Reaganomics and Prudent Taxation

Many Americans today believe that tax revenues can be increased by decreasing tax rates; and that this works through stimulating GDP (Gross Domestic Product) through competitive private enterprise, which increases taxable income, which increases tax revenues.  With several governments threatening debt default (including the United States of America); let's reflect on the legacy of Ronald Reagan and his economic policies, and see whether we can learn any lessons from the past that might help us now.

Ronald Reagan once said,

When a Republican dies and goes to heaven it looks a lot like Nassau County

Let's take a look at what's happening in Nassau County these days (link above).  The county was recently heading toward bankruptcy, financially unbalanced by tax cuts enacted by a senior Tea Party executive.  Perhaps this is a local aberration—perhaps it's unfair for us to reinterpret Reagan's words in the hindsight of current events, when he was commenting on the state-of-affairs that existed in Nassau County during his time.  Perhaps it was the Democrat, Thomas Suozzi, who drove Nassau County over the edge before giving Ed Mangano a bad hand.  If so, you wouldn't know from looking at the figures:

“Just days before Suozzi's inauguration as Nassau County Executive in 2002, the Maxwell School of Public Affairs rated Nassau the “worst run county in the nation.”  Within his first year in office, Suozzi turned a $428 million deficit into a balanced budget, leading one of the most dramatic financial turnarounds in the country.”—Wikipedia


We've just examined one arguably atypical county, in isolation.  Let's look at some hard macroeconomic figures from the tenure of the last 13 presidents of the United States:

Historical Federal Receipt and Outlay Summary—TaxPolicyCenter.org

TaxPolicyCenter.org has conveniently supplied figures in constant FY2005 USD (normalised for inflation).  Even so, it's still hard to visualise a table of raw data like this, or to understand the connections between demographics, policy and economic results.  First, we'll deal with the old humbug that decreasing tax rates normally spurs GDP growth:

Scatter plots of average U.S. taxation levels against average U.S. GDP growth, grouped by U.S. President.

There is a noticable positive correlation between U.S. federal taxation rates and U.S. GDP growth rates, for the periods in question.  If we include figures from 1940–2010 inclusive, the few stray data points outside the main correlation series are cases where the United States was fighting large-scale wars funded by borrowing.  In other words, the central premise of so-called “Reaganomics” is a fallacy: decreasing overall taxation rates from 18% decreases GDP growth rates and substantially decreases tax revenues from what they would otherwise have been (showing otherwise requires egregious cherry-picking of short-term data).

Based on the figures from TaxPolicyCenter.org that are normalised for inflation, here is a table of figures illustrating the fiscal discipline and economic results achieved by each U.S. president since 1940:

President
—Party
Attributed
fiscal y.
Annualised
surplus/deficit
Annualised
GDP growth
Av.
Unempl.
FR—D 1940–44 -17% 13% -?-
HT—D 1945–52 -2.5% 5.4% ≈4%
DE—R 1953–60 -0.5% 0.7% 4.9%
JK—D 1961–62 -1.0% 3.0% 6.1%
LJ—D 1963–68 -1.1% 4.6% 4.4%
RN—R 1969–74 -0.9% 1.8% 5.1%
GF—R 1975–76 -3.8% 0.8% 8.1%
JC—D 1977–80 -2.4% 3.1% 6.5%
RR—R 1981–88 -4.2% 2.7% 7.5%
GB—R 1989–92 -3.8% 1.8% 6.3%
BC—D 1993–00 -0.6% 3.7% 5.2%
GB—R 2001–08 -2.0% 1.9% 5.3%
BO—D 2009– -9.2% -0.2% ≈9.1%

Excepting times of emergency caused by foreign aggression, from 1940–2008, every Democratic president achieved >2% annualised GDP growth and increased the debt by less than GDP has grown; whereas every Republican president during the same period failed by this measure.

While every U.S. president since 1940 has operated on deficit spending, a rapidly increasing GDP can compensate for the rising debt burden by increasing the United States' power to repay debts previously undertaken.  The key factor in deciding policy is whether GDP growth compensates for the deficit (net borrowing); and whether it is likely to continue compensating for budget deficits in the future.  Now let's look at the cumulative figures—i.e., the current U.S. national debt:

Graph from Wikipedia showing U.S. federal debt as a proportion of GDP by president

In terms of budget deficit and GDP growth differential, President Ronald Reagan achieved poor results despite a demographic boost from post-WWII baby-boom children joining the workforce during his tenure in office and a massive reduction in oil prices.

In the 1988 vice-presidential debate, Senator Lloyd Bensen (D-Tex) quipped:

If you let me write $200 billion worth of hot checks every year, I could give you an illusion of prosperity, too.

Why would President Reagan promote a theory he must have known was unsustainable given the massive amounts of borrowing he was undertaking to fund his policies?  And why do Reagan's followers promote distorted versions of this ideology, as though harking back to a golden age?

Colour-coded graph of various U.S. economic indicators 1950–2011

—President Ronald Reagan inherited a poor but improving economic situation from President Jimmy Carter, which Reagan's policies subsequently made worse in some important ways (especially for the poor).  Only after Reagan started reversing his tax cuts did the American economy begin to improve.  Compare this with Bill Clinton's excellent economic performance (a continuous period of broad-based economic growth interrupted only by a Republican-induced government shut-down), and then further with the terrible results of George W. Bush's retrogressive policies beginning in 2001, which have not yet been rectified by President Obama.

