You Can't Soak the Rich - A Response (Part 2)

The seemingly close correlation between the total effective tax rate and total revenues (mentioned in my prior post) leads to another surprising fact. Suppose that the correlation can be represented by the following formula:

effective_rate = k * (taxes_paid / GDP), where k is a constant

Putting in the CBO's definition of effective rate, this becomes

(taxes_paid / household_income ) = k * (taxes_paid / GDP)

which becomes

(household_income / GDP) = (1/k), where (1/k) is a constant

Hence, it would appear that household income as a percentage of GDP has remained relatively constant since 1980. This is verified by the following graph:

The actual numbers and sources are at http://www.econdataus.com/inctax04.html. As can be seen, personal income as a percent of GDP has been relatively stable since 1950 (especially since 1980). If you lower the rates on one part of that income, it would seem that you would have to raise rates on another part of the income or change the amount of personal income that is taxable in order to keep the same amount of revenue.

In fact, I believe that the relative stability of revenue is largely due to a purposeful strategy by those who implement tax changes. For example, the cut in the top marginal rate from 50 to 28 percent in the Tax Reform Act of 1986 represented a proportional cut of 44 percent. If all rates had been cut by this amount with no changes in deductions or other tax measures, revenue would have fallen by about 44 percent in the first year, even if positive effects began to kick in going forward. This would have likely had serious political, if not financial, consequences. Hence, our politicians never make quite that unbalanced a tax change. According to page 13 of this Treasury document, the Tax Reform Act of 1986 also included a number of tax hikes such as the repeal of the sales tax deduction for individuals. This made it close to revenue-neutral.

The 1981 tax cut, on the other hand, was estimated by the document to have a large negative effect on revenue. However, it was followed by the Social Security tax hike of 1983 and the Deficit Reduction Act of 1984, both of which were estimated to have a significant positive effect on revenue. Hence, the general stability of revenue as a percent of GDP appears to be largely the result of a conscious tax policy, not a magical "Hauser's Law".

You Can't Soak the Rich - A Response (Part 3)

You Can't Soak the Rich - A Response

On May 20th, the Wall Street Journal ran an editorial titled "You Can't Soak the Rich". The article recalls that Kurt Hauser, a San Francisco investment economist, had stated on "this page" in 1993 that "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." As evidence of this, a chart is included which shows federal tax revenue and the top marginal rate from 1950 to 2007. Based on the this chart, the article goes on to state:

The data show that the tax yield has been independent of marginal tax rates over this period, but tax revenue is directly proportional to GDP. So if we want to increase tax revenue, we need to increase GDP.

In fact, this editorial is very reminiscent of one than ran less than a month ago titled "Obama's Tax Evasion". Both supported the proposition that tax cuts can increase revenue and both included a chart showing the relationship between two variables. And in both cases, the two variables selected were not comparable and only marginally related to the topic. That is, in both cases, the chart chose to compare apples and oranges and use this to reach a conclusion about bananas.

I addressed the problems with the prior editorial here. To explain the problems with this editorial, it helps to look at the following chart:

The actual numbers and sources are at http://www.econdataus.com/effrev05.html. The yellow line in the above chart corresponds pretty closely to the revenue line in the Wall Street Journal chart. Both appear to be in the 19.5% of GDP region. However, revenue do not seem anywhere near as flat in my chart as they appear in the Journal's chart. The reason for this is that my chart covers a range of just 14 percent of GDP while the Journal's chart covers a range of 90. Why didn't they use two scales as they did in the prior editorial? A cynic might say that they wanted to show a relationship in that chart but wanted to show no relationship at all in this chart.

