Taxing The Rich Always Fails Eventually

The solution Mr Obama proposed yesterday for increasing the federal budget was to raise taxes. He did not suggest taking a one-time chunk of money from those who earned it to sprinkle it among congresspersons, but instead demanded that a proportional permanent increase in taxes be levied (and that those monies be given to Congress to spend). The difference between these two modes of taxation is everything.

Here is the way the federal budget process has worked in practice—I do not say in theory, but in actuality. A projection is made of revenues (taxes). The government plans to spend all those monies and usually a little more. When the projections are accurate, the deficit grows only slowly, and in some years even decreases. These years are and have been infrequent; therefore it is rational to believe that these years will continue to be infrequent. It is irrational to believe that deficits will not continue to grow on average.

Much more often the projection is wrong. It is in error. It is overconfident. It is too sure. It says that more money will come in than actually does. This happens more frequently than do accurate projections.

The shortfall is recognized and then one or two things occurs, though both may also occur. The first is that the government “borrows” money, which increases the deficit and imperils future projections, making them less certain. The second is that taxes are raised. The argument is always, “Look, the hole is there. It can only be filled with money. If we don’t fill it now, danger looms.” This reasoning is often convincing because of the ever-nearness of elections.

Once the taxes are raised, new and higher projections are made based on the assumption that more money will flow to the government (and away from people). The budget is made on these projections; the government plans to spend all these new monies and usually a little more. When the projections are accurate…but never mind.

We are in an unbreakable loop. It ever ratchets up taxes and spending, which positively increases the power of the government. My proof is in this picture:

Budget Per Capita

This is the federal per-capita outlay in constant dollars. This is how much is spent and says nothing about how much is taken in. The last year of data is 2008, the remaining years are projections from that year, and are thus way too low: in other words, the actual outlays are higher than projected. Sound familiar? (I’ll be updating this chart when I get the new data.)

The peaks due to WWI and WWII are obvious, but even more sickeningly blatant is the inexorable, probably unstoppable, upward trend. The rare times of decrease are associated with rapid economic innovation which outstrips the government’s ability to regulate; however, it always catches up. Do not forget that this chart adjusts for both an increase in population and inflation. Look carefully at the vertical-axis: it is logarithmic. The spending is increasing exponentially!

Mr Obama is suggesting that this rate of increase should not only continue, but itself increase. That is, the rate of government spending per capita should accelerate. Some of this acceleration will be to expanding existing government programs, some will be to create and fund new programs (such as the many new programs under Obamacare). The ideology that drives Mr Obama is that government is good and should be larger.

That ideology is what drove most congresses and presidents, regardless of their rhetoric. The chart above is what actually happened. There is no theory to it, no ideology. A century ago the government was spending about $150 per person. It will soon spend about $15 thousand dollars. This is an increase of 100 times.

The government, in other words, is 100 times stronger than it was a century ago. And since the government is, after all, just people, those people have 100 times the power. This power is increasing. Mr Obama would have it increase even faster.

The rich therefore will grow richer but fewer in number, and the poor poorer but will increase their number. Curiously, this necessary fact will be used as an argument that the rich should pay more, which will only serve to accelerate the trend.

I am not economist enough to tell you when the breaking point will be reached, but I can say that it must come if these trends continue.

Update A numerical example. Suppose you and the Mrs. and Becky and Billy comprise a household of 4. The government will spend $60 thousand dollars on your family. In order to balance the budget, your family would have to contribute $60K in taxes. But that means you and the Mrs. must pull down about $150 – $200 thousand, depending on the nature of your deductions.

But the median household income is about $50K. Thus, the government is spending about 3 to 4 times too much per household on average.

In his speech, Mr Obama said that “millionaires and billionaires should pay a little more.” Presumably, the president was using the Chicago definition of “billionaire”, which roughly means “Those individuals (not households) earning over $70 thousand.” Taking all—not some, all—the money from “millionaires and billionaires” (real ones, not rhetorical ones) would not be enough to fund the government. The rich can pay more than their fair share and it we would still fall short.

Comments

Taxing The Rich Always Fails Eventually — 33 Comments

  1. I saw a study in 1976 on government spending and it pointed out that from 1966 to 1976 government spending almost doubled While the population increased by about 10%. Between 2000 and 2010 government spending almost doubled again. The democrats evidently believe you can continue spending more forever.

    Have you ever noticed that liberals love to spend other people’s money to do good? They evidently believe that it demonstrates their careing and compassion. They believe that doing good at somebody else’s expense is moral. Helping the poor at the expense of the rich might seem noble but it’s really not.