Perhaps Reagan's grand economic vision was just a political cover for his anti-competitive political, macroeconomic and military-industrial end-game policies against the Soviet Union—perhaps for him it was all part of a grand gambit.  Perhaps Reagan's strong dollar policy (which helped restore the dollar's credibility and restore international demand for the U.S. dollar as a reserve currency), along with the United States's increasing dependency on foreign credit, were a diplomatic manoeuvre giving foreign countries an interest in America's success as a further foil against Soviet expansionism, in preparation for more direct diplomatic overtures.  Perhaps Reagan's increased military-industrial spending was designed to exploit Soviet paranoia so as to bankrupt the Soviet state.  If so, the gambit worked and it's now time to implement a sustainable strategy—we can credit President Reagan with helping to end the cold war early, but not with being some sort of economics prodigy.  It has been said of Communism that the theory is great as long as you don't have to deal with real people in the real world (where the system is prone to corruption through centralisation of power, and where nobody maintains anything because nobody owns it).  Reagan's own tax ideology, taken to irrational extremes or repeated without re-evaluation, is no more sustainable than pure Communism.  No matter how we look at Reagan's tax policy, it was no economic panaceaReducing tax can impede GDP growth, especially in an industrialised nation with a sensible body of law and an overall taxation rate around 18%.

How can reducing tax rates impede GDP growth?

If the tax ideology of the Mad Hatter's Tea-Party was correct, GDP growth rates, opportunities for ordinary people and perhaps even long-term tax revenues would all be monotonically decreasing functions of tax rates, so that a tax rate of zero percent (or very little above zero) would most rapidly increase GDP ad infinitum so as to optimise the economy.  This idea is obviously untrue.

Theoretical graph of overall tax rates against mean/median average economic fortunes of citizens, with a curve showing an optimal tax rate for economic growth.

It would be truer to suggest that for any given social culture and economic/competitive & political/policy environment (i.e., for any given nation at a particular point in time), there is an optimal rate of taxation— so that any rate significantly above this optimum will reduce tax revenues by reducing production incentives and impeding the innovation of the competitive private sector, whereas reducing tax below the optimal rate will reduce both GDP growth and tax revenues by reducing the proportion of private enterprise that is taxed, thereby:

  1. Frightening investors with high structural deficits and ultimately, defaulting on debts unless the situation is promptly rectified.
  2. Making less resources available for helping innocent victims of the free market's foibles (who might otherwise attain financial independence as productive members of society) or stabilising the irrational herd instincts of free-market participants (necessary, for example, since throwing money at rich people in the middle of a crisis does not force them to trade it with the rest of us or take on new employees), or for levelling the economic playing-field so that everyone believes that hard work is worthwhile for them.
  3. Limiting the effectiveness of necessary regulation.  Ineffective regulation promotes harmful temporary “growth” in unsustainable industries that damage long-term growth by undercutting and displacing genuine market participants.  Unsustainable tax cuts encourage the development of speculative business ventures with little real merit to the world at large.  Lax regulation has been a major factor in every recent American financial crisis, including the latest and greatest financial disaster in living memory:

    Consider also the following, written of the Deepwater Horizon oil spill disaster:

    Photograph of Deepwater Horizon oil rig fire in Gulf of Mexico—courtesy of United States Coast Guard

    “What we found was very limited oversight of these various activities and decisions, that the agency responsible in the Department of the Interior was understaffed, [and] didn't have the inspectors and technical analysts who were up to the task fully.”
    Don Boesch, member of investigating commission

No matter how far we progress toward the libertarian ideal of universal private ownership and proactive stewardship, incidents like Deepwater Horizon and the 2008 financial crisis will continue showing us why we need a strong, accountable and well-functioning public authority to oversee those resources owned either by nobody or by everybody, and to justly enforce laws that have been enacted to protect persons, properties and environment.  Deregulation as a specific objective does not work, although simplification of the legal and tax code would help everyone.

Conclusion

Suggesting that America today needs tax-reduction, deregulation and deficit-spending “stimulus” is like prescribing an emergency weight-loss diet to cure an anorexic.  America needs a stronger U.S. federal government, with higher overall taxation rates, simpler laws, stronger regulation and better support through beneficial programmes for its poor, steady, hard-working parents, citizens, students and entrepreneurs.  Every American will benefit from a more equitable and meritocratic distribution of wealth.



President Reagan's key policy objectives

  1. Reduce Growth of Government spending—reducing government spending is only useful if the private sector will use the money for something better than the government would have done.  This is more likely if the wealth is distributed more evenly, so that the extra disposable income may be invested in meeting real needs that employ other local people.
  2. Reduce Income Tax and Capital Gains Taxcontrary to what has often been asserted, reducing taxation does not always stimulate GDP growth and there is some real-world evidence it may do the contrary.  Reagan's capital gains tax reforms might have helped to make the property investment bubble possible.
  3. Reduce Government regulation—this is only a good idea if done for specific and beneficial purposes, with a clear understanding of why that regulation was introduced in the first place.  Making the repeal of legislation a central objective is not necessarily a good idea.
  4. Control the money supply to reduce inflation—which was a real problem in his time.  In this objective, Reagan was successful and his policies helped.  Reagan's introduction of inflation-indexed individual income tax parameters was also an excellent and rational amendment to the U.S. tax régime, further helping to reduce the unjust confiscatory effects of inflation.

Limitations of this article

It only makes sense to propose increasing taxation as a solution in the context of costed proposals for how to spend the additional tax revenue, since wasteful spending does not stimulate real growth or empower a country to repay its debts.
The general distribution (including income-distribution) and enforcement of tax revenue is also an important field of policy in its own right, best used for making exploitative & harmful activities less economically attractive; and fine-tuning the degree to which various activities are taxable can substantially influence long-term economic outcomes.
Such detailed effects are largely ignored in this article.


