The Cost of Tax Cuts

There was a story on FoxNews.com today about how Alaska has lost its pre-eminence as an oil producing state as the domestic oil boom continues (thank you hydraulic fracturing, no thanks to you Mr. President). The story suggests that an unfavorable taxation structure has discouraged additional investment, and indicates that some of the politicians want to reduce the tax burden in order to remove the disincentive. Then I hit this gem:

“opponents call it an expensive giveaway to oil companies.”

An essay I wrote during the big brouhaha over extending the Bush tax cuts after the 2010 elections, popped into my head:

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I keep hearing people – members of congress, the media, the average joe on the street -Ð talk about the “cost” of tax cuts. It’s a common plaint by liberals, statists and Obama apologists/Bush blamers that the budget deficit is what it is only because of the “Bush tax cuts” of the mid 2000s. It’s also a common tactic by the same folks to say that this or that tax cut proposal will “cost” X billion dollars, adding to the deficit and growing the debt.

Before even considering the fallacy of the claim itself, I want to make one thing perfectly clear: Tax cuts do not “cost” anything.

Cutting taxes is not the same as spending money. Spending money implies the money is yours in the first place. Tax money does not belong to the government.  It is entrusted to the government by the taxpayers i.e. those who earned the money and to whom it actually belongs. We agree to provide money to the government in the form of taxes in exchange for the various services the government provides us. Taxation “costs” us, the taxpayers, money. When the government reduces taxes, it is reducing the amount of money it’s taking from us. To claim a tax cut “costs” anything is to imply that the money the tax collector doesn’t get to collect is the government’s and that the government is gifting that money to the taxpayers.

Of course, some will argue it’s a semantic argument, and it is in a way. But, importantly, it represents a fundamental world view between one rooted in self-ownership and one rooted in socialism. If one owns one’s self and the fruits of one’s labor, one cannot be told that being allowed to keep more of those fruits is a “cost” borne by the government. It is the opposite, and it is the basis of limited government, consent of the governed, and Lincoln’s famous “government of the people, by the people, for the people.” The opposite viewpoint – that the wealth one creates is not one’s own, but is owned by society and controlled by government, is at utter odds with the notion of liberty. It must be rejected outright, for concession on this philosophical point is tantamount to legitimizing slavery.

And, now, since I mentioned it, lets contemplate the fallacy apart from the semantic argument.

People who favor higher taxation often trot out Congressional Budget Office (CBO) analyses and “scores” that predict the increase in revenue from raising tax rates by X and the loss in revenue by cutting tax rates by Y. Neat appeal to authority ploy, because the CBO is considered nonpartisan. But, and of course there’s always a “but,” the CBO is bound by law to “score” proposals by the rules written by the proposers i.e. Congress.

One of those rules is that the scores are supposed to be static – no changes in behavior can be predicted. But, if tax rates change, how people conduct their business will also change. Consider taxes on cigarettes. A Google search indicates that 300 billion cigarettes are sold each year in the USA. That’s 15 billion packs. Lets say the federal government throws a $1 a pack increase on the cigarette tax. A static analysis will conclude that the government will raise $15 billion in revenue. But, history demonstrates that higher cigarette prices leads to lower consumption (basic economic theory wins out, despite the addictiveness of nicotine), so the real revenues will be less than $15 billion. And, if the tax increase is high enough, it might actually reduce consumption so much that the government actually collects less money.

Another is that the scores are supposed to accept that predicted future actions. Congress tells the CBO that the ObamaCare plan includes future cuts to Medicare. The CBO knows that those cuts are extremely unlikely to happen, because Congress has always cancelled them in the past, but it must nevertheless score ObamaCare presuming those cuts take place.

The lesson? Don’t accept on its face any appeal to CBO authority. Look deeper.

In fact, look at history.

These charts show us that total tax revenues, in both dollars and as a percentage of GDP, went up in the years after the Bush tax cuts took effect. How can this be? If cutting tax rates reduces revenue and “costs” the government money, how could more dollars and a higher percentage of economic activity find its way to government coffers? The answer – people change behaviors in response to changed rules. Lower tax rates make more economic transactions worth doing. Economic activity increases. The number of taxable events increases. You get a smaller bite, but you get to bite more pies. You end up fuller. The tax cuts didn’t “cost” anything, they actually put more money into the treasury.

But, one might then argue, no one wants to increase taxes on everyone, just the rich. Surely the rich aren’t going to be as sensitive to having more of their money taken from them – they’ve got so much already. And, people like Warren Buffett think the rich should be taxed more.

Lets look at one of my most frequently consulted sources.

It tells us all sorts of interesting things, things that run counter to “prevailing wisdom.” In the case of tax cuts, we can look at the mid 2000s and the revenue numbers that correlate with the Bush cuts. Tables 6 and 8 tell the tale. After those evil tax cuts, the rich paid more dollars, a greater share of their own income, and a greater share of the total tax burden than before. Those “tax cuts for the wealthy” ended up collecting more money for the treasury. Again, how could this be? Back to the fallacy of static analysis. Cutting tax rates stimulates the economy, people make more money, the government takes a smaller bite of a larger pie and gets a bigger mouthful than it did before.

Now, why would someone ignore the lessons of history and insist on doing the reverse of something that demonstrably generated more revenue for the treasury? Stupidity? Maybe, and Hanlon’s Razor supports the conclusion. But, perhaps, just perhaps, the driving motive isn’t revenue. That topic I will leave for another day.