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Tuesday, July 26, 2011

Thomas Sowell Weighs In

 Much to my shame I admit that I have only recently begun reading Thomas Sowell’s work. For those of you who are unaware of what I have been missing, Mr. Sowell is probably one of the most engaging economics writers out there. He is able to carry a point home with incredible ease and forcefulness. And for good reason. Mr. Sowell graduated from Harvard as an economics major, received a masters in economics from Columbia, and a doctorate in economics from the University of Chicago. The man knows his stuff.

 Introductions aside, on the 18th of July Sowell released an article entitled “Dissecting The Demagoguery About 'Tax Cuts For The Rich'”. It’s a great article for anyone who has been following the winding road that has been the deficit-ceiling talks. In it he deals with why seeking to decrease taxes isn’t such a bad idea, especially if one wishes to increase tax revenue.

“At various time and places, particular individuals have argued that existing tax rates are so high that the government could collect more tax revenues if it lowered those tax rates, because the changed incentives would lead to more economic activity, resulting in more tax revenues out of rising incomes, even though the tax rate was lowered. 
This is clearly a testable hypothesis that people might argue for or against on either empirical or analytical grounds. But that is seldom what happens.”

Later on, Sowell delivers some facts to test this hypothesis:

“The facts are unmistakably plain, for those who bother to check the facts. In 1921, when the tax rate on people making over $100,000 a year was 73%, the federal government collected a little over $700 million in income taxes, of which 30% was paid by those making over $100,000. 
Revenue spiked as tax rates were slashed. 
By 1929, after a series of tax-rate reductions had cut the tax rate to 24% on those making over $100,000, the federal government collected more than a billion dollars in income taxes, of which 65% was collected from those making over $100,000.”

Throughout, Sowell cites the example of Andrew Mellon (and does so better than I attempted to do in my last article). It’s a three-part piece and I encourage everyone to check it out. It’s good reading. Most importantly, it should cause you to really think about your philosophy on taxation as Americans wrestle with the best way to handle the debt crisis.

Here's the link to the article: http://www.investors.com/NewsAndAnalysis/Article.aspx?id=578623

As always, be sure to enjoy the article and think about it after you read it.

Tyler Holmes
Proverbs 14:15
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4 comments:

  1. The ObserverJuly 27, 2011 at 7:45 PM

    There is a general problem with trying to prove an economic theory with evidence from the real world. The fact is that the real world is far too complicated and has far too many variables to lend itself to any sort of even marginally scientific experiment. What explains the prosperity of the 1920's? Do I even have to mention the Fed and how its policies promoted margin trading? What of the Reagan tax cuts, you might ask? They were also accompanied by a period of absurd levels of military spending and research that easily cast into doubt any sort of conclusions we can draw from the period. How about the Bush tax cuts? They occurred roughly in line with the so-called "War on Terror", which increased US military spending. All of these factors will influence the prosperity of the country, and therefore the amount paid in taxes by its citizens. The number of individuals in a given tax bracket can easily be swayed by factors other than the tax rate of that bracket.

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  2. Tyler HolmesJuly 28, 2011 at 11:28 AM

    We're not talking about government spending, we're talking about government revenues. That being said, I'm not sure how military spending could explain a dramatic increase in revenue from businesses. Further, I find it hard to argue with the numbers that Mr. Sowell brought up on page 3 of part 1, specifically the paragraph dealing with the drop in taxable income under Wilson. Couple that with the 6 other times that tax cuts have increased revenue and I think Sowell has a strong point. Does it pass the rigors of the scientific method? No, but it's nothing to sneeze at.

    And even assuming that your point is valid, that we can't prove that revenue increased as a direct result of tax cuts, that shouldn't invalidate the point. Surely we can agree that tax cuts, even in some small way, can help the government bring in more revenue, for the reasons that Sowell bring up.

    And on a side note, I really appreciate reading your comments and having the opportunity to address them. I would absolutely love to see more from other people as well!

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  3. The ObserverJuly 28, 2011 at 4:16 PM

    Government spending increases revenue by stimulating economic growth. If the government drops say $663.8 billion (http://en.wikipedia.org/wiki/Military_budget_of_the_United_States), that doesn't just disappear. Much of it goes to businesses to fund large R&D projects or to purchase military hardware. Increases in spending can therefore be linked to economic growth in many industries. Wars only broaden the affect to include many companies involved in the logistics of carrying on overseas conflicts. This economic growth will make its way back to tax revenue, though at somewhat of a loss.

    To be fair, I did neglect to mention the Kennedy cuts. However, those also took place at the same time as the space race. The same argument applies. Massive increases in government spending are going to promote growth in industry and the economy that will feed back into the tax system.

    Frankly, the most compelling empirical evidence in the entire referenced article is on page 3 where he says:

    "Secretary Mellon estimated in 1923 that the money invested in tax-exempt securities had tripled in a decade, and was now almost three times the size of the federal government's annual budget and nearly half as large as the national debt."

    However, this is an estimate, and one performed under very extreme circumstances. Tax rates of 77% are rather high. The fall in rates tripled the effective income of any individual making more than $100,000 (assuming that they were paying their taxes). It's easy to see how such extreme changes can greatly impact the economy, and therefore tax revenue. In contrast, as I recall, we now have a roughly 35% tax on the highest income bracket. Tax cuts when the rates are at that level would have a far less pronounce effect.

    My primary argument here is that the empirical evidence provided is very weak. There are ways to show this empirically, but one would need to dig much deeper than simply looking at revenue numbers and basic tax statistics. If you could gather actual statistics that observed the amount of money going into tax shelters, this would be a far better metric by which to judge the efficacy of tax cuts by themselves, as there would basically be no other economic factors to consider. However, that level of information is hard to get for good reason.

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  4. StephenMAugust 16, 2011 at 11:59 PM

    I would agree that the evidence cited in this article is very broad and simple, and not as scientifically accurate as we might like. I agree with Sowell's broad point (which has been made many times before), but I don't think governments can count on this sort of change every time they cut taxes, and politicians open themselves to quite a bit of risk when making these sorts of predictions.

    Thomas Sowell, though, is one of the most brilliant economists and commentators out there today, and I encourage anyone to read his books. His works cover everything the influence of ghetto culture on black education/earnings/quality of life, the ways people groups throughout history have interacted with each other on economic and demographic levels, the mindset of the we-can-fix-everything intellectual class, day-to-day political commentary, and how to raise children with autism. His book Basic Economics is a no-nonsense, easy-to-read guide to the ins and outs of economics that is pretty much essential reading for everybody to understand how the world works.

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