Saturday, June 25, 2011

The Problem with Having Taxes That Are Too Low

Over the past thirty years, a major tenet of the conservative form of governance that Rick Santorum follows and espouses has been that low taxes are an inherent good. According to the right, lower taxes are always better. This is an utter misapplication of supply side economics.

Now, I'm not an expert in economics, but I have an interest in it and have been picking up as much as I can. But a basic tenant of supply side economics is this: sometimes lower taxes on the wealthy can lead to greater revenues, because taxes that are too high dissuade individuals from working hard. This was best seen when JFK lowered the highest tax bracket from just over 90% to around 70%. Tax revenues did in fact increase. Basic human incentives create a simple reason for this. If I only see 10 cents on every dollar I make over a million dollars, I don't have very much incentive to work to make more than that first million dollars. But what if there's capacity in my business for me to make a few hundred thousand dollars more? When I get 30 cents for every dollar I earn, I have a better reason to keep earning income. The government may only be collecting 20 cents less per dollar I earn, but I have the incentives to earn a lot more dollars.

At some point, though, I've made all the income that I possibly can. The tax structure has already created all the possible incentives for me to make as much money as I possibly can. So, for example, dropping the top federal income tax rate from 39% to 35% does very little to absolutely nothing to influence me to increase my earnings. As a result, the government receives less tax revenues from me than they otherwise would.

The low tax rates of the last 30 years have led to a massive spread in the income gap in our country. As Robert Reich explained earlier this week, the top 1% of the economy has increased their share of the economy from 10% to 20% of the economy. I disagree with other aspects of Reich's analysis, but it is undeniably true that the top 10%, and particularly the top 1%, have seen the vast majority of all economic gains in the past thirty years.

But, you ask, I thought that you said that lowering taxes induces me to be more productive to increase my income? And if the top 1% of individuals are making so much more money, isn't it because they're working harder? Here's the flaw in that thinking. As you may have heard, corporate tax rates in this country are comparatively high to other countries. Individual income tax rates, however, are low. And capital gains taxes are an extremely low 15%.

So what does that mean? It means that if you're wealthy and you run a company, you're going to put your personal wealth above the growth of your company. Why has the recovery from the 2008 economic crisis been a jobless one while we're seeing a lot of companies have near record profits? Because shareholders make 85 cents on every dollar of capital gains they receive.

Our economic incentives are skewed right now. They are skewed away from long term investment and towards short term profit. The exact lesson we should have learned from the economic crisis is that we should be wary of anything that puts short term profit ahead of long term economic stability.

19 comments:

  1. You clearly make some good and important points, but you need to go to your nearest dictionary — www.webster.com will do fine — and look up two similar-sounding but totally unrelated words: "tenant" and "tenet".

    Please, thank you, and you're welcome.

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  2. Thanks for pointing out the error, which is now corrected. Proofing errors that go uncorrected are unfortunately one of the dangers of blogging late at night and distracted.

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  3. Erm…no, you've still got an improper "tenant" in the second paragraph.

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