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Eating The Seed Corn
Higher tax rates don't grow an economy.


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The Democrats’ mantra this election year is “tax the rich.” Trouble is, taxing the rich amounts to eating the seed corn.

Take former Secretary of Labor Robert Reich’s calculation that restoring the top income-tax rate to its pre-Reagan level of 25 years ago (i.e., 70 percent) would provide an extra $200 billion in revenues, which could be used for national health insurance, middle-income tax cuts, and the like.

Do Reich and other tax-and-spenders give any thought to the economic consequences of their policy prescriptions? Presumably, they anticipate no negative effects.

Even some Wall Street analysts (who will go unnamed) are dismissing the effect of higher marginal rates should President Bush lose in November. They maintain the recovery has sufficient momentum so that a tax hike wouldn’t matter.

These analysts are as much in the wilderness as are most liberals when it comes to economics.

Frankly, Democrats haven’t been able to fashion a credible economic policy since the Phillips Curve bit the dust. The Keynesian party now claims, for example, that balanced budgets (and not deficit spending) are the sine qua non of economic growth.

It’s a ruse, of course. If the Democrats were serious about balanced budgets, they’d speak not only of tax hikes but also spending cuts. Instead, they are using the balanced-budget argument as a means of keeping money in Washington in the belief that the indefinite expansion of government, both in scope and size, is their surest way of securing and maintaining political power.

Copious tax revenues are vital to the Democrats’ strategy, so they oppose any reforms that would allow Americans to keep more of what they earn. Furthermore, in an effort to disguise their true intent, they make such nonsensical assertions as the claim that raising tax rates somehow boosts economic performance.

Fact is, most Democrats are willing to sacrifice jobs and business creation in order to keep the federal government’s take of the national economy large. Their income-tax policies actually aim to swell the federal treasury at the economy’s expense.

An economy depends on the availability of financial capital to fund new ventures, transform ideas into reality, and raise productivity. Pumping in investment capital thus creates new jobs, boosts real wages, and ups living standards.

But Washington’s tax-and-spenders ignore financial capital’s crucial role. They treat this money as if it can be taxed away from individuals (and corporations) with impunity.

Nothing could be farther from the truth. The propensity to invest rises with income. Indeed, there appears to be a threshold level, perhaps around $70,000 a year, at which households seriously begin to invest significant amounts of earnings. Those making less money typically spend most, if not all, of their income on consumption.

But economic growth isn’t driven by consumption; it’s driven by production. And production requires two types of capital — i.e., labor capital and financial capital. When Washington siphons off significant amounts of financial capital through taxation, the economy is less able to employ the other form of capital, namely labor. Which helps explain why the U.S. slips into recession whenever the tax burden becomes too great.

Besides, it’s not as if high-income households don’t already pay their fair share of taxes.

In 2001, taxpayers with adjusted gross incomes of $200,000 or more accounted for only 2.0 percent of all tax returns, but they forked over 41.3 percent of the federal income taxes collected for that year, according to the latest Internal Revenue Service data. Similarly, taxpayers earning $500,000 or more represented just 0.4 percent of all 2001 tax returns but provided 26.1 percent of the federal income-tax revenue.

By contrast, Americans making less than $75,000 in adjusted gross income filed 84.7 percent of the 2001 tax returns, yet they accounted for just 26.7 percent of federal income taxes.

A willful misreading of the economic history of the 1990s is part of the tax-and-spend subterfuge. It’s claimed that Clinton’s 1993 tax hikes, the largest in U.S. history, produced the subsequent boom. But how exactly does raising tax rates propel growth? The precise mechanism by which this supposedly occurs has never been defined other than to make wild boasts about the purported benefits of retiring federal debt.

Fact is, the ’90s boom was not the result of higher taxes but rather demographic and technological change. Many baby boom spouses re-entered the labor force as their children flew the nest. More important, though, was the IT revolution, with the proliferation of PCs and the emergence of the Internet.

As the benefits of new information technology became apparent, capital spending per worker soared — and productivity correspondingly climbed. Private nonresidential investment per civilian worker surged by a whopping 91.8 percent, rising from $4,830, in real terms, in the first quarter of 1992 to a high of $9,262 in the third quarter of 2000. During the same period, labor productivity, as measured by output per hour in non-farm businesses, increased 19.1 percent.

The lesson of the ’90s then is that the forces of technological and demographic change were so strong as to overcome the negative consequences of the 1993 tax increases. The economy boomed despite the tax hikes, not because of them.

By April of 2001, federal individual income-tax revenue was 120 percent above its pre-tax-hike level of 1992. Taxpayers, alas, weren’t doing nearly so well. U.S. disposable personal income in April 2001 was only 55 percent above its 1992 level, meaning that federal income-tax revenue had risen more than twice as fast as America’s post-tax income.

The increasing tax burden couldn’t be shouldered forever, and the economy hit a wall after federal tax receipts as a percentage of nominal GDP reached a record 21.1 percent in the first quarter of 2000. (Since the end of World War II, the average has been 18.1 percent.) Year-on-year GDP growth fell from 4.9 percent in the second quarter to 3.5 percent in the third and 2.2 percent in the fourth quarter of 2000 — and continued sliding into the 2001 recession.

Higher tax rates don’t grow an economy; high levels of investment do. And one is antithetical to the other.

– William P. Kucewicz is editor of GeoInvestor.com and a former editorial board member of the Wall Street Journal.



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