Tax Cuts, or Hikes, Are a Sideshow

This post originally appeared at Neighborhood Effects.

Washington State is considering implementing a personal income tax. Much like the federal debate over extending or expiring theBush tax cuts, this debate is a sideshow to the real issue. In our recent Capitol Hill Campus course, Dr. Bruce Yandle laid out these two charts which point to the real problem in state and federal budgets; spending.

First, this chart tracks top marginal tax rates versus federal revenue as a percent of GDP.

The government’s take of the economy has remained relatively constant since 1960, despite wild fluctuations in how we “soak the rich”. Washington’s proposed tax would only affect those house-holds making more than $200,000, so one should expect this pattern, or lack thereof, to hold for Washington’s gross state product.

The second part of the story is this; as government spending increases, there is a measurable decline in the economy.

With only one outlier in fifty-four years of data, this strong correlation indicates that spending cuts pay for themselves with a growing economy. In turn, that should produce more overall revenue with reasonable tax rates. If you live beyond your means, the problem isn’t your income, it’s your spending habit. Sometimes it’s better to take a small slice of the pie, but make the pie itself bigger.

Tax Foundation attorney Joe Henchman put the incentive mechanics this way:

Yes, such taxes will generally raise revenue in the short term without a sudden exodus of wealthy people fleeing to the state next door… . But over the medium term, the taxes will negatively impact location decisions. People expanding old businesses or creating new ones will incorporate the higher cost of doing business into their decision-making, and steer clear of the state.

States and the federal government need to break this destructive cycle.

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2 Responses to Tax Cuts, or Hikes, Are a Sideshow

  1. Thomas Merrill says:

    Graph 2 is super noisy. Without 2008 and 2009 (off years by any measure), that trend line would be closer to verticle, and then even the strongest of correlation wouldn’t help the argument.

    But while you’re on the subject, have you seen the new Envision Maine report? [http://sites.google.com/site/envisionmaine/reinventing-maine-government/Complete_report.pdf] It has some nice examples of state- and local-level policies to combat excessive spending and to positively impact business (and skilled labor) location decisions. Maine is weird, but most of these policies could certainly be applied elsewhere.

  2. Pingback: GDP vs Spending: When is More, Less? | Whiskey and Car Keys

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