Big-government liberals, class warriors and even many well-intentioned folks buy into the fusty canard that higher tax rates must be a part of an overall solution to reduce the deficit. They are unacquainted with Hauser’s Law. As demonstrated by the following graphs, Hauser’s Law proves beyond doubt that changes in tax rates (higher or lower) have no perceptible impact on tax collections.
Moreover, higher marginal rates strangle economic growth – which is the only path to increase total tax collections. Beyond a certain point, higher rates actually reduce tax revenue as proven by the Laffer Curve and the ETI (elasticity of taxable income); these are the subjects of the next MLLG email.
As shown by the preceding graph, the top marginal tax rate varied from a high of 91% to a low of 28% during the 70-year period 1940-2010. If tax collections (as a share of GDP) were influenced by marginal tax rates, the government should have experienced a veritable cornucopia of tax receipts when rates were 90% and the cupboards should have been bare when rates were 28%. The following graphic shows what really happened.
As shown above, tax collections were impervious to the marginal rates extant. Instead, tax revenue as a share of the economy remained close to the trend line which was between 17% and 19%. I cannot see any way to interpret this graph except that it proves there is no link between marginal rates and tax collections. Given this demonstrable fact (buttressed by the ETI and Laffer Curve data I will provide next week) the case for higher tax rates evaporates.
There are no rational reasons to support higher rates. In fact, Hauser’s Law has a corollary: the only way to increase tax collections is through economic growth – if you grow the economy and tax collections remain a constant share of GDP, then a voila, you have increased total tax revenue. To close this circle, lower tax rates grow the economy; therefore, since they produce the same amount of tax revenue, low rates always are the correct choice.
Why Hauser’s Law Works
Okay, so we know Hauser’s Law works but do we know why? The answer is not difficult to plumb. As with many things political, it all comes down to human nature. The internal revenue code is a living breathing 75,000 page organism. It provides abundant avenues for taxpayers, particularly well off ones, to legally work the system. Higher rates incentivize taxpayers to go to ever greater lengths to reduce taxes; lower rates have the opposite effect. People respond to incentives and to disincentives – and not just by using the tax code.
“It is all about human nature and incentives.”
When rates are high, people work, save and invest less; they retire earlier; they hide, defer and under-report income; they convert income to capital gains or do not sell appreciated assets without offsetting losses. They employ tax shelters; they shift income to lower-bracket family members; they seek out tax free income. They change the amount, location and composition of income. They exploit ambiguities and loopholes; professionals and small businesses create “C” corporations; large companies keep their funds (and jobs) in foreign countries. Some people even move into the occult economy and quit paying taxes altogether. It is all about immutable human nature and incentives.
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