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