We Are All Agnostics About Tax Policy

I want to point out that last night, after considerable analysis of tax tables going back to 1945, I discovered something quite interesting. Individual income tax rates, whether high or low, seem to have little direct correlation with whether the country experiences economic growth or not. At the end of the day, I want all my Readers, of all political stripes, to understand that this is only a little bit useful. It clears the picture up some, but not enough, to pass judgment.

And at the end of the day, passing judgment on something like this is ultimately like passing judgment on varying schools of theology, with the exception that we know for certain that taxation does exist, while the jury is at best out on God. Nevertheless, as I will argue at the end of the post, saying something like "Obama's tax hike is good" or "Obama's tax hike is bad" is ultimately like agreeing or disagreeing with the moral weight of professing adherence to the concept of the Holy Trinity -- there can never be enough information to objectively resolve the question, one way or the other.

Now, In the case of arguing about the existence of God, both believers and non-believers must ultimately concede that the question is one about which ultimate, objective knowledge is impossible; our differences arise from our reaction to this ultimate universal agnosticism. But with regards to taxation, the question is not whether taxes exist at all, but rather whether they cause a drag on the economy. Again, we are all ultimately agnostics on this, too, and this morning I intend to clarify why that is necessarily the case despite having taking a deeper look, last night, into what is really going on with the President's proposal to raise taxes and how people are reacting to it.

One of the more interesting parts of my exercise last night was modernizing the income numbers to present-day dollars to offer a more intuitive feel for what the historical taxes really meant. In so doing, it would appear that people in my income bracket would have been paying more or less the same personal income taxes all along and about the only significant changes in the postwar era are variances in the marginal rates paid by very high-income taxpayers. But I hasten to add that there are two major pieces of the puzzle that I have not looked at closely, one of which I discussed last night.

First, how does personal income translate into taxable income? This, of course, is the issue involved in tax preparation, and navigating the arcane details of the Internal Revenue Code to find ways to reduce one's taxable income and thus avoid higher marginal taxes is the reason why people spend so much money on their accountants, lawyers, and bookkeeping software. It became apparent to me as I confronted more and more modern, and therefore complex, tax regimes that are used to make this critical determination.

Now, given that I have no real ability to decide my own taxable income -- I had to hire a professional to do that for me -- it's going to be extremely difficult for me to get a good feel for what Obama's proposed tinkering around with deductions will be. What I can say with some certainty is that reducing the efficacy of a variety of deductions for higher income-earners, which is part of the Obama tax hike, is probably by far more significant than raising the top marginal tax rate by 4.6%, because it will cause bracket creep and therefore be a stealthier way of raising money from people. This adjustment of deductions and exemptions is what will really govern whether this is a tax hike on middle-class (probably only higher-income middle-class) taxpayers.

Second, there is another piece of the puzzle that I can in theory get a decent blush on, and one which is probably more important to understand than individual income tax rates anyway. What about taxes on wealth generators? With only rare exceptions, someone's salary is not going to make them wealthy. Someone reinvesting their salary into things like real estate, stocks, or small businesses will. Individuals, as a rule, tend to have relatively few employees; corporations tend to have more. So an understanding of how capital gains (individual wealth generation) and corporate and employment taxes have shifted over time is probably more important than individual tax rates.

Seeing as last night's look at individual tax rates represented some fairly exhaustive research, I'm in no mood to tackle these subjects this morning (I have a job of my own, after all). But I hasten to add that my conclusions so far are very incomplete. Here's what I have to say about tax policy at this point, based not on my former prejudices but rather on a look at the available evidence:

1. There does not appear to be any linkage between national economic growth or recession and the individual income tax rates paid by high-income taxpayers.
2. Individual income tax rates for middle- and low-income taxpayers appears to be more or less constant for the past three generations.
3. Bracketing, as accomplished through governmental manipulation of deductions and exemptions, appears to have a more powerful effect on revenue than does adjustment of the marginal tax rates for individual taxpayers, and it is impossible to describe the effects of altering these systems on the "average" taxpayer because there is no such thing as the "average" taxpayer.
4. Corporate and capital gains tax rates are likely going to turn out to have a bigger effect on national economic growth than individual tax rates, and I haven't looked at those in any meaningful way yet.

I'm looking at tax rates, government revenues, and GDP growth, not trying to make anyone feel better about paying higher taxes. I am, however, trying to understand whether individuals and the government are actually dealing with issues of taxation rationally, and my preliminary conclusion is "no" for those individual taxpayers who are threatening to diminish their own productivity to escape slightly higher marginal taxes for higher-end income. I lack sufficient information at this time to either support or oppose the Administration's proposed tax hike.

In a way this analysis confirms part of my earlier bias about tax policy -- there simply aren't enough people in those brackets to matter -- and it refutes part of it, too -- taxing high income earners does not appear to cause a drag on the economy. But this is not the whole picture and I don't know that I possess the skills to see the whole picture at all. But as I make more findings, I shall report them here. The point of the exercise is to look at data as objectively as I can and base my conclusions on real information and not political sloganeering. If that takes me away from the party line, so be it; so far, though, the result is mixed and murky.

The complexity of the system used to calculate taxable income is truly astonishing. It seems likely to me that no one can actually know that system by heart; no individual can actually acquire enough of a handle on the whole thing to have mastered it. Like lawyers, tax professionals probably can get to know significant parts of it well, but that doesn't mean they don't have to do research and look things up before giving advice and acting for their clients. What this means for those of us who are interested in normatively evaluating tax policy is that we are looking into a deeply complex system and basing decisions on assumptions that can never be complete or accurate, and for which there are always subtle and complex variances. In this way, normative evaluation of tax policy is a bit like the Hindu proverb about the three blind men all misidentifying an elephant. It may be that none of us can ever do better than those blind men saying "it's a snake" or "it's a tree" or such.

And without even trying to gather data in a meaningful way, we're really pronouncing judgment on something understood only as a matter of belief rather than as a matter of evidence. So, you may believe the tax code to be such that we can raise taxes on very rich people harmlessly. Or you may believe that doing this will cause a drag on the economy. But either way, both of those beliefs are justified at best by incomplete evidence and in many cases by no evidence at all. So like all matters of differing belief systems, the disputants will inevitably substitute emotion for logic in an effort to prevail.

Thus, the subject is not at all unlike arguments about theology. We all have our individual beliefs, form tribes with other people whose beliefs that are similar to our own, and make alliances and wars (hopefully involving words and not violence) with those whose beliefs are different. We can look at some things that happen objectively, and we can consult complex and arcane texts to support our positions. But the ultimate, complete, and objective evidence is ultimately unknowable.