Kamala Harris Advocates Destructive Tax Increases

Price controls on groceries are not the only incredibly bad idea concerning economics held by Kamala Harris. In addition, she is advocating a slew of new taxes, the worst of which are hikes on corporate income taxes. Her tax proposals would be catastrophic to the U.S. economy. Let us see why.

The Harris Tax Proposals

Harris’ first announcement of a comprehensive tax plan was presented in a North Carolina speech on August 16. In it, she advocated tax credits for housing developers and renters. In addition, she wants to increase the highest marginal income tax rate for the top 1% of earners from 37% to 39.6%.

More consequentially, she proposed a tax on unrealized capital gains for individuals having wealth greater than $100 million. Also incredibly scary is a corporate tax rate hike. During President Trump’s regime it was reduced from 35% to 21%. Now, the Harris campaign has announced they would increase it to a 28% rate. In fact, if we were being totally rational about corporate taxes, we would not directly tax corporations at all. More about this in the section below. Also very stupid is a proposal to tax the foreign income of U.S. corporations. This would have the effect of either decreasing U.S. foreign trade or of driving U.S. corporations to headquarter overseas. Either way, the U.S. economy would suffer.

Why These Tax Increases Are Destructive

A very old and wise saying is that “if you want less of something, tax it more.” Ergo, every tax is destructive of the economy to some degree. However, some taxes are more destructive than others. In this section, I will concentrate in particular on what I think are the two most dangerous Harris tax proposals. They undoubtedly would drive our economy toward destruction.

The first of these is the proposal for a tax on unrealized capital gain for taxpayers who have wealth greater than $100 million. That is, if an investor buys stock and its value rises, even though the investor has not sold the stock to realize a profit, the investor would be taxed on a gain he has not realized. Not only would such a tax discourage investment in the economy, it would motivate investors to sell their stock on even small gains. If an investor held onto a stock after a small stock price increase, the additional tax would reduce his assets with no gain for him whatsoever. This would lead to an inefficient churn of the stock markets.

Critics say such a tax would stifle economic growth. It also might create a slippery slope down which we might find even higher taxes on unrealized gains. In addition, there would be compliance issues with disputes on valuations.

Harris’ second even more stupid idea is to raise corporate taxes. Progressives claim corporations can and should pay a great deal more to “pay their fair share.” An unspoken, implicit assumption is the increased financing of government programs would actually be useful, and would not be harmful to the economy or to society in general. The reasons why this is not usually the case can be found here.

Another recurring progressive point is that we need to increase taxes on companies to stop budget deficits and halt the growth of our already enormous national debt. According to the Federal Reserve Economic Database, our GDP in 2023 was $27.36 trillion, while our federal national debt was $32.74 trillion. That makes the national debt a humongous 119.66 percent of GDP! At least on the surface, this point seems to make a lot of sense. However, the real problem is the amount of government spending, not a lack of government taxes to fund that spending. This is especially true because, as already noted, government spending is often harmful to society. This fact can be confirmed empirically by plotting real GDP growth versus total government expenditures as a percent of GDP. This plot is shown below using data from Q1 1960 through Q3 2019.

This scatterplot tells us that increased government spending is generally an enemy of economic growth. There is a large degree of scatter about the trend line. This fact emphasizes that there are a great many other factors that help determine GDP growth. Nevertheless, the trend line has a definite negative slope. Also, as total government expenditures exceed 25 percent of GDP, the scatter about the trend line dramatically decreases as government spending plays a greater role in the economy. To increase real economic growth to 4 percent or more, this graph strongly suggests government spending should be limited to around 5 percent of GDP.

The graph above is a particular example of what is called Rahn’s curve. It postulates government spending has an optimum level for GDP growth, above which economic growth will generally fall as government spending increases. The graph above suggests that the optimum level for growth purposes in the U.S. is at 5 percent of GDP or less. In fact, the Rahn curve can be shown valid for all developed OECD countries, as shown in a similar plot below.