Methodology & data

Here is my processed copy of the data from TaxPolicyCenter.org incorporating historical data from the U.S. Bureau of Labour Statistics, containing formulae that demonstrate my method:

Microsoft Excel® file with source data and charts


Laffer Curve

Link from the “Reaganomics” article on Wikipedia:

Laffer Curve—Wikipedia

The Laffer Curve is slightly different from what my article discusses.  The Laffer Curve is about tax-revenue optimisation (in isolation of other factors).  My article is about overall competitive optimisation for one particular country over the long term which takes into account the effects of taxation on GDP growth, hence, my scatter plot (which appears to be the bottom left corner of a similar curve) is of overall taxation rates against GDP growth rates.  (I suppose that the distributions to which this article alludes might be more peculiarly characterised by a specific market/culture/policy-environment to which they are applied, than the Laffer Curve may be—but further work will need to be done in this area, to know for sure.)


Reader challenge

It would be interesting to look at the distribution of normalised & 6-year-averaged overall taxation rates against GDP growth rates, for a range of large countries around the world—excluding tax-haven microstates, and grouping nations by colour according to the level of mechanisation in their industries.  It may be possible to obtain the necessary data from the IMF.  Can anyone put together a report on this?


Disclosure

One immediate family member of Professor Roger Porter, who is listed by a cited Wikipedia article as one of the chief architects of modern Republican economic, is among the author's old personal friends through common membership in The Church of Jesus Christ of Latter-Day Saints.
I offered Professor Porter the right of reply, and hope to be enlightened by his views on the subject.

16 thoughts on “Reaganomics and Prudent Taxation

  1. Milton Friedman worked in the Reagan administration. Before that, he championed unregulated free market capitalism in Chile and whereever else he could. I am inclined to believe Naomi Klein’s [The Shock Doctrine] depiction of the failure Friedman’s economic policies in Chile. Seems like politicians are trying to implement the same policies here now.

  2. This is the kind of vision and analysis that SHOULD be happening in the USA:

    Instead, the United States has this:

    —almost total exposure of the people at the bottom of the economic food-chain, to the wild and whimsical fluctuations of the “Free Market”; and a suggestible electorate that doesn't know what's good for them and who can be scared by the rich into voting against their own best interests on the spurious grounds that sharing the wealth is socialism, and as we all know, socialism led to the demise of the Soviet Union (the old arch-enemy of the American people).

    Fear cannot produce good policy.  Instead, real vision is required:

    Where there is no vision, the people perish…
    —Proverbs 29:18

  3. No comment about economic advice of the scriptures, but in old New Zealand there was a saying: God provides worms for the birds, but He doesn’t drop them in their nest”.
    Entitlements without reciprocal effort end in tears.
    Taxes are a waste to a wastrel warmongering government.

  4. @Baboo666: Agreed. Your point explains in terms of incentivisation, why policy must not shift too far toward the “socialist” side of my theoretical graph, and why tax revenue from hard-working people must not be used to bribe undeserving electors or to fight unjust and ultimately “unprofitable” wars.  Tax revenue must be spent instead retraining injured or displaced birds for hunting in new ways.  We must not allow a few big, thoughtless birds to make a killing on property development, without effectively compensating the birds whose nests and work-places are uprooted in the process.

  5. Matthew,

    My most obvious criticism of what you present here is that the nature of our tax code means that growth in GDP results in higher taxes, not vice versa. As the economy surges more people hit higher tax brackets which increases the amount the government collects relative to GDP. From 2007 to 2009 the tax code essentially stayed the same though the tax revenue to GDP % fell something like 3 points. Over that time period the number of people filing with taxable income over $1,000,000 decreased by 40%. As a result the taxes collected from that group fell by $700 billion.

    You mentioned that we should close corporate tax loopholes. I agree with that as long as we dramatically lower the corporate tax rate. Our current rates are the highest in the world. Lower the rate and make everyone pay it. Stop giving companies breaks that have enough money to influence politicians.

    There are certainly other things to criticize as well when you venture off into other things.. The US government had collected billions in taxes in order to prepare the nation for future oil spills following Exxon Valdez. What did those billions get us? It is like a town paying more taxes for a fire department to be built only when there was a fire they didn’t have a truck. In such an event the answer wouldn’t be to give those same people more money. You might spend more money, but heads would roll from those that ripped you off already. You talk about vague financial reform, but the problem with our current crisis was the government’s involvement not their lack of involvement. In a basic sense you have to understand why a bank would write a loan that wouldn’t be repaid. They without government intervention. Then you get to bail outs the government is essentially subsidizing risk. That happens almost anytime you have a “public/private partnership”. Such things are notoriously corrupt. If they were legitimate you wouldn’t need tax payer money. Private parties would be willing to finance it with their own money.

  6. Austin,

    Thank you for your thoughtful remarks.  I believe the key question you are raising is,

    “Can higher taxation help increase growth [in certain circumstances], or does low growth cause reduced tax revenue [in a progressive system of taxation]?”

    — The truth is somewhat more complex than my article presently suggests.  Both propositions are valid partial explanations for the correlation observed in my scatter diagram, and both effects work in tandem to generate the results observed.  I've been contemplating the ideal way to present this dichotomy, and have been planning to edit some revisions into the article to make this point clearer.

