Riedl’s Myth 8, Part B

Yesterday, I had a post on Brian Riedl’s Myth 8, which reads:

“Myth #8: Tax cuts help the economy by “putting money in people’s pockets.”
Fact: Pro-growth tax cuts support incentives for productive behavior.”

In the post, I showed that the data since the Reagan administration simply doesn’t Riedl’s fact, unless tax cuts are not pro-growth, or Americans insist on behaving in ways that counter whatever incentives are thrown at them. I note that I have looked at this issue before, as has PGL, sometimes using longer data sets, sometimes using state data, and so forth.

Myth 8, or rather the fact that Riedl puts forth, is popular among conservatives so I thought I’d write a post about the storyline itself.

I will start by noting that I couldn’t tell you what life is like, on a daily basis, for folks like Richard Scaife, Holland Coors, Steve Forbes, Holland Coors, and the other Heritage Trustees . This is not to imply they’re bad people or idiots or anything of the sort. It is to say that my situation is very far removed from theirs, probably farther removed than the situation facing a Central Asian peasant, so in some ways, a Central Asian peasant and I would have an easier time understanding each other than, say, Steve Forbes and I. (I will stick to Steve Forbes in this essay, largely because I’ve actually heard him speak on taxes, whereas I haven’t, um, enjoyed the privilege with the Heritage Trustees.) Which means – just as I don’t claim to understand Steve Forbes, my guess is he doesn’t understand the vast majority of Americans whose situation much more closely resembles mine than his.

Since the Trustees are the ones in charge at Heritage, and since they are at the top of the business world (however it is that they got there – no doubt some of them consider themselves entrepeneurs), it is easy to assume that the way they do business applies to everyone else in America, or would, if only they were smart enough to be at the top of the business world too. So I figured I’d try, as best I could, to put myself in the shoes of folks like that. And it occurs to me that perhaps the fact Riedl cites might actually apply to Steve Forbes in some way.

See, Steve Forbes might actually pay a little bit of attention to taxes when he’s making a business decision. My guess is, if it happens, its in the lines of telling some underling to move money from some investment vehicle in low tax jurisdiction A to low tax jurisdiction B. Another way I would imagine (and imagining this is not difficult for me – regular readers may recall I worked at one of the big accounting firms doing transfer pricing for the worst year of my life) folks like Mr. Forbes taking into account tax rules is by setting up pass through corporations in some low tax jurisdictions and claim that’s where you’re actually doing business. (According to the CBO 20% of the returns on investment abroad by US companies from 1993 – 2003 came from Ireland and Bermuda. Ireland and Bermuda. If there’s some way to explain that 20% of the returns of all American companies abroad came from Ireland and Bermuda without invoking tax fraud on a massive scale, I’d love to hear it.)

But let’s leave out “business decisions” that are nothing more than accounting gimmicks and focus on activities that Adam Smith might have recognized as productive. In other words, activities that increase the size of the pie, rather than ways to free ride upon a system paid for by others. Let us say that Mr. Forbes thought up a way to make some highly desirable product (what would be the current day analog of Adam Smith’s pins?) at a small fraction of the cost they cost anyone else to make. Would GW era top marginal income tax rates of 35% really be more likely to get Mr. Forbes to pick up the phone and tell one of his subordinates to put the business plan in motion? Perhaps the gain to an extra few tens of millions is minor to a guy like Steve Forbes but the costs of picking up the phone are not high either. A 45 percent difference in his tax rate (and here I’m assuming his accountants are incompetent) shouldn’t make a difference.

The rest of us also don’t function that way. When I left the corporate world to start my business, I had big dreams, but I didn’t have big expectations. In fact, I didn’t expect to make what I was making in the corporate world. (And I haven’t so far!) What I was looking for was to be my own boss. Most of my friends also have their own businesses. And guess what – not a one of them, not the ones that have been successful and not the ones that have been unsuccessful, took marginal tax rates into account when looking to start their business. That’s now the way its done.

But its not just entrepreneurs, or people who consider themselves entrepreneurs… Was someone less likely to take a position as head of a Fortune 500 company in 1993 because the marginal tax rates rose from 31% to 39%? Seriously? What about a position as a mid-level manager, or a janitor?

Now, at extremely high rates, perhaps there’s something to it. Reagan used to love to tell the story of how he made only 4 movies a year – if he made a fifth, it would put him in a 91% tax bracket, and it wouldn’t pay. Now, this was during WW2, and the country was fighting for its survival. (As an aside, my grandfather, who was older than Reagan, and had two kids, and thus was completely exempt from the draft never cut back on hours he worked during the war. While Reagan was patriotically bitching about his tax rates, my grandfather was apparently unpatriotically touring Western Europe in a Sherman. Come to think of it, we have a similar situation going now. Or perhaps it has – maybe when Ledeen complains about American troops “sitting in air-conditioned quarters and drinking designer coffee”, he should in fact give praise that the troops are behaving more like Reagan than my grandfather and his buddies.)

In the end, as I noted in my previous post, the story told by guys like Forbes is very attractive. There’s a big free lunch in it – pay less and get more. But its wrong as we’ve seen when we looked at data in post after post. The world doesn’t work that way, at least for the range of taxes we’ve observed in recent decades in the US. In fact, when these “pro-growth” policies get enacted, we end up with slower growth. Its OK for a guy like Steve Forbes – where he’s at, its hard to lose whatever happens. But the fact that he’s advocating that he should be allowed to both decrease the rate of increase in the collective pie, and to take a larger slice at the same time, should be concerning to the rest of us.