A frequent talking point of some
true believers in supply side economic theory is the idea that if only
government would lower taxes in any given year the nation would have a bigger
revenue intake the next year, due to the business innovation that would be
caused by the lower tax rates. The
problem with this revenue boosting theory is that it doesn’t work. The simple math involved in the equation
shows that there is no way an analyst can look at the dynamic and find that it
is based in reality. Here is a very
simple demonstration of why lowering taxes does not in fact lead to a
corresponding increase in government revenue in the next tax cycle.
Say for example a taxpayer takes in
$100 dollars one year (yes I know this is not a normal yearly income, but the
example is simpler this way) and their usual tax rate is 30%. Further, imagine that this year, the
government has decided to lower their rate to 20%. So instead of taking in $30 from the taxpayer, the government
only takes in $20 that year. However,
the government then tells those concerned with the deficit not to worry and
they say that they will make up that $10 in forgone revenue next year when they
tax all the income generated by the growth in business that will occur in the
next year. Now imagine that the next
year comes around and it is again April 15th. The government still expects to take in $30
from that taxpayer (in fact they promised they would). How much income will that taxpayer have to
earn that year to yield $30 at a 20% rate? The answer (assuming that the tax rate has remained 20%) is $150! That’s right, the taxpayer would have to find
a way to earn $150, even if he only earned $100 the year before. He would have to take that $10 savings from
the previous year and turned it into $50 in increased income! He would have to,
in effect, invest that $10 in a way that would have a 400% return (the first
additional $10 the investor got back the next year would simply be him breaking
even on his $10 investment). And he
would have to do this for the government to simply break even in terms of the
revenue it takes in.
In order for the revenue to grow, the investor would
have to get better that a 400% percent return. To put this in perspective, a talented professional trader on Wall
Street is considered to be doing his job well if he can consistently yield 10%
growth. If he can yield 20% he is
considered an elite money manager. Even
at the very height of his swindling, Bernie Madoff would never have to gall to
approach a potential speculator and state that he had a plan whereby every
investor in the country would be guaranteed to earn a 400% percent return on
their money in only one year’s time. Anyone actually asserting this would simply be gambling on the fact that
you don’t have any conception of the numbers involved as they try to sign you
up for a plan that doesn’t exist. I
point out this obvious dynamic because (strangely) the Republican party is
making people believe that when they come to power they will both lower taxes
and by doing so lower the deficit. This
will never happen, of course. If the
government is given the chance to do what they tend to do, they will lower
taxes (for the exceedingly wealthy) even as they have thoroughly refused to
name any substantial programs to be cut, they will almost certainly increase
the deficit.
Further, this 400% investment mentioned above would
have to be earned just to get the $30 out of the taxpayer the year after the tax cut was implemented. The
taxpayer would have to do even better than a 400% rate of return to make up for
the ten dollars that was not paid in the year of the actual tax cut. You see the above analysis is simply what
must be earned by the taxpayer for the next tax cycle to bring as much as the
first one had if there had not been a tax cut. Even if the government somehow unbelievably gets $30 out of the taxpayer
in the next cycle the total taken in regarding the two cycles (when policy is
implemented, and the next) will still be less than it would have been unless
the taxpayer earns an even more amazing investment. Considering the government will only get $20 out of taxpayer in
the first cycle it will need to get at least $40 out of him to bring in as much as
if he had paid in $30 one year and thirty the next. To get this $40 dollars in year two at a 20% rate the taxpayer
will have to use that $10 savings from year one and invest it in such a way
that his earning in the next year will shoot up from $100 to $200. He will, after that extra $10 is given to
him in year one, need to find a way to get a 900% return.
All of this being said, I am more committed to
creating a reasonable tax rate plan for this country and in keeping taxes low
than you might expect from reading this article. I simply wanted to make it clear that lowering taxes, in and of itself, is not an
effective strategy when it comes to reducing the size of the deficit.