The economics of tax policy is largely the economics of incentives. When governments impose high tax rates on something, you get less of that thing.
My left-leaning friends acknowledge this is true, but only selectively. They openly agitate for higher taxes on things like tobacco (or sugar, or energy) and they correctly argue that higher tax rates will lead to less smoking.
As a libertarian, I don’t want to control other people’s lives, so I’m not a big fan of such taxes, but the underlying economic analysis is correct.
Unfortunately, my friends on the left often forget economic analysis when looking at tax rates on productive behaviors such as work, saving, investment, and entrepreneurship.
It is also important to realize that not all taxes are created equal. Whether politicians are cutting taxes or increasing taxes, the economic consequences will vary depending on the details.
For instance, even though I just stated that I don’t favor higher “sin taxes,” raising the tax burden on things like cigarettes will do less economic damage than increasing marginal tax rates on labor and capital.
There are also good and not-so-good ways of lowering taxes, and we have an example of this from Michigan.
As reported by Craig Mauger and Candice Williams of the Detroit News, there’s a big budget surplus in Michigan and politicians are debating whether to reduce the rate of the state’s flat tax or to give one-time tax rebates. Here are some excerpts from the story.
Michigan Gov. Gretchen Whitmer and the Democratic leaders of the Legislature are preparing a sweeping tax relief proposal they say will reduce tax bills by more than $1 billion and include rebate checks that could be issued directly to residents. The Friday agreement focuses on a plan to ease taxes on retirement income, boost a tax credit for low-wage workers and issue “inflation relief checks” in place of a potential cut in the state’s personal income tax, which was expected to be triggered by growing revenues, according to a source familiar with the plan. …as the state sits on a surplus of more than $9 billion, Republicans in the House and Senate have called for a broad tax cut for Michiganians and the preservation of the potential automatic drop in the personal income tax rate, which is being caused by language in a 2015 law. That policy tied the income tax, currently at 4.25%, to revenues for the state’s general fund. …based on preliminary fiscal year 2022 revenue figures, the revenue trigger would be activated and lower the income tax rate for the 2023 tax year from 4.25% to 4.05%. …“The Democrats’ proposal is a head fake intended to hide their attempt to rob Michigan taxpayers of an income tax cut in favor of funding a corporate welfare slush fund — prioritizing big corporations over Michigan families,” said Sarah Anderson, executive director of the Michigan Freedom Fund.
Michigan Democrats want more than rebates. They also favor “an exemption for public pensions” and “economic development subsidies for businesses.”
At the risk of stating the obvious, a lower rate for the flat tax will be far more beneficial to the state than one-time rebates and special favors for bureaucrats (who already enjoy higher compensation than workers in the private sector).
And a lower rate on the flat tax also would be far preferable to special handouts for businesses (which inevitably translates into corrupt cronyism).
I’ll close with a final point about overall fiscal policy. The Michigan tax fight is also a spending fight. Democrats are focusing on tax rebates in part because they are a one-off event. They’ll return some money to taxpayers this year, but there are no long-run savings.
By contrast, a cut in the state’s flat tax produces long-run savings for people. As the story noted, “Rebates are typically one-time spending bursts, while cuts in the income tax rate usually are kept in place for multiple years.”
Needless to say, politicians who want to spend more money prefer one-time rebates over permanent tax cuts.
P.S. Pursuing sub-optimal tax policy is not just a left-wing problem. Some folks on the right favor things such as child credits. That kind of tax cut will reduce tax liabilities for families, but those families quite likely would be better off in the long run with growth-oriented reductions in marginal tax rates on labor and capital.
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Image credit: Steven Depolo | CC BY 2.0.
