This is section ninePOLITICAL ECONOMY AND ELECTRONICS
Ronald Gordon Ziegler The controversy that has swirled around such supply side economic theories as that represented by the Laffer Curve as to the relationship between tax rates, economic activity, and government revenue generation has increasingly become one of the differentiation points between liberals and conservatives, as those classifications have come to be identified in the contemporary period. Even with his effort to present a less liberal face in the rhetoric of the 1996 Presidential campaign, whether that is taken to be substantive or rhetorical merely, Bill Clinton could not bring himself to endorse the concept of across the board substantial tax cuts, though he did counter such initiatives by Republican candidates with targeted tax cut plans, if they could be directed by the federal government. For some, it was difficult to put great stock in the probability of even these, given the abrogation of his 1992 campaign pledge for a middle class tax cut when he subsequently pursued and achieved passage of a huge tax increase. It should not have been so problematic for him to do this, but as difficult as it was for him to come to grips with the theoretical conceptualizations involved, it is apparently even more of a hurdle for others of liberal stripe in both parties and particularly for such members of Congress. Even George Bush had trouble with the idea. During the 1980 nomination campaign, Bush rejected Reagan's talk of increasing government revenues by cutting tax rates as 'voodoo economics.' Thus, for some, it was not difficult to find him agreeing with the Democratic leadership in Congress to sign on to a big tax hike. This was precisely the wrong medicine for the time. The effort to revive the economy and generate revenues should have been addressed by cutting tax rates. This should not have been a difficulty for the President who put such emphasis in his campaign on his having met and shaken hands with President Kennedy some thirty years earlier. The inability of other leaders in Congress such as Senator Edward Kennedy to fathom this point is all the more bewildering. Indeed, one of the principal reasons I had little difficulty with 'Reaganomics' was my recollection of Kennedy's arguments for the tax cut measure he proposed back in 1962. John Kennedy is often portrayed as a rather 'liberal' President, but that characterization is far from appropriate, at least when it comes to economic policy. Even more broadly than that, however, there are some striking policy parallels which exist between Kennedy and Ronald Reagan (there are also admittedly some major differences -- Kennedy was no Reagan). Both for example, championed huge tax cuts as part of their economic program. There will be those who will protest that there were distinct differences between the two agenda, because the JFK tax cut was a 'demand' side tax program which was directed primarily at the middle and working classes, while Kemp-Roth had a definitive supply side orientation which provided the biggest tax rate reductions for the upper income levels. But that was the key element of the Reagan tax cut, and also one of its primary successes. Since the 'rich' have the greatest discretionary income, the provision of lowered tax rates for them would stimulate greater investment and other economic decisions. But this would be a valid observation for any tax rate which was more directly linked to economic activity, such as the capital gains tax, which is important to anyone even indirectly 'invested' such as anyone who has savings, stocks, insurance, or other such investments. Every time the capital gains tax has been increased, the revenue generated by it has tended to decrease or, at minimum, climb more slowly. And whenever it has been cut, the revenue generated by it has risen. The role of profit as the fuel of the economic engine is a vital recognition and reality. Reducing 'profit' is a sure way to dampen economic activity. And yet, this aspect of the Kennedy tax plan completely eludes most observers. In addition to his general tax cut proposal, he won enactment of an accelerated depreciation tax allowance for businesses (aka, tax cuts for the rich?)-- a prime example of at least the theory expressed as supply side economics. There are additional parallels between the two Presidents, as well. Both, for instance, achieved huge 'peacetime' military build-ups. And while it might be suggested that evaluation of Kennedy on such measures is unwarranted because he had so little time in office, and that had he had more time, he would have struck off in the direction that was taken by LBJ's Great Society -- JFK did propose many of the measures eventually enacted under the Great Society, from Medicare to the War on Poverty -- that does not alter the parallel course where they both followed it. The actual relationship between tax rates and revenue generation is quantifiably verifiable. It has been suggested that the lowered tax rates on the higher income levels in the 80's actually led to their increased economic activity so that their incomes in fact rose causing them to pay higher taxes, or more of the total tax proportionally than they had paid before at the higher tax levels. Conversely, when the Clinton tax plan penalized the 'rich,' they produced less economic activity and consequently paid a lowered overall tax and smaller portion of the total tax paid. What is proposed here is that there is an empirical relationship which can be not only demonstrated but structured into a rather generalized theory of that relationship. In order to construct this analysis, some macroeconomic data has been gathered. The levels of GDP, Personal Income, Government receipts, and the Consumption component of the GDP statistic for recent years has been collected. An average federal tax rate has been calculated as the Personal Income over Government receipts. This statistic is not precisely comparable to the tax rates in the tax code because it looks to an overall average across brackets and after whatever deductions, etc. the law allows(it also underrepresents the actual total tax burden substantially). Also calculated for this examination are a statistic of Consumption as a percentage of GDP, Personal Income as a percentage of GDP, and Consumption as a percentage of Personal Income. Utilizing this date and these statistics, it is possible to show the inter-relationship among them. In many respects, what is demonstrable might be called tautologies on the nature of the data and statistics used, but they provide some important insights into the functioning of the economy, as well as a general law of interrelationship which approaches the degree of rigor that is found in the laws of physical science.