In any event, I would contend that the biggest problem with the Journal's chart is the use of the top marginal rate. This rate tells you absolutely nothing about the levels of the other tax brackets or other changes in the tax code. A much better measure is the effective tax rate. A brief definition of effective tax rate is given here as "actual income tax paid divided by net taxable income before taxes, expressed as a percentage". Following is a more complete definition from page 4 of the source of the data in my chart:

Effective tax rates are calculated by dividing taxes by comprehensive household income. Comprehensive household income equals pretax cash income plus income from other sources. Pretax cash income is the sum of wages, salaries, self-employment income, rents, taxable and nontaxable interest, dividends, realized capital gains, cash transfer payments, and retirement benefits plus taxes paid by businesses (corporate income taxes and the employer's share of Social Security, Medicare, and federal unemployment insurance payroll taxes) and employee contributions to 401(k) retirement plans. Other sources of income include all in-kind benefits (Medicare, Medicaid, employer-paid health insurance premiums, food stamps, school lunches and breakfasts, housing assistance, and energy assistance). Households with negative income are excluded from the lowest income category but are included in totals.

In the above chart, the purple line is the effective rate that corresponds to the yellow line showing revenue from all federal taxes. Similarly, the blue line is the effective rate that corresponds to the red line showing the revenue just from individual income taxes. Note that the first two variables use the right scale and the second two use the left scale. As can be seen, an amazing thing happens when you compare the proper variables of the effective tax rate and the corresponding revenue. There is a very close positive correlation. That is, the effective tax rate and the corresponding revenue tend to go up and down together by similar amounts.

Of course, one could still contend that tax cuts can increase GDP growth. That would mean that, even though a cut in the effective tax rate would decrease revenue as a percent of GDP, that would be as a percent of a larger GDP. The issue of whether or not tax cuts appear to have noticeably effected GDP is addressed here. In any event, this is not what is proposed by "Hauser's Law" which the editorial's author stated is "as central to the economics of taxation as Boyle's Law is to the physics of gases". Hence, "Hauser's Law" as put forth by this editorial appears to be flatly false. Fortunately, Boyle's Law seems likely to hold up much better.

You Can't Soak the Rich - A Response (Part 2)

You Can't Soak the Rich - A Response (Part 3)

Are the 52 Months of Job Growth Under Bush Significant?

Early into his 2008 State of the Union, President Bush said the following:

To build a prosperous future, we must trust people with their own money and empower them to grow our economy. As we meet tonight, our economy is undergoing a period of uncertainty. America has added jobs for a record 52 straight months, but jobs are now growing at a slower pace.

On February 1st, the Bureau of Labor Statistics released new jobs figures for January, showing a loss of 17,000 jobs. This ended the streak but Bush continued to mention the record of 52 consecutive months, often crediting it to his tax cuts. For example, on February 8th, Bush said the following during remarks to the Conservative Political Action Conference:

Despite these dire predictions, the tax cuts we passed contributed to a record 52 months of job creation. (Applause.) They helped produce strong economic growth -- and the increased revenues from that growth have put us on track to a balance our budget by 2012. (Applause.) Here is the bottom line: tax relief works. (Applause.)

Bush similarly mentioned the 52 month record and the role that his tax cuts played in bringing it about on February 25th and March 12th as did Vice President Cheney on March 10th and April 25th. It was of course mentioned by a number of other sources as well.

Was this 52 month record truly a significant achievement, surpassing the oft-mentioned job creation under Reagan and Clinton? Following is a graph generated on the Bureau of Labor Statistics website showing the monthly job growth in total nonfarm jobs since 1980:

Monthly Growth in Total Nonfarm Employment, Seasonally Adjusted (in thousands)

The actual numbers and sources are at http://www.econdataus.com/jobgro50.html. As can be seen, there were 52 consecutive months of job growth under Bush, from September 2003 to December 2007. However, Clinton missed having 86 months of consecutive job growth (from April 1993 to May 2000) by just three slight monthly declines of 16, 18, and 19 thousand jobs. And Reagan (combined with H.W. Bush) missed having 82 months of consecutive job growth (from September 1983 to June 1990) by just one monthly decline of 93 thousand jobs.

Did Bush's tax cut provide some special protection against small monthly declines? To answer this, one must first be aware of the fact that the job numbers are "seasonally adjusted". Without seasonal adjustment, the numbers would show a loss every January, at the end of the holiday season. In fact, they show a loss in every January on record (since 1940) and losses of over 2 million in every January since 1990.

