Taxes and Economic Growth: Real World & Simulations
by Mike Kimel
Taxes and Economic Growth: Real World & Simulations
Over the past few years, I’ve posted many times on an unpleasant reality: despite the fact that so many people believe otherwise, in general, lower taxes do not result in faster economic growth. It is really too bad, because we could all be better off if only lower tax rates led to faster economic growth. However, the association between slower econoimc growth and lower tax rates is something we can see in data from the US, whether we use national level data, state and local data, or anything in between.
Here’s a post I wrote not that long ago noting that when top marginal tax rates are below about 65% or so, cutting taxes is associated with slower economic growth and raising taxes is associated with faster economic growth. Here’s something a bit more academic showing the same thing.
As I’ve noted before, there’s a logical reason why lowering top marginal rates slows economic growth (except when top marginal rates are very high), and it should be obvious to anyone who has ever run a business: the easiest way to avoid, or at least postpone paying taxes for is not to show taxable income. If your business looks like it will show a profit, reinvest the revenues, pushing up costs and voila, you don’t have any profits for the IRS to tax. But, by doing so, you are also strengthening the company, which means setting the stage for faster growth in later years. And you’re more likely to follow this strategy, rather than consume your profits, the higher the tax rate.
Notice that this little story depends entirely on the self-interest of people in the economy. Money collected in taxes could be put in a big hole and burned, and the story would still work. (Of course, the story works better if whatever is collected in taxes is actually used productively, but that isn’t a requirement.)
The response I’ve gotten via e-mail and commentary comes overwhelmingly in two flavors: a. You lie about the data and you don’t understand how people react to changes in tax rates. b. That may be what the data shows, but it can’t possibly work in theory so it must be wrong.
I can’t help the group folks in group a – I’ve offered up my spreadsheets, and frankly, anyone should be able to replicate it – this stuff ain’t rocket science. But this post is for the folks in the second group.
For grins and giggles, yesterday I made a simple little simulation tool in Excel which is intended to look at the behavior of a very wealthy person reacting to changes in tax rates. In any given period, the person consumes some percentage of the wealth they happen to have. The remainder, the savings, are allowed to grow. Individuals get a benefit from both consumption and holding wealth.
Their goal is, given the tax rate, to maximize the discounted weighted consumption & wealth over all the periods of their working life. I set tax rates at 0%, 10%, 20%, … 90%, and used Excel’s solver tool to determine the percentage of wealth they will select under each tax rate.
Results are as follows:
Figure 1
Given the parameters selected, here’s what we find: the higher the tax rates, the lower the less of their wealth people consume in any given period and overall. However, the greater the wealth they accumulate… which is essentially the story I’ve been telling to explain the data. As noted previously, in general, higher taxes lead to faster economic growth.
A few additional comments:
a. The simulation is simplistic, and it does not show the quadratic relationship between taxation and growth we see in the real world data. I believe that this can be resolved simply by taking into account satiation resulting from consumption.
b. The simulation indicates that increasing tax rates makes people worse off (the discounted sum of the weighted wealth and consumption tends to be lower for higher tax rates).
b. i. However, they leave behind more wealth. Put another way – individuals in any given period are made worse off, but their descendants are made better off.
b. ii. A more realistic scenario probably shows increased returns as wealth increases. (Mr. Romney, to use one example, has investment options available to him that you and I do not, and Mr. Buffett has options available to him that Mr. Romney does not.) Higher taxes might very well make a person worse off today but better off in the long run. Its great to live during the Gilded Age, a period during which tax rates fell from 75% to 24%… provided you die before the effect of the Gilded Age spits out the Great Depression.
c. Because of the way taxes are defined in this model, they play a similar role to compulsory savings. Put another way: this model can also explain countries with relatively low taxes but compulsory savings, such as Singapore.
d. The model also explains Tyler Cowen’s Great Stagnation.
e. Government spending does produce a benefit, though that is ignored by this model.
I haven’t decided whether I want to spend time improving the simulation tool, but, as usual, if anyone wants my spreadsheet, drop me a line. I’m at my first name (mike), my last name (kime), at gmail.
I question the assumption that inheritance of vast wealth is a social good. One of the virtues of capitalism in its early years was the rise of the middle class and the decline of the rentier class, resulting in less rent extraction. Tody the effect is the opposite.
Participation rate:
http://research.stlouisfed.org/fred2/series/CIVPART
+
Corporate Profits:
http://research.stlouisfed.org/fred2/series/CP
=
http://research.stlouisfed.org/fred2/graph/?g=6Uz
Private wages / GDP:
http://research.stlouisfed.org/fred2/graph/?g=6Uy
Throw in the $700B/yr trade deficit and we’re building up one helluva velocity problem for the working class.
My 1965 World Book Encyclopedia article on “Economy” had a great picture of a circle of townsfolk all trading goods and services among each other for money. What happens when that chain is broken and money leaves the circle?
How does a lower tax rate on corporate profits fix that?
