First the "Rich", and then YOU!

Probably like a great many of you, I am getting sick of hearing about the fiscal cliff, or more accurately, of hearing about the proposed "solutions" to the fiscal cliff.

It seems that the President and Congressional Democrats, and to some extent Republicans as well, think the only solution is to tax the "rich" and maybe talk about some spending cuts, maybe, some time in the future.  I think history has pretty well shown that when the government talks about tax increases and spending cuts the pattern is usually tax cuts now, spending cuts never. 

The truth is, the United States government, and many of the states as well, have a spending problem, not a revenue problem.  According to the New York Times, the federal deficit for fiscal 2012 was $1,100,000,000,000.00, or put another way, we spent 45% more than we took in.  The President's plan to raise taxes would result in an increase of revenue of about $40,000,000,000.00 in the first year.  There has been no solid suggestion on how we would take care of the remaining $1,060,000,000,000.00 beyond a few promises of spending cuts totaling about $100,000,000,000.00.  Assuming those actually materialized (which I doubt) we would still have $960,000,000,000.00 to make up to come close to balancing the budget.  (There is no way to know if we would see the same amount of revenue in future years as the tax payers changed their finances to minimize the impact.  I suspect we would not see even that much of an increase in revenue in future years.)

Some Democrats have admitted that taxing the "rich" is just a start, but that the truth is that everyone will have to pay more in taxes.  Howard Dean, former governor of my state has said:

The only problem is -- and this is initially going to seem like heresy from a progressive is -- the truth is everybody needs to pay more taxes, not just the rich. And it's a good start. But we're not going to get out of this deficit problem unless we raise taxes across the board, to go back to what Bill Clinton had and his taxes. And if we don't do that, the problem is the pressure is going to be on spending even more.

Presumably the pressure he is speaking of is pressure to cut spending.  Heaven forbid.

Income Tax information from http://www.irs.gov/file_source/pub/irs-soi/09in11si.xls

My apologies for the readability of the spreadsheet.  You can find a copy of it here.

So just how much are we talking about having to raise taxes to balance the budget if real spending cuts are not being considered?  There are certainly a number of ways to approach it, but for simplicity I will only share a spreadsheet of one possibility, though I will mention a couple others in the text.

In the spreadsheet above, the first 5 columns are taken directly from the IRS publication linked in the caption.  I've added colored bands to the adjusted gross income levels to more or less correspond to the 6 tax brackets in the current system.  The effective tax rate is the average of the adjusted gross income paid as taxes, not the actual official tax rate.  There is a roughly 10-15% difference between the official tax rate and the effective, likely due to deductions and the progressive nature of the system (i.e. the income that falls in lower brackets are taxed lower even if your total income is higher.)

The remaining columns are calculated using the IRS information with the effective rate modified so that the total income taxes paid will offset the current deficit.  The total projected taxes collected is shown in the second column from the right in the yellow highlighted row.

In this particular solution, everyone's effective tax rate on their adjusted gross income is increased by 16.3% and we end up with a small surplus of about $3 billion.   The final column in the spreadsheet shows how much the average return for any given income level would go up.  I can pretty safely assume that no politician would ever actually suggest this solution given the pretty dramatic increases in taxes for everyone, especially those with lower incomes.  For example, people in my income level, $20,000-$25,000, would see their taxes more than quadruple.  If we wanted to actually start paying down the debt, say by about $200 billion a year (it'd only take 80 years to pay it off at that rate), we'd be looking at an increase in the effective tax rate of about 19%, which would increase the tax for my income level by a factor of 5.

Another solution I looked at was making the increase in taxes "progressive", with the higher increase going to the top bracket and each bracket lower would halve the amount of the increase.  In this solution I used we could balance the budget by raising the effective rate on the top bracket by about 46%, 23% on the next, 12% on the middle and so forth.  The lowest bracket would only see about a 2% increase.  While this would likely be a bit more attractive politically as it affects the "rich" more, people in my income level would see their taxes go up about 60% and those filing returns showing around $50,000 would see their taxes about double.  So again, this is likely not something any politician would dare suggest.

