Sunday, December 28, 2014

Do Tax Cuts Really Increase Tax Collections?

Stephen Moore is the Chief Economist for the Heritage Foundation which receives its funding from folks who hate to pay taxes and only like government when it does good things for them.  The Washington Post provided Moore with an opportunity to broadcast the Heritage message.  Apparently, it did so without the benefit of editing or fact checking.  There are so many things wrong with this article that it is hard to know where to start.  One would expect, however, that Moore should not contradict himself in his article.  I will simply point out the contradiction and let Paul Krugman and some of the commentators in response to his article address some of the other problems with Moore's article.

Ostensibly, the article is about the durability of the Laffer curve which holds that tax revenues will increase as the tax rate rises up to a maximum point;  they will then begin to fall as the tax rate increases further.  Nobody would argue against that point.  On the other hand, there is a lot of disagreement about the inflection point.  That is, at what tax rate do we see a decline in tax revenue? Ronald Reagan cut the top income tax rate from around 70% to around 28%.  Tax revenues increased during the Reagan administration, and we also had a period of economic growth.  The Heritage Foundation and other think tanks, funded by the same folks who fund Heritage, have been claiming that our experience during the Reagan Administration proved that the Reagan Tax cuts validated the Laffer curve, and more importantly, the superiority of supply side economics to demand side economics which have been destructive of our economy under President Obama.

Moore knows that the Laffer curve has often been called the Laugher curve by economists because the inflection point is undetermined.  He acknowledges that point in his article.  He points out, however, that liberals want to increase taxes on carbon emissions because they understand that you get less of something when you tax it. They seem to agree with Laffer that high tax rates will cause people to work less and also decrease business investment.  Laffer claims that most economists agree that you get less of something when you tax it.  That is often true, but his curve also shows that you get more tax revenue from higher tax rates up to the inflection point.  The Laffer curve does not tell us that lowering the tax rate will always increase tax revenue.  Higher tax rates increase tax revenue until we get to the indeterminate inflection point.

Moore also fails to tell us that Reagan increased taxes during his administration.  He substantially increased the regressive Social Security tax rate which helped to pay for the huge reduction in the top marginal income tax rate.  This shifted the tax burden from the highly paid to lower income citizens because there is a cap on the Social Security tax. The Social Security tax rate falls as one's income increases. Even worse, Moore includes Social Security tax revenues along with income tax revenues when he reports the increase in tax revenues under Reagan.  Federal tax revenues, excluding Social Security taxes, increased by only 20.8% under Reagan.

We expect economists who decide to make a career at think tanks like Heritage to support the mission of their employer.  Its unfortunate, however, that one of our most widely read newspapers would provide an unfiltered platform for Heritage to spread its message to the public without a more critical review by its editors.

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