Taxes Are Not Created Equal

I’ve been working on a paper about America’s looming fiscal crisis. Earlier today I drafted a short (and as-yet-unfinished) section about tax policy that goes as follows:

Three decades ago, supply-side economists first argued that high marginal tax rates would discourage work, saving, and investment, and that well-crafted reductions in those tax rates could help boost long-run economic growth. Those observations have since become part of the fabric of mainstream economics. Meanwhile supply-side economics transformed into a doctrine that endorsed any tax cut at any time and that peddled the idea that tax cuts would inevitably pay for themselves.

Both of those notions are nonsense. Tax cuts rarely, if ever, pay for themselves, and they can do more damage than good.

As policymakers begin to confront our budget challenges and the conversation shifts from tax cuts to tax increases, it is essential that they understand the now-mainstream insight that taxes are not created equal. Taxes on income, for example, are usually worse for the economy than taxes on consumption. That’s why there’s a rising chorus of economists recommending the introduction of a value-added tax, rather than higher income taxes, if our nation decides it wants to support substantially higher government spending. High tax rates similarly tend to be worse for the economy than low rates. That’s why economists usually favor broad tax bases and low rates, rather than narrow tax bases and high rates. Finally, it’s preferable to levy taxes on bads rather than goods. Where appropriate, taxes on pollution (e.g., emissions of greenhouse gases) should thus be preferred over taxes on working, saving, or investing.

Little did I know that I have a subconscious ESP link with Bruce Bartlett over at Capital Gains and Games. In a long post setting out some of the themes in his new book, Bruce writes:

Everything that was true about [supply-side economics has] been fully incorporated into mainstream economic thinking and all that was left was a caricature.

All economists now accept the importance of marginal tax rates to economic decisionmaking, and organizations like the National Bureau of Economic Research publish vast numbers of papers on this topic.

During the George W. Bush years, however, I think [supply-side economics] became distorted into something that is, frankly, nuts–the ideas that there is no economic problem that cannot be cured with more and bigger tax cuts, that all tax cuts are equally beneficial, and that all tax cuts raise revenue.

12 thoughts on “Taxes Are Not Created Equal”

  1. Any guess as to when the finished article will be available? And, will it be on either NBER or else someplace ungated? (The nice thing about alumni email addresses is NBER papers are still available.)

    1. Hi Justin — Not sure when I will be done. This is really an essay, not a paper, so not in the NBER vein. But thanks for your interest. I will post here (or, at least, a link) as soon as I can.

  2. “Finally, it’s preferable to levy taxes on bads rather than goods.”

    That’s why I’ve never understood the long-standing and passionate conservative objection to a high death tax.

    If we increase the tax on death, that will drive down the death rate, which surely is a worthy public policy goal.

    1. Re: If we increase the tax on death, that will drive down the death rate, which surely is a worthy public policy goal.

      Not in all cases 😉
      In fact, some people seem to be walking arguments for retroactive abortion.

      (just goofin’ around; hope no one is offended by the dark humor)

      1. No, offense, Brooks.

        Although, to be honest, I had rather hoped my comment might provoke some observation on how, for example, cartoonish right-wing folk theories regarding the effects of taxation on incentives fall apart under even modest probing[*].

        Or, perhaps, reflection on how highly-concentrated cheap-money hand-me-downs are toxic to a mass-media-oriented representative polity, our structural fiscal deficit being but one salient example.

        Or, best of all, maybe a discussion of the interrelationship of these two points.

        But circumstances being what they are, I suppose a retroactive abortion joke will have to do.

        ([*] I must say, though, that “those notions are nonsense” is a pretty good place to start.)

      2. Not what you guys have in mind, but just to illustrate Bruce’s point about the mainstreaming of research on tax incentives (and perhaps making use of Justin’s NBER access), let me offer:

        Dying to Save Taxes: Evidence from Estate Tax Returns on the Death Elasticity
        Wojciech Kopczuk, Joel Slemrod
        NBER Working Paper No. 8158*
        Issued in March 2001

        This paper examines data from U.S. federal tax returns to shed light on whether the timing of death is responsive to its tax consequences. We investigate the temporal pattern of deaths around the time of changes in the estate tax system periods when living longer, or dying sooner, could significantly affect estate tax liability. We find some evidence that there is a small death elasticity, although we cannot rule out that what we have uncovered is ex post doctoring of the reported date of death. However, the fact that we find that postponement, rather than acceleration, of death is more likely to occur suggests that this phenomenon is at last partly a real (albeit timing) response to taxation.

