Taxes and the Economy

Operative DT writes in:

Oh Hirsute One,

I apologize for my infrequent updates. The myrmidons are coming along well, though your suggested airborn/air assault/ballet cross-training has them a bit perplexed. Thankfully they’re only allowed to think on Tuesdays between 21:00 and 21:05, so it’s not an issue.

The Czar recalls the order was for ballistic cross-training. But let’s see how the Ronds De Jambe à Terre are progressing before we stop anything.

The purpose of this epistle, though, is to beg your wisdom in dealing with a friend. He writes, “Does anyone have some links to these economic models that show reduced corporate tax income rates stimulates the economy? There has been a lot of talk about those merely lead companies to cut payrolls, reduce capital improvements and focus on maximizing profits at the expense of growth and expansion. Tax breaks to companies for new employees and capital improvements stimulates the economy.”

How can one possibly reason with such colossal ignorance? To think that by increasing a company’s revenues would encourage them to lay people off? That only tax breaks can encourage a company to grow? Surely only women, civilians, and Protestants are so weak-minded.

Great question, and timely, too.

First, the reason your friend may be having difficulty finding models that link lower tax rates to layoffs and reduced capital improvements and reduced expansion is because there are none. He or she will find it as difficult as finding evidence that tapirs encourage over-fishing. One has nothing to do with the other.

Outside of a good Economics 101 textbook, this question is timely because President Obama asked essentially the same question in the debate: how on earth can President Romney expect to improve revenues by lowering tax rates? The math doesn’t check out.

We would like to address both points.

Does lowering tax rates improve the economy?

Better hope so, because President Obama is also getting around to recognition that a lower corporate tax rate will improve things a lot. He has had four years to do something about it, although it is clear that Democrats secretly admit this all the time. Heck, if higher taxes stimulated the economy, why do liberals want to use tax as a penalty, like a carbon tax on energy inefficient manufacturers? Because higher taxes hurt, silly!

Most of the links out there work hard to debunk the idea that lower taxes slow the economy, or at least have no effect. This of course is mixing up different terms: which tax do you mean? Do you mean corporate income taxes? Or personal income tax, or payroll tax?

And the big answer is yes: lowering corporate tax rates is a major driver for the economy. Curiously, this is more so than lowering payroll taxes or even income taxes. [The link has a lot of math that will probably scare your friend.]

This explains a lot. It explains why both the President and the Governor are talking about lowering corporate tax rates: they help. It also explains why, to Obama’s incredulity, Mitt Romney said he has no plans to lower tax rates for the wealthy significantly: because it doesn’t make enough difference. Note that the thousands of websites condemning the Romney-Ryan plan are really good at mixing up their taxation types to convince us that Republicans will hurt the economy.

What is critical, however, is understanding how a personal income tax and a corporate tax can become intertwined. The Czar acknowledges that he has more trouble getting this point across than any other: a small business owner and his or her personal income taxes are affected by the business they own.

For example, a large corporation follows a simple tax model: you make your money. You pay your expenses. You get taxed on what is left.

A small business owner has to follow a different model: you make your money. You pay your taxes. You then pay your employees with what is left. If taxes go up, the employer gets hurt quick. This is why corporate tax rates are so critical to understand.

Sorry, but that is indeed how it works. And when Democrats talk about raising taxes on those who make over $250,000, they fail to realize how many millions of small business owners fall into that category. The Czar will post more on this shortly with some examples.

The point is simple: if someone is indicating that lowering tax rates does not help the economy, and they cannot explain the individual effects of personal income tax, payroll tax, and corporate tax rates, they are invalidating their argument.

Can you increase revenue by lowering taxes?

This is what Barack Obama finds so laughable about Mitt Romney’s proposals. How does lowering a tax rate increase how much money you get? Ha ha ha! Silly Romney.

Except, to a point, it is true. And, after a certain point, the opposite becomes intensely true. This is the whole point behind the Laffer Curve. Dr. J. explains this pretty well, but here it basically is: Art Laffer developed a model that proves that at one end, low tax rates bring in no money at all. That is indeed the President’s point, and he is right.

As you raise the tax rate, you bring in revenue. So far so good.

After a certain point, though, tax revenue begins to drop: it gets so hard to pay taxes that people stop earning real income. When they stop earning real income, they stop paying taxes. And eventually at 100% tax rates, you collect zero again.

So where is the perfect point, where you bring in the most amount of money and keep the most amount of tax payers? History demonstrated it’s around 15%-25%, depending on the unemployment rate at the time. Right now we have high taxes and low employment, which is a bad combination.

But what about the President’s claim that his new new plan will use the tried-and-true Bill Clinton model of high taxes to spur high income? After all, taxes were high under Clinton and more millionaires were created under his watch than anywhere in history?

Trying to link a specific tax rate to economic growth or trouble is a recipe for disaster, because so many factors come into play. Hey, if one tax rate worked perfectly well, we would use it for all purposes. But the reality is different: you have corporate income taxes, payroll taxes, and personal income tax, as we stated before. But there is also capital gains tax.

During the Clinton years, the President failed to mention, America was booming thanks to the post-Reagan tax cuts across the board. The brief recession of 1991-1992 was the short-lived result of the end of the Cold War, with millions of defense employees hitting the streets. When they were reassimilated back into the work force, the tech sector boomed. And taxes went up to grab all that cash.

Yes, millionaires were created. But the President also failed to mention that in 1999, everything choked on the high tax rates that Obama wants to get back to. Evidently, he failed to remember the recession of 2000-2001, which Bush corrected by again extending tax cuts.

The President is very good at forgetting little bits of history that prove Democratic tax-and-spend philosphy is a certain failure.

But your friend does not need a model to prove lowering corporate taxes spurs economic growth: he needs to talk to business owners and figure it out for himself. Or herself.

Fellow Gorms, feel free to add to this. The brevity of space does not permit a full analysis and the Czar welcomes addenda.

About The Czar of Muscovy

Божію Поспѣшествующею Милостію Мы, Дима Грозный Императоръ и Самодержецъ Всероссiйскiй, цѣсарь Московскiй. The Czar was born in the steppes of Russia in 1267, and was cheated out of total control of all Russia by upon the death of Boris Mikhailovich, who replaced Alexander Yaroslav Nevsky in 1263. However, in 1283, our Czar was passed over due to a clerical error and the rule of all Russia went to his second cousin Daniil (Даниил Александрович), whom Czar still resents. As a half-hearted apology, the Czar was awarded control over Muscovy, inconveniently located 5,000 miles away just outside Chicago. He now spends his time seething about this and writing about other stuff that bothers him.