Thursday, May 10, 2018

Laffer Curve strikes again: lower tax rates produced more revenue

The results of last year's Trump tax cut are starting to roll in, and they should not be surprising to students of the Laffer Curve or readers of this blog. As I noted last October, not cutting taxes rates is boosting the deficit:
Since early last year (February 2016, to be exact), when talk of tax cuts began to spread and politicians on both sides of the aisle began to agree that our corporate tax rate—the highest in the developing world—should be cut, revenues from corporate and individual income taxes have flatlined, despite the fact that personal incomes have increased by almost 5%, trailing earnings per share have increased 8%, and the stock market has jumped some 30%.
Indeed, there was zero growth in federal revenues beginning in February 2016 through the end of last year. Further, as I predicted back then, "if the tax code is reformed, and marginal tax rates on incomes, capital gains, and corporate profits are reduced, Treasury will see an almost immediate surge in revenue." And it is happening.

Today's April Treasury report showed that April tax receipts not only set an all-time record, but were fully 12% higher than last April's receipts. People and corporations had been postponing income and accelerating deductions for the 22 months leading up to last December's landmark tax reform, and now they are beginning to realize that income and stop postponing deductions. Tax receipts are once again growing, and there is every reason to expect more of this for the foreseeable future.

Chart #1

As Chart #1 shows, individual income tax receipts have jumped this year, led by very strong receipts in April. Corporate income tax receipts are still soft, but that's not too surprising considering the huge reduction in the corporate tax rate. In any event, individual income tax receipts account for the lion's share of federal income, and they have once again turned up in decisive fashion. 

Chart #2

As Chart #2 shows, spending has been rising at a fairly constant rate (about 4% per year) since 2015. On a rolling 12-mo. basis, federal revenue has risen at a 3.4% rate over what it was a year ago, and it could easily be recording 5-6% rates of growth going forward. With just the tiniest bit of spending restraint, we could see the budget deficit hold steady or decline between now and year end.

Chart #3

As Chart #3 shows, the federal government's finances are very dependent on the health of the economy. They always deteriorate during and after recessions, and they almost always improve during periods of growth. The recent increase in the budget deficit is anomalous in that regard. But when seen through the lens of the Laffer Curve, it is understandable and thus likely temporary.

The Laffer Curve can be summed up as follows: people respond to incentives, especially changes in tax rates. When there is talk of a future reduction in tax rates, it is reasonable to expect tax revenues to decline in anticipation, then subsequently rise once the rates have been cut. Business investment was weak in anticipation of a reduced business tax rate, and now it should be stronger, with the result being more jobs, more income, more profits, and more revenues to Treasury.

The one thing to worry about is the spending side. Spending discipline unfortunately is lacking in today's Congress, and the unchecked growth of entitlements promises to wreak havoc with federal finances in coming years.

29 comments:

George Phillies said...

It might be advisable to wait and see how much of this was a one-time event corresponding to cash coming home from Europe, which after a while comes to an end.

Scott Grannis said...

If this were due to overseas cash coming home, then it would almost surely show up in the corporate income tax revenue category. As Chart #1 shows, all the pickup in federal revenue is coming from the individual income tax category. Corporate income tax revenues have been weak/falling year to date.

steve said...

This is rich. Dems don't what to bitch about-but they'll find something.

https://www.investors.com/politics/editorials/republican-tax-cuts-fairness-rich-share-paid/

George Phillies said...

Excellent point.

Mike Kruger said...

And eventually the effect of no longer accelerating deductions will normalize. unless one can accurately adjust for that effect, as well as the (current) upward momentum of the business cycle, etc. it's too soon to praise Arthur Laffer. We've got just one quarter's worth of data.

I agree corp tax rates needed to come down. (Think Japan's rates may have been higher, for what it's worth.) Prob didn't need to cut all the way to 21% IMO.

As for that article, let me just say that there's a reason nobody in the investment business reads Investors Business Daily.

steve said...

"As for that article, let me just say that there's a reason nobody in the investment business reads Investors Business Daily".

What a stupid comment. All IBD did was to reference study done by two university professors! IF you had read it you would have known that.

Ron Gruner said...

