Saturday, December 18, 2010

Three popular fallacies

Have you noticed how some people discuss tax policy as though they were helping Santa describe who gets what toy or how many?  Give earners a break on their taxes by lowering the rate and, they think, they've just done them a special favor.  However, hike their taxes and, you are doing them no wrong, they should just be grateful you didn't take it all.

The discussion inevitably devolves into a claim of just how much said tax break "costs" Americans in "lost revenue".  There are three fallacies required to arrive at this distorted notion.
  1. That all income and property belongs first to the gov't and we are lucky for whatever they deign to let us keep.  The government is not protector of property, but owner of it from its inception.
  2. That government spending levels are a given and can be held hypothetically constant while we determine the contribution of tax rate changes to raise or lower the deficit. 
  3. Also presumed to be constant are the rates at which we earn money, most outrageously, that we work just as hard no matter what we earn after taxes. Incentives effect behavior in every aspect of human desire and endeavor except employment.
You have to believe every one of these fallacies or the arguments against lower tax rates fall apart.  Let's take them in reverse order.

3. Incentives matter, except when they don't
We get coupons in the mail. At the food store we're told that if we buy one box of crackers, we get another one free. Companies pay for all or part of your health care insurance, put money in your retirement account, allow you to purchase shares of stock at a discount, maybe even a bonus at Christmas time. We promise our kids ice cream if they eat their veggies. My mom wielded a special disincentive she called "the black belt" that put an end to a good deal of bad behavior when I was growing up.

We understand incentives. We use them because they work.  So why, in discussions of tax policy, do we pretend that people are immune to incentives (and disincentives) to work. We are supposed to believe that people will show up and work just as hard regardless of how the government increases or decreases their net pay by lowering or raising the tax rates.

Having been poor, I can well recall that the ever-present need for money led me to work extra hours just about any chance I got. And the threat that my unreliable car was going to break down in an unforeseen way provided a disincentive against turning down opportunities to sock away a little extra bread. Thirty years later with the wolf nowhere in the vicinity of the door, I am much more responsive to incentives and disincentives, as I have rediscovered along the way the joys of goofing off (especially when goofing off with the family I love). It takes something extra to get me off the couch and into the office (more often than not, that incentive is the work itself which I enjoy when it involves some new puzzle). We had two rounds of layoffs where I work; that's a strong disincentive against slacking.

It is never explained what makes decisions to work or stay at home immune from incentive. Never are we told what puts work beyond the reach of a the calculus that informs most of our other decisions large and small. Could it be that in fact incentives do apply and that lower tax rates would result in more hours worked, more wages taxed and that the decline in tax revenue would not be exactly proportional to the decline in tax rate?

Consumers are smart. People will switch credit cards when offered 2% cash back.  They will increase their spending when they get 5% cash back instead of 2% on rather small purchases. They will refinance their homes to lower their interest rate 1%/year on payments that comprise roughly one quarter of their expenses.  And we are supposed to believe that savvy earners will not respond to a 4% decrease in tax rates on every extra dollar they make.

2. Every penny of government spending is required
Some people will acknowledge that raising tax rates depresses GDP and that money the government leaves on the table can be used to build businesses and put people to work.
Every dollar released from taxation, that is spent or invested, will help create a new job. -- JFK

But then these people say, "O, how we wish we could let people keep their property, but because the government has to pay its bills, tax revenue must be raised. And borrowing is no substitute for taxes, it merely shifts the tax burden from one generation to the next. No," they say, "taxes must be raised; we have no choice."

But of course we have a choice. We could simply decide not spend the money to begin with.  To believe that tax rate cuts are "blowing a hole in the deficit" (what a strange and inaccurate way of phrasing the issue) one has to believe that it is solely a lack of revenue that creates the deficit rather than the excess in spending. But in fact, raising revenue or lowering spending each have an equal effect on the budget.

A small portion of federal government spending is not really necessary. Yes, a small fraction, but a fraction of a very large number represents some real cabbage.  The rule in our household is that we don't buy what we can't afford.  We don't pretend to have access to money we will never get.  Most of us live by that simple rule.

How is it we have convinced ourselves that money spent by Congress is hallowed and money spent by those who earned it is tarnished by greed? Some have invented the notion that money spent by government helps the economy to a greater extent because of a multiplier effect: $1 spent by the government becomes $1.40 through a kind of magic that defies intuition. The theory is that the government is giving this dollar to people who will spend it immediately, putting back in circulation more quickly. This, of course, completely ignores the cost of distributing this boodle. Congress and all its agencies, the Executive and all its agencies, those who hand out this dough do not work for free.

And what is the cost of not taking the money? Zero.  It actually costs nothing to let people keep their own money. It's not hard to understand this, but what is hard to understand is why the state spenders refuse to rate the value of our spending as highly they rate their own.

Congress can avoid the half a trillion dollar deficit that high tax proponents claim to hate by not spending that half a trillion dollars. The real cost to the American people when spending exceeds revenues by a half a trillion dollars is the excess spending, not the constraints on revenue.

This points to another trick -- when they talk about the "cost" of a tax policy, by convention, they talk about its cost over 10 years. It would be difficult to find $500 billion to cut out of a single year's budget, but that is not the challenge. The challenge is to find a mere $50 billion in each of ten years. That's less than 1.5% of the budget (and about 1% of the proposed 2020 budget of $5 trillion).  Over the last 5 years the unemployment rate has gone from around 5.5% to around 9.5%, a 4% reduction of the workforce.  If the employers of this country, in aggregate, could of necessity cut back on its workforce by 4%, don't you think we could find 1.5% of the federal budget to cut?

Imagine going to your boss with the following argument: "Boss, I just bought a $50,000 car that I cannot afford.  I figure that given the high monthly payment on this car, I will run a monthly deficit of $500.  Thus, I figure that over the course of the year, the meagerness of the salary you pay me will cost me and my family $6,000. In short, you are costing me $60,000 over the course of 10 years.  What are you  going to do about this?"

1. It's our money, not yours
We're told we have to raise tax rates on high earners or it will "cost" Americans half a trillion dollars. We'll "lose revenue". Balderdash! The dollars are inanimate and agnostic. They don't care where they go.  The dollar resides in one account or the other. Nothing ever gets lost.

People who complain of "lost revenue" are suffering under the illusion that they have money that never really belonged to them to begin with. Despite rhetoric to the contrary, as the law is written today, each person actually owns all of his own money -- every cent of it.  And he deserves every cent that he has earned because whoever has paid him has done so in an even exchange of some sort.

At no point does this money belong to the government, nor to the American people in aggregate. So they have no call to say they lost some of this money.  In fact, the royalist notion that our government was instituted to possess our property rather than to protect it is the reverse of the idea that inspired our founders to declare us an independent nation. It is as un-American as any idea you could name.

So tax rate cuts for high earners are not giveaways to the rich, because the money has never been ours to give away.

Bear in mind these fallacies and read this article by economist Alan Blinder who claims that anything other than a tax hike on high earners is tantamount to Scrooge beating Tiny Tim to death with his own crutch.


milkchaser said...

Here's another article that inspired this post: "Fiscally Irresponsible Friday: Trading for some magic beans" by Phillip Davis

Big E said...

Very good. Right on target.

bizandlegis said...

Good post and nice blog

Biz and Legis