Saturday, January 26, 2008

The Supply-Siders Strike Back!

Here's one to be read and thought about. This is about as good a defense of supply-side economics as you're going to see:
Over the last 25 years, the bottom 75% of all taxpayers' tax payments fell and their tax rates fell. This is the group the Democrats are targeting for tax cuts.

The important point here is that, over the last 25-plus years, the only group that experienced an increase in income taxes paid as a share of GDP was the top 1% of income earners. Even the top 2%-5% of income earners saw a decline in the GDP share of their income taxes paid.

But now we get to the secret sauce, and the essence of what really happens in the realm of tax rates, incomes and tax payments by the rich.

We have accurate data on both the total taxes paid by the top 1% of income earners, and on their comprehensive household income as measured by the Congressional Budget Office. From these two data series we can calculate the effective average tax rate for the top 1% of all income earners.

Surprise, surprise: The effective average tax rate for the top 1% of income earners barely wiggles as Congress changes tax codes after tax codes, and as the economy goes from boom to bust and back again (see chart).

The question is, how can that effective average tax rate be so stable? The answer is simply that the very highest income earners are and have always been able to vary their reported income and thus control the amount of taxes they pay. Whether through tax shelters, deferrals, gifts, write-offs, cross income mobility or any of a number of other measures, the effective average tax rate barely budges. But this group's total tax payments are incredibly volatile.

For the low- and middle-income earners, the effective average tax rate has tumbled over the past 25 years, and so have tax revenues no matter how they're measured.

Using recent data, in other words, it would appear on its face that the Democratic proposal to raise taxes on the upper-income earners, and lower taxes on the middle- and lower- income earners, will result in huge revenue losses on both accounts. But some academic advisers to Democratic candidates have a hard time understanding the obvious, devising outlandish theories as to why things are different now. Well they aren't!

Here's the chart:

None of this obviates the simple fact that the income of the top 1% has skyrocketed over the past 30 years. But let's remember that the goal here is to maximize tax receipts, not implement social justice. One needs to consider the fact that it's just not that easy to redistribute wealth. The wealthy have some say in that, irrespective of what happens to the tax code. The point about the rich being able to defer income to avoid taxes is well taken.

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