Spending and Deficits Force a Rethink of Hauser's Law
"at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments." - Ibn Khaldun
President Obama's latest budget proposal has brought government spending, and the very real economic burden that the latter entails, back into the news. And with debate about spending and the proper role of government set to resume, it's perhaps proper to rethink the alleged good of bounteous federal revenues.
As numerous economic thinkers have observed in modern times, there's a very consistent quality to federal revenue collection. My H.C. Wainwright colleague David Ranson has termed the latter "Hauser's Law" after Kurt Hauser, the San Francisco money manager who first discovered the empirical reality concerning tax collection.
Specifically, Hauser found that no matter the headline tax rate on income, the federal government has for decades been the recipient of roughly 19 percent of GDP. Given this historical truth, the logical argument made here and elsewhere is that since Treasury will receive 19 percent of GDP no matter the tax rate, the best plan is to maximize revenues by seeking the income tax rate that is most economically stimulative.
To put it more clearly, expand the economic pie as a way of expanding government revenues. On its face this thesis is hard to argue with.
But given a second pass it's fair to say that the argument paradoxically presents problems for the long-term health of the U.S. economy. Perhaps even more oddly, the problems result from the extreme economic productivity of the American workforce.
Simply put, Americans generate a lot of taxable wealth, and those revenue streams that flow toward the federal government are what make it so easy for Washington to consistently spend at levels well beyond the government's annual collections. We have budget deficits for sure, but what might need to be rethought is why we do.
Why does the U.S. annual run nosebleed budget deficits?
The answer to the above question seems an obvious one, and that's true regardless of one's ideology. Different conclusions will be drawn here, but the answer to the non-riddle seems to settle on a federal government spending beyond what it collects on an annual basis.
Of course many on the left would argue that the deficits could be closed if only we taxed top earners more. Evidence supporting this resides in the Clinton years when briefly our federal government went into surplus after our 42nd president succeeded in raising the tax on the largest incomes to 39.6 percent.
The problem with this theory is that during the 1960s and ‘70s, when the highest tax rate on the biggest earners fell in the 70 percent range, is that the federal government ran large budget deficits. After that, military spending reductions that to some degree were made possible by heavy spending on same in the '80s help to discredit the taxation argument made by the left. It's also the case that revenues really skyrocketed once a lower capital gains tax was implemented in 1997; the lower rate an incentive for those with gains to sell appreciated holdings, and in doing so, generating taxable events.
On the right, many attribute large budget deficits to Washington's addiction to spending, but rather than starve the addiction, they seek revenue maximization through tax rates that maximize economic activity. It's fair to argue that both sides miss the point.
Indeed, while it's tautological that budget deficits result from Congress spending beyond its means, what's not so clear is why U.S. deficits are so easily financed. One argument that seemingly doesn't achieve a lot of exposure is that we have nosebleed budget deficits not because Treasury doesn't collect enough in the way of revenues, but precisely because our tax system has over the years proven too successful at collecting revenues.
The Federal Income Tax
As noted earlier, whether it was the 90 percent income tax rate that prevailed in the 1950s, or the 28 percent top rate that was achieved in 1986, Washington's revenue take has historically settled around 19 percent of GDP. But rather than cheer this empirical reality, we should instead be concerned.
If it's acknowledged that the Founding Fathers wrote the Constitution to first authorize the federal government, then bestow on it very limited powers, 19 percent of our GDP is far too large of a number for a government that is supposed to be severely limited in scope. That Treasury collects this amount yet our federal government still runs major deficits is a strong signal of a government operating well beyond constitutional limits.
For evidence supporting the above claim, we need only consider the Departments of Energy, Education and Commerce, not to mention Fannie Mae, Freddie Mac, Social Security, and most recently, ObamaCare. Whatever one thinks of the good or bad of any of these, the simple reality is that nowhere in the Constitution is the federal government authorized to involve itself in how we educate ourselves or power our cars, and it's similarly not empowered to inform our retirements or how we tend to our individual health.
But politicians being politicians, it's inevitable that they'll devise ways to dole out favors (the positive electoral effect for doing so very much debatable), and their ability to do so is greatly enhanced by a tax code that raises government revenues in impressive amounts. If the money's there, politicians will spend it, and huge revenue streams have over the decades led to a massive increase in the government's footprint.
A conclusion that could be made here is that the political class has proven very skillful at raising revenues from the citizenry, but this is not something to embrace. These gargantuan revenues are what enable the federal government to operate well beyond its means, and constitutional limits.
Why Budget Deficits?
