Saturday, February 9, 2008

Taxes and the Economy

The Democrats and Republicans have recently agreed to an economic stimulus package that includes tax rebates for many Americans. The idea of giving the taxpayers some of their own money back is a tacit admission that more leaving money in the hands of taxpayers is good for the economy.

In fact, tax cuts almost always prove beneficial to the economy. Since the 1920s, tax rates were cut by Presidents Coolidge, Kennedy, Reagan, and Bush. In each case, instead of costing the government money, tax revenues actually increased after the tax rates were decreased.

To understand why this is true, think of a tax as a punishment. For example, “sin taxes” on alcohol and tobacco are meant to decrease the use of those substances. Environmentalists have recently proposed increasing the federal gas tax in an effort to curb carbon fuel consumption. An income tax works the same way. As tax rates rise, people are discouraged from being productive. Why should they work more since, when they do, the government takes an increasingly large share of their paycheck?

When tax rates are decreased, the opposite is true. People are encouraged to work more and earn more money because they keep more of what they earn. The government’s share, although smaller in percentage, is greater in terms of actual dollars, because the taxpayer’s paycheck is larger.

The benefits of tax cuts do not stop there, however. Since the taxpayers have more disposable income, they are able to spend more. Higher spending helps businesses to earn profits, which are taxed, but which are also reinvested into the business. As the business grows, it hires more employees. More people earning a paycheck means more tax money for the government as well.

If lower taxes are such a good thing for the economy, then why is lowering taxes so controversial? One reason is that unless you look closely at the data, you won’t realize that lower tax rates means more tax revenues. Another reason is that many politicians use class warfare and a “tax the rich” philosophy to win votes.

Taxing the rich is a bad idea for several reasons. First, in the US, the people in various income groups are constantly churning. The people who earn the least frequently see their earnings rise dramatically, while the people who earn the most often see their earnings decrease. There are no static rich and poor classes in the US.

Second, the rich already pay a disproportionately large share of federal income taxes. According to the US Treasury, the top 5% of taxpayers earn 30% of all income, but pay 53% of the taxes. The top 1% of taxpayers pays 33% of all taxes. The top 50% of taxpayers pay over 90% of taxes. On the other hand, after President Bush’s tax cuts “for the rich” (according to his opponents), the share of the bottom 50% of taxpayers fell from 4.1% to 3.4%.

Finally, the “tax the rich” philosophy imagines that the rich do nothing but live off of the work of the rest of society. This is not true. The rich are consumers and producers. They buy houses, clothes, cars and other items and services, which help to create jobs in companies that make and sell consumer items.

The rich are also producers. Most wealthy Americans are nouveau riche, not old money. Most wealthy Americans are rich because they worked hard and earned it. They created companies that, in turn, created jobs. These companies benefited society as a whole as well as their owners.

If the rich are taxed at higher rates, then they have fewer dollars left to either spend or invest into their businesses. Taxes that target the rich often end up hurting the poor. For example, when Congress passed a luxury tax on items such as yachts and expensive jewelry in the 1990s, the rich simply stopped buying those items from American companies. The jewelry industry lost 330 jobs and the yacht industry was nearly destroyed, costing 7,600 workers their jobs.

An even better solution than tax cuts would be to enact a tax plan that does not punish productive behavior. The Fair Tax, championed by presidential candidate Mike Huckabee, is such a tax. The Fair Tax eliminates income and payroll taxes in favor of a national sales tax. A prebate is paid to all Americans in an amount up to the poverty level. This ensures that Americans in poverty will pay no taxes. Workers keep all of their pay with no taxes deducted. There are no tax deductions, shelters, or returns to fill out. You simply pay a tax when you buy a product.

A plan such as the Fair Tax would tax consumption, so the wealthy would continue to be taxed heavier than people who consume less. People who wish to save money would be able to save more since no tax would be withheld from their pay.

Most importantly, with the penalties for production removed, the US economy would flourish. The tax burden on existing US companies would be removed stimulating growth, but foreign companies would also flock to invest in the US due to the business friendly tax climate.

If this sounds farfetched, it is not. Several countries in Eastern Europe, such as Slovakia, have already enacted business friendly flat taxes. As a result, their economies are booming. These countries have learned that Socialism is a drag on the economy and are running towards capitalism and free markets, while Western Europe and the US march towards socialism.

Easing the tax burden of businesses and individuals is one of the easiest ways that the government can stimulate the economy. Tax cuts are helpful, but our burdensome tax code is in dire need of overhaul. If we delay too long, we may find ourselves left behind by the rest of the world.


No comments: