Question Re: U.S. Tax Policy And Its Relationship To GDP

[ImagesandWords]

I’m reading Tom Woods’ new book “Rollback”. On page 12 in the first paragraph, Tom cites economist Jeffrey Rogers Hummel as stating that data suggests that “20 percent (of federal tax revenue?) is some kind of structural-political limit for federal taxes in the U.S.”.

My question is: If true, why is 20 percent the “natural brick wall” that is run into as it relates to GDP? What is it about this relationship that prevents the percentage from exceeding 20 percent? I really want to understand what Tom is talking about here. Thanks in advance.

[TheNcredibleEgg]

The idea is called “Hauser’s Law.”

The proposition was first put forward in 1993 by William Kurt Hauser, a San Francisco investment economist, who wrote, “No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP.”

Hauser cited Arthur Laffer’s concept of the Laffer curve in his original article. While the two concepts are similar, Hauser’s Law was put forward as an empirical observation whereas the Laffer curve was thought of theoretically.

In a May 20, 2008 editorial by David Ranson, the Wall St. Journal published a graph showing that even though the top marginal tax rate of federal income tax had varied between a low of 28% to a high of 91%, between 1950 and 2007, federal tax revenues had indeed constantly remained at about 19.5% of GDP. The editorial went on to say, “The economics of taxation will be moribund until economists accept and explain Hauser’s Law. For progress to be made, they will have to face up to it, reconcile it with other facts, and incorporate it within the body of accepted knowledge.”

However, 2009 tax collections, at 15% of GDP, were the lowest level of the past 50 years and 4.5 percentage points lower than Hauser’s Law suggests. The Heritage Foundation has stated that the recent world economic recession pushed receipts to a level significantly below the historical average

[ImagesandWords]

@TheNcredibleEgg

The idea is called “Hauser’s Law.”

The proposition was first put forward in 1993 by William Kurt Hauser, a San Francisco investment economist, who wrote, “No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP.”

Hauser cited Arthur Laffer’s concept of the Laffer curve in his original article. While the two concepts are similar, Hauser’s Law was put forward as an empirical observation whereas the Laffer curve was thought of theoretically.

In a May 20, 2008 editorial by David Ranson, the Wall St. Journal published a graph showing that even though the top marginal tax rate of federal income tax had varied between a low of 28% to a high of 91%, between 1950 and 2007, federal tax revenues had indeed constantly remained at about 19.5% of GDP. The editorial went on to say, “The economics of taxation will be moribund until economists accept and explain Hauser’s Law. For progress to be made, they will have to face up to it, reconcile it with other facts, and incorporate it within the body of accepted knowledge.”

However, 2009 tax collections, at 15% of GDP, were the lowest level of the past 50 years and 4.5 percentage points lower than Hauser’s Law suggests. The Heritage Foundation has stated that the recent world economic recession pushed receipts to a level significantly below the historical average

O.K., thanks, but this still does not answer the “why” question. What is it about its relationship to GDP that this number cannot exceed 20 percent (allegedly)?

[TheNcredibleEgg]

Sorry - my first post was the extent of my help. I’m too layman to explain Hauser’s Law - or whether or not it’s a law, per se.

Perhaps someone else on here knows more. Or I just googled it and saw several links that might explain more.

Why? Higher taxes discourage the “animal spirits” of entrepreneurship. When tax rates are raised, taxpayers are encouraged to shift, hide and underreport income. Taxpayers divert their effort from pro-growth productive investments to seeking tax shelters, tax havens and tax exempt investments. This behavior tends to dampen economic growth and job creation. Lower taxes increase the incentives to work, produce, save and invest, thereby encouraging capital formation and jobs. Taxpayers have less incentive to shelter and shift income.

I found that paragraph in a WSJ article. It attempts to explain why - but really doesn’t seem to help much. As far as I udnerstand, Hauser’s Law is based on empirical evidence that tax rates always seem to fall under 20% - and I don’t know if there is any actual explanation as to why that is so.

[EmperorNero]

When government raises tax rates beyond a certain point tax revenue goes down because high taxes have economic side-effects. People try to avoid taxes by investing in tax exempt government bonds instead of building factories. That’s why tax cuts can lead to an increase in tax revenue.

[ImagesandWords]

@TheNcredibleEgg

Sorry - my first post was the extent of my help. I’m too layman to explain Hauser’s Law - or whether or not it’s a law, per se.

That’s o.k., I appreciate it nonetheless!

[ImagesandWords]

@EmperorNero

When government raises tax rates beyond a certain point tax revenue goes down because high taxes have economic side-effects. People try to avoid taxes by investing in tax exempt government bonds instead of building factories. That’s why tax cuts can lead to an increase in tax revenue.

Can anyone verify EmperorNero’s answer? It does make sense to me and seems perfectly logical.

[ImagesandWords]

@EmperorNero

When government raises tax rates beyond a certain point tax revenue goes down because high taxes have economic side-effects. People try to avoid taxes by investing in tax exempt government bonds instead of building factories. That’s why tax cuts can lead to an increase in tax revenue.

Thank you EmperorNero for your answer. It was exactly what I was trying to understand. I actually e-mailed Tom Woods and he clarified what was being said in the book.

[EmperorNero]

Thank you EmperorNero for your answer. It was exactly what I was trying to understand. I actually e-mailed Tom Woods and he clarified what was being said in the book.

Cool, can you post what he wrote? The other day I tried to find the article where he explains it, but it might have been in a video. It wouldn’t surprise me if he explains it later in Rollback.

And there’s always google, of course:

http://townhall.com/columnists/ThomasSowell/2010/11/16/deficit_reduction/page/full/

http://www.heritage.org/research/reports/2003/08/the-historical-lessons-of-lower-tax-rates

http://www.house.gov/jec/fiscal/tx-grwth/reagtxct/reagtxct.htm

[resist272727]

@EmperorNero

When government raises tax rates beyond a certain point tax revenue goes down because high taxes have economic side-effects. People try to avoid taxes by investing in tax exempt government bonds instead of building factories. That’s why tax cuts can lead to an increase in tax revenue.

To some degree that’s true . . . but mostly for the rich. Tax cuts for the rich will raise taxes in the long run because the rich will get richer faster and it will give people less incentive to dodge taxes and more incentive to make profitable investments. But if the federal government wants to raise lower and middle-class income taxes and social insurance taxes they can do so easily, but they have to have public approval in order to get re-elected. Also, the population will get taxed more effectively in the long run because people will make more on average, or if tax brackets are not indexed to inflation.

But state and local governments can easily raise more revenue because they are mainly funded by sales taxes and fees. Never forget the state and local governments!