My good friend and co-blogger Too Short and I got into an argument yesterday over whether President George W. Bush's administration will go down as one of the worst in American history. Among other things, Too Short objected strenuously to the income tax cuts that President Bush shoved through Congress a few years back. Evaluating the alternative takes some mental heavy lifting, so get ready to push uphill against the big-government mindset.
To my buddy's way of thinking, income tax cuts for "the rich" are a Bad Thing™ in a time of war, and we Americans should follow our grandparents' example during World War II and "sacrifice for the war effort" ... translated as "pay more taxes." Now I don't recall Too Short advocating a revival of programs like rationing and price controls and the WPA, which all went together with the 1930s-1940s package. Then again I might have just missed it when he said it. He wouldn't be the first to substitute wishful thinking for free market realities.
I argued that income tax cuts in wartime are not inherently a Bad Thing™. When taxes in general are excessively high, economic activity tails off as people lose their incentive to work, save, and invest. Next, government revenues shrink because the total amount of money available for taxation has shriveled. The big government advocate instinctively responds by raising taxes, which deepens the downward spiral (the Laffer Curve illustrates the general concept nicely).
If you're a government official trying to fund a wartime military machine, having no tax revenue is truly a Bad Thing™. A logical government in that situation lowers tax rates to stimulate the economy and raise tax revenues. Now it can buy guns and butter and F-22 Raptors. Pretty straightforward stuff so far, right?
My compadre Too Short retorted that I wasn't figuring in federal payroll taxes, which tend to hammer the poor. It was a point well taken since so far I was only talking about income tax cuts. I couldn't puncture his counterclaim because I didn't have the necessary data at my fingertips, so I asked for a temporary ceasefire.
I went looking for ammunition, and to my surprise I found that I was far more right than I realized.
The Tax Foundation pored over the dry, dusty tax and spending data collected by all levels of American government between 1991-2004, and they found that for every $1.00 of taxes that the poorest Americans forked over, they got $8.21 back.
While the U.S. tax system is progressive, the distribution of government spending makes the overall fiscal system more progressive than is apparent from tax distributions alone. Using a microdata model we estimate the distribution of federal, state and local taxes and spending between 1991 and 2004. We find households in the lowest quintile of income received roughly $8.21 in federal, state and local government spending for every dollar of taxes paid in 2004, while households in the middle quintile received $1.30, and households in the top quintile received $0.41. Overall, tax payments exceeded government spending received for the top two quintiles of income, resulting in a net fiscal transfer of between $1.031 trillion and $1.527 trillion between quintiles. Both taxes and spending appear to have large distributional effects on households, and these effects have grown since 1991. The results suggest tax distributions alone are an inadequate measure of progressivity, and policymakers should examine both tax and spending distributions when judging the overall fairness of policy toward income groups.
Did you catch that? Yes, payroll taxes hit poorer people harder than they hit rich people. But when you account for all federal, state and local taxes and government spending on entitlements, my pal Too Short's idea of "increasing our sacrifices" via higher taxes on "the rich" just doesn't cut it. The folks at the lower end of the income scale more than make up for their payroll tax losses, and the folks higher up the line get royally hosed.
Remember that those dastardly "rich people" that our leftist friends love to hate are the very ones who risk their capital to create businesses, conduct research on new technology, and hire the rest of us. Without "the rich" we don't produce the best bullets and boots and cell phones. Without "the rich" our economy loses its advantage over the rest of the world.
Look at how we punish success:
Let that sink in for a moment. Does that seem like a wise idea in peacetime? How much less so in the middle of fighting a war!
Now look at it another way. Focus on the blue bars below:
Don't repeat my initial mistake by looking at tax rates alone. You'll miss the big picture. Always, always, always figure in government spending when you're trying to figure out how to pay for a war. Our steeply progressive tax-and-spend system takes money from America's most productive people and showers it on the least productive. While you can make a good argument for keeping some parts of the social safety net, we're way beyond the point of absurdity now.
Here's a slightly more detailed summary of the report:
While many studies answer the question of who pays taxes in America, the question of who gets the most government spending is often overlooked. Just as some Americans bear a larger portion of the nation's tax burden than others, some Americans also receive a larger share of the nation's government spending.
This report summarizes the key findings of a comprehensive 2007 Tax Foundation study of federal, state and local taxes and government spending. The results show that when we consider the distribution of government spending as well as taxes, it provides a dramatically altered view of how U.S. fiscal policy affects Americans at different income levels than is apparent from the distribution of tax burdens alone.
Overall, we find that America's lowest-earning one-fifth of households received roughly $8.21 in government spending for each dollar of taxes paid in 2004. Households with middle-incomes received $1.30 per tax dollar, and America's highest-earning households received $0.41. Government spending targeted at the lowest-earning 60 percent of U.S. households is larger than what they paid in federal, state and local taxes. In 2004, between $1.03 trillion and $1.53 trillion was redistributed downward from the two highest income quintiles to the three lowest income quintiles through government taxes and spending policy.
These findings suggest tax distributions alone do not tell Americans how much the nation's fiscal system is helping or hurting low-income households. To answer that, we must look beyond tax burdens to government spending as well. Lawmakers who ignore the distribution of government spending risk making policy judgments based on an incorrect set of facts about the United States fiscal system.
In my buddy Too Short's defense, he joined me in criticizing runaway federal spending that makes drunken sailors look frugal. Reasonable folks are tired of creeping socialism, and we expect to see some real spending cuts before 2009's over. And I'm not talking about the Washington version of "cuts."
So what's the bottom line? Income tax cuts are still a good idea, and so are cuts in entitlement spending. If we do both, the economy will surge forward and government revenue will increase along with it. That translates into much more money available for the military. Seventy-year-old notions of "sacrifice" will punish the most productive Americans and further erode our military readiness.
Sorry, old buddy. You lose this round.
Tax Foundation report and accompanying Frequently Asked Questions
Update: TooShort's response