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Tax Revenues and Hauser’s Law

Last Monday, we growled about higher taxes, whiskey and car keys, largely basing it on the famous P.J. O’Rourke quotation, “Giving money and power to government is like giving whiskey and car keys to teenage boys” and a great essay by Stephen Moore and Richard Vedder that appeared in the Wall Street Journal.

Almost as a follow-up, the Wall Street Journal published an op-ed last Friday by Kurt Hauser, chairman emeritus of the Hoover Institution at Stanford University, last Friday titled, “There’s No Escaping Hauser’s Law. Specifically, he argues:

“Tax revenues as a share of GDP have averaged just under 19%, whether tax rates are cut or raised. Better to cut rates and get 19% of a larger pie.”

Briefly, Mr. Hauser explains Hauser’s Law this way:

"Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."

“Over this period there have been more than 30 major changes in the tax code including personal income tax rates, corporate tax rates, capital gains taxes, dividend taxes, investment tax credits, depreciation schedules, Social Security taxes, and the number of tax brackets among others. Yet during this period, federal government tax collections as a share of GDP have moved within a narrow band of just under 19% of GDP.

“Why? Higher taxes discourage the "animal spirits" (1)of entrepreneurship. When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income. Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments. This behavior tends to dampen economic growth and job creation. Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs. Taxpayers have less incentive to shelter and shift income.”

The importance of tax rates and tax revenues as a percentage of GDP is that the Co-Chairs’ Proposal (aka the Bowles-Simpson deficit reduction commission) “(c)aps revenue at or below 21% of GDP. Steve Manacek explains why this is a problem at Ricochet on November 10, 2010:

“The more important problem is on the revenue side. According to Office of Management and Budget figures, federal revenues have NEVER reached 21% of GDP. In fact, only in Bill Clinton’s final year in office – and during WW II – did revenues even exceed 20% of GDP. During the whole time from 1960 through 2008, federal tax revenues almost always fell between 17 and 19% of GDP, only occasionally rising above 19% (chiefly in Clinton’s second term) or below 17% (G. W. Bush’s first term). Even President Obama’s FY 11 Budget has federal revenues rising only to around 19% of GDP by 2015. So the 21% “cap” represents two full percentage points of GDP above what we have experienced even during historically “high” tax environments.”

So excuse me for thinking deficit should be reduced only by cutting government spending. 

HT Rush Limbaugh for the link to Ricochet and Frank Emerson for the column by Mr. Hauser.

(1) By the way, InvestorsWords says the term “animal spirits” was “coined by British economist John Maynard Keynes to describe consumer confidence and its impact on the economy. The term was first used in Keynes's "The General Theory of Employment."

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