    Before we consider the problem of drifting tax brackets further, please note that my scatter-plot does not cover the period since the 2008–2011 recession started.  If the scatter plot did cover the recent recession period, you would observe that its trend might extend well beyond the limits displayed (see my Excel spreadsheet file for more details).  Besides my article partially normalising for this effect over the long term (and besides the U.S. government largely doing the same thing by regularly realigning tax brackets, especially in modern times), I don't believe that the U.S. system of taxation is actually progressive enough to fully explain the observed correlation.  Add to this, the fact that income tax constitutes a comparatively small proportion of overall U.S. taxation.  Nonetheless, let's consider your example as though it was typical: the point is still worth considering.

    The continual drifting* of nominal individual income-tax parameters relative to real earnings might be considered (in the language and world-view of my article) to be an automatic “tax-cut” in bad times, or an automatic “tax-hike” in good times; at least in terms of the proportion of overall GDP taken by the government in tax revenue.  In some ways, it is this proportion, rather than the real-terms value of tax revenues raised, that really matters.  Indeed, adherents of Reaganomics implicitly cite the reduction of this proportion (taxation as a percentage of GDP) as a key policy objective, as a means of reducing the relative size of government, which they assert will make a country more economically efficient.

    In my original study and writing for this article, I anticipated the points you raise; and did everything possible to filter out short-term effects such as this drifting* of tax brackets.  For example:

    • Averaging or annualising statistics over presidential terms (typically four to eight years, during which time a coherent ideology is typically being promoted), so that short-term effects such as the “dot-com crash” or the contemporarily growing real-estate bubble, might not unduly tarnish any president's reputation;
    • Using inflation-normalised figures in constant FY2005 USD (you might benefit from examining my raw data, to get a better feel for my methods).

    Reagan wisely enacted tax code reforms so that tax brackets would shift automatically (to some degree) according to inflation or other relevant macroeconomic measurements, without congressional approval being required on each occasion.

    http://en.wikipedia.org/wiki/Economic_Recovery_Tax_Act_of_1981

    Over the timescales of a typical presidency, the long-term continuation or correction of the drifting* effects we are discussing might be considered an outcome of ideological decisions made by the prevailing regime, and an outcome of their macroeconomic policies (for which we may hold them responsible).  Indeed, the calibration of these parameters is a primary method of governmental control over the economy.  So in the context of my article, I believe it is quite correct to regard this drifting* as a form of tax-cut or tax-hike.

    In relation to my central point, if the doctrine of Reaganomics was correct (so that tax reductions are the primary means by which we might boost GDP, and so that this effect would be more powerful than all countervailing effects, in good times and bad times alike); then we should expect to see absolutely the opposite correlation to the one shown in the scatter plot, and furthermore, the opposite correlation to the other scatter plots present in my Excel spreadsheet containing raw data (linked from the main article) which show time-delayed correlations between taxation and GDP growth.  SO while there may be much truth in the principles of Reagaonomics, there are also countervailing principles which are more correct, more powerful and more applicable in modern American circumstances.

    In addition to the broad assessments we might make by considering uncorrected bracket-drift* to be a tax-hike/ tax-cut; we may alternatively draw similar conclusions based on careful analysis of the real-world effects of legislation.  There are various articles I've looked at that aren't cited in my article, such as:

    http://en.wikipedia.org/wiki/Tax_Equity_and_Fiscal_Responsibility_Act_of_1982

    — This article contains a table of data showing the real effects of historical Reagan-era tax policy on overall tax revenue in the years after each tax-relevant law was enacted (effects which businesses might have anticipated and planned for).  Ideally, I should be looking at more of this kind of data, but it's generally hard to come by — it takes a lot of effort for economists to produce numbers like these — so instead, I've done a more general study looking at a broad set of data that are normalised as far as possible. Naturally then, it's hard to draw accurate detailed conclusions from this study because fine details are NOT in sharp focus: one can only draw broad conclusions out of the emerging picture.  The more analytical methodologies that this article alludes to (that describe mechanisms and causal relationships rather than mere correlations in data-sets) deserve closer attention than I have given them so far; but crucially, none of the data or studies or statements from credible economists that I have found contradicts my thesis in any significant way.

    If we examine the record of what the politicians SAID they were doing (or, trying to do); we come up with a surprisingly clear picture:

    1. Reagan cut taxes massively for the wealthy (and not by much, for everyone else) and the economy noticably tanked (despite already being in recession).
    2. Reagan quietly started abandoning his famous policies by partially reversing his tax-cuts relative to GDP, and the U.S. economy noticably improved just in time for the 1984 elections.
    3. Bush I (George H. W. Bush) won the 1988 presidential election after famously promising to continue Reagan's original “tax-reduction” small government ideology by opposing any new taxes during his term in office.  Bush was subsequently forced by growing budget deficits arising from the continued failure of Reagan's economic policies into acquiescing with congressional Democrats' demands for increases in taxation rates and spending.  The U.S. economy subsequently began improving.
    4. Clinton balanced the books, increasing overall levels of taxation and partially reversing Reagan's errors.  The economy surged for an extended period of time.
    5. Bush II took a surging U.S. economy and applied big tax-cuts for the wealthy; furthermore starting two unfunded wars (in contrast to previous presidents who had funded wars with tax increases).  The U.S. economy noticably tanked, with unemployment rising significantly even before 9/11 or either of Bush II's wars.
    6. We must be careful not to misjudge Obama in 2011 because we simply don't have enough data yet.  On a similar measure, Reagan would have been rejected in 1983; but here goes:  Obama came into office promising change and social justice, but due to Republican intransigence (perhaps from them having drunk their ideological kool-aid too deeply), Obama has been unable to make any real headway: the Republican congress (under Boehner, acting under political duress as a stooge of Tea Party extremists), has demanded the broad implementation of their own most extreme ideology and vision during the tenure of a Democratic president!  The Republicans won't even raise the debt limit to cover the costs of expensive programmes (like TARP) that they commissioned themselves during Bush II's final months!