The final solution I looked at was what tax increase would be necessary if only the "rich" were to see their taxes go up to balance the budget.  If we define "rich" as the president does as only those making more than  $200,000 per year, then we would have to raise their effective rate by about 57%, making their effective rate about 80%.  Remember as noted above the official tax rate runs about 10-15% higher than the effective, so we'd be looking at an official tax rate for the highest earners of 90-95%.  While to some this might appear to be acceptable, I think most economists would agree that actually taking 80% of the income of the top producers in the country would have some pretty serious negative effects on the economy.

In fact, all the solutions I mentioned here would have a pretty extreme negative effect on the economy.  The Tax Foundation ran a simulation using President Obama's proposal and found that there would be negative effects in all parts of the economy from GDP, hours worked, pay rate, capital stock and etc.  This was at the relatively modest proposal of just raising the official tax rate 3 to 5% on the top two tax brackets and increasing capital gains taxes.  I cannot even imagine what effect a tax increase of 10 times the size would do.

Raising taxes is not a viable solution for our financial situation, especially not if the focus is "making the rich pay a little more."  But as then Senator Obama said in 2007, raising taxes on the "rich" is not about revenue, but about "fairness."  Until those in government actually agree to take serious action to cut spending, there is no real solution to the financial problems of this country.

Notes:  There is a likely a fair amount of error in the estimates I made above.  This is because the latest data I could find regarding income tax broken down by income bracket is from 2009, information about the sources of federal revenue is from 2011 and the budget deficit is from 2012.  When taken together, I don't believe this changes the overall picture, though the details would obviously be different.

Add in to that that I am looking only at increasing personal income taxes and not other forms of taxation.  However, since in 2011 income taxes and social security taxes (which to my mind are essentially the same) accounted for 47.4% and 35.6% respectively of federal revenue, I don't believe this changes the overall result either.

Still further, given my understanding and the data available, I wasn't able to accurately reflect the progressive nature of the taxes.  Meaning, even the "rich" paid a lower rate for their income that falls in the lower brackets.  I believe that this is part of the reason for the difference between the effective tax rate and the official one, along with deductions.  For the first to solutions, I don't think this is a huge issue, but it almost certainly is for the last.  The effect of this would likely be the need for an even higher increase or applying that increase to lower income levels, which just makes the solutions even less palatable.

Lastly, I have no way of knowing if it is even possible to actually collect such increases in effective tax rates as mentioned above.  There would be huge incentives, especially among the higher earners, to adjust their finances to minimize the impact.  Even those at more modest income levels might find incentives to work less, especially if they are on the bubble between tax brackets.

Regards.


Sources
http://www.irs.gov/file_source/pub/irs-soi/09in11si.xls
http://www.nytimes.com/2012/10/13/business/federal-deficit-for-2012-fiscal-year-falls-to-1-1-trillion.html?_r=0
http://www.realclearpolitics.com/video/2012/12/06/howard_dean_the_truth_is_everybody_needs_to_pay_more_taxes_not_just_the_rich.html
http://www.heritage.org/federalbudget/federal-revenue-sources
http://townhall.com/tipsheet/katiepavlich/2011/07/15/flashback_obama_says_raising_taxes_not_about_revenue_but_about_fairness
http://taxfoundation.org/article/simulating-economic-effects-obamas-tax-plan

I Like Ike's Restrained Spending

There has been a lot of talk lately about the "good 'ol days" in the 1950s, when we had good economic growth, strong labor unions and high top marginal tax rates.  One of my favorite blogs, Cafe Hayek, has done a number of posts regarding this.  I would recommend that you take a look.