Yet another set of historical data that teaches a great deal about taxes in general is the data that forms Hauser’s Law. What Hauser’s Law asserts is that no matter what the tax structure is, federal tax receipts will always be within a percentage point or two of 19.5 percent of GDP. As shown in the plot below, this law has been operative in the U.S. since the late 1940s.

This remarkably constant relationship between total tax revenues and GDP has been quite independent of the top individual tax rates, as shown in the graph below.

However, this law appears to be very particular to the United States. The reason Hauser’s Law operates in the United States and not in Europe has to do with the highly progressive nature of American income taxes. In 2018 the top 20 percent in income received 52 percent of U.S. total income, but paid around 87 percent of income taxes. The lowest 60 percent received about 27 percent of total income but paid essentially no net federal income tax. Almost all federal income tax revenue comes from the top 20 percentile. This implies that revenue is limited to a fraction of the 52 percent of total income earned by the top 20 percentile. As a fraction of GDP, it is even smaller still. This is because much of GDP is not personal income, but is retained by corporations for investments. The result is Hauser’s Law.

A frequent commenter on this blog once stated he thought Hauser’s Law could be repealed. After all, many European nations tax around 40 percent of national income. Yet to do that, they must levy the maximum tax rate on the lower middle class. To repeal Hauser’s law, the U.S. would have to abandon its highly progressive tax rates and adopt the much flatter taxes of Europe. This does not seem politically possible.

Given the empirical data displayed above and the progressive arguments about corporate taxes, we are prepared to examine why the progressives are so dreadfully wrong. Not only are they wrong about increasing corporate taxes, but the optimum policy socially would be to levy no taxes on any company. Here are some neoliberal justifications for no taxes on any company whatsoever:

1. Our Focus Should Be On Wholesale Reductions Of Government Spending, Not On Increasing Anyone’s Taxes.

If what we are concerned about is the economic health of the nation, Rahn’s Curve screams out to us we should be totally concentrated on the largest possible reductions in government spending. Rahn’s Curve informs us the optimum level of government spending is 5 percent of GDP or less. Compare that low level with the latest Q3 2019 expenditures of 38.5 percent of GDP for governments at all levels and 22.6 percent of GDP for the federal government.

In addition, Hauser’s Law instructs us that the amount of government revenue is not determined at all by tax rates, but by the size of the GDP. If the GDP increases with a reduction of taxes (which it generally does), then we can only increase government revenue by decreasing tax rates.

These facts pose a very real problem because so little of the federal budget is in discretionary spending. Almost all federal spending consists of mandatory spending. Mandatory spending is on auto-pilot and can be changed only by changing laws. As can be seen in the pie chart below, the FY 2019 federal budget gives 62 percent of federal spending to mandatory spending (Social Security, Medicare, Medicaid, interest on the national debt, and other), and 38% to discretionary spending (Defense and all other discretionary). All defense spending accounts for only 21 percent of the budget.

Moreover, estimates by the Committee for a Responsible Federal Budget guesstimate that the vast bulk of the spending growth between 2018 and 2028 will be in the mandatory categories of Social Security, Medicare, Medicaid/ACA/CHIP, and interest on the national debt.

Clearly, with spending and growth in that spending heavily concentrated on mandatory expenditures, an actual reduction in federal spending as a fraction of GDP would require very heavy political lifting. Such a reduction will require politically unpopular steps such as increasing the Social Security retirement age, reducing Social Security benefits, and increasing the maximum individual income to be taxed for Social Security.

2.  All Taxes Are Destructive To Economic Growth, And Corporate Taxes Are The Most Destructive Of All.

All government taxes are destructive to economic growth to one degree or another. This is not a surprising statement, given that Rahn’s Curve instructs us that increasing government expenditures would reward us with decreasing economic growth. Individual income taxes reduce individuals’ demands for goods and services. Taxes on corporations reduce their ability to invest in new productive capacity, hire new workers, or raise their employees’ wages and salaries. In addition, governments are notorious for their inability to allocate their tax revenue productively.

