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Hauser's Law and Taxes PDF Print E-mail
Sunday, 28 November 2010 01:32

On a site I frequent, the recent article from Kurt Hauser came up and succinctly stated the empirical fact that the Federal Government gets about 19% of the GDP.  Higher tax rates don't increase the Federal Government's take; it still gets 19%.  So the focus for those looking to raise revenue (something that should be questioned strongly, and acted on only after spending is cut back significantly) should not be increasing taxes (since it doesn't work - Hauser's Law) but growing the GDP.  And as expected, a person on the political left simply couldn't understand the logic.  So I explained...



Hauser's Law states that the Federal Government will get about 19% of the GDP in revenue. Doesn't matter what the tax rate is, the Federal Government will get that amount. So if revenues to the Government are to go up, changing the tax rate itself will NOT directly increase those revenues; it will still get the same share of the GDP.


Thus, the ONLY way to increase revenues is to increase the GDP as a whole; since the Federal Government's take of the GDP is constant with respect to taxation rates, then growth of the entire pie - and consequently the Federal Government's share - is the goal.


The OECD has an ongoing project to map growth rates to taxation rates. Of particular interest to you might be page 9 of that PDF, in the conclusions section. Here are some key takeaways:


There are several ways in which tax policy can influence productivity:


? One option is to reduce the top marginal statutory rate on personal income since it has an impact on productivity via entrepreneurship by affecting risk taking by individuals. While empirical research has pointed to conflicting ways in which entrepreneurship could be affected, in this study a reduction in the top marginal tax rate is found to raise productivity in industries with potentially high rates of enterprise creation. Thus reducing top marginal tax rates may help to enhance economy-wide productivity in OECD countries with a large share of such industries, though the trade off with equity objectives needs to be kept in mind. It is also possible that cutting top marginal tax rates could increase economy-wide productivity through composition effects, by increasing the share of industries with high rates of enterprise creation.


? A second option is to reform corporate taxes, as they influence productivity in several ways. Evidence in this study suggests that lowering statutory corporate tax rates can lead to particularly large productivity gains in firms that are dynamic and profitable, i.e. those that can make the largest contribution to GDP growth. It also appears that corporate taxes adversely influence productivity in all firms except in young and small firms since these firms are often not very profitable. One possible implication is that tax exemptions or reduced statutory corporate tax rates for small firms might be much less effective in raising productivity than a generalised reduction in the overall statutory corporate tax rate. This reduction could be financed by scaling down exemptions granted on firm size as they may only waste resources without any substantial positive growth effects.


? A widely-used policy avenue to improve productivity is to stimulate private-sector innovative activity by giving tax incentives to R&D expenditure. This study finds that the effect of these tax incentives on productivity appears to be relatively modest, although it is larger for industries that are structurally more R&D intensive. Nonetheless, tax incentives have been found to have a stronger effect on R&D expenditure than direct funding.

? Lower corporate and labour taxes may also encourage inbound foreign direct investment, which has been found to increase productivity of resident firms. In addition, multinational enterprises are attracted by tax systems that are stable and predictable, and which are administered in an efficient and transparent manner.


Basically, the OECD has found that lower tax rates result in a higher GDP growth rate. Lower personal AND corporate tax rates. Thus the pie grows faster, and the Federal Government's static 19% share results in a greater total absolute number of dollars.


We've also seen it with the capital gains tax, where cutting the tax rate resulted in a net increase in the number of dollars collected for that tax. The Federal Government's share of capital gains may have been reduced, but the resulting increase in activity taxed as capital gains was so large that the net total dollars the Federal Government received increased.


There is a correlation between taxation and GDP growth; the OECD study is enlightening! Lower taxation tends to increase GDP growth; that is pretty much shown by the OECD's own research, as well as the results of capital gains tax rate cuts here in the US. Lower taxes cause the GDP to grow faster.


If Hauser's Law is correct (and no one's been able to really tear it apart), then the best way for the Federal Government to increase its own revenues would be to focus on growing the GDP. And that means cutting tax rates.


Lastly, particularly note the highlighted portion of finding 3 above:

Nonetheless, tax incentives have been found to have a stronger effect on R&D expenditure than direct funding.


Essentially, it is better to leave the dollars in the hands of the company, than to tax it and then return it as Federal-Government spending. In other words: stimulus spending is a worse return on "investment" than cutting taxes. It's better to not collect the dollar at all, than to collect it and then return it back.


Lower tax rates grow the GDP faster; Hauser's Law means that such an increase in GDP would result in more Federal Government revenue. Higher taxes will reduce GDP growth, and Hauser's Law means that such a reduction in GDP growth will result in a reduction in the growth of revenue to the Federal Government.


Tax cuts result in faster GDP growth. The OECD's empirical data analysis shows as much. Hauser's Law (also a strictly empirical data-based conclusion) means that a Federal Government drowning in debt should seek to grow the GDP as much as possible, rather than try to extract more tax dollars via higher tax rates.


Put the two together: cut taxes and more dollars will flow to the Federal Government. That's not some wild theory, that's the hard, empirical facts talking.

Last Updated on Sunday, 28 November 2010 01:42