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Friday, October 19, 2012

Taxes: What you need to know

Ahhh, taxes.  Generally speaking, the word itself is like kryptonite to a politician's career.  Rarely is the issue of taxes going to give positive ratings - even when the politician wants to cut them.  This election cycle, taxes are a huge issue.  While the economy is struggling, the last thing people want is to have more of their shrinking monetary value disappearing into government coffers.

This is why Obama's fear tactic of "Romney's going to raise taxes on you by $2,000 and raises taxes on the rich!" schpiel is so effective, despite it being egregiously deceitful (which we will cover in a moment).  One of the main purposes of this article is to explain taxes in a way that will show you why Obama's plan does not work, and has a history of not working, and why Romney's plan (yes, he has one contrary to leftist talking points) will work and has a history of working.  

The first thing you should know about taxes is that tax rates are inextricably linked to economic growth.  Tax rates can, and have been proven to, affect production.   This is what is called the Laffer Curve.  The basic ideas of the laffer curve is that there's an optimal point where the tax rate will yield the highest tax revenue (the money the government collects from taxes) and if you go above this rate, tax revenue will actually decrease because the incentive to produce shrinks while the incentive to save increases.  This happens so much that if you were to have a 100% tax rate, the revenue would be pretty close to 0 since why work and be productivity if the government is going to take it all away anyway?  Note that the Laffer Curve doesn't always advocate for lower taxes, but can should the current tax rate be higher than the calculated optimal rate (which can vary based on economic conditions).   The core take away here is that tax reductions can lead to more jobs and more tax revenue.  

The next thing you should note is that when tax policy is considered by Congress, the effects of the tax change on the economy are not taken into account.  They just believe that lower tax rates = lower federal revenue and higher tax rates = higher federal revenue.  This is important to understand because it puts into perspective how Democrats and Republicans tend to tackle fiscal matters.  Democrats, in their ever expanding government programs, simply see raising the tax rate to get more money to fund more projects.  And while Republicans try to work with what they have by not increasing rates and reducing spending, they're also not necessarily above raising rates to meet their own budgets, assuming raising the rates would equate to a proportional increase in revenue.  Neither side really considers the economic impact, or possibility, when considering tax rates.  Though when it comes to those taking the laffer curve into account, there seems to be more Republicans behind it than Democrats.

Let's put it into a simple formula:  F = T x I.  Federal Revenue = Tax Rate x Income.  Many do not consider, or believe, that the value of T will affect the value of I.  But, according to the Laffer Curve it does.  Know who else believed in the Laffer Curve?  Ronald Reagan.  "Reaganomics" as it's dubbed reverently by the right and derisively by the left,  led to a 25 year (1982 - 2007) explosion of economic growth the world has never seen.  It had its ups and downs, like a couple mild recessions, but overall it was his tax policies that nearly doubled federal revenue simply by slashing tax rates.

I think you can see where I'm going with this. If we were to apply the Laffer Curve to both Obama's and Romney's plans, you'd see the opposite effect of what the left is claiming what will happen.

First, when it comes to taxation and Obama's claims to not raising taxes on the middle class, let's not forget that Obamacare has plenty of hidden taxes that, while not hitting american families directly are going to hit businesses (with many already feeling the pain), which in turn affects employment and wages.   Obama's plan to raise taxes on the rich will only exacerbate the problem since the rich will do what they always do when they feel the pinch:  save, not spend.  And in this case, spending would mean growing more business and  hiring people to meet those business requirements.  But that's not going to happen.  So the affect of Obamacare's increased burdens and the higher taxation on the rich?  A sluggish economy that doesn't go anywhere (kind of like it is now).  Not only does it not stimulate economic growth, it stifles it and might give slightly more money for the government to spend on whatever.  There are other economies that have practiced practice this type of high taxation.  The Soviet Union was one and you can see how well their economy turned out for them.  China is another, though they've grudgingly been embracing more free market ideas which have, not surprisingly, led to their economic boom.

Now, however, let's look at Romney's plan (yes he has one).   He's proposing a 20% tax cut across the board for everyone and a more competitive corporate tax rate.  This is where liberals amusingly claim he's going to increase taxes on the middle class.  It goes like this:  Because he wants to lower the tax rates, that means there's going to be less federal revenue to meet the budget and that the only plausible way to do so is to increase taxes on the middle class.  Aside from the fact that raising taxes on the middle class because he needs money after he just cut taxes them making absolutely no sense, the critique is missing the laffer curve component where the lower tax rate will spur enough economic growth to cover the perceived revenue gap. If we go back to our formula, you can say that Romney's plan lowers T so that it will in turn increase I enough to make F break even, if not increase.   And in the process of doing so, more jobs are created.  Once again, this has precedence with the Reagan tax cut that led to the biggest explosion of economic growth in human history.  Now I'm not saying Romney's going to usher forth another Golden Age, as his cuts aren't as ambitious as Reagan's were.  However, the same positive will definitely come from an economy that has been struggling to breath these last four years.

Once again, I want to reiterate that this is not a justification for full blown all out tax reduction everywhere because at a certain point on the Laffer Curve lower taxes will result in lower revenue.  I tend to believe we're on the high side such that some tax reductions will lead to growth and more federal revenue.  That's what Romney's plan is doing:

Lower taxes to increase economic growth and therefore federal revenue without having to raise taxes.  

It's been done in the past and it will be done again.  So next time you see about Romney raising taxes on the middle class, just remember the Laffer Curve and that the talking is an egregious deception.