In fact, a study by economists of the Organization for Economic Growth and Development (OECD), entitled Tax and Economic Growth, concludes that corporate taxes are found to be most harmful to growth, followed by personal income taxes, and then consumption taxes. The OECD also found corporate taxes are particularly harmful to companies that are in the “process of catching up with the productivity performance of the best practice firms.”  In addition, “lowering statutory corporate tax rates can lead to particularly large productivity gains in firms that are dynamic and profitable, i.e. those that can make the largest contribution to GDP growth.” This study used data from all of the OECD countries.

3. Corporate Taxes Contribute So Little As a Percent of GDP, We Might As Well Reduce Them To Zero.

The progressive argument that corporate taxes have grown increasingly smaller as a fraction of GDP and therefore corporations are “not paying their fair share,” can be stood on its head. We know from Rahn’s Curve government expenditures decrease GDP growth overall. We also know from the OECD that taxes in general and corporate taxes, in particular, are harmful to economic growth.

Knowing corporate taxes are harmful even if small as a portion of GDP, we might as well reduce them all the way to zero. Then, we get the “biggest bang for the buck” in the allocation of capital for various uses.

4. Increasing Tax Rates Does Not Increase Government Revenues.

In addition, increasing individual and corporate tax rates most definitely will not increase government revenues in the U.S. With Hauser’s Law limiting government revenues to around 19.5 percent of GDP, the only viable strategy for larger revenues is for the government to adopt growth-oriented policies. The most likely result of simply increasing tax rates would be to decrease GDP growth. Increased taxes would motivate corporations and individuals to move their capital to foreign tax havens. It would also discourage productive investments. By decreasing economic growth, rising tax rates would actually tend to reduce government revenue.

5. Growing GDP Does More To Enhance Social Welfare Than Most Government Programs.

Much of the previous discussion implicitly assumes that encouraging GDP growth does more for the common social welfare than most government programs. In particular, an underlying assumption is that individuals and companies do a much better job allocating capital than governments. Historical evidence that this is indeed true can be found in the following posts:

• Historical Lessons on Economics and Politics
• More Historical Lessons From Europe
• Lessons From The Developing World
• The Human Development Index and Economic Freedom
• Comparing Economies of All Countries on Earth in 2018

The last two posts, in particular, demonstrate that countries with the least government control of the economy do the best for their peoples. Countries with the freest economies provide the largest per capita GDPs with more even distribution among the population than for more government-controlled economies. In addition, the most economically free nations provide the greatest life expectancies and the highest average education level.

A final progressive notion less often heard is hostility to our modified territorial tax system for corporations. In a territorial tax system, only corporate income produced in the United States would be taxed. Profits earned in other countries would be taxed only in those countries and would not be touched by the U.S. In a worldwide tax system, the U.S. would tax corporate income no matter where it was earned. Until the enactment of the Tax Cuts and Jobs Act in 2017, the U.S. had a modified worldwide system; corporate income in other countries was taxed only when companies brought that income back to the U.S. What most progressives advocate is a return to a pure worldwide system. Not only would all income be taxed, no matter where earned, but it would be taxed even if not repatriated to the U.S. This would have the effect of either discouraging foreign trade, or encouraging companies to move their headquarters to other countries, making them foreign companies not taxable on foreign earnings.

Conclusions

All of the empirical evidence reviewed above shout out that Harris’ proposals to increase taxes, especially corporate taxes, make absolutely no economic sense. Progressives argue that low corporate taxes benefit only the rich. After all, it is predominantly the rich and the middle class who invest in corporate stock and bonds. However, this assertion is easily debunked. The rich benefit only when they sell their stock at a profit, or when they receive dividends from their stock. In those cases what they receive is taxable as capital gains or as personal income. None of this involves corporate income retained by the companies.

How are retained corporate profits used? Obviously, the largest portion would be used for investments to increase their economic output and profits. This includes investments in plant and equipment, and investments in employee training. Profits are also used to increase employee pay, which helps companies to retain and hire skilled labor. All this is to the ultimate benefit of society as a whole. Taxing companies on their retained income does nothing but decrease the size of the GDP from what it would otherwise would be. The poor and the middle classes are all hurt by any and all corporate taxes.

Remember all this when you go to the polls.

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