December 31, 2002

Twenty Years After Supply-Side Revolution, Washington Still Favors Higher Taxes

The U.S. has the most sophisticated financial markets in the world. Yet, its financial reporters and financial policymakers are anything but sophisticated.

In a recent Wall Street Journal article (Dec. 19), reporters Jeffrey Ball and Karen Lundegaard confused depreciation--a business expense--with a reduction in the price of a consumer product. Business owners, the journalists reported, could get up to $21,560 “off the price of a big sport-utility vehicle.”

Failing to realize that depreciation of equipment is neither a tax break nor a reduction in price, the reporters went on to complain that fuel inefficient SUVs received larger tax breaks than fuel efficient hybrid gas and electric cars, again repeating their confusion of a business expense (depreciation) with a tax incentive.

Before laughing at the Wall Street Journal’s financial sophistication, or lack thereof, save a hearty guffaw for your government in Washington.

Did you know that the Treasury’s Office of Tax Policy and Congress’ Joint Committee on Taxation are filled with experts who cannot calculate the impacts that changes in tax policy have on tax revenues, saving, consumption, and economic growth?

Ask the experts who occupy these important policy positions what relative prices and, thereby, incentives change when marginal income tax rates are raised or lowered, and you will draw a blank stare. The economic policy of the United States is calculated on the back of an envelope with the assumption that changes in taxation do not change economic behavior.

The experts maintain that if tax rates rise, the same amount of income is taxed more, thus revenues rise. If tax rates are lowered, the same amount of income is taxed less, thus revenues are lost.

It is a disgrace that these static estimates are still in use twenty years after the successful supply-side revolution ushered in by President Reagan.

A recently published Cato Institute policy analysis, “Reforming the Federal Tax Policy Process” by David R. Burton, urges that dynamic estimation replace the ancient static analysis that severely handicaps the performance of our economy.

Under present practice, it is impossible for policymakers to acknowledge what helps and what hurts the economy.

Indeed, there is a bias toward higher tax rates inherent in static analysis. The assumption that higher taxes do not negatively impact economic behavior permits policymakers to claim that higher taxes benefit the economy by lowering the budget deficit (or public debt) and reducing interest rates.

Dynamic estimates are being held hostage by class warfare. Dynamic estimates would show that raising taxes on “the rich” impair the job opportunities and income growth of the nonrich. Once this is made clear, “soaking the rich” loses its political appeal, and the propagandistic basis of the redistributionist welfare state collapses.

The political left is too heavily invested in propaganda and redistribution to permit modern economic calculation to enter the offices of Treasury’s Office of Tax Policy and Congress’ Joint Tax Committee. Consequently, the U.S. economy hobbles along impaired by static estimation. Every 20 years or so, the government suspends the static logic and renews the economy with a supply-side tax cut, thus reaping the economic benefits that static estimation denies.

It would make far more sense, and produce a happier polity, to adopt dynamic analysis and open the calculations to oversight and public debate. It would do wonders for the economics profession as well.

Dynamic analysis would do more for “the pursuit of happiness” than removing Saddam Hussein as secular ruler of Iraq. Indeed, the U.S. can buy Hussein as an ally for much less money than will be spent on invading Iraq.

President Bush would win more kudos from the electorate from turning the economy around than he will from getting American sons, husbands and fathers killed in an Iraqi desert.

The risk of American forces becoming a permanent fixture in the Middle East is real, and the tax burden of that will make the economy static.

Paul Craig Roberts is the author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow’s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.