Just the other night I saw a new version of this as a meme on Facebook.  It showed a picture of President Eisenhower with the following information:

"The Last Republican" - Dwight David Eisenhower
Was the last Republican to balance a budget
Refused to lower taxes
Paid down the national debt
Spent money to create jobs
Interstate highway he built returned $6 for each $1 it cost
He did not lower taxes, cut spending, kill jobs or increase the debt
He was the last fiscal conservative

Some of this is factually true.  He was the last Republican President to have a balanced budget and did pay down the national debt.  Other items I think are less clear cut, such as spending money to create jobs which is not something the government can actually do.  One item is actually false and is mentioned below.  Also, it leaves aside just how much role the president has  in any of this list as it requires Congress to actually do them.

As it is mentioned twice, I get the sense that the taxes are meant to be the main focus here, and if we'd only go back to such higher rates, the economy would be strong, we'd be paying down the debt, creating jobs and more.  I believe there are a number of factors that would tend to indicate that the prosperity of the 50's was in spite of the higher tax rates rather than because of them, but for this post I want to look at the implicit claim that if we'd just raise taxes, everything would be fine.

The graph below shows the top marginal income tax rate (the pink line) as well as federal revenue (purplish line) and expenditures (dark green line) as a percentage of GDP.  The blue line is a simple trend line for federal revenue over time.  I've also added a couple other bits of data as well.  The green vertical bands indicate major wars: Korea, Vietnam, Gulf War, War on Terror (working left to right).  The pinkish vertical band marks the period of Eisenhower's presidency.

So there are a couple of interesting things to see in the graph.  The first is that for the first 20 years indicated on the graph, federal expenditures as a percentage of GDP stayed fairly constant.  Something that wasn't mentioned in the list of Ike's virtues, and in fact is falsely stated as something he didn't do, is that he was the only president since 1950 to actually cut government spending, and not just in the modern sense of spending less than an automatically increased baseline spending.  Between 1953 and 1954 it appears that federal spending decreased in real (inflation adjusted) dollars by about 4% and was essentially flat between 1954 and 1955.

The second interesting point is that the line indicating federal revenues runs pretty consistently around 18% of GDP.  There are a few years when it gets higher, near or slightly above 20%, but it tends to drop back down to the 18% range.  This consistent level of income is despite the wide range of top marginal tax rates.  So not only do higher rates not result in increased long term revenue, they are also likely to reduce economic growth.  According to Tax Foundation chief economist William McBride, "Nearly every empirical study of taxes and economic growth published in a peer reviewed journal finds that tax increases harm economic growth."

Also note that as rates have come steadily down, the trend of federal revenues has risen slightly, seeming to indicate that over the long term, lower tax rates can lead to higher revenue as a percentage of overall GDP.

If we were currently spending the same percentage of GDP as Eisenhower did during his 8 years in office, 16.6% on average (as opposed to the current ~25%), our current deficit would be something like $190 billion instead of the $1100 billion it actually is.  If in addition revenues were at the long term trend line, we'd have a surplus of about $200 billion.  So maybe the reason Ike was able to pay down the debt was because he restrained spending rather than kept taxes high?

[Please do not assume that I think the government should be spending 16.6% of our GDP, as I believe that a lot (most?) of what the government does today it actually does not have any business or authority to do.]

One final note from the graph which doesn't have anything to do with Eisenhower is marked by the red vertical line indicating 1971.  I noticed that prior to this, the lines for federal revenues and expenditures track pretty closely together, with revenue being higher than expenditures most of the time.  After 1971, these lines diverge quite a bit and in general expenditures are always higher.  

The most likely event to have caused this was that in 1971 President Nixon took the United States off the last remnants of a gold standard, making the dollar a fiat  money.  Since fiat money is not connected to any objective standard of value, governments can create as much of it as they might want.  Not surprisingly this results in higher inflation.  In the 40 years prior to 1971 inflation averaged about 2.5% while in the 40 years since, it has averaged about 4.4%.

