Saturday, February 06, 2010

When does cutting taxes make sense?

I'm involved in a debate on the wisdom of cutting taxes elsewhere on the web, so I thought I'd post a summary of when cutting taxes makes sense.

Cutting Taxes Makes Sense... when taxes are already very high.

Cutting taxes from 60% of GDP to 50% is much more productive than cutting taxes from 30% of GDP to 20%, even though it's the same 10% of GDP. The difference is, people's take-home pay, and thus investment potential, is increased by 25% in the first example, but only 14.3% in the second. If you go one better, and cut from 20% of GDP to 10%, you'll only provide a 12.5% increase. It's the same 10%, but it provides twice the return when taxes are already high. Eventually, you'll get to a tipping point where the economic growth generated by the tax cut does not compensate for the lost revenue in any reasonable time horizon.


Cutting Taxes Makes Sense... when you're a developing country.

This is the law of diminishing returns at work. Investments in developing countries produce very high returns. Investments in developed countries don't. The total revenue gains from economic growth are much larger in developing countries.


Cutting Taxes Makes Sense... when you're not running a deficit.

If you're running a deficit, you're not releasing any more investment money into the economy because you're sucking it all up again in the form of borrowing.


Cutting Taxes Makes Sense... when you can simplify the tax code.

If you can reduce the distorting effect of the tax code by cutting taxes, e.g., eliminating a tax entirely, then it is beneficial.


So did the Bush tax cuts make sense? No. We're a comparatively low-tax, developed country that's running a deficit, and we made the tax code more complex in the process.

Go team!

8 Comments:

Blogger Prof. Roger Kovaciny said...

You forgot the most important ones.

Cutting taxes makes sense when your public sector is too large. And your public sector is too large when government is doing all kinds of things that governments by their very nature don't do at all well.

Cutting taxes makes sense when Parkinson's Law applies. That law states that bureaucracy tends to grow at a fixed rate independent of whether the amount of work to be done is growing, stable, or shrinking, or whether--in some cases--any work is being done at all, as for instance in the case of the British Maritime Board he refers to whose responsibilities had been eliminated entirely.

Cutting taxes makes sense when you have people in charge of the beast who are Fabian socialists and whose goal is eventual totalitarianism. The Communists wanted worldwide domination NOW. Fabian socialists, like Islamic totalitarians, are more patient. But the same end is in view.

Cutting taxes makes no sense when government is rapacious, out of control, and there is no other way to get it under control than to starve the beast. Ronald Reagan proved this when his tax cuts turned the Democrats into born-again budget-balancers.

And cutting taxes makes sense when it's a moral issue. Here in the Soviet Union overt and hidden income taxes were about 98% of income, not that the authorities kept all of that for themselves of course. They just confiscated the value of almost everything you produced while it was out of your control, so a $500 job was only paid $10. Then they subsidized the things they thought their herd of human cattle needed. Flats were a dollar a year, trolley passes a nickel a month, cafe meals a penny. Apart from the fact that such high taxes don't work and the Soviet Union collapsed economically, it is immoral to take that much of people's money away from them. To an overzealous publican one Roman emperor rebuked: "I want my sheep sheared, fleeced."

Cutting taxes is also a moral issue when a large proportion of it is taken from the productive to buy the votes of unproductive idlers and to reward political favorites. Obama single-handedly undid the welfare-state reforms forced on Clinton. Unmarried women are once more being paid to breed future Democrats and criminals, criminals whose very existence leads to the voters demanding a more powerful state with more police and prisons.

12:40 AM  
Blogger Octavo Dia said...

Cutting taxes makes sense when Parkinson's Law applies.

Parkinson's law applies to bureaucracies, of which government is made. If this is the case, then cutting taxes always makes sense, which is demonstrably false.

5:20 PM  
Blogger Octavo Dia said...

Cutting taxes makes sense when your public sector is too large.

Your justification in this paragraph is a non-sequitur. It doesn't address why it makes sense, it just defines the term "too large."

5:22 PM  
Blogger Octavo Dia said...

Cutting taxes makes sense when you have people in charge of the beast who are Fabian socialists and whose goal is eventual totalitarianism.

This is self-contradictory. Unless the "Fabian socialists" are cutting taxes themselves, then they are by definition not in charge when the taxes are cut.

6:18 PM  
Blogger Octavo Dia said...

Cutting taxes makes no sense when government is rapacious, out of control, and there is no other way to get it under control than to starve the beast.

The context seems indicate that the "no" is misplaced. If this is correct, then this contradicts your previous assertions. If cutting taxes raises more revenue, then starving the beast would involve RAISING taxes.

6:25 PM  
Blogger Octavo Dia said...

And cutting taxes makes sense when it's a moral issue.

This is the only one of the above that's valid. "Even a stopped clock..."

6:33 PM  
Anonymous Roger Kovaciny said...

I noticed a mistake in my post--I left out the "not" before the word "fleeced." Other than that, your first reply assumes that I would keep cutting back to zero, which you know is not true; cutting taxes, unless balanced by increased debt, will also and automatically shrink the public sector, which in most Western democracies is too large; Ronald Reagan forced through a Democratic Congress the tax cuts that reduced our public sector in the 80's, so except for him, Fabian socialists WERE in charge; you're right about the misplaced "no" but in the real world cutting taxes can be used to starve the beast.

Sure is easier to proofread when you can see a printout. Two mistakes in one post!

11:56 PM  
Blogger Octavo Dia said...

but in the real world cutting taxes can be used to starve the beast.

An October 2007 study by Christina D. Romer and David H. Romer of the National Bureau of Economic Research found: "[...] no support for the hypothesis that tax cuts restrain government spending; indeed, [the findings] suggest that tax cuts may actually increase spending.

I doubt it. All "starving the beast" will do is encourage more borrowing and force more spending off the books.

7:18 PM  

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