Both congressional Democrats and President Obama have suggested that raising tax rates on wealthy Americans will result in a corresponding increase in tax revenues.
If people were robots, that might work. However, people subject to sharply higher taxes don't like having to pay them. And they will act accordingly.
This phenomenon has been known for, well, centuries. But its most famous exponent is probably economist Arthur Laffer. In the 1980s, Laffer once again demonstrated that both a 0% income tax rate and a 100% tax rate would generate zero revenue. The optimal tax rate—the rate that will generate the greatest revenue for the government—must therefore lie somewhere in between. And, as tax rates rise beyond a certain threshold—whatever that may be—revenues will actually decrease.
Another, more colorful way of putting the same concept came from Jean Baptiste Colbert, the Minister of Finance under King Louis XIV of France in the 17th century. Colbert wrote: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
But neither Laffer, nor Colbert, were the first economists to recognize the decreasing utility of increasing tax rates. In 1377, the Islamic scholar Ibn Khaldun wrote:
"In the early stages of the state, taxes are light in their incidence, but fetch in a large revenue…As time passes and kings succeed each other, they lose their tribal habits in favor of more civilized ones. Their needs and exigencies grow…owing to the luxury in which they have been brought up. Hence they impose fresh taxes on their subjects…and sharply raise the rate of old taxes to increase their yield…But the effects on business of this rise in taxation make themselves felt. For businessmen are soon discouraged by the comparison of their profits with the burden of their taxes…Consequently production falls off, and with it the yield of taxation."
What's more, real world experience has demonstrated time and again the truth of the Khaldun's analysis. Tax cuts in the 1920 and again during the Kennedy administration led to sharply increased revenues for the U.S. government. The same phenomenon occurred in Eastern Europe when several of these countries instituted a flat tax in the 1990s and early 2000s.
The opposite effect—that increasing tax rates too high lead to decreasing revenues—has also been repeatedly proven. A recent example comes from the United Kingdom, where the government recently announced it would tax individuals earning more than £150,000 (about $250,000) annually at a 51% rate. The unsurprising result? Highly compensated U.K. residents are leaving the country in droves. For instance, hedge funds managing an estimated $15 billion have already fled in response to the impending tax. U.K. tax lawyers say that a large portion of their work is now devoted to counseling wealthy residents on how to leave the country.
What's the real reason, then, that Congress and Obama want higher tax rates? To answer that question, you only need to recall Obama's campaign promises. For instance, Obama promised to raise capital gains taxes, purportedly to lower the budget deficit. But then, Obama made an incredible admission in response to a comment that increasing tax rates was likely to decrease revenues and make the deficit worse.
In that case, would Obama want to lower the rates? No, Obama answered, the real issue was fairness. Apart from revenue, apart from the deficit, he wanted to raise taxes because doing so would be "fair."
That, dear readers, is what we're dealing with here. Barack Obama, now President of the United States, has no interest in reducing the budget deficit. He only wants to do what he believes is "fair."
And that means the budget deficit won't be reduced, unless investors stop buying Treasury debt. It also means you can count on a continued erosion in the value of the U.S. dollar, and a corresponding increase in gold and other commodities.
As an American, it pains me to see our currency devalued because of our reckless politicians. But, since I can do nothing to stop Obama from increasing taxes in the name of "fairness," at least I can invest accordingly. And so can you. A nice pile of gold stored safely in an offshore vault would be a good start…
Copyright © 2009 by Mark Nestmann
(An earlier version of this post was published by The Sovereign Society, https://banyanhill.com/)
