Higher Tax Rates Can Lower Revenue

I normally don’t watch Sunday morning political TV.  I gave it a chance after this week’s election results.  I watched some of This Week with Christiane Amanpour.   I watched the interview with Rand Paul and the segment on raising taxes with Mike Pence and David Stockman (former budget director with Reagan).  I was surprised at the hostility Amanpour had toward Paul and Pence.

One theme Amanpour pushed in both segments was raising taxes.  She tried to get Rand Paul to agree that his desire to balance the Federal budget would require a tax increase.  The entire Pence/Stockman segment was on this topic.

It took longer than I expected to bring up this point, but Pence finally mentioned it in the back-half of his segment: raising taxes could result in lower Federal revenue.

Stockman disagreed saying that a $100 billion tax increase could increase revenue by $90 billion.

Amanpour then advanced a logical fallacy by appealing to Stockman’s authority on the matter, implying that Stockman was right because he was the “architect of massive tax cuts.”

At that point Pence could have pointed out that Stockman being “the architect of massive tax cuts” doesn’t mean his assertion that tax increases result in higher government revenue is correct.  That’s what’s known as a logical fallacy and fallacies are far too common.  This particular fallacy is called an appeal to expert or appeal to authority.

Then Pence should have asked the architect of massive tax cuts what happened to government revenue in 1986, the year his “massive tax cuts” went into place?

Here’s the Federal government revenue for some of the fiscal years surrounding the “massive tax cut” in 1986 that lowered the top income tax bracket from 50% to 28% from this source:

1985    $734 billion

1986    $769 billion

1987    $854 billion

1988    $909 billion

1989    $991 billion

Stockman could assert that the Federal government would have had even more revenue in 1986-89 if he hadn’t cut taxes, but that’s something we will never know because it didn’t happen.  Since we don’t know what would have happened, we can’t make any sound conclusions on that point.

There are two solid conclusions we can make from this data.  First, a “massive tax cut” does not appear to significantly hurt revenue and it might help.  In fact, if you look at the government revenues around other significant tax cuts you will see s similar pattern.

Second, since a tax cut may not hurt revenues, and may help, a tax increase may not increase revenue.

This isn’t as intuitive to folks on the left as it is to those on the right.  The left tends to assume that everything else (e.g. size of economy) remains constant, or close enough.  If they were correct, then raising tax rates increases revenue.  After all, 20% of 100 is greater than 19%.

However, the economy is dynamic and people do respond to incentives.  Higher tax rates cause a smaller economy (now and in the future) and more tax avoidance, while lower tax rates cause a bigger economy (now and in the future) and less tax avoidance.  In this case, 19% of 105 is greater than 20% of 100.

Nobody can tell you exactly how much the size of the economy and tax avoidance will change with differing tax rates.  Not an economist nor David Stockman.  If they tell you they know with a high degree of confidence, then there’s one thing you can be certain of, they can’t be trusted.

But the fact is that the size of the economy does change with tax rates.  Higher tax rates can lead to lower government revenue.  That’s enough for me to not really want to take a chance on that tactic when deciding how to balance the budget.