Actor Gérard Depardieu's decision to flee France for Belgium to avoid a 75 percent marginal tax rate on incomes above $1.3 million sends a message we here in America should heed: Those who are singled out for tax increases are not stationary targets. The means of avoiding and evading the taxman are legion.
U.S. government agencies routinely issue estimates of how changes in the tax code will affect the flow of revenues to the treasury. President Obama says the tax changes he has been seeking will bring in $1.6 trillion over a decade. But such estimates assume taxpayers are something other than human beings who engage in purposive action.
People like to keep the money they make—why shouldn't they?—and they typically avail themselves of every legal (and not-so-legal) strategy to do so. Change the tax environment by raising rates or adversely modifying the rules, and taxpayers, especially those in the upper echelons of earners, can be counted on to modify their conduct accordingly; there's no reason to think their wish to hold on to their money has diminished just because the tax code has changed.
Known Long Ago
Economists as far back at J. B. Say and Gustave de Molinari in the 19th century understood this. As Molinari wrote in his 1899 book, The Society of To-morrow, "The laws of fiscal equilibrium set a strict limit to the degree within which it is possible to impose new taxes, or to increase the rates of those already in force. The relative productivity of taxes soon shows when this point has been overstepped, for then returns not only cease to rise, but immediately begin to fall."
Things can work in the other direction too. Other things being equal, cutting tax rates can prompt revenues to rise. This is not to say rising revenue is a good thing. As Milton Friedman once said, if a tax-rate cut brings in more revenue, the rates weren't cut enough. Hear, hear!
Nevertheless, revenues can increase after a rate cut. Case in point: the rate cuts of 2001 and 2003, the so-called Bush tax cuts, which President Obama had been hoping would expire for the top 2 percent of earners. According to the Congressional Budget Office, revenues increased from $1.9 billion in 2003—when all the cuts kicked in—to $2.3 billion in 2008 (in constant 2005 dollars). At that point the Great Recession hit, and of course revenues then fell.
Tax revenues always fall in a recession because when people lose their jobs they stop paying the income tax. Companies also pay less as economic activity slows down. When would-be tax raisers today complain that revenues are a smaller percentage of GDP than in previous years, that is the reason. It's not that the tax rates are too low.
Aside from recessions, for the past 60 years federal tax revenues have been rather steady at just under 19 percent GDP regardless of the tax rates. The top income-tax rate has ranged from a low of 28 percent in 1988-90 to a high of 92 percent in 1952-53, yet the flow of money has been a fairly constant proportion of the economy. This would seem to confirm the apparently controversial hypothesis that taxpayers are purposive human beings who can be counted to modify their behavior according to the incentives and disincentives that government places in their paths.
Yet most politicians don't get it. In The Wall Street Journal a few years ago, W. Kurt Hauser, formerly of the Hoover Institution, noted:
“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.”
"Hauser's Law" seems quite robust. Over 60 years, "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," Hauser writes.
The explanation is simple enough for a child to understand, though politicians have difficulty with it:
“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,” Hauser