The problem is wealth concentration. Anybody who says otherwise is defending their position on this pyramid.
Do you really believe that the 35% corporate tax rate has not driven manufacturing out of the country? (It has)
Do you really believe that cutting taxes on workers by 2% the past two years has not directly benefitted the economy? (It has)
Min,
Back in 07 or so, I wrote a series of posts on the inheritance tax. I noted that it would make sense to have a 100% inheritance tax above some level simply because otherwise, you are allowing a person to make decisions about money after they die that you don’t let them make about other things. (There’s no “if I die, cast my vote for Mitt Romney in November, and for Sarah Palin in 2016. Oh yeah, and make sure that if my corpse is selected for jury duty I vote guilty.”)
But that ain’t gonna happen.
That said, we’re socially better off if each individual leaves behind wealth (say, a paid for house, a thriving business, whatever) than if each individual leaves behind nothing but a few empty tins of caviar.
Bruce K,
I feel like I’m getng into a sidetracked debate, but free riding is always an issue, particularly when its encouraged rather than discouraged.
It used to be that the CEO of a big company making stuff in the US might travel on Air Force One with the President on some foreign junket and the President would put in a good word about the company’s products with his foreign counterpart. These days, the CEO still gets on the plane with the President, the company’s products still get the full court press from the US gov’t, but the company, for all practical purposes, is not a US company and doesn’t benefit the US in any way. Put another way – there’s freeriding on the public tab.
Who wouldn’t want to set up shop in the Caymans if they could make use of American infrastructure (legal and physicial) rather than the equivalent from the Cayman Islands? It’s like paying the mortgage on a two bedroom condo and getting to live in Bill Gates’ house for free.
Besides, as I recall, the folks who are now wailing about taxes driving out manufacturing were the same folks who were telling us, circa 1980, about how offshoring was a good thing. I remember Uncle Milton telling us that it was a good thing for us that we were getting the Japanese and the Taiwanese to make stuff for us in exchange for little pieces of green paper.
“If your business looks like it will show a profit, reinvest the revenues, pushing up costs and voila, you don’t have any profits for the IRS to tax.”
Sorry Mike, but this is in incredible over-simplification of tax planning and business operations.
STR,
Of course its a simplification. But tis nto like most businesses don’t have a wish list of stuff – perhaps plans for stuff to be invested in later years – that they can’t put money into on short notice. Let’s be realistic – even very big companies manage their earnings.
That said, you said its an incredible simplification – please tell me what isn’tt credible. Because I’ve seen this done, up close and personal. I’ve even been in the position to say “let’s do this thing” once or twice. I hate to think that reality is not credible.
A follow-up: note that I am not talking about the company buying trips to Jamaica to whatever for its principals or officers. I am talking about a company moving up investments or making investments that had previously been considered but were rejected due to lack of funds, and which remained very attractive business propositions once the funds got freed up.
Krasting
as always arrives breathless at the starting line.
the “2% tax cut” means the government is borrowing money. i am surprised to see that you favor increasing the deficit.
the payroll “tax” is supposed to pay for the retirement of the people paying the tax. Obama and his friends have found a way to get the people to spend their retirement savings on a good cause…increasing Wal-mart’s purchases from China.
mike
Uncle Miltie did not seem to understand the relationship between little pieces of green paper and jobs, not to mention industrial infrastructure.
a man after Krastings own heart.
mike
i accept your numbers, and can easily believe your “reason” accounts for some of the effect.
i have to say, however that i really do not trust any economic “models.” they are inherently self serving and simplistic to the point of delusion.
i’d like it if you actually researched your assumptions, or your models “if this then this” mechanics.
then i would strongly suspect that a large, if not the largest, cause of growth in the economy from higher taxation comes from the fact that the government really can spend your money better than you can…. up to a point.
note, i don’t like taxes any better than Krasting. I do take advantage of “deductions” to reinvest what would otherwise be taxable “profits,” but I am in a low tax bracket my decisions are not driven by the tax rate as much as by the need to invest to grow. a zero tax rate would have the same effect.
i am inclined to think that money earned at the high end of the tax rate spectrum is money that has diminishing utility both as consumption and as investment… so that by “taxing” it the government merely diverts it from relatively useless money-investment or gambling into economic activity that produces more economic activity where it is needed most… among those who have not yet reached the point of diminishing utility of money.
coberly,
I have been writing about the fact that lower taxes <> faster economic growth since my first post in 2006. It isn’t something any of us is happy with – we’d all like to pay lower taxes, but really, it would be better if we lived in the real world than the free lunch world.
This simulation is merely an attempt, after 5 years, to model what the statistics show. There are plenty of models out there that model unreality, so I don’t see the problem with modeling something we actually observe. The model, as I note, points out some interesting results… which also flow from the data.
