What Most People, Including Ben Stein, Are Missing About Raising Tax Rates

19 Oct, 2012 by John Hawkins

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Ben Stein is a smart guy and I usually agree with him, but I very respectfully would like to note that I think his latest comments about taxes are way off base — and probably not for the reason that most people think.

“I hate to say this on Fox — and I hope I’ll be allowed to leave here alive — but I don’t think there is anyway we can cut spending enough to make a meaningful difference,” Stein told the three shocked co-hosts. “We going to have to raise taxes on very rich people, people with incomes of like say, 2, 3 million a year and up, and then slowly move it down.”

“You do not think Washington just has a spending problem?” Steve Doocy wondered.

“I do not think they just have a spending problem,” Stein explained. “I think they also have a too-low taxes problem. And while all due respect to Fox, whom I love like brothers and sisters, the taxes are too low.”

The economist noted that even more revenue could have been brought in during President George W. Bush’s presidency if taxes had not been cut.

“The evidence is that there is no connection between the level of taxation and the level of economic activity,” he pointed out. “The biggest growth we’ve ever had in this country was roughly 1941 to roughly 1973, that was the best years we ever had and those were years of much, much higher taxes than we have now, during war time and during peace time. So, the economy can grow very fast, even with much higher taxes. And we’re going to have to do something.”

“Taxes were like 70, 80 percent!” Doocy exclaimed.

“I know,” Stein agreed. “And yet, we were very prosperous, we were extremely prosperous. I mean, the highest rate was in the 90s during parts of the 50s and, yet, we were very prosperous.”

Stein’s argument might superficially seem to make sense, but it ignores Hauser’s Law.

Over the decades, tax rates have varied quite a bit. They’ve even gone up as high as 90% in some brackets. Yet, the actual amount of revenue coming in doesn’t change very much in relation to GDP. It’s almost as if conservatives are right and people do react to higher tax rates by changing their behavior. Maybe they work less, take more loopholes, lobby Congress to create loopholes, invest differently, move industry offshore, etc., etc…it really doesn’t matter.

The key thing to take away from this is that the amount of revenue the government can bring in via the income tax is, for whatever reason, more inelastic than most people think. That’s yet another reason to put more emphasis on balancing the budget via spending cuts as opposed to trying to fix the problem with tax increases.

Now, if Hauser’s law is as spot-on as it has been in the past and it’s going to be difficult to raise the government’s revenue level much beyond the 20% of GDP mark, this is one hell of a scary graph.

Put simply, the tax rate may have been much higher back then, but that doesn’t mean people were actually PAYING THAT RATE. As Thomas Sowell noted in my latest interview with him:

Another thing that a lot of people don’t seem to get is that higher tax rates on the rich don’t necessarily mean higher revenue and it doesn’t even mean that the rich will necessarily end up paying a higher share of the taxes. Here’s an excerpt from the book, from the essay.

“The facts are unmistakably plain for those who bother to check the facts. In 1921 when the tax rate on the people making over $100,000 a year was 73 percent, the federal government collected a little over 700 million in income taxes of which 30 percent was paid by those making over $100,000. In 1929 after a series of tax rate reductions had cut the tax rate to 24 percent on those making over $100,000 the federal government collected more than $1 billion in income taxes of which 65 percent was collected from those making over $100,000.”

Explain to people how that can be.

Well if you’re in one of those top brackets and the rates go up to very high levels, then it pays you to accept a low rate of return from say tax free municipal bonds even though a higher rate of return is available in the market. That’s because the market rate, the government is going to take 73 percent of it. So you’re going to end up with less than if you purchased municipal bonds. Once the tax rate gets down to 24 percent, then you’re better off taking your money out of the municipal bonds, putting it in the marketplace where you can get a higher rate of return and even though the government taxes are there (because) you’re better off on that balance. More important though, the economy is better off because instead of financing boondoggles by local municipal governments, you’ll be financing the building of railroads, factories, and other kinds of capital that raise the national income and output.

Long story short, even if we raise taxes to sky high rates, we shouldn’t expect to see a corresponding increase in income.