to expand the economy and government revenues.

The Times bemoans tax cuts that are "mainly for the rich," but when we consider that the rich account for the majority of federal revenues, it's merely stating the obvious that they'll be the biggest beneficiaries in dollar terms. Importantly, the truth that the rich gain the most from tax cuts only tells half of the story.

What the Times' editorialists ignore is that the wages captured by workers are a function of available capital. When the rich are able to save their surplus income rather than hand it over to the government for immediate consumption, those savings fund existing and new corporations that must hire workers in order to grow and become profitable.

The Times editorial argues the opposite in proclaiming that a "spectacular increase in corporate profits" (that occurred alongside the Bush tax cuts) has materialized "at the expense of workers' wages." But in suggesting the latter, the editorial contradicts itself. As evidenced by the migratory nature of U.S. workers, it's a certainty that profitable companies eager to expand regularly bid against their competitors for available labor, and in doing so, drive up wages. Just this week, Stephen Rose of the Progressive Policy Institute laid this out in empirical terms for the Wall Street Journal; noting that for three quarters of the U.S. workforce since 1979, "economic growth translated into earnings gains."

Many will point to the 25 percent left behind, but this shouldn't be mistaken for evidence that we need higher taxes to aid the aforementioned 25 percent. For one, nearly all workers start at the bottom of the economic ladder; using the experience gained to increase their output and pay. Secondly, with wages once again merely a function of available capital, the best way to increase economic opportunity for all workers is to grow the economy and corporate profits in such a way that businesses possess economic incentives to hire and train the less fortunate so that they can engage in more valuable work. Tax increases would simply reduce the capital available to lift marginal workers from the bottom rungs.

Somewhat surprisingly, the Times editorial spotlighted Canada as a worthy country for the U.S. to emulate for the fact that its citizens pay five percentage points more of GDP in taxes. What the Times left out is relative stock-market performance in both countries since the U.S. began cutting tax rates, with the Dow Jones Industrial Average up over 1500 percent since 1981 versus 620 percent for Canada's main stock index. Stock indices by definition track profits and economic growth, and while it would be hard to do a counterfactual, it's a safe bet that U.S. revenues on local, state and federal levels would be much reduced had we followed the Canadian economic model.

In pressing for higher taxes stateside, the Times would like the U.S. to use the presumed revenue gains to pay for among other things, "decent unemployment insurance." What's forgotten is that due to our relatively low tax structure, we've regularly enjoyed what some economists refer to as "full employment" such that unemployment benefits are blessedly not as necessary here as they are in high-tax countries that predictably struggle with higher rates of unemployment.

Ironically, the Times editorial concluded by saying that as "economic growth has decelerated, corporate profits are losing steam and the growth of tax revenue has begun to slow. This pretty much guarantees that the revenue will prove too low to face the challenges ahead." Without commenting on the Times' revenue assumptions, its point about slow economic growth coinciding with low government revenues is valid. Thankfully we know that as GDP grows, so do government revenues. Unwittingly the Times makes the argument for more tax cuts, because the latter have an impressive history when it comes to growing the economy and revenues.

John Tamny is an editor at RealClearMarkets. He can be reached at jtamny@realclearmarkets.com.

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