Economics

The State Tax Cut “Failure” That Was Really a Success

In June, Kansas state Republicans voted to raise taxes after slashing them heavily in 2012. They actually overturned the governor’s veto against the plan. Liberals call this a failed experiment in low taxes, but they are blind…

I borrowed this headline from a good article at Mises.org that explains why this tax “failure” was still a success.

But first, USA Today provides a succinct summary of the Kansas tax experiment:

Gov. Sam Brownback pitched his tax-cut plan with classic “supply side” economics. Lost revenue from lower rates, he argued, would be made up with surging growth and rising incomes.

That never happened. In 2014, the first year in which the cuts were in effect, revenue from the state’s individual income tax plunged by more than $700 million, a 25% drop. Since then, tax receipts have stagnated at their reduced levels.

The governor made predictions of growth for implementing his plan, but the results didn’t match his promises:

The promised revenue from increased business activity and higher wages never materialized. In fact, Kansas’ economy has not responded to this enormous fiscal stimulus in any measurable way. According to the St. Louis Federal Reserve, the state’s annual rate of growth in personal income has been stuck in the low single digits since the tax cuts went into effect.

So, the whole thing has been judged a massive policy failure. Typical are liberal assessments like this one:

“This failure probably cost us $4 billion,” said Burdett Loomis, a University of Kansas political scientist who has written extensively about the Brownback years. “It absolutely should put an end to the theory that tax cuts for the rich end up helping everybody, but you can’t kill it. It’s a vampire idea. No matter how many times it’s proven wrong, it keeps coming back.”

The liberals love this. Governor Brownback, because he’s ignorant of economic cause-and-effect, made promises that he shouldn’t have. So, his failure gives ammunition to big-government liberals who are more than happy to see the tax rates tick steadily upward.

WHAT WENT WRONG

First, Governor Brownback made the wrong promises. The USA Today article mentions “supply side economics.” This theory predicts that tax cuts will increase government revenue. That’s an error that infiltrated an otherwise sound theory in 1974. It’s called the Laffer Curve, named after a California economist. It assumes we want to maximize government revenue (why would we want to do that???), and the theory never specifies how long we should wait for the effect to appear.

Economist Murray Rothbard saw this as a spade, and called it one. It’s pure politics. That’s why politicians promote the theory: “It was advanced as a means of allowing politicians to square the circle; to come out for tax cuts, keeping spending at the current level, and balance the budget all at the same time. In that way, the public would enjoy their tax cuts, be happy at the balanced budget, and still receive the same level of subsidies from the government.”

In the case of Kansas, they got their tax cuts, kept spending at the same levels, but now the deficit is threatening to sink them.

On the other hand, the prevailing theory of economics preferred by the Keynesians who dominate the colleges, universities, think-tanks, banks, Federal Reserve, and the government prefer increasing government revenues. They think government spending stimulates the economy. They believe in “demand side economics.” It is consumption, they say, that makes us richer. This is in contrast to the supply-side theory (minus Laffer’s contamination) that productivity is what makes us richer.

Adam Smith, author of The Wealth of Nations, believed productivity made us richer. This productivity is funded by a nation of thrifty citizens. They save their money instead of living beyond their means. They lend their savings to entrepreneurs who invest that money into businesses that improve production techniques, resulting in cheaper goods and services.

A nation of citizens who spend every dime they make have no money to lend to entrepreneurs. They are short-sighted.

The modern economic structures of the world are extremely mixed. This means they are generally free market economies that have been infiltrated here and there by the tentacles of government. It’s like adding a drop of urine to purified water. The whole thing is tainted. It’s hard to filter the urine out. You can’t just strain it.

TAX CUTS VS TOTAL GOVERNMENT SPENDING

So, to hope for massive economic revival in just a handful of years by cutting some taxes is futile – especially when the government doesn’t even cut back on its spending at the same time. To understand the effect of government interference in the economy, you need to imagine what it would be like trying to pick the yeast out of bread dough. 

Analyses critical of the tax cuts report that state revenue fell $700 million per annum since the tax cuts were enacted. That’s a disaster, they say!

But is it?

Governments tax productive citizens and give that money to unproductive citizens. The productive citizens and the unproductive citizens have a different set of “wants.” Sure, there is some overlap, like in the category of food, but even then the types of food the two classes buy are different.

So, government taxation and income redistribution alter the demand for goods and services, and thus the price structure, throughout the entire economy.

JUST A FRACTIONAL DECLINE

Government spending is so pervasive and abundant these days that in Kansas, trimming taxes by a few percentage points is just a drop in the bucket.

So now, let’s put the $700 million drop in tax revenue in perspective for a minute:

  • The GDP of Kansas was $143 billion in 2013.
  • Annual state and local government spending was $26 billion.
  • In 2013, total federal spending in Kansas totaled $24 billion.
  • That means that redistributed income from government sources made up 35% of the state’s economy.

Seven hundred million dollars represents just 0.5% of the state’s total GDP, and just 1.4% of the total government spending the politicians are pumping into the state’s economy.

What kind of miracles should we really be hoping for, here, in such a short amount of time?

And that’s the problem. Voters are short-sighted. They want instant results. They are neither forward thinking, nor can they delay gratification. The declining savings rate of Americans proves that both our optimism and future orientation is declining.

It’s hard for them to see anything that isn’t visible before their very eyes. This is why ancient pagan cultures built idols: they needed to see physical representations of their gods at all times. Knowing an invisible God is present requires having too much faith.

SEEING THE THINGS UNSEEN

The article at Mises.org explains what actually happens in the economy when taxes are cut:

Lower taxes do contribute to higher economic growth and for everyone. This is because income that is not spent on taxes or otherwise, but saved — especially by the rich who have most of the savings — is put into bank accounts, money markets, stocks, bonds, and private equity, etc. (i.e., what some critics call “hoarding”). This saved income is the source of capital that businesses use to pay workers’ wages, as well as to support factories, office buildings, and tools and equipment that workers use to produce goods and services. . . .

The more incomes that are saved instead of taxed, the more investment, production, and economic growth our economy experiences. Productivity-enhancing capital from savings is the only source of increased economic growth.

But what should the effects of this tax-cutting policy be? Where should we look to find the results, and where did the Kansas governor go wrong in his prediction?

The Kansas Republicans were correct, therefore, in assuming that lower tax rates cause greater economic growth. However, like most economists, they assumed that economic growth would show up in the form of increased wages, business revenues, and GDP. They further believed that these additional incomes would result in increased tax revenues that would offset the reduced revenues caused by lowered tax rates.

Since they were looking for results in the wrong places, they made bad promises:

The problem with this thinking is that economists characteristically attempt to measure economic growth in monetary terms, which comingles two different concepts. Economic growth actually consists of and is defined by an increase in physical goods and services, not an increase in quantities of money. . . .

The practice of measuring real, physical production in monetary terms led Kansas economic planners into the error of thinking that increased economic growth would result in higher money incomes and thus higher tax revenue from incomes. They were looking in the wrong place for the benefits from lower taxes.

The economy is national and international. Kansas politicians should understand this. The federal government collects income tax revenue from a worker in Texas and pays it out to a Social Security recipient in Kansas. In the same way, tax cuts in Kansas ripple outward into the greater economy beyond the state’s borders:

In sum, though every bit of extra capital helps the economy somewhere, it should not be expected that such a small tax cut would benefit Kansans, specifically, to a noticeable degree. Lowering state income taxes helps economic growth, but the benefits are spread nationally and not directly traceable through economic statistics such as GDP, nominal wage growth, or unemployment.

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