    U.S. economic data, combined with historical records of what politicians say they were doing, and what economic evidence backs up; show that Republican/ Tea Party dogma is dangerously myopic nostalgia: Reagan's economic policies clearly failed by almost any pragmatic measure.  It is not unreasonable to conclude that reversing Reagan's errors might actually stimulate the U.S. economy, especially in the present circumstances.  Comparatively high taxation during the 1950's and 1960's did not stop those decades from being decades of very high growth compared to what the USA is currently experiencing (growth that was apparently unimpeded by very high taxation of capital gains at that time); there are no good reasons why the effects of tax policy might have fundamentally changed, and we might therefore expect that a modest and wisely distributed tax-increase will not substantially impede the U.S. economy in the future.

    I am not proposing a new economic panacea.  There are upper and lower limits to the tax levels that would boost GDP, and these limits vary according to circumstances.  I do not pretend to know what these limits are, except that they are surely above 18% overall federal taxation as a proportion of current U.S. GDP (present levels of overall taxation are at 15% of GDP: taxation rates have been substantially reduced in real terms since the recession, hot money is being pumped into the U.S. economy from new external debt, and yet we've not even seen a hint of GDP growth rising or recovering from it!)  In addition to the mechanisms I have proposed in this article, I can think of many other reasons why reduced taxation might powerfully reduce GDP growth in modern America, and why increased taxation (focused correctly as you suggest, on the activities that ought to be taxed more) might powerfully boost GDP growth.  Some of these reasons have been effectively articulated by other commenters on Reuters blogs, including this one by you:

    …Balancing the budget and paying off the debt won't be easy.  Though I think if we were doing that that people would be much more optimistic.  That kind of optimism would ultimately lead to growth…

    Excerpt from comment by AustinG on Reuters.com article

    Your comment relates to the relationship between surplus/deficit and GDP/ GDP-growth.  My article relates primarily to the relationship between tax revenues as a proportion of GDP, and GDP/ GDP-growth.  These two relationships are inseparably connected in the present crisis: in context of the fact that overall U.S. taxation levels are among the lowest in the industrialised world (giving plenty of head-room for increases in taxation without impeding competitiveness), little has been gained economically from Reagan's, Bush I's and Bush II's tax-cuts, and since the unemployed and sick particularly need the government's help in getting back into productive work at this time, the only wise course of action is for America to increase overall taxation (especially on those most able to pay), increase spending on infrastructure (especially where this improves labour mobility), and slash unnecessary spending on non-mission-critical programmes.  In short: America has been taking the wrong medicine, and more of the same will not help.

    To be sure that I am not avoiding your main points, I'll address a few final issues:

    To clarify the precise extent to which uncorrected individual tax-bracket drift* is responsible for falling tax revenues, we will need more data.  Your comment suggests that you have access to the kind of data I would need in order to understand this better.  Will you please share some links with me so that I can have a closer look at this?  Otherwise, I might attempt to answer the question from the opposite angle, accounting for the relative effects of recession on tax revenue by proportion, by first deducting the effects of known tax-cuts.  (I don't know when I'll get around to this, but I believe it could be done this way, as it has been done for Reagan's tax policies.)  Please note that the effect of tax-bracket drift is not the only effect this article fails to mention that might affect my main scatter plot.  Other important effects include corporate tax planning (bringing income and expenses forward and backward in their accounts, through various accounting devices; so as to optimise their tax expenditures.)  Corporations that think the tax regime will soon become more generous are thereby incentivised to postpone accounting for their income and bring forward accounting for their expenses; and vice-versa.  It would be nice to be able to completely filter out all of these effects before drawing our broad conclusions (rather than merely filtering the data so as to make the “noise” somewhat less prominent while emphasising the “signal” we are looking for), but I don't yet know how I might do that completely, other than what I've done:

    • Applying various normalisation and averaging techniques to filter out effects that are likely to be more powerful than the effect we are looking for, or effects of shorter or longer duration/frequency;
    • Examining 1st, 2nd and 3rd derivatives (increases, rates of increase, accelerations in increase) in the economic metrics to attempt to focus on the effects we are specifically looking for.  Similarly, using time-delayed (time-interval) correlations to achieve a similar effect.

    As you can surely see, I've worked pretty hard to make sure I'm not misleading my audience in any way.  I'm happy to discuss the limitations of my work, and any ways in which I can improve it.

    You suggested that U.S. Corporate tax rates are the highest in the world.  This is not really the case: you rightly mention for instance that U.S. corporation tax rates vary substantially e.g. between industries or business locations.  This variation might be corrected somewhat, and if such an equalisation were implemented there might be no contradiction between the need for overall tax increases (e.g. through removing tax breaks & loopholes) and the need for standard corporation tax rates (considered before tax-breaks and deductions) to fall.  In the context of U.S. federal expenditures at 25% of GDP, alongside U.S. federal tax revenues of 15% of GDP; I sincerely doubt however that the required effect can be achieved by a modest weeding exercise.  Washington is going to need some root-and-branch reform.