I'm new here so it may have already been pointed out that the Laffer Curve probably should have been named the Mellon Curve as the idea goes back to at least Treasury Secretary Mellon's book, Taxation, where he wrote, "The first object of taxation is to secure revenue...The problem is to find a rate which produces the largest returns. Experience does not show that the higher rate produces the larger revenue. Experience is all the other way." Mellon also wrote "give tax breaks to large corporations so that money can trickle down to the general public in the form of extra jobs."

Almost 100 years ago...

Matthew Grech said...

If anything, I believe even more than you do in the Treasury-boosting aspects of tax cuts. I am not surprised in the least that the Treasury is collecting more, not less.

What is shocking is that we're about to run a $1.2 trillion deficit in the same year of these burgeoning tax receipts. This is about 6% of GDP; 5-6% of GDP has long been held to be the danger zone.

I don't know how or when the madness of our spending will bite. But it is mad.

Scott Grannis said...

Matthew: if current trends in revenues and spending persist, my numbers point to a FY18 deficit of about $720 billion, or 3.5% of GDP.

Scott Grannis said...

Ron: To be fair, Laffer is quick to acknowledge that his famous curve is not something he invented. He just explained basic principles of taxation and commonsense that were apparently being overlooked. Reagan often quoted an ancient Muslim sage named Ibun Khaldun in regards to the same ideas and common sense.

Thanks for the Mellon quote, however, as I had not heard that before. Smart man that Mellon!

Matthew Grech said...

Well, I was thinking the first full FY after the cut, or FY 19. (This would avoid the probable one-time benefit of the taxes on repatriated profits.) But even on FY18, I'll take the over, probably well over 720B.

I hope you're right, of course. The lower the better. But whatever the number the point still holds. We must at least not lose ground, deficit-wise, in boom times. 5% deficits, at this point in the cycle, is an abject failure of govt.

Benjamin Cole said...

Trump added that the U.S. had gotten nothing out of the "$7 trillion [spent] in the Middle East over the last 17 years." ---Newsweek

Yes, the United States can easily come closer to balancing the budget.

GenX Politico said...

So taxes were raised on residents of "blue states" which has led to higher income tax receipts, as professionnals in those urban states produce more econmic activity.

As to spending restraint: most federal spending goes to old people in the form of entitlements. Substantially all of the growth in feederal spending comes from those programs. How much less Medicare should we have and which retirees are not going to get it?

George Phillies said...

"taxes were raised" The changes in the deduction rules, the $10,000 limit, will not have a visible impact until next Spring, I believe. The change in the standard deduction, which I do not claim to understand in detail, will affect all states in the same way. My own tax rates go up, as the brackets for the 3x% rates cut in at low dollar values.

Rich said...

The premise of your argument is invalid.

The higher taxes that I paid in April 2018 vs. 2017 were from income generated via capital gains in tax year 2017, which is paid in April 2018.
This income was booked well before the tax law passed.

I paid higher taxes from realized gains in the stock market, which rose significantly in 2017. I doubt that my behavior of selling investments into a rising stock market, which generated higher tax receipts, was unique to me.

What on earth does economic behavior engaged in before taxes were lowered have to do with the Laffer curve?

The Cliff Claven of Finance said...

Cherry-picking the month of April 2108
to make a point is bad economics,
without mentioning March 2018 and
the 2018 fiscal year (to date).

I'll do that for you:


MARCH 2018 US BUDGET DEFICIT SETS RECORD:
(1) Federal spending in March 2018
was the second highest month
on record.

(2) The March 2018 budget deficit of $208.7 billion
was the biggest March budget deficit in US history.


2018 F.Y. US CORPORATE INCOME TAXES PAYMENTS DOWN:
-- Net corporate income taxes collected
totaled $120.8BN for the seven months
of fiscal year 2018,
(from October 2017 through April 2018),
down $39.2 billion (or 24.5%)
from the corporate taxes collected
in the same seven months
one year earlier.


2018 F.Y US BUDGET DEFICIT UP
-- The US budget deficit for the first seven months
of the 2018 fiscal year was $385 billion,
up from $344 billion a year earlier.
.
.
Claiming the corporate tax cuts will increase
corporate tax payments is voodoo economics.

The Reagan tax cuts were accompanied by
a tripling of the federal debt (during his two terms),
even worse than the doubling of debt under Obama.

