Lies du Jour, Part One

There are two particularly annoying meme’s being pushed right now by the Right about Obama and the Democrats:

1. That Obama created the deficit
2. That Obama raised taxes.
3. There are both true and both bad and thus both are reasons to vote Republican.

First things last: neither is true. And we'll get to that in part two.

But let me put that aside for the moment, and first point out the absurdity of the idea that the deficit can be your #1 issue when you’re calling for TAX CUTS! Now… am I saying tax cuts are BAD? No. Not at all. They stimulate the economy. That’s right. You read that right. They DO. In fact the idea that cutting taxes can stimulate the economy if every bit as much part of the Keynsian economic model as the fact that increasing spending stimulates the economy is. And both work the same way: The multiplier. If you cut taxes, or increase spending you increase the income of America by [some multiplier, greater than 1] times the amount of the change. And like wise raising taxes and cutting spending will have the same negative effect: the income of America will change by [some negative multipler, greater than -1] times the amount fo the change. Conservatives are more than happy to accept the tax half of the Keynsian model, but for some reason they can never seem to swallow the spending side of it. And the real kicker is that the multiplier ofr spending are GREATER than the multipliers for taxes. The end results is that a balanced budget always has a multiplier of “1.” If you raise taxes AND raise spending by [X] collective income will INCREASE by [X]. If you cut taxes AND cut spending by [X] collective income will DECREASE by [X]. They never buy it, but if you take an economics course, regardless of the ideology of the professor, you will learn this. It’s a FACT.

BUT… that’s all about the effect on the ECONOMY. If you’re concerned about the ECONOMY? Fine, cut taxes. (Or increase spending, whatever.) But you can’t be expected to be taken seriously if you’re talking about cutting taxes to decrease the DEFICIT. (Well, OK, yeah you CAN, only because there are a lot of real idiots in this country. In any case you SHOULDN’T BE taken seriously by ANYONE.) Because that’s like saying, “My credit card debt is getting too high, so I better quit my job.” The deficit is SPENDING minus TAXES. So… if you lower taxes, you can ONLY increase the deficit!

Duh!

Now… some will argue that the multiplier effect I mentioned earlier can fix this. That if we cut taxes (for example) the resulting growth will result in more tax revenue. (Or at least as much as we had before.) That’s the idea behind the now widely discredited Laffer Curve. Personally I think Laffer had a legitimate point, but he his partisanship caused him err when trying to figure out where exactly on the curve we were, as well as what the exact shape (slope) of the curve is, and where the center of it is. In any case, let me demonstrate why tax cuts (or spending icreases, for that matter) will never “pay for themselves,” why they will ALWAYS contribute to the deficit, unless offset by spending cuts (or tax increases):

  

Let say you’ve got a company with $100 in taxable income (profit) and we’re taxing them at 30%. (That a bit higher than most US corporations pay, but it makes the math easier.) SO you get $30 in tax revenue from them.  How much growth would they need to see for a 5% reduction in taxation to “pay for itself.” (Meaning: for it to be deficit neutral.) Well… to get that same $30 at just a 25% rate of taxation, they’d need to make $120 in pre-tax profit. IOW: they’d have to see 20% growth! Note: Few companies EVER see 20% growth, and a 5% tax cut on it's opwn just ain’t going to do it! How do I know this? First of all, most companies require a Return on Investment of just 10%, 15%, 20%... something on that order. To turn that $5 of tax savings into $20 of income would require a 300% return! And if a company had a way to get a 300% return on their money? They’d do it. Period. Right now. They’d find a way to beg, borrow or steal that $5 they needed. But guess what? There are not a whole lot of projects out there with a 300% ROI. None really. At 20%, that company would made $101 in taxable income from that $5 investment and pay $25.25 in taxes. IWO – we added $4.75 to the deficit by doing this.

Even IF one considered the multiplier effect, the results are still nowhere near where they need to be. To turn a $5 tax cut into $20 of taxable income requires a multiplier of FOUR. And no legitimate economist goes throwing numbers like THAT around lightly. I'm not saying it's impossible, just that your going WAAAY out on a limb to assume it.  Here, for example, is a graph by Mark Zandi of Moody’s showing the benefit of each dollar spent on various parts of the stimulus package in 2008:

(And yes, I know that looks like crap bleeding over like that, but it look worse shrunk down. So just deal.)

Now, granted one could claim this is “just some liberal rubbish,” but do you notice how the highest multiplier is still under TWO? (~1.7) Even for the “liberal” stuff that he'd be trying to sell?! Nothing ANYWHERE NEAR the four that we'd need.

Now, that 300% return (multipler of 4) only applies to a 5% cut from a 30% base tax rate. Here’s a chart I worked up, showing how much growth you’d need (and the required multiplier) for a given tax cut to pay for itself. Feel free to go in there and monkey with the numbers if you want. The point still stands.  You can see that unless you’re talking about very small tax decreases, from very large rates, you’re talking about growth rates that are only ever talked about in classroom examples. They have no place in business projections (indeed any business would go broke VERY FAST if it relied on this kind of growth assumption) and should have no place in policy discussions.

"Part Two" will show why, in addition to being assinine when taken together, both a flat out FALSE individually as well.