by Fergus Hodgson
Director of Fiscal Policy Studies
The American Institute for Economic Research has just released a revealing graphic—one which highlights the impossibility of covering prevailing spending levels through taxation alone.
As Julie Ni Zhu notes, in “the postwar period, the highest personal income tax rates have been as high as 92 percent and as low as 28 percent, while corporate tax rates have ranged from 35 to 53 percent.” Yet federal receipts have broken 20 percent of national output only once, reaching 20.6 percent during the tech boom of 2000, and averaging 19.6 percent.
Federal spending, on the other hand, reached a record level of 25.5 percent in 2011, almost a full 5 percent of the economy beyond even the highest revenue levels since World War II. Federal spending has grown even faster than the economy, and that follows record spending at the North Carolina state level as well—14.4 percent of total state income in fiscal year 2012.
The inference is that once expenditures rise about 20 percent GDP—within the United States context—no rate of taxation will pay for it.
Individuals and businesses postpone income, find tax shelters, move assets offshore, and hire armies of accountants and lawyers to protect their income. Some even move to lower-tax countries. Higher taxes can also slow economic activity by reducing the personal rewards for working, innovating, and investing.
If you are familiar with the Laffer Curve, you will understand that the author believes the apex of the federal curve sits at around 20 percent of the United States economy. The bottom line: A long-run fiscal balance necessitates substantial federal spending reductions, and little closure can come from higher rates of taxation.