Evan Soltas
Jan 3, 2012

Advice for the Taxman

How to boost revenue in an era of deficits

I can't think of a pair of graphs which are more important than the ones above. They depict the two paths to increasing revenues, barring a fundamental change in the nation's tax policy (by, say, adding a value-added tax).

One might characterize the former scatterplot as the "supply-side" economist's perspective, illustrating how the maximization of federal government revenues has been dependent on an extended period of high GDP growth. Indeed, one is able to easily spot the early 90s recession, the dot-com bust, and the current recession on a time-series graph of federal government revenues. They line up as perfectly as any two economic variables might, and while that would not be per se an illustration of causation, the causative mechanism is all but apparent: low taxes represent a lower fixed cost on firms and spur investment and consumption.

One might characterize the latter scatterplot as the "modern liberal" economist's perspective -- or rather, the illustration of the factual flaws in such a perspective. Unfortunately for the modern liberal, the argument that a higher top marginal tax revenues produces higher revenues is simply not supported by the data. Nor is the argument that lower top marginal tax revenues produce lower revenues. And this is a very important point, because it has become an article of faith among this group that the "Bush tax cuts for the rich" are responsible for lower federal revenues. As we see in the first scatterplot, though, the low federal revenues are entirely consistent with the supply-side understanding of weak revenues in a weak economy. Indeed, if the Bush tax cuts had been responsible, would we not have seen the outright collapse of federal revenues under John F. Kennedy* (top rate from 91 percent to 70 percent) and Ronald Reagan (top rate from 70 percent to 28 percent)? The magnitude of their tax cuts, frankly, puts those of George W. Bush (39.6 percent to 35 percent) to shame. Yet we saw no change in revenues not explained by economic performance.

The lesson here is simple, Mr. Taxman: you grow revenues by ensuring that the political environment best facilitates "the uniform, constant and uninterrupted effort of every man to better his condition," from which "the natural progress of things toward improvement" shall come on its own.