Mike as almost always I think you have it right and I think Coberly’s last comment about people gambling with money is right too. I will add a point I have made a couple of times in other strings. there is much lamenting that people in this country do not save enough and that Americans by and large do not put away anywhere near enough for retirement. This is despite the fact that the federal governemnt will let you defer taxes on present day income if you save it for retirement as well as deferring taxes on the accumulation. When tax rates are low that does not seem like such a good deal, but when tax rates are higher it has more and more appeal with the result that savings rates should go up and Americans should put away more for their retirement–and contribute more to the cost of government in their retirement than they would if they are just eking by on whatever is left of social security. More money is also available for investment in the economy. This is not a generational deferral like the accumulatio of wealth vs consumption in your model, but occurs in a lifetime. The second point is that companies do not transfer jobs overseas because of the corporate tax–they transfer their profits overseas and then lobby Congree for tax holidays to bring the profits back. They send jobs overseas to take advantage of lower wages and less regulation. In any event, your model is not reflecting what happens at the corporate tax level. The model works at the small business level where the owner/operators have the opportunity at year end to increase the businesses expenses and thus avoid paying any corporate tax. Because the individual rates are so low they typically increase their salaries/bonus the profits rather than increase expenses which will grow the business. Then instead of saving the money for retirement they invest in various forms of gambling enterprises run by Wall Street. In any event, keep up the good work. Just because it is counter intuitive to simple minds–ie the GOP and Ayn Rand–does not mean it is wrong. In fact, I would say it is right–sort of like Keynes and austerity.
I think people are trying to take away too much from this post.
If you asked people to use their intuition to predict what your simple model will produce, they would likely get it backwards.
Intuition sucks. This is an exercise in demonstrating why you should not depend on intuition.
mike
as always i fail to make myself clear. mostly i am on your side. my statement that i don’t like taxes was intended to ward off the comments from the right about us tax loving liberals.
looking a little harder at your notes, i think you are reasonably fair with both yourself and your “simplification.”
so i’d add that simply having more money is apparently very rewarding to some people, whether they spend it or not. so don’t worry too much about more mr richfellow reducing his satisfaction to the benefit of his heirs.
nor, i think, is “satiation” necessarily the best word to describe reaching a point where the things you would buy, or invest in, return lesser “benefit” than they did at a lower level of spending. presumably you already bought what you wanted most (if you could afford it) or needed most (keeping in mind that those things which are “wanted” most often turn out to be less pleasurable in the owning than they were in the imagining), and presumably you already invested in those investments likely to provide the highest return.
but anyway, i am on your side. just trying to make things clear… to me if no one else.
Arne
i agree that most of the time intuition can get you into trouble. But without intuition you are never going to know what data to collect.
In fact the “scientific method” as taught in schools is backward. All science begins with intuition. The power of “science” is that it insists upon ways to check intuition against “reality.”
I can remember in grade school being taught that “cooking” was discovered when a cave man accidentally dropped his meat into the fire. All other great inventions or discoveries were also explained as “accidents,” leading me to think that the people who wrote schoolbooks… including those used in graduate school, had never had a creative thought in their lives.
Though of course I am quite prepared to believe that “creative thought” is largely the result of accidental discoveries by neurons trying out different combinations…
I think observations b and e ought to combined conceptually when thinking about the implications of the model. The taxes are used to purchase public goods, including safety, security, and infrastructure that enables money-making activities, and to make “transfer” payments, such as retirement benefits. Taxes are not simply a subtraction that makes people worse off, as if all the taxes are flushed down a toilet (salaries to politicians excepted).
PJR,
Correct, but there is a subtle point to what I’m doing. This model doesn’t violate any of the right’s narrative to reach the real world conclusion: you can assume the government is completely useless, and that people’s primary motivation is to avoid taxes, and you still get the same result.
Mike,
the easiest way to avoid, or at least postpone paying taxes for is not to show taxable income. If your business looks like it will show a profit, reinvest the revenues, pushing up costs
There is a huge flaw in your reasoning: “Investmenrt” spending is NOT a deduction from current income. Instead it is depreciated over from several to many years. There is no mechnism by which higher tax rates lead to increased investment.
“That said, we’re socially better off if each individual leaves behind wealth (say, a paid for house, a thriving business, whatever) than if each individual leaves behind nothing but a few empty tins of caviar.”
The key term is “each”. That ain’t gonna happen, either.
Where is Henry George when you need him?
“What happens when that chain is broken and money leaves the circle?”
What you call globalization? 😉
“the payroll “tax” is supposed to pay for the retirement of the people paying the tax. Obama and his friends have found a way to get the people to spend their retirement savings on a good cause…increasing Wal-mart’s purchases from China.”
The trust fund is credited as though the tax were paid, right?. It is a subsidy for current workers, without the expense of collecting the tax and sending rebate checks.
“This model doesn’t violate any of the right’s narrative to reach the real world conclusion: you can assume the government is completely useless, and that people’s primary motivation is to avoid taxes, and you still get the same result.”
