Monday, May 16, 2022

No need to raise taxes!

In my experience, politicians are almost always late to the party. At a time like now when tax revenues to Treasury are soaring, why is anyone talking about raising tax rates? 

Chart #1

Chart #1 shows the major sources of federal revenues. As should be obvious, the biggest gains by far have come from the tax on individuals' income. In the 12 months ended April '22, individual income tax receipts were 31% higher than they were for the 12 months ended April '21. The increase had nothing to do with higher tax rates, and everything to do with strong gains in employment and nominal income, plus a bonanza due to realized capital gains in the stock market. 

Chart #2

Chart #2 shows the history of federal spending and federal revenues, as measured by rolling 12-month sums.  Thanks to surging revenues and plunging spending, the deficit over the previous 12 months has fallen from a peak of $4.1 trillion in March '21 to $1.2 trillion in April '22.

Biden is correct to say that the deficit has plunged more under his administration than it did in any other, but he is wrong to imply that it was due to anything he did. His Covid-related emerging spending in the early months of his administration boosted the deficit to its all-time record, and his failure to pass "Build Back Better" (i.e., his failure to spend even more) allowed spending to decline. His failure to boost income tax rates helped the economy to recover, and that in turn boosted tax revenues. In other words, he "succeeded" in bringing down the deficit because he failed to make it worse.

If gridlock prevents Congress from spending more and raising tax rates, it is reasonable to expect the deficit to continue to decline, as the economy continues to recover from the ill effects of Covid and the depressing effects of too much spending.


Benjamin Cole said...

Excellent post.

By the way, the corporate income tax has become such a small portion of federal revenue that it is reasonable to consider total elimination of that tax.

I would prefer shrinking federal outlays to offset the revenue loss, but if necessary, higher fuels or tariffs could suffice.

Scott Grannis said...

Corporate income tax has averaged a little over 9% of total federal revenues over the past 50 years. While not insignificant, it would make economic sense to eliminate the corporate income tax. After all, businesses are not the ones who pay the tax; the burden of the tax falls mostly on consumers, employees, and shareholders. Why? Because businesses must make a minimum profit in order to stay in business. If costs and/or tax burdens rise, they must pass on those costs to others.

The one area of tax that could easily be eliminated is the estate tax. Over the past 50 years, this has generated only 1% of total federal revenues. Over the past 25 years, it has generated only 0.6% of total federal revenues. In the past year, estate taxes generated only $29.6 billion for the federal government. I'd be willing to bet lots of money that individuals spent almost as much in tax accounting, preparation and avoidance strategies. Heck, Congress voted to give $40 billion to Ukraine with hardly a second thought. It's just isn't a lot of money, but it creates tremendous and perverse disincentives among the population. Consider: I could squander $50 million in Las Vegas and the IRS could care less. But if I give $50 million to my kids the IRS wants to tax the difference between $50M and $12M at a very high rate.

This is a tax that should be summarily executed. We would all better off.

Chris_in_NJ said...

Dear Scott:

Love your blog & agree with the idea that Corporate Income Tax ought to be done away with-- I'm also of the view that Long Term Capital Gains ought to be taxed at 0%.

As well, to accelerate repatriation of earnings stashed-away in foreign accounts & luscious tax havens just offshore-- I'd be supportive of granting corporations & individuals a **one-time** amnesty to re-shore the money without taxes taken ; but after this one-time amnesty grace -- if Uncle Sam's ire was directed to claw back loot by way of Truth & Honor Raids with help of the IRS, Federal Marshals & white hat helpers, I'd lose not a single night's sleep.

I believe you would agree that radical tax reform is needed more than ever-- would you agree that a Rightful dose of radical truth-seeking is needed as well and if so, which other ways would you encourage the repatriation of resources which America requires to build a prosperous and just future for all?

Scott Grannis said...

Chris: I completely agree with you on the capital gains tax. As my mentor Jude Wanniski used to say, the capital gains tax is essentially a tax on prosperity. Since it is almost always the case that when you tax something you get less of it, a tax on prosperity is absurd. Why should we tax those who are successful at building a business or investing and taking risk? Moreover, taxing capital gains amounts to double- and triple-taxation. A business that is successful must pay tax on its profits, and investors must pay tax on the dividends they receive (which come from after-tax profits), and then investors must pay tax on the degree to which the business succeeds. This is extremely inefficient and perverse, as it punishes those who work hardest and most successfully to create jobs and prosperity.

For that matter, there should be no tax at all on capital gains, regardless of how long the security is held. Taxing short-term capital gains at a higher rate only discourages people from selling and redeploying their investment to something they believe offers better forward-looking opportunities. It also reduces market liquidity because it works to freeze capital that might be better used elsewhere.

I think it was Friedman who said that a "good" tax is one that does not distort or influence people's decisions.

As for profit repatriation, it can be encouraged simply by making the US tax code more reasonable and less burdensome. A country that is capital friendly will almost always be a prosperous country.

Politicians should be focused on minimizing tax and spending burdens (yes, government spending is a burden for the economy because it is almost always inefficient) instead of trying to maximize tax revenues.

Benjamin Cole said...

Well, when you think about it, we should never tax productive behavior, but that includes working for a living.

That's suggests property taxes, consumption taxes,fuels taxes,import tariffs might be the way to go.

Scott Grannis said...

There is a very good case to be made that consumption taxes are the way to go.

randy said...

Consumption tax with a hefty quarterly pre-bate to all taxpayers is an effective way to reduce the highly regressive nature of this option.

Chris_in_NJ said...

Hat tip, Scott. Will include Mr. Jude Wanniski on my Jersey shore summer reads list!

honestcreditguy said...

Flat tax is the only way to actually even plays into equality across all races...

steve said...

Always thought consumption tax has merit. The left will argue it is regressive-which is true. would need to have allowances for food, clothing and shelter of some sort. Anyways, so apolitical as to be moot.

Benjamin Cole said...

Honestcredit: the problem with any income tax, whether personal or corporate, is that they eventually become a domestic and international shell game. In addition determining what is actually income is genuinely debatable.

Determining income can be fudged, legitimately or otherwise, in a thousand different ways. Adjusted gross income, where do we begin? The tax code is 72,000 pages of unintelligible gibberish.

Apple makes all of its profits in Ireland.

In contrast, property taxes, consumption taxes, fuels taxes, and tariffs are relatively straightforward and not as susceptible to gaming. Oh, any tax can be dodged, but collecting income taxes has become an international gong show.

randy said...

Interested in Steve's mood on the bond market. I know nothing about bond trading - but at least there's a range of yield to play with?

Diane Nugent, president, Victoria Capital Mgmt., Inc. said...

Given the fact that many state governments benefit from the level of federal taxation, it might be worthwhile to shoe the state governments' surplus for 2021 and estimated for 2022. What will they do with that money and how will it affect your outlook?

leo said...

is recession coming?

alpacino said...

Scott, do you have any further insights into the markets decline? Seems to be orderly, lots of overpriced tech stocks have been hit hard. Thanks

Ataraxia said...

Calculated Risk likes to say the housing market is the business cycle. The housing market has surely turned.

davidbauer said...

Scott, of all the analyses I have read about why this is or isn't the 1970's redux yours is the most compelling. Thanks for sharing your work, knowledge and experience with us!