Secondly, the method for calculating the seasonal factors changed in June 2003, just 3 months before the 52 month record started. The following explanation can be found on the Bureau of Labor Statistics website:

Concurrent seasonal adjustment

Beginning in June 2003, the CES program converted from its current practice of updating seasonal factors twice a year to updating them every month. Concurrent seasonal adjustment is technically superior to semiannual updates because it uses all available monthly estimates, including those for the current month, thereby eliminating the need to project the seasonal factors. With the introduction of concurrent seasonal adjustment, BLS no longer publishes seasonal factors for CES national estimates. For more information, please read the following paper on concurrent seasonal adjustment. (HTML) (PDF 182K)

Following is an excerpt from the first link:

As Table 1 illustrates, concurrent adjustment produces a smoother seasonally adjusted series for Total Nonfarm plus all nine industry divisions. Taken with the results from Figure 1, this indicates that CES will benefit from a switch to concurrent seasonal adjustment by producing employment series with less variability in the over-the-month changes.

Hence, the 52 month record may be largely due to this change to concurrent seasonal adjustment. In any event, the above graph seems to show that the average monthly growth was higher under Reagan and Clinton. This can be seen much more clearly in the following graph which shows the 12-month growth in jobs since 1950:

12-Month Growth in Total Nonfarm Employment, Seasonally Adjusted (in thousands)

As can be seen, average job growth was clearly higher under Reagan and Clinton. This is also clear from my prior post of March 18th. In addition, the above graph shows that the length of positive job growth was much longer under Reagan and Clinton if one uses a longer unit of time (12 months in this case).

In summary, it seems clear that the record of 52 consecutive months of job growth is not indicative of superior job growth. Consecutive months of positive job growth is just one of many indicators and, in my opinion, one of the more flawed and least significant. Some would call the use of this statistic while ignoring other statistics to be cherry-picking. At the very least, it shows the importance of examining the data yourself and/or getting opposing views on any statistics that one comes across in the political arena.

Do Capital Gains Tax Cuts Raise Revenue? (Part 3)

In my prior post, I referenced a chart in an April 18th Wall Street Journal editorial titled "Obama's Tax Evasion". The same basic chart shows up again in a May 6th video clip from CNBC. The chart first appears about 4:45 into the clip and reappears at about 6:09, near the end of the interview. At that point, the host Trish Regan is speaking with John Irons from the Economic Policy Institute. Following is an excerpt of the conversation:

Trish: John, there we go with that capital gains history graphic that I was telling you about, very interesting stuff here because it's showing you, the more you tax, the less you take in.

John: Well again, the problem with that is that it's cherry-picking the timing on this. When you look over longer-run periods of time, if you do lower the capital gains tax rate, you will see lower revenue over the long run.

Trish: Yes, that said, it did go all the way back to 1962 so it was, you know, it did have some history in it.

The chart does go back to 1962 but John Irons is correct that the changes that the chart shows are short-term changes. For example, realizations spiked in 1986, just before the increase in the tax rate was to take place and peaked over the course of the stock market boom in the late nineties. But neither increase in revenues held.

In any case, this once again brings up a couple of serious problems with the chart. As mentioned in my prior post, the chart shows the capital gains realizations, not the taxes derived from those realizations. Since tax revenues are the chief focus of the debate, that is what we should be looking at. In addition, the chart shows the maximum capital gains tax rate but leaves out the descriptor maximum. This gives no information about the other tax rates that are contributing to capital gains tax revenue. Hence, if one looks just at the maximum capital gains rate, one should look just at those revenue that are paid at that rate. As that data is probably not available, it's likely best to look at total tax revenue compared to the average capital gains tax rate. This is shown as the purple line in the chart in my prior post. That posts also lists additional problems with the Wall Street Journal chart.

It's understandable that a person could look at the chart and, on first impression, think that there was something of an inverse relationship between capital gains tax rates and revenues (mistaking realizations for revenue). However, it's disturbing that so many people in the media seem unable to investigate the facts beyond looking at a simplistic chart. That especially goes for media who are mediating presidential debates and reporting in financial newspapers and on financial cable networks. It will be interesting to see if any of those in the media will admit that the issue is a bit more complex than they have portrayed. Lacking that, they should at least fix the chart so that the variables are correctly labelled and are in fact the variables that they are talking about.