Very important point! It is not an argument that the gov’t can spend your money better than you can. It is that taking some of your money away can be a good thing. (Something that austerity advocates should agree with. ;))
sammy,
Let’s take a not very hypothetical. Let’s say a couple used their savings to start a small property management company. Said property management company owns a few single family residences that it uses as rental properties in Akron, OH. In years in which they don’t need the income from the rental properties to live because they’re bringing in income from other sources, what do they do? Well, say the properties showed a profit of $35K. Well, it turns out that $35K buys them another fixer-upper. Additionally, the $35K of new expenditures (not to mention what will be spent on fixing up the property) is the difference between profits of 35K and 0 at the end of the year. At the same time, it also means the property management company will bring in an additional $850 a month or so in revenue, depending on characteristics of the property. I trust you notice that depreciation doesn’t appear anywhere in this not very hypothetical story.
Now, let’s get to hypotheticals. Say that the couple has a tendency to splurge – the husband has his eye an boat, and the wife wants to buy jewelry. Are they more likely to take out the profits of $35K if their tax rate is 80% or if the tax rate is 20%? I would submit that they are more likely to forego the boat and the jewelry and reinvest the $35K in another fixer upper if the tax rate is 80% than if its 20%. After all, at 80%, they’re only keeping 7K of the 35K in profit. I have no idea how much a boat costs, not having much interest in such things, but I imagine 7K is not enough to buy much of a boat.
I think Sammy is correct for most businesses as long as you assume that the definition of investment is precisely the one used by the IRS and assume that tax law does not currently have “temporary” investment and depreciation breaks designed to encourage more investment. However, the first assumption is a mistake and the second assumption is wrong more than it is right in most years.
Real example. A small business recently experienced a growth in income and the owner decided to hire another person to find more work for the company so the company could expand further in coming years. That added employee is a tax-deductable expense, not an investment, to the IRS. His alternatives: spend the extra income on IRS-defined investments which, this year again, are tax-deductable up to a certain limit; or take the money for himself, paying more taxes either on the business profit or in personal income taxes. The last option is appealing if taxes are low, but it’s unwise if tax rates are very high. Fortunately for this company’s growth prospects, the owner does not feel a near-term need to take more money for personal consumption, like fancy cars and bigger houses and gold faucets, and judges that growing the company’s value without paying taxes is a solid investment strategy.
Your example applies only to some business owners, but when I listened to George Bush at the folowing link,
http://economistmom.com/2012/04/george-w-bush-please-dont-put-my-name-on-those-tax-cuts/
(at about 3 minutes in), I thought, this is exactly the opposite of what Mike Kimel has been posting.
Mike,
If the couple buy a $35K fixer upper, this is not a deduction from taxable income and thus the couple has no tax incentive to do it. In fact theis investment will be depreciated over 30 years, making it a very poor tax shelter at all.
“Do you really believe that the 35% corporate tax rate has not driven manufacturing out of the country? (It has) “
http://research.stlouisfed.org/fred2/series/CP/
Someday you will make an assertion that is not utterly reality-challenged.
“Obama and his friends have found a way to get the people to spend their retirement savings on a good cause…increasing Wal-mart’s purchases from China.”
and higher rents:
http://research.stlouisfed.org/fred2/graph/?g=6VM
2% tax cut, 2% rise in rents.
Min
where is the money going to come from to repay the Trust Fund?
if you get in the habit of robbing your piggy bank to “stimulate” yourself you are going to have a problem.
there was no need to take the money from Social Security. if they wanted to borrow money for a stimulus they could have borrowed it by selling Bonds and used the money to create real jobs.
Don’t imagine that “the trust fund is credited” is the same as “the workers paid for their own retirement.” differences matter.
sammy
pardon me. i think this is simply… wrong. first i can “expense” some investments instead of taking x years depreciation.
second, even if i take x years depreciation, i reduce my taxes each year by the amount of the depreciation. and clearly, if that doesn’t reduce my taxes, l can invest even more money until the depreciations add up to enough to reduce my taxes to zero.
which is where some of those 40% of the people who don’t pay taxes come from.
“where is the money going to come from to repay the Trust Fund? “
same place it’s going to come from to pay the interest on the trust fund. That’s been Congress just printing new Special Treasuries too.
While optically the FICA tax holiday is bad, fundamentally and philosophically it is no different than a 2% tax cut on the first ~$115,000 of wage income. It was more administratively efficient to ship it as a FICA cut though.
Arne,
I really thought I didn’t have to listen to that man smirk any more.
sammy,
Of course its not a deduction from taxable income. Its an expense. A legitimate business expense for the small property management company the couple operates as the property will generate additional revenues in the future (the new addition should pay for itself in five years and change).
Troy
it is philosophically VERY different. the difference is between the workers paying for their own retirement, and having the government borrow the money which increases the debt which is what Paulson has been yelling about all these years… only it used to be a lie. Now Obama has made it a true. And in the long run it is “the rich” who will repay the debt… that is also “philosophically different” from the workers paying for their own retirement.
the interest on the Trust Fund is NOT paying for Social Security. It is paying for the stuff the government bought with the money it borrowed FROM Social Security. That is another “philosophical” difference.
