Want More Tax Revenue? Increase Jobs Not Rates
The Obama campaign has amplified its push on increasing taxes on the wealthy and has painted Mitt Romney as a Robin-hood in reverse saying that he wants to take from the poor and give to the rich. The attack on Romney is incorrect as the real truth is that it is the current Administration that is failing, once again, to recognize that the problems facing the economy has nothing to do with the current tax rate structure.
It is election season, however, and the Obama campaign's "eat the rich" rhetoric will play well with the 22% of the population that is either unemployed, discouraged, working part-time for economic reasons or have just given up looking for work. It will also play well with the rest of the country that are living paycheck to paycheck as real wages have been on the decline over the last couple of years while the cost of living has risen. While the speeches, finger pointing and podium pounding will certainly tug at the heart strings of those living in a recessionary economy - it only serves to deflect attention from where it should be directed - employment.
The current administration, since the recessionary lows, has seen employment increase in the U.S. While more informed individuals will quickly point out that employment growth has been primarily observed in lower paying retail, service, healthcare and temporary hires - it has been an increase in employment nonetheless. Likewise, the economy, as measured by GDP, has grown albeit at a very sub-par growth rate.
Unfortunately, it is this very anemic, and lower end, employment that allows Obama's attacks on the rich to reverberate so loudly. Since the beginning of 2009 full-time employment is still lower by 1.485 million jobs. The rest of the employment has come from temporary hires which have surged by 1.585 million jobs during the same period. This has suppressed median family incomes exacerbating the problem of maintaining their standard of living leading to record levels of dependence on government assistance.
However, Obama's own employment record, as poor as it is, is evidence that the real answer for increasing economic growth, and tax revenue for reducing the deficit, is not from raising taxes but rather by increasing employment. The chart shows the annual changes in employment, federal receipts and GDP. Not surprisingly when employment has increased federal receipts and economic growth have followed. With an economy that is currently greater than 70% based on consumption - higher levels of employment leads to higher levels of consumption.
Consequently, increasing taxes on "the rich" has the exact opposite effect. In a weak economic environment, where aggregate end demand is low, businesses remain on the defensive. Increasing productivity to suppress employment and wage growth, combined with extensive cost cutting, are the primary weapons of choice to protect profitability. By threatening to increase taxes, or actually doing it, businesses and individuals become more defensive in order to combat higher taxation which reduces consumptive capabilities and stifles end demand.
The chart shows the top marginal tax rate (the rate that the rich would pay) going back to Calvin Coolidge. There are two important points to be made: 1) Tax rate adjustments have a very limited impact on economic growth as the economy very quickly absorbs and adjusts to the rate and; 2) tax revenue is much more correlated with economic growth. The first point is critical. When tax rates are adjusted, either up or down, there is an immediate, but brief, reaction to the adjustment. In every instance where tax rates were increased - tax revenue and domestic growth were negatively impacted as businesses and individuals adjusted spending to accommodate for lower incomes. Secondly, as I stated, tax revenue growth is much more closely associated with economic growth as shown in the next chart.
It will surprise most people that over the last 50+ years regardless of the level of tax rates - tax receipts as a percentage of GDP have remained mired between 16 and 21%. Why? Because when you raise taxes; you lower economic growth and less revenue is collected. When economic growth slows, or slides into a recession, tax revenue also slows. This is why during recessions tax collections are at the lowest and during periods of economic growth they are at their highest.
While the current administration continues to demonize "the rich" for not paying their fair share - the real culprit is the administration itself. The continued lack of actions to provide fiscal policy measures to promote economic growth, a health care plan that has guaranteed higher taxes in the coming year and continued expansions of federal debt to GDP continues to stifle both economic and employment growth. With the level of federal debt rising - the increasing levels of debt service continues to rob from future economic growth as revenue is diverted from productive uses.
The chart shows the Federal Debt to GDP overlaid with tax revenue and economic growth. When debt to GDP was on the decline both economic growth and tax revenue were on an increasing trend. However, as debt to GDP began to climb the economic growth rate began to deteriorate.
Today, what is not understood by the current administration, is that we are mired in a "balance sheet" recession. The deleveraging process is compounded by a sub-par growth economy and high levels of unemployment. Dependency ratios on government welfare incentivizes individuals to be less productive leading to lower productivity and reduced demand.
It is this lack of final demand from consumers that keeps businesses from creating jobs or expanding. The NFIB (National Federation of Independent Business) has continually reported that "poor sales" are a major concern of those surveyed. Furthermore, those saying this is a good time "expand" their businesses remains at recessionary levels. This isn't the type of backdrop that you need to create jobs or economic growth which would increase tax revenue for the government in a "healthy"manner. Raise taxes in this type of environment and you guarantee that economic growth will be reduced even further.
While Obama may refer to Romney as "Romney Hood" - Romney has the right idea of focusing on economic growth first which will provide revenue growth later. Obama's plan is the same as the "Sheriff of Nottingham" who tried to tax his way to prosperity from the meager earnings of the serfs in his kingdom. It will work for a while but ultimately those serfs will rise up and revolt.