Year GDP PI* G# C Avr Tax Rate** C as % of GDP C as % of PI PI % GDP 1995 6.98t 6.21t 1.199t 4.78t .193 68 77 89 1994 6.74t 5.70t 1.175t 4.63t .206 69 81 85 1993 6.34t 5.38t 1.148t 4.38t .213 69 81 85 *includes transfer payments #includes all sources of government revenue(except borrowing), such as fees, which are effectively taxes. **this does not mean that tax rates in the code have been reduced, but that growth of GDP has slowed.
The most immediately striking indication from the table is that through these years, the actual average tax rate has been declining. How can that be accounted for against the backdrop of the higher tax rates of the tax code that were enacted for 1993 onward and given the fact that the actual tax rates overall did not change during the period? Obviously, though, the levels and kinds of economic activity people engage in do change from year to year(and very much in response to the tax code), and the kinds of income, deductions available and/or utilized, the proportion of income in the various tax brackets, and more, would produce such results. Among the things it demonstrates, however, is that higher tax rates on the upper quintiles will lower their economic activities and their subsequent tax and share of the tax -- thus increasing the tax burden of lower income levels, and most especially on the middle classes. COROLLARY # 1 Increasing the tax rate on the wealthiest quintile effects an actual tax increase on the middle class. The relationship which results among this set of data and statistics (admittedly on the nature of the statistic itself), is important, and one that can be quite useful. In particular, there is an empirical relationship among Government revenues, Personal Income, and the average tax rate in any given year. Government revenue is obviously going to be the product of Personal Income and the Average tax rate, but because of that Government revenue divided by Personal Income will be equal to the tax rate, and Government revenue divided by the tax rate will equal Personal Income. These identities can be visually represented:
GOVERNMENT REVENUE ------------------------------------------------------------------------------------------------------------- | PERSONAL INCOME | TAX RATE
or,
G __________ | PI | TR.
While it should be reiterated that this construct is, in reality, a set of identities rather than equations, as such, the fact that the relationship is stipulated also makes it useful in various ways, which will be examined shortly. But what makes the formula particularly intriguing is its approximation of the Ohm's Law in electronics:
E __________ | I | R.
The various components will also interact in precisely the same way as they do in the Ohm's Law. And, just as in electronics where E, representing voltage is a 'flow', G or government revenue is a 'flow' which is a function of Personal Income much as I for amperes is the 'pressure' behind the voltage. Further, the tax rate is a factor or impedance just as R for Ohms represents resistance in electrical circuitry. For each of the years on the table, this could thus be constructed:
1995 1994 1993 1.199 1.175 1.148 ________ _________ __________ | | | 6.21 | .193 5.70 | .206 5.38 | .213
The various identities or equations derived here are postulations of the relationships: E = I x R or, G = PI x TR 6.21 x .193 = 1.199 R = E/I or, TR = G/PI .193 = 1.199/6.21 I = E/R or, PI = G/TR 6.21 = 1.119/.193 for the data from 1995. The implications of this relationship are very important and are actually corollaries of Ohm's Law in variation for political economy. For instance, on E/I x R or G/PI x TR, it follows that any increase in TR will result in a decrease of G, or if TR is increased, in order for G to remain constant, PI would have to increase. COROLLARY # 2 Any increase in tax rates will result in a diminishment in personal income, and/or a diminishment of government revenue (or in their rate of increase). The term diminishment is used instead of decrease because the process described is actually a dynamic one which extends over time and periods, and since the various components each alter from year to year, G may actually increase in absolute value while diminishing in relationship to the other components. It also follows that in order for Government Revenue to actually increase, there must be an increase in Personal Income. And, further, a reduction in Tax Rate should result in an increase of Personal Income, and vice versa, as for example:
2 2 _______ _________ | to | 4 | .5 5 | .4
COROLLARY # 3 In order for government revenue to increase at the most efficient rate, Personal Income must rise. COROLLARY # 4 A reduction in tax rates will result in an increase in Personal Income. COROLLARY # 5 A reduction in tax rates will cause a greater increased level of economic activity.. COROLLARY # 6 A reduction in tax rates will cause an increased rate of growth in Personal Income (and GDP). The statistics for the last three years are compiled here on these categories to test this tax/revenue relationship:
Year GDP PI C G C as % of GDP C as % of PI PI %of GDP Avr Tax Rate 1995 6.98 6.21 4.78 1.199 .68 .77 .89 .193 1994 6.74 5.70 4.63 1.175 .69 .80 .85 .206 1993 6.34 5.38 4.38 1.146 .69 .81 .85 .213 (first four columns are in trillions of dollars)
Selecting the data for 1995 as exemplary, it is possible to follow through the economic process using this 'Ohm's Law' to estimate the impact on the economy of increasing or decreasing tax rates. At the existing average tax rate for 1995 of 19.3 %, the revenue collected by government is 1.199. What would happen to revenue collection if the tax rate were increased to 22.3% or cut to 16.3%? This tax reduction would approximate the 15 % tax cut of Bob Dole's 1996 campaign (actually it amounts to 15.6%) With a + 3 % tax increase, the effective tax rate should increase. Continuing on the 1995 data, we begin with the Personal Income level of 6.21.This would yield government revenue alteration:
^ TR Average Annual Tax Rate G Consumption C as % PI as C as % of GDP % GDP of PI no change 19.3 % 6.21 X .193 = 1.199 4.86 .68 .89 .77 - 3 % 16.9 % 6.21 X .163 = 1.199 4.86 .69 .85 .80 + 3 % 22.3 % 6.21 X .223 = 1.385 4.86 .69 .85 .81 A) 6.21 PI1-----> 1.199G1 -----> 1.38 G2 ------> 4.6 C2 ------>5.97 PI2 -----> 1.33G3 ( + .18 on (- .18) (C2/.77) (PI2 x .223) 3 % tax hike) B) 6.21 PI1----->1.199G1 -----> 1.01 G2 ------> 4.97 C2 ----->6.45PI2 -----> 1.05G3 ( - .19 on ( + .19) (C2/.77) (PI2 x .163) 3 % tax cut)
Scenario A -- with the tax increase from 19.3 to 22.3 % The data based Personal Income yielded a Government Revenue of 1.199 at the original tax rate of 19.3 %. The increased tax rate of 22.3 % would yield an expected revenue of 1.38 (.18 higher than the original government revenue. The Keynesian formula for estimation of GDP is C + I + G + Xn, but the increase in G has to come from one or more of the other components of the formula. Here, for sake of simplicity, it assumed that it all comes from Consumption, it being reduced by the amount of the increased government revenue (In reality, it would come only in part from C, and would also reduce the other components altogether a total of .18). ^ G -----> ^ C. Thus, G rises to 1.38 (1.199 + .18), and C2 is .18 lower than the C1 of 4.38. Consumption was found to be .77 of PI, so with the new Consumption of 4.6, the new PI is 5.97. And that Personal Income at the new tax rate is anticipated to yield a government revenue of 1.33. Scenario B -- with the tax cut from 19.3 to 16.3 %. The same process is followed with the lower tax rate to produce a government revenue, after the tax cut, of 1.05.
Year Personal Income Marginal PI Government Revenue 1993 5.38 --- 1.148 1994 5.70 + .32 1.175 1995 6.21 + .51 1.199 1995 at 19.3% at 22.3 % at 16.3 % 19.3% 22.3% 16.3% 19.3% 22.3% 16.3% 6.21 5.97 6.45 + .51 +.27 + .75 1.19 1.33 1.05
Personal Income in subsequent years can be expected to change (generally upward barring intervening variables of a recession, etc). The amount of change will depend in large measure on the tax rate the economy is burdened under. For the 19.3 % tax rate, the amount of change here is estimated as the average of the previous two years -- the others are also calculated in the same manner; that is, for 22.3 %, the average of .32 and .27 for .3, and at the 16.3 % rate, the average of .32 and .75, or .53. (Rather than remaining constant as they are shown here, the marginal adjustments would not be so static, but would repeat the same function of change annually as they did from 1995 to 1996 -- they are held constant for this examination for simplicity and explanatory clarity). Continue