  3. Donald,

    FYI, in 2007 I compiled a list of (mostly) conservative economists explicitly rejecting that myth that “tax cuts always/generally (or the W Bush tax cuts in particular) increase revenues”. I compiled it to show dittoheads who were sure the myth was truth, and I excluded liberal economists since the dittoheads would simply dismiss their views completely and reflexively.

    Of course, most simply responded that they didn’t need to listen to economists because they could see for themselves that revenues increased after the Bush (and Reagan and Kennedy) tax cuts. I Explained to them that, even leaving aside Reagan’s tax increases that followed his tax cut, revenues generally rise over the years regardless of tax rates (due to inflation and even in real terms due to the norm of expansion regardless of tax cuts, increases, or neither) and that they can’t even establish legitimate correlation if they cherry pick their data points — ignoring what happens to revenues after a tax increase or no change — and I got through to a few, but most (most were hard-core dittoheads on basically just covered their ears and screamed defiantly “Yeah, right — I should believe you rather than my own lyin’ eyes! Revenues went up after tax cuts. Case closed.” Pretty tough shells on those coconuts. Hard to penetrate.

    But probably a greater obstacle to a responsible fiscal course-correction is the absolute “Don’t feed the beast” argument (1) that if they reject any tax increases long enough, our long-term fiscal imbalance will be solved entirely on the spending side (or darn close to it), and (2) that every dollar of incremental revenue from any tax increases will only lead to an incremental dollar (or more) of spending, leaving us only with higher spending rather than lower deficits, ceteris paribus. See my comment on that Bartlett thread Both assumptions are apparently invalid, and if so, it is critical that experts with credibility on the right debunk them.

  4. Thanks, Donald, now that’s the spirit!

    No doubt the “small death elasticity” observed would, upon closer examination be due to a rather larger elasticity in so-called “heroic measures” to prolong the lives of the elderly and infirm.

    Unfortunately, from a public health perspective, it appears that increasing the death tax does little if anything to disincentivize death.

    However, from a fiscal policy point of view, this opens up new research horizons; who knows what other tax increases we may find which incur little to no economic disincentives?

    Where do I submit a grant application to study the tax elasticity of trophy wives?

  5. On a more serious note, when you write, “taxes on income, for example, are usually worse for the economy than taxes on consumption,” in what ways does that differ (if at all) from saying, “taxes which concentrate wealth, for example, are usually better for the economy than taxes which diffuse wealth”?

    And is there not some point at which further disincentivization of consumption becomes worse for the economy, not better? It seems your formulation here is is vulnerable to the same type of open-ended interpretation that seen in the Laffer curve degenerating into “tax cuts increase revenue”.

  6. From the earliest days of supply-side economics, there have been those who have taken its fairly commonsense prescriptions relating to lower tax rates to ridiculous lengths. The most obvious examples were the ideas that supply-side economics suggested that any tax cut was good, or that nearly all tax cuts paid for themselves through the higher growth they generated.

    Norman Ture, my mentor, who was advancing the principles that became supply-side economics when the great Jack Kemp was still throwing footballs for Buffalo, would never agree to either of those extreme positions, and neither do I.

    There may be a few instances in which tax cuts “pay for themselves”. Capital gains cuts and the repeal of the death tax may, repeat may, be examples. But supply-side economics does not argue that this will hold in general, even for reductions in marginal income tax rates.

    Just because a few of the irrationally exuberant who happen to call themselves supply-siders take these positions does not indict the vast majority of supply-siders who continue in Norman’s tradition,whether they know it or not. Don, and even Bruce, should know that.

  7. What about the flip side of the Laffer curve? Isn’t it possible that increases in marginal tax rates can lower overall tax revenues? Seems much more likely than tax cuts paying for themselves.

    1. Hi Otto — It depends on where we are on the Laffer curve. There may be some instances in which raising tax rates would lower revenue. But my sense is that for most of the major tax rates one would consider, we are still on the left side of the Laffer curve (i.e., the region with rate increases raise revenue, and rate reductions reduce revenue). But there are people who disagree — for example, some folks believe the revenue-maximizing capital gains tax rate would be lower than the 15% rate we have today.

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