This column is implying that
that tax cuts 'pay for themselves',
which has been proven wrong many times
in economic history.

Scott Grannis said...

Cliff: I'm relying on the fact that federal revenues were flat from Feb '17 through Dec. '18. That this was a period during which there was widespread speculation that there would be significant cuts in corporate and individual income tax rates. And the fact that on a year over year basis federal revenues have been increasing during the current calendar year, particularly in April.

The size of the federal debt is not as meaningful as the size of the debt as a percentage of GDP. On that basis, as I have shown in previous posts, Obama contributed more to the burden of debt than all prior presidents combined.

Tax cuts have indeed paid for themselves. The top marginal tax rate has been cut significantly in the past several decades, but federal revenues as a percent of GDP have not fallen and are now in fact very close to their long term average. I have shown this in previous posts.

The top marginal tax rate was about 70% for most of the 1950-1980 period, and was subsequently cut to about 40%. Yet federal tax revenues as a percent of GDP today are just about the same as they were in the 1950-1980 period. This is powerful evidence that tax cuts can pay for themselves.


The Cliff Claven of Finance said...

"The size of the federal debt is not as meaningful
as the size of the debt as a percentage of GDP."

WRONG.
Interest is paid on the "size" of the debt,
not the percentage of GDP.
Since the debt will never be repaid,
the interest expense is most important.
... along with the crowding out effect.
.
.
On that basis
...Obama contributed more to the burden of debt than all prior presidents combined.
WRONG BASIS
Reagan tripled the debt
Obama doubled the debt
Tripled is bigger than doubled !
.
.
.
Tax revenues seem to stay in a small range,
as a percentage of GDP, no matter what the
income tax rates are. My guess is there's a limit
to how much money the goobermint can squeeze
out of people before they avoid and evade taxes.

Scott Grannis said...

Cliff: when you go to a bank to get a mortgage, do they only want to know how much you want, or do they want to know how much you want and how much you make? Obviously the latter, since how much you can safely borrow is a function of your ability to pay, which is directly related to your income. The burden of debt must always be expressed relative to one's ability to service that debt. GDP is an excellent proxy for national income. Debt/GDP is thus an excellent measure of the burden of our national debt.

It is a fact that the burden of our national debt rose much more (about twice as much) under Obama than it did under Reagan. Reagan increased the burden of debt from 24.7% to 38.6% (an increase of about 14%), while Obama increased it from 47.5% to 75.4% (an increase of about 28%.

Yes, federal debt under Reagan approximately tripled (from $840 bil. to $2.4 trillion), and debt under Obama approximately doubled (from $6.8 trillion to $14.3 trillion). But the economy grew MUCH more during Reagan's term than it did under Obama's.

amritsari said...

What I know is that my taxes here in California are going up by about 25% for 2018 because of the limitations to state and property taxes. Thanks Trump.

Also - California with its liberal high tax policies is running a budget surplus while Kansas tried tax cuts and failed miserably. Funny how you don't talk about that.

Tell-Tale Investor said...

Scott, Because Argentina's inflation numbers are dominated by necessary increases in electricity tariffs, is it really inflation or just prices rising from unsustainable, subsidized levels? Is there a way to strip that out to know the real inflation numbers? At some point, comparisons look better, etc.

Scott Grannis said...

Tell-Tale, re Argentina’s inflation numbers. I could argue that since electricity is only a small portion of the Argentine CPI, it can hardly dominate the inflation numbers. But to me the overwhelming part of the inflation story is the 30% annual increases in the money supply that have been occurring for almost all of the past decade. Those numbers are huge, and they are in the end necessary in order to support inflation in the range of 25-30% for years and years. There is no legitimate way for Argentina or anyone to minimize the amount of inflation the country has been suffering. It’s real and it’s ongoing. Subsidized prices for energy and foodstuff are a distraction from the reality of massive money-printing.

The Cliff Claven of Finance said...

Cliff: when you go to a bank to get a mortgage, do they only want to know
how much you want, or do they want to know how much you want and how much you make?

Cliff sez:
The bankers just look at me and say "no"!
I hadn't borrowed money in so long that
when I leased a new car in 2016, they
told me I had "no credit rating at all".
.
.
.

