Tuesday, December 10, 2002

Economic Sophistry on Your Right

I found the following in an article by Lew Rockwell:
Let's not reform taxes. Let's eliminate them, starting with the income tax. That is not unrealistic. The income tax this year will yield $1 trillion for the federal government. Cutting that amount gives us a budget equal to the federal budget of 1987. Was the government intolerably small back then?
Needless to say, I was suspicious. Government has certainly grown since 1987, but I couldn't believe it had grown that much. I strongly suspected that Rockwell had failed to adjust for inflation, but I was too lazy to prove it. But today, a colleague to whom I'd mentioned the article pointed me to the right numbers in a public finance book, which I confirmed using online government statistics. In 2002 (estimated), the government spent $1,827.5 billion, of which $879.5 billion came from individual income taxes. The difference is $948 billion, or just under $1 trillion, of revenue from sources other than individual income taxes. And indeed, it turns out the government spent 1,004.1 billion in 1987, or just over $1 trillion. So Rockwell appears to be correct -- except that all of these are nominal figures.

Once we adjust for inflation to put things in real terms, it turns out that $948 billion of current dollars is worth only $594 billion of 1987 dollars. In other words, abolishing the individual income tax would only leave us with enough money to cover about 59% of the expenditures we had in 1987. Now, don't get me wrong -- I'd love to see the federal budget slashed to 59% of its 1987 size, or smaller for that matter. But let's be honest about it: abolishing the individual income tax (without replacing it with something else) means radically downsizing government. No two ways about it.

Rockwell errs in a couple of other ways as well. In arguing against the consumption tax, he responds to the claim that a consumption tax doesn't tax savings as follows:
But the government should not be in the business of prodding us into a particular pattern of saving and consumption. It should leave that up to us. Saving is great to the extent it reflects individual preferences. Consumption is great in the same way. But there is no way to know a priori what the right mix should be.
The question, then, is how different taxes affect the savings-consumption trade off. It turns out (if you do the math) that an income tax biases people toward greater consumption by altering the effective rate of interest, whereas a consumption tax is neutral in that regard. So if Rockwell really believes that government should not "prod us into a particular pattern of savings and consumption," he should favor the consumption tax as an alternative to the income tax. (He is right, however, the politicians might cleverly introduce a consumption tax and then conveniently "forget" to repeal the income tax it was supposed to replace.) Rockwell continues:
And think of this: the degree to which the consumption tax discourages consumption is the same degree to which it does not raise revenue. How does the tax-hungry state deal with that paradox?
There is no paradox here. The extent to which *any* tax discourages the taxed activity (consumption, smoking, whatever) is the extent to which it does not raise revenue. If the demand for (or supply of) the activity were perfectly elastic, then no revenue would be raised at all, as people would just quit the activity altogether. If it were perfectly inelastic, then the government could raise as much revenue as it wanted without affecting the activity level at all. But in the real world, almost nothing in life is perfectly elastic or inelastic -- and that means the government can raise (some) revenue while simultaneously reducing (but not eliminating) the activity.

I know Lew Rockwell wants to reduce the size of government, and I sympathize. But fallacious and economically unsound arguments will get us nowhere.

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