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Growth Grade for Diamond and Saez — Solid, and Well-Earned, F

May 1, 2012 by Brian Wesbury

Last week, Peter Diamond and Emmanuel Saez published an Op-Ed in the Wall Street Journal titled “High Tax Rates Won’t Slow Growth.” They argue that when it comes to tax revenue, the US is not close to the top of the Laffer Curve, and raising tax rates to 50%, or even 70%, would boost revenue and reduce the deficit. Even if they are right, why on earth would the U.S. do that? Why would a nation confiscate 70% of what its most productive citizens make and redirect those resources toward a government-chosen objective? Why would a nation discriminate against those who most fruitfully multiply their talents? The only way to possibly justify such a confiscatory, 70%, tax rate is if the income that is to be taken is immorally or illegally earned, if high incomes are damaging to others, or if it can be proven beyond a shadow of a doubt that government investment is more productive than private sector investment. None of these arguments holds water. Almost all income earned by high-income individuals is earned in a competitive market, by serving other people. Football players work their tails off to be the top draft pick. Executives live on the knife edge, trying to make decisions that bring value. Small-business owners twist themselves into knots attempting to deliver quality products at attractive prices to customers who could shop elsewhere. Surgeons go to school forever to perfect their craft. Programmers live on Twinkies and Red Bull and don’t sleep. These heroic efforts to become a better athlete, doctor, executive, small-business owner, or inventor would not be undertaken if the rewards were limited. Moreover, rapid changes in technology always concentrate wealth. Just as Carnegie, Rockefeller, Ford, and Walton have demonstrated, new industry reaps widespread rewards. Bill Gates earned about $10 from every person in the world as Microsoft software enhanced the lives of six billion people. Name any cutting-edge technology company of the past three decades and you will find among its founders and executives vast wealth. Why? Because their products help other people, not because they rip people off. According to data aggregated by the Tax Foundation, total adjusted gross income (taxable income using IRS definitions) was $1.63 trillion in 1980 and $7.83 trillion in 2009. Yes the top 1% saw its share of that income rise from 8.5% to 16.9%. And, yes, the bottom 50% saw its share fall from 17.7% to 13.5%, but that smaller share in 2009 was $1.05 trillion, a 265% increase from the $288 billion earned by the bottom 50% in 1980. The bottom 50% also saw its share of total taxes fall from 7.1% to 2.25%. In other words, it is true that incomes at the top have risen faster than average incomes, but it is not true that any group has been made worse off. Incomes and living standards for all Americans, including those in lower-income brackets, are up. At the same time, tax burdens for those in lower-income groups have fallen substantially. Diamond and Saez argue that per-capita real GDP growth was higher (2.23% annually) between 1950 and 1980 when top marginal tax rates were high, than it was between 1980 and 2010 (1.68% annually) when top tax rates were lower. But saying that tax rates were the dominant factor in these 30-year periods is unnervingly simplistic. First, very, very few people actually paid the top tax rates. Second, state and local tax rates were much lower than they are today. Third, most foreign countries had similar high tax rates, which meant moving was not a benefit. Fourth, the U.S. was alone at the top, economically, in the post WWII world — our competitors had to rebuild. Fifth, government was significantly smaller. Non-defense federal spending averaged just 10.6% of GDP between 1950 and 1980, but 16.6% between 1980 and 2010. In 2011, non-defense federal spending was 19.4% of GDP — a record high. The reason the U.S. has a large deficit these days is not because tax rates are too low; it is because spending is too high. The last year in which the U.S. had a surplus in its budget was 2001 — federal spending in that year was 18.2% of GDP. Since then, total federal spending has never been lower than 19% of GDP and last year it was 24.1%. The U.S. has never balanced its budget when spending was greater than 19.5% of GDP. Raising tax rates won’t do it. Spending cuts are the only way. Finally, Diamond and Saez argue that high tax rates are justified if government can earn higher returns from investment than the private sector. Every once in a while government gets lucky, but over time, no government planned or controlled economy has proven that it could outgrow a system of free market capitalism. Europe tried and failed. The Soviet Union tried and failed. Diamond and Saez, if allowed, would try and fail as well. Raising tax rates to 70% cannot possibly create wealth. The Growth Grade for this proposal is a solid, and well-earned, F.


Author

Brian Wesbury
Brian Wesbury

2012 Economic Growth Fellow

Brian Wesbury is chief economist at First Trust Advisors L.P. in Wheaton, Illinois. He is a member of the Academic Advisory Council of the Federal Reserve Bank of Chicago. Formerly he was vice president and economist for the Chicago Corporation and senior vice president and chief economist for Griffin, Kubik, Stephens, & Thompson. From 1995-96 he served as chief economist to the Joint Economic Committee of Congress. His most recent book, “It’s Not As Bad As You Think,” was published in 2009 by John Wiley & Sons. He received an M.B.A. from Northwestern University’s Kellogg Graduate School of Management and a B.A. in Economics from the University of Montana.

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