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  • Higher Taxes = Deficit Reduction? Maybe in a Static Economy

    A Washington Post article today reports that letting the Bush tax cuts expire would nearly close the fiscal gap. This static logic misses two key dynamic aspects of the economy: (1) the political incentives that higher taxes bring about, and (2) the economic incentives of such policy.

    1. Political Incentives. With higher revenues initially coming in from higher taxes, there would be a stronger political incentive to increase spending. That is, taxpayers have no guarantee that their higher tax payments would actually go to deficit reduction. If history is any lesson, it is more than likely that Congress would lever up on the higher tax revenues, expanding the government even more with borrowed funds. The net result: Deficits would remain, but now there would be an even higher level of overall debt.

    2. Economic Incentives. Why is there a call to put a tax on carbon? Because some believe that we should use less carbon. If the tax works and people use less carbon, what happens to the revenue from a carbon tax? It decreases. Similarly, if you place higher taxes on labor and capital income, you get less labor and capital income. Therefore, the dynamic revenues from the higher tax rates would actually be less than expected. Furthermore, the economic harm from discouraging the very activities that contribute to the growth of the economy (i.e., create income by using our resources to produce, save, invest, and innovate) would put the economy on a slower growth path that would weaken the U.S.’s competitive position in the global economy.

    It is critical that the government implement policies that take account of the way incentives— and therefore decisions—change. In a dynamic economy, these small decision changes create feedback effects that can snowball and change the growth path of the entire economy.

    A slower growing economy hurts everyone, as the recent economic recession so detrimentally demonstrated. Unfortunately under the new tax policy, this slower growth would no longer be considered recessionary; we and our children would view it as “normal,” never realizing all the growth opportunities that would have led to higher incomes, more job opportunities, and new goods and services to enjoy. In an ever-changing and adapting economy, these are the opportunity costs that should be considered.

    Posted in Economics [slideshow_deploy]

    6 Responses to Higher Taxes = Deficit Reduction? Maybe in a Static Economy

    1. Craig Warren , Utah says:

      It seems as though our politicians have forgotten or never learned a key business (and economic) principle. In business if your product is not generating enough total revenue, your only option is not to just raise the profit margin. You also have the option of increasing sales. In some cases that may require reducing the profit margin to accomplish the increase. You also have the option to reduce costs. The same principle holds true for taxation. If you need more tax revenue your options are not limited to raising the tax rates. As was the case during the Reagan years, reducing tax rates stimulated businesses to grow and expand, which in turn produced much higher tax revenues. On the other side of the coin, if you raise the profit margins (or tax rates) quite often you reduce sales volume which can lead to revenues that are the same or lower than when you started. If you raise taxes now and stall business growth, What have you really accomplished?

    2. Drew Page, IL says:

      Give them more to spend, in the form of higher taxes, and they will find more ways to spend it.

      I recently listened to one of Obama's speeches decrying George Bush's unfunded wars and unfunded tax cuts as the reason for the deficit. He conveniently forgot to mention the impact of his actions on the deficit he inherited. Yes, Bush did spend a hell of a lot of money, a ton of which went to provide prescription drug benefits to those on Medicare. Now tell me, how many liberals, 'progressives' and Democrats voted against this in order to control "government spending"? And when Bush reached across the aisle to join Ted Kennedy in coming up with his "No Child Left Behind" program costing billions in expenditures "for education", how many liberals, 'progressives' and Democrats voted against this, in order to control government spending. These bills were just as "unfunded" as the wars in Iraq and Afghanistan and the tax cuts, but I didn't hear any complaints about them.

      Obama pushed legislation through the Democrat controlled House and Senate and spent more money in 19 months than all previous administrations combined going all the way back to George Washington. His Stimulus bill, cost $860 billion (more than the total cost of six years of war in Iraq) and unemployment, that was supposed to be limited to 8%, went up to 10%.

      I don't blame Obama for the Fannie Mae and Freddie Mac failures, but I do blame him for not insisting they be included in his "financial reform" legislation.

      Mr. Obama and his Democrats have spent trillions when we didn't have any money in the bank. Imagine what they will spend if we allow them to raise taxes and give them more.

    3. Tim AZ says:

      Sadly most of the Heritage Foundation members who write these articles. Are unable to refrain from projecting their own ideology upon this regime when they attempt to understand the regimes intent of their actions. If one refuses to acknowledge their opponents ideology, then one will always be confused by their opponents actions. You cannot achieve any semblance of hope if you refuse to understand your opponents intentions through their ideology. Ignorance is bliss, and may seem to be the polite thing to practice, but it will also ensure your own enslavement.

    4. Leon Lundquist, Dura says:

      I think you are onto something, Karen. Voo Doo Economics might work (at least on paper) if our Economy were perfectly flat. Knock our GDP down far enough then anemic growth can be touted as "Economy Rebounds Twenty Percent!" Nevermind the fact that twenty percent of nothing is still nothing. "Gosh! I'm so happy my income doubled! Now I can go buy that pack of cigarettes!"

      I do blame Obama for the collapse of American Real Estate. Don't you remember ACORN? The Community Redevelopment Act? Those birds were creating bad loans like flipping pancakes, and amazing, by intimidation of the Banks. It was thought owning a home gave the People incentive. Now ACORN (whatever new name it is) is encouraging people to break into houses and squat. The real economic theory practiced by the Society Of Bums (SOBs) is Stealing, there is no way to make it work. It is Stealing! I'm sure there is a Professor at Harvard who can write up a nice paper, and we can have more and more advanced methods of Stealing. But it will remain as just what it is, Stealing. It doesn't work.

    5. Brad, Chicago says:

      To follow up on Drew, my fellow Illinoisan (is that really what we call ourselves?), it seems to me that half the time Obama spends blaming Bush is spent saying how similar they are. i.e. We shouldn't complain about spending, because Bush did it, too. If he is nothing like his predecessor, the policies and actions of the latter shouldn't matter in a critique of the former.

      Also, be careful with your quotes, Drew. The spending comparison (at least the way I've heard it) is from Reagan back to Washington. I wonder what Bush's and Clinton's spending compare to? Then again, I recently read a comment on another site that made a good point. It's not really the President that spends the money. It's really Congress that brings up the ideas. The President has the veto to dissent if he doesn't like something, but he's not really the source of the spending.

      To comment on Craig, in Utah (what do they call people from Utah? I hope it's better than "Illinoisan" – ill-annoyin'), I've thought about the options open to government with some recent talk about our sales taxes. The county board president wanted to raise sales taxes 0.25%. How much does that really hurt the average person, even over the course of a year? It doesn't hurt very much. However, it probably expands the county budget by hundreds of thousands or millions of dollars. Why do they need so much more money? They should be required to explain the purpose of the revenue, before they ask for more. Then again, they'd probably just lie about it, anyway.

    6. Tyler, Hawaii says:

      The crux of the issue is, to me: how much would the tax cuts shift Aggregate Demand? I can't think that cutting taxes on incomes above a certain point would shift Aggregate Demand all that much. So by this logic, it would probably best to institute the tax cuts above a certain point, as the incentives to not earn would be small.

      Furthermore, why is a deficit such a bad thing? Its the paradox of thrift: saving is bad for the economy in these situations. Following the Keynesian model (which it looks like Obama supports), America should be running a deficit right about now. The biggest threat to America isn't high taxes or a deficit, its Japan Syndrome.

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