Lower Taxes, Fater Ecomomic Growth

Published February 1, 2005

Tax policy is not rocket science, and it’s not nano-technology. It’s straightforward. When you tax something, you get less of it. When you tax the creation of wealth and income, you get less wealth and income. When you lower the taxes on the creation of wealth and income, you end up getting more. That’s about as straightforward as you can get.

In all the research I’ve done on taxes, I have never come across an example of a country, anywhere, any time, that has significantly reduced tax rates without realizing a significant improvement in economic performance. Nor have I come across an example of a country that has raised tax rates significantly without later experiencing disappointing economic performance.

Here in the United States we had a major cut in key tax rates a year ago, and over the past year we’ve seen impressive economic performance. Of the top 15 major developed countries in the world, the United States is number one in the past year in terms of economic growth, and it is number one in the past year in terms of reducing the unemployment rate.

Tax Pressure Mounting

In spite of the logic and evidence in this area, there are huge forces at work that will bring pressure to raise tax rates during the balance of this decade. The first is the expense necessary to fight the war on terror. Huge increases in resources are needed to fight that battle, and there is pressure, of course, to pay for them by raising taxes. Second is the growth in entitlements, both Social Security and Medicare/Medicaid, as a result not just of new benefits but also demographics: More people are becoming eligible.

In addition, because of a compromise reached with respect to last year’s tax cuts, there will be an automatic reversal of those cuts at the end of the decade if nothing is done.

Additional pressure is coming from the progressivity of our tax system. As a result of the recent cuts in taxes across the board, 44 million households–roughly half of all households–no longer pay income taxes. Recent data show that the top 3 percent of income earners now pay roughly 40 percent of the income taxes.

It’s going to become a little less politically attractive to argue for cutting taxes when roughly half the households in the country don’t pay taxes. It’s also going to be more tempting to argue that “someone else” who’s very well off should pay an even larger share of taxes.

Economic growth, however, can neutralize these pressures to raise tax rates, because tax revenues increase as incomes rise. The public is fairly well aware that increasing tax rates suppresses economic growth. In addition, the very size of government and its rapid growth over recent decades means there are many reform opportunities at hand.

Two examples come quickly to mind: Social Security and health care.

Social Security Returns Poor

Social Security is one of the oldest and, it turns out, one of the most wasteful of all government programs. Had individuals been allowed to invest their money privately, instead of sending it to the government, they would have been able to get three to five times the monthly income at retirement than the government promises them: three times the monthly income if they had invested only in safe and secure bonds, five times if they had invested in the riskier stock market.

I have no argument with the government requiring people to put aside some of their income for retirement. My objection is to what the government does with that money. Instead of allowing people to put it into individual accounts, the government takes that money and immediately uses it to pay other retirees. And whenever it has money left over, the government spends it on other things. This prevents the money from being invested in productive enterprises.

The movement to allow people to put a portion of their Social Security taxes into individual retirement accounts is a dynamic way to alleviate some of this potential waste.

HSAs Promise Savings With respect to health care, we have the same dynamic. With health savings accounts (HSAs), the amount of money you or your employer pay for health insurance, which now tends to be around $9,000 to $10,000 a year, is broken up into two portions. The first portion is given to the individual to use to pay directly for routine medical expenses. The balance is used to buy catastrophic health insurance that kicks in after your medical expenses pass a certain relatively high amount in a year.

The early research on this approach, from the early 1980s when pilot medical savings account programs were put into effect, showed a 50 percent savings on routine medical expenses when people spent their own money as opposed to using third-party resources to fund them. As HSAs become more widespread and popular, they create the potential to save enormous amounts of money.

Right now Americans spend a trillion-and-a-half dollars a year on health care expenses. The potential savings are as much as $750 billion per year.

Robert Genetski ([email protected]) is president of Genetski Financial Advisors.