    My article ignores almost all of the details of taxation and spending.  I agree with all of your points on these issues, with one point of caution: just as there are both good and corrupt governments (and government officers); there are both good and corrupt businesses (and officers of business).  When it comes to assessing the details, we must evaluate fairly and pragmatically whether the competitive environment of private enterprise confers the correct incentives for achieving the desired outcome; and whether it is more or less likely to do so (all things considered) than the equivalent government programmes.  Your points about efficient procurement and spending are good ones, and you might be interested to learn of the success of John Prescott's policies during his tenure as U.K. transport minister, when he persuaded Gordon Brown to strictly ring-fence or “earmark” all revenue from environmental congestion charging for the exclusive use of public programmes within the transport sector that reduced congestion, improved the environment and improved labour mobility.

    I believe that despite its shortcomings, my article clearly demonstrates that modern America needs a bigger and more proactive, interventionist government, not a smaller and less involved one.  The rich need less support and the poor need more.

  7. I am a numbers guy so I am reluctant to admit this(and I will look at your numbers more when I have time, this is my initial reaction). The numbers don’t always tell the whole story. Our economy doesn’t have a science lab where we can isolate a couple of variables and see what happens when we just change those. GDP can itself be misleading in many ways. There is an estimated $100 billion in Medicare fraud that is spent every year. Take that fraudulent spending away and technically GDP would go down.

    In modern society we have many more tools available to us than generations past. Why then do we need a government that intervenes MORE in a relative sense than it did generations ago? Money taken from taxpayers by the government isn’t spent efficiently and it isn’t even really used to help the “poor”. You see this with urban housing all the time. The slumlord takes in millions for some housing project that never seems to materialize. Look at the people close to the President from Chicago. Many fit that description.

    There is corruption both in the spending of government and the taxing of people and business in getting money for government. All of which is inefficient in an economic sense. Why provide one person a tax credit for buying a specific type of water heater? I would argue that the specific tax rates should be lowered across the board and most of the credits and deductions eliminated. Politicians use those types of tools to curry the favor of political donors. What sense does it make that we subsidize ethanol more per unit of energy than any other source? Doing so provides no economic value or environmental value.

    The larger point that I am driving at is that in a theory it might seem like more centralized power and spending would help. In practice it does not though because you have imperfect human beings with THEIR own agendas, desires, etc… who would be making those decisions. Just like in theory the most efficient form of government would be a single authoritarian ruler. The problem is that if there was a person who could do that job effectively they wouldn’t have the ambition to ever get it. So how would you select them? Also consider this if the pro-centralized government crowd really believed in government shouldn’t they be making it as efficient as possible? You can’t find an example of them actually doing that.

  8. You're right about there being serious drawbacks to unregulated or ineffectively audited government spending.  In this situation, most officers of government soon see themselves as arbiters of an almost infinite pot of money that gets replenished each year or even automatically increased in response to overspend!

    “There is an estimated $100 billion in Medicare fraud that is spent every year.  Take that fraudulent spending away and technically GDP would go down.”

    Correct: GDP would technically go down.  But GDP-growth would increase if you removed the fraud.  In the case of outright fraud (where 100% of the money is wasted), convincingly removing that fraud would make GDP-growth and confidence increase so fast that you might not even notice the short-term loss in GDP.  (Now, if only there was an easy way to identify fraud in general!)

    The market needs regulation and everyone (no matter how rich) needs education, healthcare and emergency services for the free market to function efficiently, with maximum opportunities and minimum risks for any and all; rich and poor alike: it's no use being a millionaire if you catch Ebola, tuberculosis or pandemic 'flu, or if you're forced to retreat into a fortified mansion to avoid this fate (as European nobility did during the Black Plague) because the government didn't provide any health services for the poor.  Certain essential regulatory roles cannot be impartially fulfilled by a market participant: you can't privatise the police or the SEC, for example, without increasing existential or systemic risks for everyone.  If the government is going to have the personnel and financial fire-power to regulate the free market meaningfully; they'll need more than a tiny fraction of total GDP to do so.

    I'm a “numbers person” too, so here's a rough numerical illustration:

    Current situation: taxing 15% of GDP; spending 25% of GDP
    Hypothetical scenario: tax 18% of GDP; spend 25% of GDP.  Result:

    • Decrease free-market GDP by 3.5% (from 85% to 82%)
    • Increase tax revenue by 20% (from 15% to 18%)
    • Decrease government deficit by 30% (from 10% to 7%)

    Decreasing the federal deficit by 30% would certainly improve GDP & GDP-growth by more under present circumstances than a 3.5% marginal loss of free-market GDP would do so, e.g. by improving business confidence as you have suggested.  Confidence is the basis of all business transactions.  (Please note: these figures are for federal taxation only, and do not include state taxation.  It is an exercise for another article, perhaps an exercise for the reader; to gather data relating to the sum-total and examine long-term correlations relating to a more complete picture.  Nonetheless, I still believe that sufficient data have been gathered to state with some confidence that the size of the U.S. federal government is presently sub-optimal: increasing its relative size should improve U.S. economic fortunes.)

    …if the pro-centralized government crowd really believed in government shouldn’t they be making it as efficient as possible?

    Instead of reducing the size of government, you should get more auditors on the case of wasteful government spending, strengthen fiscal accountability structures, reform procurement to eliminate pork-barrel spending bills, earmark specific taxes for the support of specific government programmes, beef up the SEC, EPA and various other regulatory departments, and spend more on public infrastructure.  We have very few power cuts in the United Kingdom except those caused by natural disasters, and any power cuts we do have never last more than a few hours; usually only a few seconds once every few months: I know this because I run equipment that monitors the power supply almost 24/7, and my figures match those published by others.  Does that make you jealous?  Our electricity system was reliable when run as a public service and it's continued to be reliable since privatisation since the system is well regulated by well written laws and by an effective regulatory body (OFGEM).  If big government was the problem, the UK electricity system would be a disaster compared to its U.S. counterparts; but strangely, the exact opposite is true!

