Can We Really Increase Tax Revenue?

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Today, I want to share a chart with you that I find amazing.  (This is the first time that I’ve posted some pictures.  I’m hoping this works through the blog and email system – I’m a technological idiot and many people would take out the word “technological” from this sentence.)


If you look back over the past 60 years, our federal tax revenue has consistently been around 18.5% of GDP.  Think about this…we’ve had high tax brackets, low tax brackets, etc.  But, regardless of the tax rate, the tax revenue has been very consistent.


The following chart comes from a great chart book (2010 Budget Chart Book) that is put out by the Heritage Foundation. 


“Tax Revenue”

Tax Receipts

Of course, a significant issue is whether lower or higher taxes impact our real GDP growth rate.  If they do, then you could argue that tax revenue may always be 18.5% of GDP, but GDP is higher under one particular policy (and 18.5% of higher GDP is a good thing).


I spent a little time looking at some academic papers and other sources concerning this issue.  Interestingly, there is little evidence that tax rates have a tremendous impact on GDP.  Even the research that supports lower taxes indicates that the gains in GDP are limited.  Obviously, it’s difficult to examine tax brackets as a “stand-alone” cause of high or low GDP growth. In addition, most of the research only involves small changes in tax rates.



Eliot Spitzer wrote an interesting article concerning this issue.  He also concluded that there is little direct relationship between tax rates and growth.  He showed this with a chart:


“Tax Rates and GDP Growth”

Tax Rates and GDP Growth

The main takeaway is that (in the absence of other evidence), GDP and tax rates don’t seem to be directly related. That means that we’re stuck with collecting taxes that equal approximately 18.5% of GDP and we probably can’t drive GDP much higher by lowering tax rates.


Right now (and I reserve the right to change my opinion!), this makes me think a few things:

1. I find it hard to believe that our tax system is going to change significantly – I have to believe that we’re going to keep collecting an amount of taxes that is somewhere close to 18.5% of GDP.




2. If you agree with point 1, then most of the argument about taxes is really about who is going to pay the 18.5% (who should we tax more and who should we tax less – a very politically charged issue).




3. The primary way to fix the budget (over the long term) is to spend less.  In other words, our spending has to get down below 20% of GDP.  Obviously, this is a difficult time to limit spending.  But, it needs to be a realistic long-term goal.




4. If we do increase taxes by a tremendous amount (because we’re going to need a tremendous amount of revenue if we don’t cut spending), I have to believe that it will be inflationary.  In addition, while I mentioned conflicting evidence, I do believe that if we have a HUGE increase in taxes, this could easily slow the economy.

In the next week or two, I’m going to have some short posts on where the government’s revenue comes from and where it goes.  I’ll just preface those comments by saying that if we can’t increase our tax revenue and our outflows are increasing, you have to be scared about the future.


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