There is more than one person in the United States.
I love response b, the classic “Sure it works in practice, but does it work in theory?”
“if you get in the habit of robbing your piggy bank to “stimulate” yourself you are going to have a problem.”
What is this robbing the piggy bank mentality? With any real life insurance, you don’t stash the premiums under the mattress or in a hole in the ground. We are not squirrels.
The money for Social Security comes from where it always comes from. The longer we stay in a depression, the worse for Social Security and all gov’t programs, not to mention the Main Street economy. Our main focus now should be economic recovery.
cutting taxes is like picking up the crack pipe.
a doddle to start, a bitch to stop
Bruce:
In a nut shell, no corporate income tax at 35% has not driven corporations out of the US. What rock have you been hiding under?
– Between 2008 and 2011, 30 major corporations paid no federal income tax. 26 of them still enjoy negative taxes. The remaining 4 paid less than 4%. How burdensome! Impact of $205 billion. Only in America, land of opportunity!!!
– Of 280 corporations:
– 111 paid 17.5% or less and > than “0”
– 98 addition corporations paid less than 30% and more than 17.5%
– 71 paid more than 30%
“Corporate Tax Dodgers” http://www.ctj.org/corporatetaxdodgers/CorporateTaxDodgersReport.pdf
Of course its not a deduction from taxable income. Its an expense.
Mike,
You need to take an accounting course. Probably a finance course too. Or run your theory by someone you trust that has some expertise in this area, since you don’t listen to rusty or me, before you take your hypothesis “on tour.” The sooner the better.
Keith,
You have to have a theory, otherwise its just coincidental.
A key assumption of your mode is that individuals value holding wealth as well as consuming it. If you look at the behavior of very wealthy people, this assumption seems totally justified–folks like Warren Buffet consume much less than they could afford to.
People who assert that lower tax rates always lead to greater economic growth generally use models which make the opposite assumption–that individuals don’t place any value on holding wealth. It seems to me that this is implausible, and I’ve never seen anyone try to justify it.
A key assumption of your mode is that individuals value holding wealth as well as consuming it. If you look at the behavior of very wealthy people, this assumption seems totally justified–folks like Warren Buffet consume much less than they could afford to.
People who assert that lower tax rates always lead to greater economic growth generally use models which make the opposite assumption–that individuals don’t place any value on holding wealth. It seems to me that this is implausible, and I’ve never seen anyone try to justify it.
A key assumption of your mode is that individuals value holding wealth as well as consuming it. If you look at the behavior of very wealthy people, this assumption seems totally justified–folks like Warren Buffet consume much less than they could afford to.
People who assert that lower tax rates always lead to greater economic growth generally use models which make the opposite assumption–that individuals don’t place any value on holding wealth. It seems to me that this is implausible, and I’ve never seen anyone try to justify it.
Run,
Corporations have never paid one red cent of tax to the U.S Government and never will. If they actually did pay taxes then prices and employment would never shift everytime taxes raise or lower.
Hint:Hint!
sammy,
I’m not going to get into every detail of the property. Yes, there are many ways to “write off” the expenses that depend on whether one is a passive investor or active manager, or whatnot. I frankly haven’t paid attention to what the hypothetical accountant is doing, but I’ve been assured its precisely what the previous hypothetical accountant was doing too.
That said, my understanding is that even if you’re simply going to depreciate the asset, the purchase of the new property generates a lot of costs: insurance, mortgage (if any), repair expenses (and the hypothetical comparative advantage of the hypothetical property management company is buying dilapidated property and fixing it up better than new), real estate taxes, and maintenance.
Now, if you go the straight line depreciation rate, getting rid of that 35K of property means buying not just one new rental property, but several of them…. which is just going to boost future earnings by even more than if you only bought one.
sammy,
Yes, but right now, in this country, we’re operating under a theory that doesn’t work in practice: cut taxes and get faster economic growth. Even the lefty economists believe it, hence the hoops Romer and Romer jump through.
I suspect the model could work with no valuation on wealth… provided the interest rate wasn’t too high relative to the growth rate in savings, and provided people don’t quite know when they’re going to die.
That said, it does seem to me that people do value having wealth. A snarky example – Meg Whitman’s kid going around telling people he is a billionaire.
Run,
Plus Mike has shown (previous post to this) that corporations paying no income tax do soby investing in their company vs. giving out profits and thus paying taxes. This increases growth and helps the economy! You should actually be celebrating this!
🙂
Islam will change
A few weeks ago, I said to Dan in an email exchange that in my dreams, Obama reads Mike’s AB posts on this subject and then actually discusses it in the campaign. It wouldn’t be hard, I think, for Obama to make this point in about three regular (not long and complex) sentences. And it would help, tremendously, in refuting the apparent belief by a majority of voters, according to recent polling, that Romney would be better on the economy.
