There's No Escaping Hauser's Law
Even  amoebas learn by trial and error, but some economists and politicians do  not. The Obama administration's budget projections claim that raising  taxes on the top 2% of taxpayers, those individuals earning more than  $200,000 and couples earning $250,000 or more, will increase revenues to  the U.S. Treasury. The empirical evidence suggests otherwise. None of  the personal income tax or capital gains tax increases enacted in the  post-World War II period has raised the projected tax revenues.Over  the past six decades, tax revenues as a percentage of GDP have averaged  just under 19% regardless of the top marginal personal income tax rate.  The top marginal rate has been as high as 92% (1952-53) and as low as  28% (1988-90). This observation was first reported in an op-ed I wrote  for this newspaper in March 1993. A wit later dubbed this "Hauser's  Law."Over this period there have been more than 30 major changes  in the tax code including personal income tax rates, corporate tax  rates, capital gains taxes, dividend taxes, investment tax credits,  depreciation schedules, Social Security taxes, and the number of tax  brackets among others. Yet during this period, federal government tax  collections as a share of GDP have moved within a narrow band of just  under 19% of GDP.Why? Higher taxes discourage the "animal  spirits" of entrepreneurship. When tax rates are raised, taxpayers are  encouraged to shift, hide and underreport income. Taxpayers divert their  effort from pro-growth productive investments to seeking tax shelters,  tax havens and tax exempt investments. This behavior tends to dampen  economic growth and job creation. Lower taxes increase the incentives to  work, produce, save and invest, thereby encouraging capital formation  and jobs. Taxpayers have less incentive to shelter and shift income.On  average, GDP has grown at a faster pace in the several quarters after  taxes are lowered than the several quarters before the tax reductions.  In the six quarters prior to the May 2003 Bush tax cuts, GDP grew at an  average annual quarterly rate of 1.8%. In the six quarters following the  tax cuts, GDP grew at an average annual quarterly rate of 3.8%. Yet  taxes as a share of GDP have remained within a relatively narrow range  as a percent of GDP in the entire post-World War II period.This  is explained once the relationship between taxes and GDP growth is  understood. Under a tax increase, the denominator, GDP, will rise less  than forecast, while the numerator, tax revenues, will advance less than  anticipated. Therefore the quotient, the percentage of GDP collected in  taxes, will remain the same. Nineteen percent of a larger GDP is  preferable to 19% of a smaller GDP.The target of the Obama tax  hike is the top 2% of taxpayers, but the burden of the tax is likely to  fall on the remaining 98%. The top 2% of income earners do not live in a  vacuum. Our economy and society are interwoven. Employees and  employers, providers and users, consumers and savers and investors are  all interdependent. The wealthy have the highest propensity to save and  invest. The wealthy also run the lion's share of small businesses. Most  small business owners pay taxes at the personal income tax rate. Small  businesses have created two-thirds of all new jobs during the past four  decades and virtually all of the net new jobs from the early 1980s  through the end of 2007, the beginning of the past recession.In  other words, the Obama tax increases are targeted at those who are  largely responsible for capital formation. Capital formation is the life  blood for job creation. As jobs are created, more people pay income,  Social Security and Medicare taxes. As the economy grows, corporate  income tax receipts grow. Rising corporate profits provide an  underpinning to the stock market, so capital gain and dividend tax  collections increase. A pro-growth, low marginal personal tax rate  stimulates capital formation and GDP, which triggers a higher level of  tax receipts for the other sources of government revenue.It is  generally accepted that if one taxes something, one gets less of it and  if something is subsidized one gets more of it. The Obama administration  is also proposing an increase in taxes on capital itself in the form of  higher capital gains and dividend taxes.The historical record  is clear on this as well. In 1987 the capital gains tax rate was raised  to 28% from 20%. Capital gains realizations as a percent of GDP fell to  3% in 1987 from about 8% of GDP in 1986 and continued to fall to below  2% over the next several years. Conversely, the capital gains tax rate  was cut in 1997, to 20% from 28% and, at the time, the forecasts were  for lower revenues over the ensuing two years.In fact, tax  revenues were about $84 billion above forecast and above the level  collected at the higher and earlier rate. Similarly, the capital gains  tax rate was cut in 2003 to 15% from 20%. The lower rate produced a  higher level of revenue than in 2002 and twice the forecasted revenue in  2005.The Obama administration and members of Congress should  study the record on how the economy reacts to changes in the tax code.  The president's economic team has launched a three-pronged attack on  capital: They are attacking the income group that is the most  responsible for capital formation and jobs in the private sector, and  then attacking the investment returns on capital formation in the form  of dividends and capital gains. The out-year projections on revenues  from these tax increases will prove to be phantom.(The Wall Street Journal; Mr. Hauser is  chairman emeritus of the Hoover Institution at Stanford University and  chairman of Wentworth, Hauser & Violich, a San Francisco investment  management firm. He is the author of "Taxation and Economic Performance", Hoover Press, 1996).