Friday, December 7, 2012

Tax Rates and Tax Cliff

Bush Tax Cuts and Federal Revenues

An increase in tax rates on the rich, or anyone else, does not always lead to increased government revenues. Historically, almost the opposite has occurred. Over 50 years ago, President Kennedy lowered tax rates and Federal revenues grew dramatically. President Reagan did the same thing with the same result when he took office.
Even the much-maligned Bush tax cuts did not reduce Federal revenues. In 2002 the Federal government collected 1 Trillion dollars in income taxes and 1.88 Trillion in total revenues. By 2007 after five years of Bush “tax cuts”, Federal income tax collections went up by 50% to over 1.5 Trillion dollars, and total government receipts exceeded 2.5 Trillion. In 2007 the total federal deficit was a mere 160 Billion dollars, the same it had been in 2002. Only with the recession did income tax revenues go down to 2002 levels although total government receipts stayed higher.
Today, total Federal government revenues are the highest they have ever been. Unfortunately, in the last five years massive government spending has far outstripped the increased revenues produced by the Bush cuts. Even if the President were to tax those making over $250000 at a rate of 100%, it would not come close to dealing with the massive debt roll accumulated during his previous four years in office.
Ironically for conservatives, it would appear that reductions in tax rates lead to increased government revenues and only enable more government spending. At the same time, it would appear that raising tax rates would actually lead to less revenue for Washington? Why should this be so?
In the last election campaign Governor Romney tried to make the point that lower tax rates would actually grow the economy and produce greater revenues for the Federal government. Most people, including those who should know like politicians and newspaper editors, could not understand the concept.
But there is another factor. Increasing tax rates only increases tax avoidance strategies both legal and illegal. Recently, a noted political commentator suggested a national lottery where people would be entered in the drawing for the huge payout if they would only submit their tax returns to audit. He estimated that 2 Trillion dollars of income goes unreported every year. His scheme is a crazy one but it illustrates the insanity of our whole tax system.
Increasing tax rates on the rich or anyone else will only encourage more tax avoidance since the potential reward gets greater. If someone’s income is taxed at a 50% rate rather than 25%, the potential reward for deferring, sheltering, or otherwise hiding income has doubled.
How many contractors do you know who prefer to receive payments in cash? How many people do you know who receive unemployment benefits, but who at the same time work “under-the–table” somewhere? If people in such negligible tax brackets risk breaking the law for such a small return, what do you suppose the prosperous will do?
For example, you can raise the tax rate on capital gains, but people will only pay the tax when they finally sell the asset that has increased in value. If the government raises the tax rate on dividends, corporations will just reduce or even eliminate their dividends. Investors will also cut back or even sell their positions in dividend paying stocks in anticipation of an increase in tax rates. I’m not making this up. Just recently, Costco announced a record $7 per share dividend before the end of this tax year. The company is headed by one of President Obama’s major supporters in the last election.
Inevitably, increases in tax rates never produce the expected tax revenues. Just look at the state of Connecticut. Two years ago newly elected Governor, Dannell Malloy, and an overwhelmingly Democrat legislature pushed through the largest tax increase in State history. Now, the expected revenues have failed to materialize, and the Governor’s hapless aides can only blame the failure of the economy to grow over the past two years. ### 
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