Of course, a simple explanation by Obama of Keynesian economics would be a big help, too. Hopefully, Obama will realize—and I think he’s finally starting to—that he needs to do that by pointing out the effect that the huge layoffs of teachers, firefighters and police officers, because of state and local budget constraints, have had on the economic recovery.
Thank you PJR–you do understand the way business–at least those small business job generators work.
The wealth you describe is wealth in the form of real assets. Those assets continue to exist after the death of the owner, even fi their is a 100% inheritance tax. The only difference is in who owns the asset.
Now, when it comes to incentives, we may need to tell a different story, but the incentive stories that we commonly hear are built around an agenda, rather than around actual evidence. What do we know about the behavior of the holders of real wealth at various inheritance tax rates?
The wealth you describe is wealth in the form of real assets. Those assets continue to exist after the death of the owner, even fi there is a 100% inheritance tax. The only difference is in who owns the asset.
Now, when it comes to incentives, we may need to tell a different story, but the incentive stories that we commonly hear are built around an agenda, rather than around actual evidence. What do we know about the behavior of the holders of real wealth at various inheritance tax rates?
Beverly,
Obama can talk all he wants. No one listens to him anymore. He’s had 3 years to translate words into actions and he’s failed miserably. He can talk all he wants – tell me when Obama DOES something to actually start implementing one of Mike’s suggestions.
Like lets start by Obama championing a big tax increase.
And the states that are getting their fiscal house in order will be doing well in the future (see Wisconsin). States like California who continue to dig deeper won’t be keeping up. Now I’m not big on total austerity, but I bet every state government can find plenty of places to cut administrative bloat without once touching a police officer or firefighter or teacher. Start with all the jobs with the word “Diversity’ in the title.
The state beuacracies always start by cutting muscle and bone first to protect the fat. If I can find the list of bloat in the California state gov. that was posted awhile back I’ll put it up. The combined budgets alone would practically re-capitalize the UC system.
Why again does the Dept. of Education have a SWAT team and why do we need federal Bunny inspectors for magicians? Plenty of fat.
Islam will change
Mike,
I don’t think the big positive effect of higher tax rates on the top is that it encourages reinvestment into the business. I think that would be a rather small effect. Rather, I agree with the slightly different focus I think Troy and Terry touch on.
If they did choose to take the profits as income (which I think they would do so at about the same rate whether their marginal income tax was high or low), they would either A) invest or B) spend it (at least the portion not paid in taxes).
A) If they invest, they are adding to loanable money, pushing down interest rates, and basically increasing investment elsewhere (in another business, etc.). This is basically the same effect as reinvesting in the business in the first place.
B) If they spend, they are increasing demand in the economy, which contributes to the Fed reducing the money supply more than it would otherwise (assuming a period of full employment). This reduction in money supply increases interest rates, which encourages slightly more saving from others. (In theory, people save an amount roughly equal to the amount spending was increased). Basically, this wealthy person’s spending results in more savings for everyone else.
I think the real difference in the higher tax rates would be the effect of paying those taxes. High-income earners have a low propensity to spend. So when they take that income, they A) invest it more than they B) spend it, compared to the general population. Taxes they pay are a different path (C) for the income to take. With increased taxes on high incomes, the government requires less taxes from other income groups (or less cuts to benefits to other groups, etc.).
That means more money is taken from a low-propensity-to-spend group, and less money is taken from a high-propensity-to-spend group. Overall, this is an increase in aggregate demand. Again assuming full employment, the Fed reduces the money supply to counteract the increased demand, which increases interest rates, which causes the general population to save more money.
The net result is that average people have a higher rate of savings. The middle class has become more resilient to economic downturns. I think this is the key component.
The wealthy already buy what they want, and they continue to do so without much change if the economy slumps. And they may be able to contribute to demand for yachts and mansions, but they can only buy so many consumer goods or visit so many restaurants, etc. It is the cumulative spending of the general population that keeps average consumer good and service businesses operating.
I think that’s what we see today, as luxury industries continue to do fine and even boom, but it’s not enough to counteract the much bigger industries that cater to average people.
Tim,
As I’ve noted on other posts, there are, of course, other effects that matter. (Heck, I’ve noted on this post that this version of the mdoel pretends the effect of gov’t spending is zero.)
You are absolutely right about marginal propensities… when I used to teach, I used to give an example: a wealthy person and a poor person both wake up one morning with a big gaping sore, oozing pus. Now, say a week later, both get a gov’t rebate a la GW Bush 2001. Which one sees the doctor? A – the poor guy. The rich guy saw the doctor the day he got the hole. The poor needed the boost of income to be able to afford it.
That said, I am focusing on this explanation for a reason – every step in this explanation fits the right wing narrative, and is, in fact, an integral part of the right wing narrative. Arthur Laffer and GW Bush together can’t argue with this because their story cannot be true without every step of this story being true. (Of course, where their story fails is the extra assumption they are making which this story does not: untaxed profits will be reinvested efficiently.)
buff,
Careful – that comes close to being a distortion of what I wrote. You are leaving out mechanisms.
