Lower Tax Rates Often Lead to Higher Tax Revenues


Tax rates and structures influence a population's behaviors. If a particular country has very high tax rates, people are going to do everything they can to avoid those rates and keep their own money; and who could blame them? The immediate reaction to this kind of response is that loopholes need to be closed so that "the rich" pay their fair share. But maybe there's a better way of making sure everyone is actually their taxes: reducing the rates.

In his new book Discrimination and Disparities, Thomas Sowell describes a paradoxical idea, that by reducing tax rates the government may actually take in much more in taxes.

All that the government can do in reality is change the tax rate. How much tax revenue that will produce depends on how people react. There have been some times when higher tax rates have produced lower tax revenues, and some other times when lower tax rate have produced higher tax revenues.

In the 1920s, for example, the tax rate on the highest incomes was reduced from 73 percent to 24 percent– and the income tax revenue rose substantially — especially tax revenues received from people in the highest income brackets.

In terms of words on paper, the official tax rate was cut from 73 percent to 24 percent. But in terms of events in the real world, the tax rate actually paid — on staggering sums of money previously hidden in tax shelters — rose from zero percent to 24 percent. This produced huge increases in tax revenues received from high-income people, both absolutely and as a percentage of all income taxes collected. That is because 24 percent of something is larger than 73% of nothing.

But none of these facts has made the slightest difference to those who continue to call tax rate reductions “tax cuts for the rich,” even when high-income people end up paying more tax revenue than before. The very possibility that tax rates and tax revenues can move in opposite directions has seldom been mentioned in the media — a crucial error of omission.

It goes contrary to what we might initially think. But when rates are lower, people may be more willing to pay that rate than keeping their money in tax havens elsewhere. Economics professor Mark Perry puts it this way:

We know with certainty that a decrease in the Tax Rate (%) will increase the Tax Base (and vice-versa), because of the incentive/disincentive effects of taxes summarized in the common saying that “If you tax something, you get less of it; if you subsidize something (or tax it less) you get more of it.”

To show an example in the opposite sense, Congress passed a luxury tax in 1990 expensive cars, boats, jewelry and furs, and private planes with the expectation that revenues would greatly increase. But, the tax money that did come in was about $97 million less in the first year than anticipated.

Perhaps a better way to "get the rich people to pay their fair share" isn't to hike tax rates sky-high, but to have overall lower rates, fairer rates, for everyone.