Tuesday, May 31, 2011

Effective vs. Statutory

(HT: Special Ed) Bruce Bartlett has an interesting piece on the NYTimes Economix blog today in which he attempts to show that for all the complaining from the right, tax rates today are lower than ever, because the effective rate is lower:
Historically, the term “tax rate” has meant the average or effective tax rate — that is, taxes as a share of income. The broadest measure of the tax rate is total federal revenues divided by the gross domestic product.

By this measure, federal taxes are at their lowest level in more than 60 years. The Congressional Budget Office estimated that federal taxes would consume just 14.8 percent of G.D.P. this year. The last year in which revenues were lower was 1950, according to the Office of Management and Budget.

The postwar annual average is about 18.5 percent of G.D.P. Revenues averaged 18.2 percent of G.D.P. during Ronald Reagan’s administration; the lowest percentage during that administration was 17.3 percent of G.D.P. in 1984.

In short, by the broadest measure of the tax rate, the current level is unusually low and has been for some time. Revenues were 14.9 percent of G.D.P. in both 2009 and 2010.
What Bartlett doesn't seem to realize is that he's given the precise reason why he's absolutely wrong. To oversimplify a bit, what we want is for the effective tax rate to be as maximized as possible. As our tax rates slide higher the greater one's income, the higher the effective rate means that the greater the percentage of taxes are being collected from those on the higher end of the scale. The argument he's making is precisely the argument Republicans have always made: When we lower the statutory tax rates, it stimulates the economy which translates into greater income for all, giving a higher tax base to be collecting from. (Bartlett doesn't address this point at all.) On top of that, the effective tax rate rises, meaning that there is a combination of people moving out of lower tax brackets and people in higher brackets having increasing incomes - all of which result in higher tax revenues and a higher effective tax rate.

The primary significance of a low effective tax rate is not that tax rates are too low, but rather that the economy is struggling mightily, suppressing incomes and lowering the amount of taxes they're able to pay.