Consider two companies paying very low taxes. One of them is subject to very low tax rates and has a lot of special tax exemptions written into the law specifically for its benefit. It pays very low taxes, but pays out big dividends. Another is subject to very high tax rates but chooses to continue reinvesting rather than paying dividends.
Only in one of those cases is the government policy encouraging growth. And it isn’t the policy that most economists would say is growth inducing.
kharris
that’s true, but i think Mike’s point was that the real assets would not get created if the high tax rate did not “encourage” the shift from personal consumption to investment.
as for the actual behavior, I think that Mike’s data about the relation between tax rates and growth in GDP is reasonable evidence.
for myself, i don’t care much for stories about “incentive.” as you say, they are built around an agenda. in any case I care less about “growth” and more about the “general welfare,” including, by the way, the welfare of “the rich” who sometimes fail utterly to understand that their welfare depends to a considerable extent on the welfare of the poor.
Min
I agree, but the main focus has been on killing Social Security while blaming it for “the deficit.”
as for the piggy bank, it make a huge difference whether you put your money in the piggy…. or savings… or even investment… as opposed to just throwing it in the street and hoping “the economy” will return it to you tenfold.
there is a reason why we have legal claims of ownership.
Beverly
well, you are right, and you are hopelessly naive.
the voters think Romney would be better for the economy not for any rational reason or anything Obama could say to the contrary. They think it because R is a republican (and says he’e be better for the economy.) That’s all it is. The same way Tide washes your clothes whiter than white.
buff:
Do I detect a hint of sarcasm in your comments? I believe what we are discussing is
– accelerated depreciation
– stock options for upper levels of management
– offshoring profits
– industry specific tax breaks
Mike is correct that accelerated depreciation on investments from profits reinvested in the company would lead to the avoidance of taxes. However, this has been abused by the 30 or so I mentioned.
sammy
i was going to drop out of this, but Mike’s description accords with my experience, and my accountant’s.
Beverly,
Thanks for the vote of confidence, but Obama has very clearly concluded that whatever GW Bush was doing on almost anything was the rihgt path. Experct more GW-lite going forward.
There are a couple of comments above that I want to respond to. No, none are bt sammy. I don’t understnad why any one continues to reply to that fool other than to point out that he is either a deceiful obfuscator looking to waste bandwidth or a fool.
I agree with Beverly that it would be worthwhile for Obama and others to try to explain in simple sentences why cutting taxes is antitheticle to economic growth and that the argument that it promotes growth is half right. it promotes the growth of the wealth of the already wealthy.
Terry ppoints out that workers in this country don’t save enough, especially in regards to their future retirement. Terry, didn’t you hear that the average worker doesn’t earn enough to pay his current bills, never mind saving for a rainy day or a sunny seniority. Median individual annual income, that’s 50% earn more and 50% earn less, is about $28,000 according to the last census data. That’s not household income, the new way to describe how well off American workers are. If the entire family is put to work they may survive financially. So much for saving and taking advantage of all those tax advantaged savings ploys. Oh, almost forgot, 50% of workers don’t earn enough to pay taxes so they can’t benefit from all those tax tricks. That’s for the upper middle class. I just recently realized that my wife and I saved enough so that with our pensions and Social Security benefits we’ll owe as much to IRS when we take the 401 money out as we would have paid to begin with. So it’s done little good to put it into a tax advanntaged account in the first place, but it did feed the families of all those fund managers who skimed off about .85% every year for helping my retirement savings bounce up and down like a Duncan Supreme.
Then from Ken Almguist we have this gem of an insight, “If you look at the behavior of very wealthy people, this assumption seems totally justified–folks like Warren Buffet consume much less than they could afford to.”
What can one say to that. Things roll better on wheels. People with a small fraction of Buffet’s wealth can’t sepnd what they earn. Even if they tried to. There are just so many things to buy. True, if you “only” earn $500,000 annually you can’t buy the Spelling mansion for $85,000,000, but with a little adjustment you’ll find yourself overwhelmed with stuff in just a few years and have to invest the rest. (I can’t seem to get rid of this stupid italics.)
And Buff, is this statemnt for real? “And the states that are getting their fiscal house in order will be doing well in the future (see Wisconsin).” See Wisconsin with the worst employment record in the country. Oh maybe its only second worst. So if we lay off all public workers and send our kids to work rather than to school (because we won’t have any teachers who know how to cope with their jobs) we’ll be responsible like that jerk Walker, a groveling sychophant if ever there was one. Let’s hope that in spite of all the Koch money rolling in the people of Wisconsin come to their senses.
There are a couple of comments above that I want to respond to. No, none are by sammy. I don’t understand why any one continues to reply to that fool other than to point out that he is either a deceiful obfuscator looking to waste bandwidth or a fool.
I agree with Beverly that it would be worthwhile for Obama and others to try to explain in simple sentences why cutting taxes is antithetical to economic growth and that the argument that it promotes growth is half right. It promotes the growth of the wealth of the already wealthy.
