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Thursday, April 21, 2011

Taxes, Growth and Government Revenue

Most conservatives believe that less meddling by government is good for society. This belief includes taxation. Its even asserted that lower taxes increase government revenue.

I ran into the precisely opposite view by a professor named Robert Ricketts in an article titled, Do Tax Cuts Increase Revenue? The article stated,

"It is a widely held belief in the U.S. that cutting tax rates actually increases government tax revenues.... Regardless of the effect of changes in tax rates on the economy, it is important to recognize that the idea that tax cuts increase government revenues while tax increases decrease them is a myth."

The article cites this graph. Click on it to see it full sized. The graph states it is comparing outlays and revenue as a percentage of Gross Domestic Product.

As Ricketts' graph shows, revenue decline as a percentage of GDP is the result to expect if the tax cut stimulates economic growth. Tax revenue still increases, despite (and because of) the fact that the tax bite is a smaller portion of growing GDP.

Ricketts claims his graph shows increasing taxes increases economic activity and government income. I don't know if Ricketts is confused or if he is trying to hide the fact that cutting taxes will help the economy grow and government income increase.

The key is that the tax cuts stimulates GDP growth. This makes government demands on the economy appear to shrink, even as the government coffers gain income.

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In each of the last three cuts in marginal tax rates, revenues received by the U.S. Treasury have increased. Coolidge cut tax rates in the 1920s, Kennedy cut marginal tax rates in the 1960s, and Reagan cut them in the 1980s.

Under Coolidge, marginal tax rates were cut from the top rate of 73% to 24%. The economy rewarded this policy by expanding 59% from 1921 to 1929. Revenues received by the federal treasury increased from $719 million in 1921 to more than $1.1 billion 1929. That's a 61% increase (there was zero inflation in this period). Growth averaged more than six percent annually. We are currently growing at 2.5%.

Under Kennedy, marginal tax rates were cut from a top rate of 91% to 70%. In real dollar terms, the economy grew by 42%, an average of 5 percent a year from 1961 to 1965. Tax revenue to the U.S. Treasury increased by 62%. Adjusted for inflation, they rose by one-third.

Under Reagan, marginal tax rates were cut from a top of 70% to 28%. Revenues (from all taxes) to the U.S. Treasury nearly doubled. According to the Budget of the U.S. Government, FY 1997, Office of Management and Budget. Revenues increased from roughly $500 billion in 1980 to $1.1 trillion in 1990.

Mackinac Center


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The policy implication for Obama's tax increases bode badly for government revenue. Given the S&P rating reduction for US Government debt, we cannot raise the debt ceiling without grave results. And given that increasing taxes will reduce government income, the only thing left is to reduce government expenditure.

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