Obviously the latter, since how much you can safely borrow is a function of your ability to pay, which is directly related to your income. The burden of debt must always be expressed relative to one's ability to service that debt. GDP is an excellent proxy for national income. Debt/GDP is thus an excellent measure of the burden of our national debt.

Cliff sez:
The above is economic nonsense.
GDP is mainly created by the private sector
and that sector has plenty of debt to service too!

Government "income" is nowhere near spending
so borrowing is mandatory every year.
More debt every year with slow GDP growth too.
In fact, there are data to show that high levels
of goobermint debt (over 100% of GDP)
cause slow GDP growth,
crowding out the private sector

Since the goobermint debt is not going to be repaid, ever,
only the interest on the debt is important.

When interest rates are low, the interest burden
on the federal debt is low too.

But deficit spending still matters when rates are low,
because the debt never goes away ... it keeps growing ...
and if interest rates / inflation rate rise,
the interest burden grows even more.
.
.
.
Yes, federal debt under Reagan approximately tripled (from $840 bil. to $2.4 trillion),
and debt under Obama approximately doubled (from $6.8 trillion to $14.3 trillion).
But the economy grew MUCH more during Reagan's term than it did under Obama

Cliff sez:
The economy grew faster under Reagan, so at least we got something
in return for the debt. But we still have the Reagan debt to pay interest on.
And we still have the Obama debt to pay interest on forever.
And Trump may add $1 trillion of debt in the next 12 months too ...
while interest rates are rising.

Adding more debt each year is bad economics for a household,
so must be bad economics for a nation ... especially one that does not know
how it will pay Social Security, Medicare, Medicaid and government
pensions to retired baby boomers without significant tax hikes.
Or should we just borrow more money for those programs too?

The worst characteristic of debt is that by borrowing money,
a government can grow spending as a % of GDP with little
immediate pain on the taxpayers -- "painless government growth"
is like increasing the borrowing on a change card and just making the
minimum payment each month. In my opinion, as a libertarian,
we'd have a significantly smaller government sector if
tax revenues more closely matched government spending.
Taxpayers want more government services but
don't want to pay for them.

Johnny Bee Dawg said...

Cliff: tax revenue comes from profits and paychecks. We need more of both.
Robust GDP is a result of increasing profits and paychecks.
Debt to GDP ratio is not "economic nonsense". Its a good indirect measure of government's ability to pay its debt.
Falling debt to GDP is an important move in the right direction.
You are right that debt never goes away....it just becomes less significant if GDP is growing faster.
GDP never goes away, either.

Scott Grannis said...

Re adding debt when interest rates are low. It's true that interest rates have been exceptionally low for most of the past decade, which has also been a time of historically slow growth and low inflation. But it's not necessarily true that all the debt added in the past decade will blow up the economy when and if interest rates rise. It's important to remember that interest rates tend to rise as economic growth picks up and when inflation picks up. Faster growth and higher inflation will be seen in much faster nominal GDP growth. More inflation and more growth will also mean higher nominal wage and salary growth, faster growth in income taxes paid, and slower growth in spending on economic stabilizers such as food stamps and unemployment insurance.

It's entirely possible that we can grow our way out of what today seems to be a huge burden of debt. Rising interest rates needn't pose a problem to servicing today's debt, since rising interest rates will most likely go hand in hand with rising incomes and a bigger tax base, which combined will result in rising tax collections.

Benjamin Cole said...

The Laffer Curve...or is it a laugher?


Goldman: U.S. fiscal outlook 'not good'

The fiscal outlook for the U.S. "is not good," according to Goldman Sachs, and "lawmakers might hesitate to approve fiscal stimulus in the next downturn."

The bank expects the federal deficit to increase from $825B (or 4.1% of GDP) to $1.25T (5.5% of GDP) by 2021, and by 2028, it forecasts the number to balloon to $2.05T (7% of GDP).

---30---

Let's hope Goldman Sachs is wrong!

steve said...

https://www.forbes.com/sites/stancollender/2018/05/20/trump-may-be-the-most-fiscally-reckless-president-in-american-history/#2570b75d564a

FYI

Johnny Bee Dawg said...

Georgetown, Berkeley, and NYU.
Kewl article

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