Friday, November 26, 2010

Hauser's Law illustrated

There's a nice op-ed in today's WSJ by Kurt Hauser in which he reiterates his observation, first made over 17 years ago and dubbed "Hauser's Law," that regardless of how high income tax rates are, there appears to be an upper limit (about 19%) on the share of total income that can be captured by the federal government. If the same amount of revenue (as a % of GDP) can be realized with two different tax rates, it's obviously preferable to use the lower rate, since this minimizes the distortions that arise when marginal tax rates are high. The charts above and below provide the data to back up key portions of the article, parts of which I include here, but it's worth reading the whole thing.

The Obama administration's budget projections claim that raising taxes on the top 2% of taxpayers, those individuals earning more than $200,000 and couples earning $250,000 or more, will increase revenues to the U.S. Treasury. The empirical evidence suggests otherwise. None of the personal income tax or capital gains tax increases enacted in the post-World War II period has raised the projected tax revenues.
Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate.
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.
The target of the Obama tax hike is the top 2% of taxpayers, but the burden of the tax is likely to fall on the remaining 98%. The wealthy have the highest propensity to save and invest. The wealthy also run the lion's share of small businesses. Small businesses have created two-thirds of all new jobs during the past four decades and virtually all of the net new jobs from the early 1980s through the end of 2007, the beginning of the past recession.
The Obama administration is also proposing an increase in taxes on capital itself in the form of higher capital gains and dividend taxes.
The historical record is clear on this as well. In 1987 the capital gains tax rate was raised to 28% from 20%. Capital gains realizations as a percent of GDP fell to 3% in 1987 from about 8% of GDP in 1986 and continued to fall to below 2% over the next several years. Conversely, the capital gains tax rate was cut in 1997, to 20% from 28% and, at the time, the forecasts were for lower revenues over the ensuing two years.
In fact, tax revenues were about $84 billion above forecast and above the level collected at the higher and earlier rate. Similarly, the capital gains tax rate was cut in 2003 to 15% from 20%. The lower rate produced a higher level of revenue than in 2002 and twice the forecasted revenue in 2005.

HT: Russell Redenbaugh


Benjamin said...

As the risk of sounding a bit wild-eyed, I would like to see federal outlays targeted to 16 percent of GDP.

True, some sacred cows would have to be gored, but we could lock in lower tax rates. Scott Grannis looks at the top tax rate, but I prefer to lock in lower average tax bites.

I think 16 percent is doable--after all does anyone really think the Dep't of Ed. actually accomplishes anything? How about the USDA? HUD?

Our Defense Department is double where it was in 2000, when it was already swollen, parasitic and ossified. Forgotten now is that we used to demobilize after a war, and that we remained mobilized only because of a cold war (and bureaucratic inertia). The Cold Ware is over--Russia is joining NATO from what I read.

Forgotten is that the Founding Fathers detested standing militaries. Time to sunset our cold war military.

Can we not eliminate the Commerce Department? The Labor Department?

With these cuts, we could bring federal outlays down to 16 percent of GDP. Oh, it would start to grow again, but at least we could accumulate huge savings until the lard-snufflers got back into the saddle.

The top top tax rate does not worry me as much as the total tax bite--that is what I would like to see brought down, to about 16 percent.

marmico said...

Hauser's Law debunked.

The threshold issue is why compare top individual marginal tax rates with total government revenues and not individual income tax receipts?

In the second chart, why are you conflating top marginal tax rates and capital gains realizations? Compare rates to receipts.

The only obvious spikes on this chart is that capital gains tax receipts/GDP rose substantially in 1986 due to the 1987 Reagan tax increase (duh) and the dotcon stock market bubble during Clinton.

In any event, it's the effective tax rate, not the top marginal tax rate, that is determinative of government receipts.

Scott Grannis said...
This comment has been removed by the author. said...

It's amazing this stuff has to be 'relearned' every few years.

Scott Grannis said...

The first chart compares top income tax rates to total federal revenues (including social security). That may not be a perfect comparison, but I think that's valid since top earners pay the lion's share of total income taxes and social security receipts are a relatively constant % of income. The second chart compares capital gains tax rates to capital gains receipts, which is the only valid comparison.

marmico said...
This comment has been removed by a blog administrator.
Bill said...


So glad you had a good Thanksgiving. We're actually seeing some improvement in commercial real estate in Georgia. Our real estate lawyers are much busier than they were last year and it looks like there will be more deals next year (unless you're right that the economy will fall off a cliff again). Thanks again for all your wit and wisdom. I look forward to your instructive posts on a daily basis.

Scott Grannis said...

Marmico: I will not tolerate personal insults of any sort on this blog.

W.E. Heasley said...

Mr. Grannis:

Most excellent post.

Kurt Hauser and Art Laffer have pointed out on numerous occasions that the simple mathematical proposition that simply increasing tax rates yields additional revenue is trumped by the economic phenomena behind such tax increases. The math is quickly spoiled by economic phenomena.

Behind the simple math vs. economic phenomena proposition of raising taxes is a political-economy proposition: politicos view human capital and capital as fixed whereas economics clearly shows human capital and capital are in fact mobile. That politicos fail (possibly purposely fail) to account for the fact that most human capital and capital, in the short, medium, and long run will seek the lowest tax environment. Raising taxes merely facilitates the mobility.

marmico said...

Good to hear that Bill. The problem I have is that Georgia banks have gone bust (Sheila Bair & the FDIC Friday evening take-outs) more so than other states. It kind of reminds me of Texas in the S&L bust 2 decades ago. I assumed that the bankruptcies are construction loan related, which of course was my premise, supra.

Grannis, your Interactive Brokers account only charges 0.76% margin interest for a big leveraged swap guy like you. Why do you need a 4.5% mortgage interest rate + points on your residence at your age and station in life? And I bet dollars to donuts that your existing mortgage loan is no longer non-recourse. Swap guys like you know nuttin' about personal risk management.

Rick said...

marmico's chart proves Hauser's point. Hauser's point was that changes in the rates in the top brackets have only a limited effect upon tax revenues expressed as a percentage of GDP.

Whether one graphs individual income tax receipts or total income tax receipts as a percentage of GDP, those percentages fluctuate only within a small range. In both charts, when that percentage moves closer to the top of the range, a recession usually follows.

Public Library said...

Letting the rich keep more does not equal more spending and investment in the economy. Pure and simple. I think Buffet voiced this opinion more than a few times. said...

Marmico, can you fill me in on your comments ..."Grannis, your Interactive Brokers account only charges 0.76% margin interest for a big leveraged swap guy like you. Why do you need a 4.5% mortgage interest rate + points on your residence at your age and station in life? And I bet dollars to donuts that your existing mortgage loan is no longer non-recourse. Swap guys like you know nuttin' about personal risk management.

November 28, 2010 7:27 AM"

We are in process of re-fi'ing at 4 percent no cost to us 15 year, and I thought we had, and would be getting a non recourse. You imply to Scott this may not be case anymore, and are you saying you could be better off just margin accounting your home loan?