    Politicians use those types of tools to curry the favor of political donors. What sense does it make that we subsidize ethanol more per unit of energy than any other source?

    Perhaps some president needed extra votes from agricultural states in order to pass a bill on a pet project?  This sort of horse-trading and pork-barrel-spending goes on all the time in the USA; less so (though it still happens sometimes) in the United Kingdom.  Bio-ethanol makes some sense, since it helps support U.S. farming (a key strategic industry in the event of any disruption of world trade or production), providing a backstop to the loss of food/ fuel availability in the event of a long-term foreign supply crisis.  The problem is that this policy wastes taxpayer money distorting the free market to obtain questionable benefits, and this technology makes food much more expensive most of the time by making food convertible with fuel and thereby placing local food consumers in almost direct competition with distant energy consumers.  Observed results of bio-ethanol technology:  the environment still suffers as fossil fuel use continues unabated (instead of converting the existing economy to greener technology, economic activity is expanded), a real estate bubble starts in farm-land and more forests are cut down to support the investment frenzy, and food prices now fluctuate according to the whims of the oil market helping to price poor people out of the market for good quality food.  This is not the sort of technology that should be given taxpayer support, and there are many more projects like this that should just be abandoned.

    I would argue that the specific tax rates should be lowered across the board and most of the credits and deductions eliminated.

    I agree — I think the same thing every time I complete my tax-return in the United Kingdom, and I have learned from various reliable sources that the U.S. tax-code is much more complicated than ours.  Simplifying the system will significantly boost GDP-growth in the long term.  This reform is long overdue: see the 2nd comment in this thread, and follow the hyperlink to “IFS Mirrlees Review” for more information on how this is being done now in the United Kingdom.

    Perhaps you should move over to the United Kingdom?

  9. [...snip...]There is a reason that net population flow tends to be this way instead of that way.  The US isn't the UK though in terms of central governance.  The US has 5x the population and 40x the geographic area.  That makes central decisions more difficult for a number of reasons.  Think about the problems with the EU and that is just shared currency and monetary policy.  Try governing an area that big with the same laws, programs, etc… for everyone.  If the EU was the country and the UK the state the people would be better off with a limited role for the EU.  The reason is that the populations are large and there are geographical diferences as well.  What works as environmental policy in New York doesn't in Alaska.  Yet any federal laws would apply to both.[...snip...]

    [...snip...]Sometimes private isn't necessarily better.  Private isn't better by itself it is the free market that is makes it better.  More specifically it is the competition in that market that makes it better.  If we had state run phone companies the last 50 years we might still pick up the hardline phone and tell the operator who we want to call.  Competition is not just on price and service of current products, but on expanding into new ways to fit the demands of consumers.[...snip...]

  10. [...snip...]Why do you believe that only the government can provide people with healthcare and education?  It seems to be because they currently provide them for you.  Imagine if there was a government program providing people with shoes.  If it was to be eliminated then there would likely be many protests about where people would get their shoes.  Yet in a world in which the government does not provide shoes everyone seems to have them.  They have them in all shapes and sizes and often times for different specific purposes which can simply be the color of ones outfit.  There is little that the government “provides” that couldn’t be provided in the free market.  The government should focus on things that only it can provide.  Things like defense, infrastructure, environmental concerns, etc… .

    You even get people with some notion that everyone should have a “right” to things like “healthcare”. How can a person have a right to something that does not exist unless another person provides it for them? Whose rights are most important the doctors, patients, or the tax payer who is funding it?

    [...snip...]The environment still suffers?  According to the EPA pollution levels are way down from a couple of decades ago.  Emissions from a car rolling off the lot today are 95% less than cars 30 years ago.  In the US at least an electric car is being fueled primarily by coal.  Due to the inconsistent way they supply energy solar and wind can only ever be secondary energy sources.  There is currently a semi-scandal going with “loans” the US government has given to some solar energy companies. Most of the companies that get loans seem to be run by major donors to the Obama administration.  You have companies that got hundreds of millions of dollars in loans going bankrupt within a year.  It is more evidence of why you shouldn’t have the government “investing” in those kinds of things.  More evidence that the people in government are simply self interested human beings and not some benevolent sect that makes choices based on what is best for the greater good.  Generally speaking that is always the case which is in essence the argument for limited government.

  11. AustinG wrote:

    What works as environmental policy in New York doesn’t in Alaska. Yet any federal laws would apply to both.

    There are strengths in the federal model of government.  Local & state governments can try out new laws before harmonising them at the federal level in a way that takes account of local nuances.

    Sometimes private isn't necessarily better.  Private isn’t better by itself it is the free market that is makes it better.  More specifically it is the competition in that market that makes it better.

    You're right that private isn't necessarily better.  Private ownership doesn't automatically make the market more competitive.  Instead, markets are often dominated by a cosy club of suppliers, who decide on golfing trips or over collusive phone-calls or by “price leadership”; what price consumers should pay for a pair of shoes, as a hidden fee for trading foreign currency, as airline fuel surcharges or for electricity in California.  In order to be beneficial, competition must be free, fair, vigorous and transparent.  Experience has shown consistently that the only way to prevent a “free market” from descending through greed into a price-gouging fiefdom is to quantitatively monitor the market and vigorously enforce a lean & manageable set of mission-critical regulation.  In most cases (with some exceptions as noted), the best system involves a competitive free market regulated by a strong government that doesn't get involved in classically commercial or non-mission-critical diversions like Solyndra.