  2. A quible – The trend is a power law type growth, not an exponential type growth. (It would be a straight line on the semi log plot if it was exponential).

    That being said, the US has put itself in an incredible bind. There will be no real changes, until the choice is taken out of the hands of the politicians. Then it will suck.

  3. Jesse,

    The plot is semi-log (the horizontal axis is linear).

    Speed,

    Love the Iowahawk!

  4. I am reminded of the old story about Nero fiddling and Rome burning. Tragic.
    Maybe BHO is not a socialist, but he sure acts like one.

  5. Revenues rarely have exceeded 18% of GDP regardless of the level of taxation. Top tax rates at 90% or 33% it doesn’t make much of a difference in receipts. The health of the economy causes receipts to drop when we enter a recession, and the more “progressive” the tax rate the sharper the drop.

    We should be trying to cap outlays somewhere near this 18% level!

    On the subject of too much confidence, I have a particular hatred of 10 year budget numbers. How do we think we can forecast the state of the economy 10, the needs of the country or international conflicts 10 years out! Even the Soviets had the modesty to stick with 5 year plans.

    Politicians love to say that they have a plan to save 4 trillion dollars. Never mind that those savings don’t kick in for another 6 years, when it will be up to a different administration to actually administer those cuts. $4 trillion sounds a lot better than the $50 billion they will actually cut in the next year.

    Cut $350 billion next year, and try to cut $350 billion the year after that, and make no claims to what you will do in 2014.

  6. “It is irrational to believe that deficits will not continue to grow on average.” If you look at the Canadian case, it has been the opposite (at least until the crisis, but things or reverting back), and budget forecasts have tended to understimate the surpluses. Seen this way, it no longer is a questioni of rational vs irrational. It’s your subjective forecast. But things can change fast (The WSJ said in 1995 that Canada was a third world country because of its uncontrolled deficits and debt!).

  7. There are so many things wrong with America and their fiscal policies are the biggest. First of all, socialism and capitalism (and democracy Joe the Plumber) are not mutually exclusive. There are a number of institutions/services that are socialised in the United States. The police service, the fire department, the library, the post office, NOAA, NASA, public schools, the military, etc, etc. If the post office was a pay per use system a letter would cost the same as a FedEx package. Why you allow people to make money off people when they get sick is beyond me. I guess that’s the motivation to help people to get better.

    The concept of socialism is not a penalty. It’s a way of maintaining a liveable and affordable society. Everyone contributes to the common good and uses services as required. Sometimes you contribute now for a time when you may find yourself in need of a particular service later, much like the insurance industry. Your taxes pay for schools even though you don’t currently have children. Your taxes pay for the marriage licence office to be open, waiting for the day you find your one true love. Like the insurance industry the government collects small payments from everyone regularly to pay for the ones who find themselves in a time of need or to provide a service.

    Capitalism allows us the freedom to earn a wage or generate profit from a business. Wages are a representation of ones labour. Profit on the other hand is the compensation for assumed risk. If you can assume someone else’s risk and provide them with a secure wage you reap their profits also. Regardless of the method, in a socialist society, we are free to generate income in the same capitalistic way. The only difference is the rich pay more in a socialist society because once you earn a certain amount of money life doesn’t get any easier or more rewarding.

    If you are smart, charming, a motivated risk taker and good at what you do, capitalism sees that you are duly compensated. On the other hand, socialism is the modulator to greed and oppression through excessive financial power. Monopolies are illegal for a reason. As an individual there isn’t much you can do with $100 million you can’t with only $50 million (except maybe bribe a few politicians… errr… donate to some political campaigns). On the other hand, the benefit to society that $50 million does in providing infrastructure, services and innovation are invaluable. Just think what 2.5% of GDP (the excess the US spends on military over the average G12 & G20 countries) could do for the American people.

    In the end there will always be those that try to game the system and take more than they give. Those people should be dealt with. There will always be waste in the system. We should find ways to eliminate that waste; we are smart people. You like to say “tax and spend”. I prefer to say “tax and provide”. Regardless, right or wrong, the system has to work. I’m just not a cold, heartless S.O.B. that can watch society crumble around me while I sit in my ivory tower on a pile of money… errr… solutions. My fellow man deserves better.

    MrC

  8. Briggs, when you post charts and tables could include a link to the original data? I’m assuming you will have just downloaded the data and the urls are in your browser history to trouble you as little as possible.

    Perhaps that should be, “to trouble you as little as possible consistent with you doing what I want” to harmonise with an earlier post.

