Tuesday, May 19, 2015

Why do tax hikes hurt economies?

So government spending increases to pay for entitlement programs, and eventually taxes will be raised in order to pay for these programs. The problem with tax hikes is, that while revenues increase initially, in the long term governmental revenues decline. Why?

Well, it's quite simple actually. When taxes get up to 50, 60, or 70 percent, such as they were in 1920 after WWI, and the late fortys after the FDR spending spree, people start to find ways to get around paying taxes.

First of all, we must say here that some taxes are necessary for maintaining infrastructure, such as building and maintaining roads, bridges and tunels, and for building government buildings, and providing for national security. In order to pay for these things taxes are necessary.

Yet when the government starts to create programs to help people, taxes usually go up in order to pay for all these programs. According to the Laffer curve, as taxes are raised to a certain point governmental revenue increases. But once that certain point is reached (say it's 40%), then people start to find ways to get around paying them.

Henry Hazlitt, in his book "Economics in One Lesson, describes how people get around paying taxes.

1. Working less. Why work two jobs when all that's going to cause me to move into a higher tax bracket, forcing me to work eight months of the year making money for the government.

2. Spending less. If they are going to take half the money I make, then I'm going to put it in a bank and save rather than purchase material items, such as new TVs, iphones, vacations, etc.

4. Less risk taking. If they lose all their money when they lose, and get to keep only 30, 40, or 50% of what they make when they win, they decide that it is foolish to take risks with their capital. Making matters worse here is that capital available for risk taking decreases due to high taxes.

Since people with money are spending less, this creates less capital for those who create jobs. With less capital, and with less risk taking, this means fewer jobs created. In other words, "the government spenders create the very problem of unemployment that they profess to solve."