Taxes and GDP

John Tamny:

Commenting on the 1920s income-tax cuts spearheaded by Treasury Secretary Andrew Mellon, a New York Times editorial suggested that Mellon "wants in reality to get more money out of [the rich] than they are now paying. But he proposes to do it by making their rate of taxation lower."

The Times' editorial stance of over 80 years ago is notable considering the views held by its present editorial board. In a recent editorial ("A Dearth of Taxes"), the Times decried tax cuts given the board's static view that a reduction in the rate of taxation paid by individuals is tantamount to revenue reduction. Modern history says otherwise.

In truth, tax collections in the U.S. tend to follow our nation's GDP pretty closely irrespective of the tax rate. As Discovery Institute senior fellow Bret Swanson recently wrote, there is a "remarkable tendency for Federal revenues to hover around 18% of GDP (and for personal income tax revenue to gather between 7.5 and 9% of GDP), no matter if tax rates are high or low."

What this means is that if we grow the overall economic pie, we expand the taxable base. Sure enough, the reductions in top marginal rates that began in 1981 helped U.S. GDP to grow sixfold over the last twenty-five years and as a result, federal revenues have hit record levels nearly every year since. The Times argues that, "This country's meager tax take puts its economic prospects at risk," but if revenue collections are in fact static as a percentage of GDP, it seems pretty clear that marginal rate cuts are the surest way to expand the economy and government revenues.

The Times bemoans tax cuts that are "mainly for the rich," but when we consider that the rich account for the majority of federal revenues, it's merely stating the obvious that they'll be the biggest beneficiaries in dollar terms. Importantly, the truth that the rich gain the most from tax cuts only tells half of the story.

What the Times' editorialists ignore is that the wages captured by workers are a function of available capital. When the rich are able to save their surplus income rather than hand it over to the government for immediate consumption, those savings fund existing and new corporations that must hire workers in order to grow and become profitable.

The Times editorial argues the opposite in proclaiming that a "spectacular increase in corporate profits" (that occurred alongside the Bush tax cuts) has materialized "at the expense of workers' wages." But in suggesting the latter, the editorial contradicts itself. As evidenced by the migratory nature of U.S. workers, it's a certainty that profitable companies eager to expand regularly bid against their competitors for available labor, and in doing so, drive up wages. Just this week, Stephen Rose of the Progressive Policy Institute laid this out in empirical terms for the Wall Street Journal; noting that for three quarters of the U.S. workforce since 1979, "economic growth translated into earnings gains."

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Somewhat surprisingly, the Times editorial spotlighted Canada as a worthy country for the U.S. to emulate for the fact that its citizens pay five percentage points more of GDP in taxes. What the Times left out is relative stock-market performance in both countries since the U.S. began cutting tax rates, with the Dow Jones Industrial Average up over 1500 percent since 1981 versus 620 percent for Canada's main stock index. Stock indices by definition track profits and economic growth, and while it would be hard to do a counterfactual, it's a safe bet that U.S. revenues on local, state and federal levels would be much reduced had we followed the Canadian economic model.

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The Times would also like to copy Canada's failed health care system. The NY times persists in the failed liberalism of the past and ignores the gains from a conservative approach to taxation. The revenue gains to the treasury are spectacular. What they do not get is that the gains would not be nearly so robust under a high tax structure they want. You can see it empirically in the states where the high tax states stagnate and the low tax states show strong growth. The willful ignorance of the NY Times on the tax issue matches its willful ignorance on the success of our operations in Iraq.