Once again, the easy answer to this question is to reply that we have deficits because government is too big, that its obligations have grown too large, and that it's spending beyond what it takes in to fulfill those obligations. If so, a similarly easy reply is that to put the budget in balance, we must figure out a way to maximize revenue intake.
Of course the problem with the latter reply is that it's no longer valid. Indeed, it doesn't take a political scientist to note that at least going back to FDR, every single president and presidential candidate has promised to rein in spending. But be they Democrats or Republicans, spending has continuously risen, as have budget deficits most of the time.
Conventional wisdom has of course pointed to a mismatch between revenues and monetary outflows, but wouldn't it be more true to say that our deficits are easily financed precisely because Congress has successfully devised a tax code that is brilliant at prying taxable revenues from the most economically productive society on earth? In short, we have budget deficits largely because investors see U.S. debt as a great bet no matter our periodic dollar devaluations underlying that debt.
They see our debt as good because with the bloated federal government effectively a front or proxy for the most economically advanced society on earth, the revenues to pay off the debt will always be there. We're able to run deficits because within the U.S. private sector we're enormously productive.
But none of this has accrued to the long-term health of our economy. Because Washington is able to spend nosebleed sums on the assumption of an ever wealth-creating private sector we now suffer the monstrosities that are Medicare, Social Security, Fannie/Freddie, and all manner of capital destroyers that ultimately detract from our economy's ability to grow.
In short, the government's ability to collect 19 percent of GDP annually speaks to a problem, not a solution. A government so successful at taxing the citizenry is one that can also spend a lot of money in wasteful, deficit increasing, economy-sapping ways. There has to be another solution.
A Consumption Tax?
One form of taxation that has not been tried in modern times is a national consumption tax. The first glance advantages are of course positive.
For one, an income tax is a price placed on productive work effort. Worse, considering what monumental wealth generators Americans tend to be, such a tax is a grand source of revenue that allows our government to harshly expand its footprint on our economy.
And then not discussed enough is how successful it is at securing revenues from the "vital few", or the greatest wealth producers with the most productivity to tax. Supply-siders often brag about how much our tax code at present takes from the top 1 percent (at present the number is around 40 percent of total federal income tax revenues), but this isn't something we should be proud of.
Not asked enough is why the rich owe so much more than everyone else. Instead, it should be said that by virtue of growing wealthy the rich have conferred myriad benefits on society through lifestyle enhancing innovations and jobs, so to then hit them with a major portion of the tax bill seems backwards.
Better it would be to let taxation on the national level be voluntary. The more one consumes, the more one pays.
Such a tax would firstly support the most economically beneficial act of all which is to encourage saving. It is through savings that we expand the capital base necessary so that good ideas can be matched with investment, and a consumption tax would aid just that.
Second, a consumption tax would be the one way that the citizenry could limit the ability of the federal government to collect revenues. If in place, it's not unfair to assume that Treasury's ability to sell bonds necessary to fund a government that always seems to grow would be reduced. If so, as in if Treasury debt is made less attractive to investors, credit would migrate elsewhere; logically toward economic concepts that tend toward wealth creation rather than capital destruction.
Third, assuming an economic downturn, downturns regularly coinciding with reduced consumption, the federal government would be forced to get by on a smaller budget alongside Americans similarly making do with less. This alone speaks to recessions shorter in duration.
Indeed, as past columns have revealed about the 1920-21 US recession, it was then that government spending was cut in half in response to the economy's recessed condition. Of course with funds left in the private sector as a result, the subsequent rebound was rather powerful, and with a consumption tax we could perhaps count on something similar.
For too long the tax and revenue consensus has settled on ways for the government to raise as much revenue as possible. Irrespective of the political party in control, the suggested plan for increased revenues has been one of reducing the federal budget deficit.
But as history has revealed in ugly fashion, politicians have very little discipline when it comes to spending, and the extra revenues have largely been used to expand existing government programs, or fund new ones. As for the deficits themselves, they've arguably been the result of investor belief that politicians are at the very least good at raising revenues from the productive class, thus making our deficits a good bet if markets are to be believed.
In that case it's time to look for modes of taxation most stimulative to economic effort, but that don't stimulate government growth through heavy revenue collection. A consumption tax would remove the existing penalty on work, would encourage savings and investment, but at the same time would make taxation a voluntary event, thus limiting not just government revenues, but also the government's ability to deficit spend given the limits imposed.
Politicians have once again shown no ability to reduce spending on their own. It's perhaps a good idea at this point to search for a tax to limit the economy retarding spending that bounteous revenues enable among politicians.