John Kerry’s Confusion
The Massachusetts senator is stuck in a static world.
The early battles among the Democratic candidates provide little guidance as to what basic economic themes would dominate attempts to undermine President Bush's fiscal policies. But now that Senator Kerry is in the limelight, let's examine the rationality of the basic economic premise that would characterize his fiscal policy if he were to become president.
One risky strategy set forth by Kerry is his commitment to repealing Bush's so-called "tax cuts for the rich." Kerry's assumption is that, by increasing tax rates on the wealthy, he will be able to reduce the deficit as rich people will pay more in taxes. Unfortunately, in theory and in practice, this proposal probably won't work.
Sen. Kerry needs to understand the implications of static vs. dynamic analysis. In his static world, a tax-rate increase means higher tax revenues. He ignores an individuals' ability to respond to rising tax rates. Arthur Laffer (an economics professor and, like Kerry, a graduate of Yale) could teach the senator a few things.
The easiest way to expose Kerry's economic shortcomings is to revisit the famous Laffer Curve, a pedagogic device that helps explain the interaction of tax revenues, tax rates, and individual behavior. The following exhibit represents Dr. Laffer's famous sketch on a napkin, which demonstrated how tax rates can undermine tax collections rather than enhance them.
The curve on the graph represents all levels of government tax revenue at varying tax rates. Obviously, at a point of 0 percent taxation, there is little if any tax revenue generated. Similarly, at 100 percent taxation, there are virtually no tax collections, as people who must give all their earnings away will not work. At some point, designated as "E" on the exhibit, there is a tax rate (varying by individual circumstances) that maximizes government revenues.
Once the tax rate rises into the prohibitive zone, tax collections fall — they don't rise. (Employment for creative tax accountants and tax lawyers rises accordingly.) For individuals in the normal zone, an increase in tax rates does produce an increase in revenues, as they are not motivated to take actions to offset the tax-rate increase. For example, when a state raises the sales tax from 6 to 7 percent, there is very little impact on consumer spending.
However, one problem with this representation is that there is no well-defined point where a given tax rate places a taxpayer in the normal or prohibitive zone. Each individual has a "break point" where a given tax rate can turn productive behavior into a vacation.
However, we do have the experience of the Reagan tax cuts. Tax revenue from the "rich" rose dramatically in the years following those tax-rate cuts. This flies in the face of the argument made by Sen. Kerry, whose proposed tax hikes on the rich could very well backfire and trigger a decline in tax revenues. If that were to happen, the budget deficit would grow — not shrink.
On the other hand, maybe Kerry understands this relationship all too well. Maybe he's just proposing increased taxes on the rich as a populist theory that will attract middle-class voters. However, while that strategy may work from an emotional perspective, it doesn't make much economic sense. Two former presidential candidates — Walter Mondale and Michael Dukakis — quickly found out that advocating a tax-rate increase is a sure way to lose an election.
nationalreview.com |
