Graphically Misrepresenting the National Debt (CBPP)

The chart below is making the rounds at liberal news outlets today. I wasn't going to comment on this because I don't like engaging in deeply partisan topics on this blog, but the stat guy in me just can't keep quiet. ;-) Here is the chart:

I'm going to take the percentages at face value. The chart selectively lists five expenditures. It then adds an alleged revenue reduction on top. The impression left is that if tax rates had been left at pre-tax cut levels, the orange part of the debt would not be with us.

This treats revenue as though it were purely a function of the tax rate. It isn't. Revenue is also deeply influenced by the overall size of the economy to which the tax rate is applied. The tax rate and the size of the economy are inextricably related. The higher the tax rate, the more money is taken out of the private sector, and the slower the economy grows. The lower the tax rate, the more money stays in the economy and the faster the economy grows. (Clearly, neither 100% taxes nor 0% taxes are feasible, but there is a range in which the logic I'm describing applies. And, of course, things other than tax rates can influence the economy's growth.) It is conceivable to end up at the exact same revenue over time using two different tax rates ... one resulting in a larger piece of a smaller whole and the other resulting in a smaller piece of a larger whole.

Therefore, the orange part of the chart should be the net difference between revenue forgone through tax rate reduction and the increased revenue received because of applying the lower rate to a larger economy. It is conceivable that the net difference is that revenue is higher than it would otherwise have been.

Here is a more helpful chart in my estimation (Source):

Revenue has averaged 18% of GDP over the past fifty years, hovering between 16-20%. As you can see, the Bush tax cuts left revenue at about 18% just before the most recent recession. Had the tax cuts behaved the way the CBPP chart suggests, we should now see revenue as a percent of GDP at historic lows. It is at 17%. Enhanced economic growth appears to have offset the revenue lost from the reduction in tax rates.

Meanwhile, spending has averaged 20.4% of GDP during the same era, hovering between 18-23.5%. Note the upward slope from 1960 to the early 1980s and the downward slope until Bush II took office in 2001. Then there is some growth in spending until the recession hits. Then spending explodes to historically high rates. There is now an eight-point difference between revenue (17%) and spending (25%). Revenue is slightly below historical averages while spending has exploded.

The Obama campaign is fixated on increasing taxes on the top 1%. If we tax all income over one million dollars, we will raise about $500 billion to apply to a $16 trillion debt. (And since most investment income would be sucked out of the private market, the economy would collapse, leaving us with a far smaller base to tax.) There may or may not be good reasons for increasing taxes on the top 1% by a couple of percentage points, but this is nearly inconsequential to addressing budget deficits that compel us to take on more debt. The answer has to be primarily focused on some combination of economic growth and reduced spending (primarily through entitlement reform.)

There. I feel better now. ;-)

Comments

[Mike]

I have no doubt that the first chart is skewed in one direction...but I'm at a complete loss as to why in the world you would ever think that the Heritage Foundation hasn't skewed the data either.

[Jim Berkley]

There's one more thing about raising taxes: People's behavior does not remain static. If someone earns $100,000 and is taxed 10%, the government gets $10,000. But lets say the government wants to get more, so it raises the tax rate to 20%. Will it get $20,000, guaranteed? That's the expectation.

But the guy with $100,000 in income isn't stupid. At 10% he's okay with the tax rate. But at 20% he's mad. So he gets an accountant to help him figure out ways to ease his new tax burden. First, he forgoes new income, because the extra work isn't worth it, if so much is taken away. Then he finds more legal ways to shelter income from taxes, such as moving investments to municipal bonds. And so he gets his taxable income to a lower level.

So perhaps in the next year, he would have stretched to earn $150,000, and paid $15,000 in taxes. But with the new tax rate, he finds ways to shelter part of his income and has only $60,000 of taxable income, yielding $12,000 in taxes at 20%. The government would LOSE $3,000 because of doubling the rates.

Quite simply, people's behavior changes with changes in their environment. If you change the rules, they'll play the game differently, and you won't get the expected result.

[Michael W. Kruse]

No question that Heritage is partisan. I don't necessarily discount data that comes from partisan sources, nor do I believe ANY source can be completely objective. I link Heritage here because it is the only place I could find that had graphed the data and I'm too lazy to go create a chart myself. ;-)

[Michael W. Kruse]

Agreed. But I think precisely measuring these impacts on a macro level is very hard. Too much other "noise" from other variables at play to get a clear picture of cause and effect.

[Dave]

You don't have to have a Ph.D in accounting or finance to come up with the first chart. Although a degree in marketing that specializes in convincing people that invented number represent truth might come in handy. Only in Washington does not collecting a tax become an expense. The number of people who no longer even question the validity of that nonsense is stunning.

Those numbers don't even begin to pass the smell test.

Every time money changes hands it gets taxed. The way to fix an economy is to get out of the way of how fast the money changes hands. Do SOMETHING to help business owners have a little confidence. Speaking as a UNIX admin, a wonderful start would be to repeal Sarbanes-Oxley. It is a huge drain on businesses that does absolutely nothing to protect investors. Anybody who says different is probably making a killing selling consulting services to help comply with it.

[Manny]

"...and since most investment income would be sucked out of the private market"

The idea that higher taxes sucks (net) investment income out of the private market implies the assumption of static income in the private market. How is this any less fallacious than the idea that increasing taxes will increase revenue, which also relies on the fallacious assumption of static income?

To be fair to the president, he has said that for every $1 in tax rate increases, he will accept $2.50 in budget cuts to achieve a reduced deficit. He has also suggested that these take place over a number of years so that the markets have time to adjust (a la Simpson-Bowles). He also suggested lowering the Corporate tax rate to compensate for this. It seems to me like he's willing to try out both ideas: raising one tax rate and lowering another.

Also, even a small decrease in the deficit is worth chipping in a few extra bucks. Since both tax-rate-growth-rate cause-and-effect models are unfalsifiable voodoo science based purely on speculation and correlation, it's only fair we try things out slowly (as the president suggested), and use feedback to find the appropriate tax rates.

[Michael W. Kruse]

Thanks, Manny.

“The idea that higher taxes sucks (net) investment income out of the private market implies the assumption of static income in the private market.”

Can you say more here? I’m not following you. Clearly if taxes increase there is less money to invest. If I have $1,000 taxed at 10%, I’ll have $900 to invest. If I’m taxed at 20%, I’ll have $800 to invest. Assume investments grow at a 10% rate in either case; there will clearly be less money with an $800 than with a $900 investment. All things being equal, the higher taxes would slow growth so I would only earn, say, 8%. The choices would be taxing investments at 10% on a bigger number versus 20% on a smaller number. The private market is anything but static. It is inextricably intertwined and dynamic.

Actually, it would not have worked well with the Tea Party wing of the Republican Party but I think it would have been interesting for Romney to embrace letting the tax rate increase the wealthiest. I don’t think the impact would be that significant on the economy and it would have taken the stick out of the Democrats hands. This would have forced the Democrats hand into talking about what they are going to cut. The Democrats tax increase on the wealthy emphasis, IMO, is a populist diversionary tactic to avoid talking about the real problem.

The really big issues are Social Security and Medicare. The president has had four years to address these and instead piled on a massive new healthcare entitlement. That is my concern.