The Magic of Tax Policy, Part I

The magician’s trick works not by hiding things, but by showing things that you don’t need to see.

Flashy costumes. Funny hats. Sexy assistants.

They are all there to distract you from the magician’s manipulation behind those clever scenes.

It’s not too different from what both sides of the tax policy and wealth redistribution debate are giving you right now.

On one side, the magicians of higher taxes like to parade out images of working class family being stiffed by fat cats and their rich trophy wives. On the other side, the sorcerers of low tax rates whip out images of evil government bureaucrats from their sleeves. These are all  emotional and visceral images meant to obscure, not to reveal .

The high tax magicians say raise taxes and all of out problems disappear.

The sorcerers of low taxes will say that cut taxes and all of our problems disappear.

You need proof that their magic exists? They’ll trot out their trick ponies — studies that back their side of the argument.

One will show you that higher taxes in the 1950’s brought on some of the highest economic growth. But they won’t tell you that the high marginal rates were never realized — no one made enough money to hit those high rates. Nor, will they tell you that the 1950’s were unique economic times, coming at the end of World War II when the United States was the only developed country relatively unscathed from the ravages of war. A massive new wave of technology and skilled labor also poured back into the workforce.

Remember. They are showing you what you want to see. Not what you need to see.

So, on the other side, low tax proponents will tell you about the low tax revolution of the 1980’s that led us out of the deep economic funk of Jimmy Carter’s socialist experiment. They won’t show you that a wave of new technology hit at precisely the same moment that increased our economic productivity. Nor, will the show you any studies that reveal a correlation between low taxes and high economic growth.

What neither side want to tell you — because it’s the true magic of economic and tax policy — is that tax efficiency is the obvious key to economic growth. Tax efficiency is the ability of the government to squeeze needed services out of each tax dollar.

If you have high tax rates and low tax efficiency, the economy will be stagnate and there will be limited wealth redistribution.

If you have low tax rates and low tax efficiency, guess what? The same.

The government will act like a big economic sponge, soaking up everyone’s hard-earned dollars and spitting out pennies of services.

Tax efficiency is not easy to measure and it’s not easy to define.

For instance, some of what the government does is hard to put a price tag on. Keeping national parks clean. Maintaining museums and battlefields. How much are they worth?

Secondly, no one has thought about devising some metrics — probably intentionally so — to measure government efficiency. I could name a dozen or so indicators of corporate efficiency, from price-to-earnings ratios to earnings-per-share growth rates, and on.

Lastly, tax policy and its economic effects are hard to determine. The economy is full of moving pieces, any one can change the trajectory of a nation’s wealth. A new technology could absorb some tax inefficiency and spin off high economic growth rates. Likewise, low taxes might not budge a deep economic funk in the manufacturing sector based on obsolete products.

Next week, I will explain some ideas on how we can creatively move away from the high tax-low tax dichotomy and create an efficient government that can provide needed services and maybe even redistribute wealth far more fairly and efficiently.