  9. Briggs,

    This is the traditional political left rules for application on public fiscal decision. Model these and see what you get over time:

    A. The additional burden should fall on the well off. (finances in difficulty)

    B. We should provide relief to those less well off (finances in superior condition).

    Apply A and B (or null) for year 2011+i (i=1,2…100) as applicable and see what result we get.

    Don’t laugh, that is what happens. Changes to the tax system should always be “progressive” and never “regressive”.

  10. The graph you show does NOT scare me. I am not surprised to see a chart that suggests a modern technological society takes a larger amount of money to run over time.

    There are many “unbreakable,” “progressive” reasons, as you and others have mentioned. Let me mention just one more — risk orthogonality. In modern society, those that bear the brunt of risk consequences are, increasingly often, not the same as those that reap the benefits. Take Japanese nuclear power companies vs Japanese fishing companies for example. Were the fishermen being compensated adequately for the risks they were being exposed to? No. And whose fault was that? Government’s. Who stops Japanese fishermen from selling contaminated fish? Government. So the role of government in risk control, management, and remediation increases over time for high tech societies. A bigger role takes more money.

    Let me mention one graph that DOES scare me. The gap between the rich and poor. (http://www.businessinsider.com/plutocracy-reborn) Does such a graph suggest America is progressing towards a more perfect meritocracy? Could be. But many believe it shows a disturbing regression towards a plutocracy. The consequences of such a belief becoming widely held, true or not, are scary.

  11. George Crews,

    I share your fear, but I believe that the way it will be brought about is by confiscatory tax policy. The second chart in the link you gave is misleading. The top marginal rate peaks in 1944 for a good reason (see my chart), and it came down only slowly because of political “friction.”

    The more rules and bureaucracy you add into the system in a demand to make it more “progressive”, the more you concentrate power and money into the hands of the few. Progressive politics are responsible for implementing what they don’t want. The “government” isn’t a thing: it’s real people (just look at those people who benefited from the “bailout”—which you and I will pay for).

    I have the sense of your argument about high tech societies and find some truth in it. But none of those fishermen were made to take to take their jobs. And nobody was forced to buy their fish. The difficulty is looking at the most pressing problem (the contaminated fish lying on the dock) and not those underlying them (how did they come about; the entire system is an intricate web).

    Rich,

    Data is right from the IRS and Census websites. Tax data is http://www.irs.gov/pub/irs-soi/07in01etr.xls ; the budget data is here.

  12. George Crews is “not surprised to see a chart that suggests a modern technological society takes a larger amount of money to run over time.”

    One wonders, however, if our modern technological society requires as much “running” as the country’s Progressives think it does and whether that running is not in the long run detrimental to society’s functioning.

  13. This article and comments has me thinking about affect of debt on the distribution of resources.

    Debt creates a transfer from the financially inept to the financially savy, and from Main St. to Wall St.

    The rich should love more Government spending. It puts the bureaucrats in the hip pockets of the plutocrats.

  14. All I know is that if I had debt, I would need to take in more money and spend less. Naïve? Perhaps! But… how pundits and economists on both sides can come up with data to support their views!? Amazing.

  15. The budget problem is insoluble, given the size of our government.

    A variety of sources suggest that our society is split into two roughly equal parts: those paying for government and those collecting from government.

    Government programs are invariably described as requiring ‘only a few dollars from every citizen’, but there are a LOT of government programs. Hence, each civilian is responsible for coughing up a LOT of dollars to pay for them

    An equally valid method of paying for government, given the roughly equal number of payers and receivers, would be to issue a government employee to each non-government employee and make the non-government employee responsible for providing the pay and benefits to his assigned govvie. (Since there is a government equivalent for essentially every civilian job description, it would probably be feasible to match civilian and govvie jobs, so that, for example, a govvie plumber would be assigned to a civilian plumber.)

    The impossibility of ‘solving the budget problem’ is now obvious: the solution requires that the civilian contribute ALL of his income to his govvie counterpart. In reality it is worse: for almost every job description, the govvie is paid MORE than his civilian counterpart, so even a 100% tax rate would not balance the budget. What happens? Exactly what you would expect. The government has no hope of collecting enough taxes to pay for itself, so it borrows the money in the name of the civilian, thus putting the civilian in increasing debt, and inflates the currency to allow itself to pay its debts in increasingly worthless currency. The inflation side of the equation, as an intended side effect, confiscates the purchasing power of the savings of frugal citizens, while allowing them (for the moment) to retain their numerical value. Since the citizens cannot buy much with their savings, they are forced to come to the government for assistance, thus proving that only a strong (in reality, omnipotent), socialist government truly cares about its citizens and is willing to ‘help’ them. Which was the object all along.

