Monday, October 24, 2011

See, this one is worth listening to...


In a previous post, I waxed poetic on the concept of incentives, as it relates to the economy and economic theory. I concluded with the following recommendation:
If a politician--or an economist--isn't talking about incentives, when it comes to the consequences of a given policy--they're not worth listening to.
Today, Martin Feldstein--former chair of Reagan's Council of Economic Advisors--offered an op-ed in the WSJ on the subject of tax reform. From the beginning of the piece (my boldface):
The Tax Reform Act of 1986, enacted 25 years ago last Friday, showed how a tax reform that includes lower rates can change incentives in a way that grows the tax base and produces extra revenue.
There you have it, boys and girls. You may freely listen to Mr. Feldstein because he's speaking the right language, the language of incentives. And Mr. Feldstein's research on tax returns demonstrates--with empirical evidence--exactly what I was arguing in my previous piece: changing income tax rates doesn't lower or increase revenues, it creates different incentives for the individual. Not surprisingly--since it's exactly what I said--the evidence shows that incentives to under-report taxable income are greater when the income tax rater is higher:
Lower marginal tax rates also caused individuals to shift some of their compensation from untaxed fringe benefits and other perquisites to taxable earnings. Taxpayers also reduced spending on tax-deductible forms of consumption.
See, when people do their tax returns--when they sit down to figure out how much money they owe the government--they look for ways to lower their tax bill. Some people even *gassteinp* cheat to lower their tax bill. Many people will tell you that cheating on one's taxes is what rich people do, but that's just not true. Far more middle class people cheat on their taxes than rich people, because there are far more middle class people. But regardless, the cheating doesn't matter because--again--just about everyone looks to lower their tax bill. That's human nature,

And one of the best ways to lower that bill is lower one's reportable income. Ask any tax accountant that you know if you doubt me. Thus, the larger the potential tax bill, the lower the reportable income will be for the individual (within the range of real, true income and what is eventually reported as income). At the same time, if the exceptions for lowering reportable income are taken out of the tax code, reportable income can't help but go up.

Those two things are exactly the focus of Feldstein's article, exactly the focus of the Reagan administration, with regard to income taxes, and exactly what should be the focus, now. Simply the tax code, lower rates, and Federal revenues will go up, economic activity will increase, and Federal revenues will go up even more.  Oh, and as an unintended consequence, employment will also increase.

This remains a very difficult concept for many to grasp, particularly those in Washington, D.C. that are charged with making the tax laws. Well okay, it's not that it's too difficult for them, so much as it is not conducive to a mindset focused on class warfare as a means of garnering and maintaining political power.

But the time for such games is coming quickly to a head, and then an end.

Cheers, all.

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