    When the free market does not result in inefficient (greedy and corrupt) oligopolies, it often results in inefficiency through duplication.  The free market only creates competition by duplication and infinitesimal differentiation of goods and services.  This increases market-place redundancy, which is a form of inefficiency.  Governmental inefficiency should be evaluated in the context of the alternative forms of inefficiency.

    Good government sometimes involves fostering advantageous competition within public programmes, and always involves auditing government procurement to ensure competitive bidding processes.  Competition and accountability are essential to the effective provision of most private and public services alike.  Competently managed government departments can gain almost all the benefits from the competitive market that a rationally managed business would, plus some excellent economies-of-scale.  With the advent of computer technology and the potential advances this may bring to accountability structures, government spending may undergo a step-change in efficiency during the coming decades, if properly supported by the necessary changes in management and accounting procedures.

    How can a person have a right to something that does not exist unless another person provides it for them? Whose rights are most important the doctors, patients, or the tax payer who is funding it?

    This is an important & fundamental philosophical question.  The supposed “rights” of one person are often in competition with the supposed “rights” of another.  I do not believe that a person who makes no effort has a “right” to anything.  I suppose therefore that the question may be reduced to:

    • Should people be rewarded according to their effort, or according to the personal profitability of their effort within the competitive environment, or according to the overall profitability of their effort for everyone in the present circumstances?  To what extent should each of these things be rewarded?
    • How can we measure “effort” or “profitability”?
    • Does the system naturally reward people according to their “effort” or “competitive profitability” without any intervention; or, are systemic adjustments required in order to reduce the profitability of harmful & selfish behaviour, or increase the profitability of beneficial & selfless behaviour?  Are any further adjustments required to increase the personal rewards of genuine effort (for example, by supporting employment for the severely disabled)?
    • To what degree is it possible, practical or desirable to put into effect the required systemic adjustments that would make the world more fair and humane?  How?  What new problems will such policies introduce? Can we find a harmonious balance between the benefits and disadvantages of public policy interventions?

    It is the most general form of the final question that I have attempted to answer in this essay; for one particular country (the United States of America) within one particular era of their development (the modern industrialised era, from 1950–2010).  The U.S. Federal government is presently too small (in terms of revenue and in terms of services to the hard-working poor who keep America running for all its citizens), too ineffective (just look at the recent performance of FEMA & SEC), too corrupt and too wasteful.

    In the context of the tax/spending/deficit data, or in the context of relatively high U.S. corporate profitability despite the present recession and wage depression; or in context a competitive comparison of tax rates between countries (in terms of mean-average tax-rates); U.S. tax rates are too low: tax rate increases are a necessary component of deficit reduction, which is crucial considering that government deficit and working-class demand are primary impediments to business confidence at the moment—perhaps the primary sources of systemic instability.  Recent decreases in tax rates and more recent profligate increases in spending have brought no advantages and must be reversed.  By increasing tax rates (at least, by general reform eliminating loopholes, tax holidays, preferential treatment for political cronies and de-facto tax advantages for foreign sweat-shops), by decreasing wastefulness in spending, by implementing wage ratio limits for government-funded executives and by restoring workers rights eroded over the last three decades; the U.S. economy can be brought to the beginning of a genuine recovery, and a measure of its former glory can be restored.

  12. An excellent article by an eminent economist, arguing for education reform and self-reliance as the primary objectives of taxation and spending policy:

    “The rich can certainly afford to pay more, but if governments increase taxes on the wealthy, they should do it with the aim of improving opportunities for all, rather than as a punitive measure to rectify an imagined wrong.”
    —The Undeserving One Percent?—by Raghuram Rajan

  13. From the final paragraph of this section about George Romney (Mitt Romney's father) on Wikipedia:

    http://en.wikipedia.org/wiki/George_W._Romney#Governor_of_Michigan

    Romney greatly expanded the size of state government while governor.  His first state budget, for fiscal year 1963, was $550 million, a $20 million increase over that of his predecessor Swainson.  Romney had also inherited an $85 million budget deficit, but left office with a surplus.  In the following fiscal years, the state budget increased to $684 million for 1964, $820 million for 1965, $1 billion for 1966, $1.1 billion for 1967, and was proposed as $1.3 billion for 1968.  Romney led the way for a large increase in state spending on education, and Michigan began to develop one of the nation's most comprehensive systems of higher education.  There was a significant increase in funding support for local governments and there were generous benefits for the poor and unemployed.  Romney's spending was enabled by the post–World War II economic expansion that generated continued government surpluses and by a consensus of both parties in Michigan to maintain extensive state bureaucracies and expand public sector services.

    The bipartisan coalitions that Romney worked with in the state legislature enabled him to reach most of his legislative goals.  His record as governor continued his reputation for having, as writer Theodore H. White said, “a knack for getting things done.”.  Noted University of Michigan historian Sidney Fine assessed him as “a highly successful governor”.

    Mitt Romney's father, as Governor of Michigan, turned a large deficit into a large budget surplus at the same time as more than doubling the effective size of Michigan's government in order to pay for education and other benefits for the poor and unemployed.  This policy was enormously successful in improving the circumstances of Michigan and its people, despite significant setbacks such as civil unrest during his term in office!

Comments are closed.