Terry points out that workers in this country don’t save enough, especially in regards to their future retirement. Terry, didn’t you hear that the average worker doesn’t earn enough to pay his current bills, never mind saving for a rainy day or a sunny seniority. Median individual annual income, that’s 50% earn more and 50% earn less, is about $28,000 according to the last census data. That’s not household income, the new way to describe how well off American workers are. If the entire family is put to work they may survive financially. So much for saving and taking advantage of all those tax advantaged savings ploys. Oh, almost forgot, 50% of workers don’t earn enough to pay taxes so they can’t benefit from all those tax tricks. That’s for the upper middle class.
I just recently realized that my wife and I saved enough so that with our pensions and Social Security benefits we’ll owe as much to IRS when we take the 401 money out as we would have paid to begin with. So it’s done little good to put it into a tax advanntaged account in the first place, but it did feed the families of all those fund managers who skimmed off about .85% every year for helping my retirement savings bounce up and down like a Duncan Supreme.
Then from Ken Almguist we have this gem of an insight, “If you look at the behavior of very wealthy people, this assumption seems totally justified–folks like Warren Buffet consume much less than they could afford to.”
What can one say to that. Things roll better on wheels. People with a small fraction of Buffet’s wealth can’t sepnd what they earn. Even if they tried to. There are just so many things to buy. True, if you “only” earn $500,000 annually you can’t buy the Spelling mansion for $85,000,000, but with a little adjustment you’ll find yourself overwhelmed with stuff in just a few years and have to invest the rest. (I can’t seem to get rid of this stupid italics.)
And Buff, is this statemnt for real? “And the states that are getting their fiscal house in order will be doing well in the future (see Wisconsin).” See Wisconsin with the worst employment record in the country. Oh maybe its only second worst. So if we lay off all public workers and send our kids to work rather than to school (because we won’t have any teachers who know how to cope with their jobs) we’ll be responsible like that jerk Walker, a groveling sychophant if ever there was one. Let’s hope that in spite of all the Koch money rolling in the people of Wisconsin come to their senses.
Jack,
Let’s go to the ultimate arbirter, the IRS:
“You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
Business start-up cost (See the note below)Business assetsImprovements
http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
Jack,
Let’s go to the ultimate arbiter, the IRS:
“You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
Business start-up cost (See the note below)Business assetsImprovements
http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
Jack,
Let’s consult the ultimate arbiter, the IRS, shall we?
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
Business start-up cost (See the note below)Business assetsImprovements
http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
Jack,
Let’s consult the ultimate arbiter, the IRS, shall we?
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
1) Business start-up cost
2) Business assets
3) Improvements
http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
Jack,
Let’s consult the ultimate arbiter, the IRS, shall we?
You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.
1) Business start-up cost
2) Business assets
3) Improvements
http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
Generally real assets deteriorate over time, no? Second Law of Thermodynamics.
I think, as many of Los Ricos understand it, their welfare depends upon being better off than everybody else. Having the only yacht in the harbor is better than having the biggest yacht in the harbor.
I agree that Social Security is in the crosshairs of our elites. Nancy Pelosi recently declared support for the Catfood Commission recommendations. With both major parties going after Social Security, the future does not bode well. In an election year, it should be an issue, but neither party is going to make it one without outside agitation.
Perhaps you and I could talk about this.
Why do you think that Obama is a Keynesian? It is plain that he is a fiscal conservative. “We are out of money now.” (2009)
Min
i thought we were. it won’t be an election issue… except to the extent either party can use it to beat up on the other party. actual sincerity not required. they are both out to kill it.
sammy
your comment doesn’t actually say anything about the tax effects of capital expenses.
are you saying that if you invest money in your business you still pay taxes on that money as income?
i believe…. and i am by no means an expert… that first, you can “expense” some capital improvements and deduct the whole thing from current income. second, those capital improvements that you “depreciate” still give you a tax deduction each year ultimately covering the whole cost. and third, even if you are arguing that you can’t get a one to one tax cut for money you invest in the business each year, you can invest enough in a given year to reduce your taxes to zero, though you would have to find another way to pay for it than just using that year’s tax savings.
i don’t suppose this will help.
@coberly
I mean, talking about how to agitate. 🙂
Bruce Kasting may have a point. Dropping business taxes to 35% may have driven a lot of companies overseas. That’s a good argument for raising corporate taxes.
That’s unlikely. Anti-business blue states have always outperformed pro-business red states. Companies always do better in an anti-business environment. High taxes, expensive labor, excessive regulation and costly real estate make businesses much more profitable and faster growing than less hostile business climates.
That’s why red states need so many federal subsidies, paid for by the blue states. They and their businesses can barely keep everyone fed, let alone prosperous. People know this which is why they’ll pay extra to live in a high tax blue state.
P.S. If we were seriously worried about government waste we’d have ended our Cold War military spending when the USSR collapsed. That’s probably the biggest chunk of waste of taxpayer money around.