    The simplified IRS form:

    1. How much did you make?
    2. Send it in.

    is looking less and less like a joke.

  16. Hi Briggs,

    I may be off topic. My earlier comment was not intended as a defense of redistributional tax policies, of which I am not a fan, but as a reminder of the, IMHO, overwhelming complexity of modern society. I mentioned that societal risk management is dimensionally more complex for modern societies. As another example, consider that a correct optimization theory for the economy would require it have robust predictability of both weather and climate — and look at the complexity of just the Global Climate Models. Therefore, theorizing the economy is controlled by the percentage value of government spending is of the same ilk as theorizing the fate of mankind hinges on the concentration value of a trace gas in the atmosphere. Both numbers are troubling to me, but neither are controlling.

    It has been established that monopolies are a “natural” attribute/defect of capitalism and that it is ethical to have governmental regulation to prevent/regulate/remediate them. I think that the orthogonalization of risk is a “natural” attribute/defect of technological capitalism (I include finance quants/etc. here) and that it is legitimate for government to regulate against it. The cost is whatever it takes. If too expensive, don’t introduce the tech.

  17. Just listening to John Derbyshire’s latest ‘Radio Derb’ (google this term if you don’t know , and he references this Blog and this graph. But Briggs, you ought to correct him. He characterises this Blog as most being mostly concerned with scientific matters, which I think is rather too narrow. Not to many science blogs reject The Beatles and promote fedoras.

  18. Recently saw a hypothetical:
    100% tax rate on the rich, however defined;
    100% tax rate on corporate profits; plus
    Confiscation and liquidation of the assets of the rich, however defined.

    Total: enough to run the government for 10 months, max.

    Then it’s all over; the economics graphs would nosedive, crash, and burn.

  19. Nice chart. It would also be interesting to plot spending as a percentage of GDP per capita. As the country’s wealth increases (also a compound growth process) you’d expect the real level of spending to increase as well. It would be more alarming if spending as a fraction of per capita GDP was rising.

  20. I’m still perplexed as to how Canuck can’t see that you can treat more cancer patients with $100 million than $50 million. It’s not the government’s job to decide how much of your money you can have and what to do with it.

  21. Wow. Some nice kneejerk reactions in here! Good to see that the chattering classes are so capable of informed analysis. George Crews and Christopher make some interesting points, but the rest is just really ideological noise. Sure, the US government is big and wastes a lot of money (Iraq, anyone?) Is this annoying and frustrating? Sure. Is it dangerous to US citizens? Not particularly. Try living in Stalinist Russia, or 19th C Ireland, or rural India, or any colonialized country, and see what oppressive state power actually looks like.

    So what does all that wasteful spending do? Some economists seem to be of the opinion that public goods (infrastructure, education, institutions) are necessary for economic growth and require governments to spend lots of money. Especially in big economies. And, as you point out, governments are not abstract, mathematical entities, they are people, and people screw up – especially when facing issues of incredibly vast complexity, such as maintaining the infrastructure and institutional framework required by a huge capitalist economy.

    But suck it up, people, and be glad that things are as good as they are. They could be much worse. Without such a big government, it is conceivable that capitalist enterprise, which can be very productive, but also has a tendency towards oligopoly, short-run profit seeking and economic disequilibria, could have, by the middle of the 20th C, completely undermined itself, and the US could be a third-world country with a plutocratic, kleptomaniac government. It might yet happen, but to think that it hasn’t happened yet because of good old fashioned liberty and enterprise struggling valiantly against oppressive government is just head in the sand, historically ignorant, ideological claptrap.

  22. JH, well met. There may have been a hint of the kneejerk in my own reaction. But I think the basic point is sound. Let me elaborate.

    Briggs’ argument against taxing the rich goes:

    (1) Taxing the rich increases revenue
    (2) Increasing revenue makes governments want to do more spending
    (3) More spending requires more subsequent revenue
    Rinse and repeat – its a ratchet effect.

    The interesting thing about this argument (apart from the fact that it doesn’t actually question whether taxing the rich will actually increase revenue, either in the short or the long run) is step (2). In effect, Briggs is assuming that government spending is driven entirely by bad projections – that is, it is entirely endogenous to the policy making process.