Regards.
Sources:

http://www.deptofnumbers.com/misc/debt-revenue-and-expenditures-as-a-fraction-of-gdp/
http://www.taxpolicycenter.org/taxfacts/Content/PDF/toprate_historical.pdf
http://www.usinflationcalculator.com/inflation/historical-inflation-rates/
http://taxfoundation.org/article/higher-tax-rates-will-sabotage-economic-growth

Rockefeller Saved the Whales

I was watching the John Stossel program on Fox Business News last night, primarily to see the segment with Yaron Brook.  The overall theme of the program was charity, but towards the end of the segment with Yaron Brook, a somewhat offhand remark was made and then repeated by John Stossel about how John D. Rockefeller saved the whales, something you are likely to never be taught in your Environmentalism class.

So, understandably curious I did a quick search and found a number of articles on the web verifying what was mentioned on the program last night.  Essentially, Rockefeller via his Standard Oil Company reduced the cost of kerosene, from 59 cents per gallon in 1865 to about 7 cents a gallon in 1895, while improving its quality.  Keep in mind this is during the period when he had a virtual monopoly (about 90% control) of oil refining in the United States.  So much for monopolies driving up prices and reducing quality.

How did this save the whales?  In the 19th century, one of the biggest (if not the biggest) driver of whaling was the need for whale oil which was the primary fuel used for lighting in western nations.  In 1856 the price of whale oil reached its peak of $1.77 per gallon, making it vastly too expensive for the average person to use, essentially reducing productive hours to daylight.

It was about this time, a few years earlier in fact, a geologist named Dr. Abraham Gesner developed a method of distilling kerosene from petroleum, which was then considered a nuisance.  His kerosene was cheaper than whale oil and burned longer and could be used in existing lamps.  This improved the quality of life immensely for the average person.

As Rockefeller pushed the price of kerosene down even further, the demand for whale oil disappeared.  In the 1840's the United States alone had more than 700 whalers but by the 1870's that number had drop to less than 40, due in large part to the impact of cheap kerosene.  Oddly, it was fashion that helped enable whaling to limp along for a few more decades as the demand for whale bone for corsets and the like allowed whaling to continue to be somewhat profitable.  This finally ended when spring steel replaced whale bone for these uses.  The last US whaler set sail in 1924 and promptly ran aground.

The source of the bulk of the information for this post came from an article in the Freeman titled "How Capitalism Saved the Whales."  It is definitely worth reading as it covers a lot more than I did here.

One quote in particular jumped out at me and I think is something people need to consider when they discuss the role of government intervention in business:

If the government fosters an atmosphere in which innovation and profit making potential are subject to whims of bureaucrats, lawyers and politicians, and not based in the abilities of creative people to find innovative solutions to public needs, innovators will not set their minds to the task, and no state whip can force them to do so.

One other interesting note towards the end of the article was the fact that many lakes in Pennsylvania were restored as oil drilling removed naturally occurring petroleum leaks that were polluting them.  Makes me wonder if we'll see something similar with hydraulic fracturing?

You can find another article about this topic here.
Regards

Is it any wonder...

This morning while browsing through the channels when I came across Carol Roth, speaking on Fox Business News where she was talking about the reasons why the economic recovery is still tepid.  I am paraphrasing a bit as I did not rewind the clip to make note of the exact wording but I believe it is fairly close.

"Amercian consumers have a lot of credit available.  They have been deleveraging and their home values have been increasing.  It is the uncertainty about the future that is keeping them from using it to get the economy moving again."

Firstly, I would argue that it isn't consumption that ultimately drives the economy, but rather production which is increased via savings and investment.  Production has to come first or their is nothing to consume.

Secondly,  are we really to believe that to get the economy moving, we should just be going out and spending as much as we can, even if we have to max out the limits on our credit cards and mortgage our homes to the hilt?  This is like the old joke that goes "I can't be broke, I still have checks!"

If this is the advice that the financial "experts" are giving to the government, is it really any wonder why they have run up a $16,000,000,0000,000 debt?