This “Iron Law of Federal Revenue” Will Change the Political Debate Forever
Resending because I forgot to link the paper in the first version
A brilliant new paper from economist Samuel Karnick of the Heartland Institute should be force-read to every congressman, and written on the foreheads of all budget bureaucrats everywhere at OMB, the Congressional Budget Office or wherever everywhere they pop up above ground.
Mr. Karnick demonstrates what he calls the “Iron Law of Federal Revenue.” It will break many Congressional hearts, but give heart to taxpayers everywhere.
What he shows, Mr. Congressman, is that if you have some great new way of spending taxpayers’ money, don’t even bother to propose new taxes to pay for it. The money just ain’t coming.
If you want to to fund a new program you need to either:
cut another program, or
pile some extra billions (trillions?) on to our $36 trillion (and counting) national debt the interest on which now exceeds the U.S. defense budget.
(Hint: don’t choose door number two.)
The Iron Law is simple and devastating to spendthrifts: No matter how much the federal government tries to take in taxes, no matter how high it boosts tax rates or how many novel taxes it imposes, the government can never get rake off more than roughly 17% of gross national product.
No matter how hard you squeeze, there is only so much juice in the orange. If you want more, you’re gonna need a bigger orange.
From the report’s executive summary. (All the emphasis is mine.)
Federal tax revenue has historically hovered within 1 or 2 percentage points of 17.4 percent of GDP since World War II, no matter what the tax rates have been and what is taxed.... nothing the government has tried over the past eight decades has ever been able to change that.
It is possible to increase tax revenues over the long term only by increasing the tax base. The only way to expand the nation’s tax base is through economic growth.
Below is the crucial graph, from the St. Louis Federal Reserve. Income tax rates varied wildly over these 80+ years, but receipts never get much past that magic line of 17.4% of GDP. And when the do, they soon head back down. “You can get 18.5 percent for a few months, but revenue will gravitate back toward 17.4 percent of GDP very soon—and probably drop below that number for a while.”
A great example, Karnick points out, comes from the Kennedy tax cut of 1964.
Before the tax cut, official tax rates were very high. The top personal rate was 91%. The top corporate rate was 52%. Long-term capital gains were taxed at 25%. The top estate tax rate was 77%.
Big, big numbers…
…that produced one very small number. The government’s cut was only 16% of GDP, even less than the long term average of 17.4%
This graph, also from the St. Louis Fed, tells what happened when the Kennedy tax cuts kicked in.
In just the four years after the tax cuts, federal income tax receipts rose from circa $85 billion to just over $140 billion, a roughly 65% increase for a compound annual growth rate of more than 13%. Compare that to the previous decade with those high rates, but low take: From 1954 to 1964 revenues rose only from $56 billion to $85 billion at a miserly compound annual rate of circa 4.3%.
The implications and potential political power of this report are enormous.
Do you remember “Point E”? That was the theoretical peak of the Laffer Curve, the income tax rate at which revenue should be maximized. At a slightly lower rate, economic activity was not depressed quite enough to actually reduce revenues. At any higher rate, the negative effect on economic activity and the increase in tax avoidance would cut into revenues. Raising rates would put revenues in reverse.
The political difficulty was that no one could demonstrate authoritatively where Point E was. Dr. Laffer did a massive survey of global tax rate changes vs. revenue. He did come up with a tentative answer: somewhere near 25%. But the difficulties inherent in comparing tax rates and regimes internationally, including national, provincial, and even municipal rates defied precision. The numbers always remained arguable, and thus politically weak.
Mr. Karnick’s Iron Law solves that problem. Year after year, outcomes hover so close to that 17.4% mark that any claim to be able to raise more revenue can justly be called deceptive. On the budget side, same deal. If Congress budgets spending to exceed that roughly 17.4 percent number, it will add to the deficit and the debt by a predictable amount.
Not being able to nail Point E was a rhetorical handicap. The Iron Law gives us a verifiable number we can cite fearlessly. And we should: over and over. Shout it from the rooftops, turn it into a cliché, repeat it so often we get sick of hearing ourselves say it—and the socialists get even more sick of hearing it.
Mr. Karnick has given us a great weapon. Lock and load.