    Now, I will assert that no-one who is informed on the current debates surrounding political process and policy making can simply assume that government spending is endogenous to the big house(s). You can argue that it’s a factor. You can argue that it’s an important factor. You can argue that its the key factor. But, in the climate of the current literature, you’ve got to make an argument. You can’t just assume it. To appear to assume it is to appear uninformed.

    Now I could be making a poor assumption here myself – I am assuming that Briggs is interested in speaking to a broad audience, not all of whom follow the blog religiously. If he is just preaching to the choir, who have already had a debate over the nature of government and governance and have decided that endogenous factors are indeed the key to spending, then I apologize.

    If my assumption is not wrong, then I think my criticism holds on two counts: firstly the role of political institutions, and secondly the need for government spending.

    On the first point (which is, I think, the most important), I would tender the cautioning words of Michael T Hayes and (as cited by Hayes) Frank H Knight in my support:

    “Developing realistic expectations regarding the potential for policy change is critically important, as the late economist Frank H. Knight observed a half-century ago:

    ‘Because reliable prediction, in terms of scientific laws, is impossible, because judgement is more important than rules, the way is open for the ignorant and romantic, the wishful thinkers, to picture political measures as working out any way they feel to be desirable. One of the most vital needs in the education of the citizen is a fair knowledge of the possibilities and limitations of democratic political machinery — of government by law, based on discussion, and responsible administration.’

    Knight believed that democracies tend to breed an unrealistic sense of how the policy process works and just how much it is possible to achieve through politics: ‘Electorates educated in and by democracy tend to combine lack of respect for “politicians” with the belief that elected officials will salisfy any craving by fiat, if only the right pressure is brought to bear’.”

    Hayes argues that no matter how you reform the system, it “would not bring an end to the need for bargaining and compromise among people who don’t agree on what we should be doing as a nation or how to bring about the results we want” (p.3). He argues that “public policies necessarily evolve gradually through a pluralistic and highly conflictual process that Charles Lindblom has termed ‘disjointed incrementalism’. There are inherent reasons why this incremental process occurs that would not go away even if we made radical changes in our political institutions” (p.3).

    (Hayes, MT 2001, The Limits of Policy Change: Incrementalism, Worldview, and the Rule of Law, Georgetown University Press, Washington,
    p. 1)

    Now you don’t have to agree with Lindblom, of course. Many informed people don’t. But you need to engage with that kind of argument. (And it’s not just Lindblom who points to inescapable institutional dilemmas within policy making, but he’s a good example.) Without engaging with those kind of arguments, you just look like you’re falling into Knight’s criticism of having an “unrealistic sense of how the policy process works”.

    It’s not all about the projections (or any endogenous factors). Not in any obvious, assumable way, anyway. There are other factors at work, and if you don’t engage with those other factors – even if only to show why they are not the key factors in this case – then the assumption of those outside the choir will be that you’re uninformed.

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  24. Ironman has a slightly different visualization:

    http://politicalcalculations.blogspot.com/2010/09/biggest-issue-of-2010-in-one-chart.html

    Bluepants:

    “As defense analyst Colin Gray Writes in a recent book about the near-term possibilities of major conflict, “Another Bloody Century,”* when considering optimism and pessimism, ‘optimism is apt to kill with greater certainty.’”

    – “Fear of China” by Robert D. Kaplan in The Wall Street Journal, on page A14, on April 21, 2006.

    * ISBN 0297846272

    The numbers don’t lie. S&P is starting to get worried, and you know hard it is to worry them.

    http://www.reuters.com/article/2011/04/18/us-ratings-usa-sp-idUSTRE73H2JT20110418

    I think the US Government is heading for a regime crisis. Just remember, Philip II, with the entire Western Hemisphere to loot, managed to go bankrupt four times.

    http://en.wikipedia.org/wiki/Phillip_II_of_Spain#Economy

  25. Walter Sobchak, the numbers do not, indeed, lie. The numbers do not say anything. They’re just numbers. That’s the whole point, is it not, of statistics? To make the numbers say something?

    The US budget crisis is, indeed, worrying. Very, very worrying. No cause for optimism at all there. And the US may well be heading for a regime crisis – although my personal take is that it would be really hard to shake things up too much unless you somehow manage to convince a hell of a lot of people in the military that things would be better some other way.

    But what does any of that have to do with the argument that the budget deficit is caused by over-projections, and that those projections are caused by too much taxing?

    My only point was that if you don’t understand how the policy process works – if you think that the only relevant factors are endogenous to the inner sanctum, for example – then you can rip the whole thing down as often as you want but you’ll just end up with the same problem tomorrow.