Neil Reynolds’ Free Lunch

Neil Reynolds’ latest Globe column promotes the myth of costless tax cuts by replicating Kurt Hauser’s month-old Wall Street Journal op-ed. “Hauser’s Law” is the notion that American federal tax revenues have consistently been about 19% of GDP since World War II despite significant changes in statutory tax rates.

The implication is that higher tax rates simply prompt more tax avoidance and evasion, which also reduce GDP. The government might as well cut taxes and collect 19% of a larger GDP.

But Hauser’s Law has been debunked. US tax cuts have significantly reduced revenue relative to GDP.

Reynolds’ only original material is the second-last paragraph, which asserts that Hauser’s Law applies to Canada:

On average, we remit to the federal government only 16.6 per cent of GDP in taxes regardless of rates. In the 1960s, it was 15.9 per cent of GDP. In the 1970s, 17.3 per cent. In the 1980s, 15.5 per cent. In the 1990s, 17.7 per cent. (From 2001 through 2009, reflecting a serious recession, revenue from all tax sources fell to 14.3 per cent.)

Is he suggesting that Canada was in recession for a decade? In fact, the recession was only in 2008 and 2009.

But federal revenue was lower relative to GDP throughout the 2001-2009 period because the federal government cut tax rates. So, Reynolds’ own numbers disprove his presentation of tax cuts as a free lunch.

He also manages to add another error in attempting to paraphrase Hauser’s op-ed: “. . . the [US] capital-gains tax rate was increased to 28 per cent from 20 per cent in 1987. Capital gains tax revenues, as a percentage of GDP, fell to 3 per cent from 8 per cent.”

Of course, capital-gains tax revenues have never been 8% of GDP. If so, they alone would have comprised more than one-third of US federal revenues.

Here is what Hauser had written: “Capital gains realizations as a percent of GDP fell to 3% in 1987 from about 8% of GDP in 1986.” (Capital gains are realized when an owner sells stocks, property or other assets for a higher price than he or she had paid. Realizations are the total base to which capital-gains taxes apply.)

Finally, it is dubious to suggest that a higher capital-gains tax rate caused realizations – and hence tax revenues – to fall in 1987. Black Monday, the largest one-day decline in stock-market history, presumably accounts for at least some of that year’s decrease in capital-gains realizations.

3 comments

  • It depends where on the curve tax levels are. Capital taxes are eaisly prone to this…… Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more–and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss.’”

  • I agree that raising tax rates above a very high level could reduce revenue. However, neither Canadian nor American taxes are anywhere near that high. In other words, we are clearly not on the wrong side of the revenue-maximization curve.

    Anyway, Reynolds and Hauser are not just arguing that lower tax rates could generate more revenue from a larger GDP. They are claiming that cutting tax rates would not even reduce the ratio of tax revenue to GDP.

  • Hi Erin,

    I did not mean to suggest that Reynolds and Hauser were correct. Only that such a curve can and does exists.

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