Warren Buffet's Comments on Taxes

CNN ran two opinion pieces on this subject.  One for and one against, each associated with the Brookings Institution and the Cato Institute respectively.  In my last post I mentioned some flaws in Mr. Buffet's analysis of our tax system.  Taxes are much more progressive than he implied because he neglected to mention corporate income tax and the way that inflation makes capital gains income look higher than it actually is.

I found the argument in supporting Warren Buffet more informative.  The author gave what I consider to be the most persuasive argument in favor of higher taxes: that it discourages government spending.  The government cut taxes under Ronald Reagan and under George W. Bush.  Under both presidents, spending was increased rather than decreased.  So much for starving the beast.  Under Bill Clinton taxes went up and spending went down.  One theory on this is that when the price of something goes up people tend to demand less of it.  People see a deficit as putting government spending on sale and so they demand more of it.  A surplus has the opposite effect.

If this is correct the approach of the Republican presidential candidates seems counter-productive.  Alonzo Fyfe has published two interesting posts covering this subject.  One commented on the fact that all of them have said that they would walk away from any deal that included any increases in tax rates.  The other other on the essay against Buffet in the link above.  The point I would like to make is that by taking the position that any deal that includes an increase in taxes should be out of the question, they are preventing themselves from accepting any likely deals that would reduce the deficit or even create a surplus.

Apparently the choice is not between higher taxes and lower spending, but how much we want to raise taxes and lower spending.  This is what people who favor lower taxes on the basis that they will spur investment miss.  Lower taxes will not increase business investment because they will lead to higher spending.  Suppose the government reduces taxes by $1.  If this results in an increase in spending of say 10 cents, then it will have the effect of increasing debt by $1.10.  Thus even assuming that all of that dollar was to be invested, investors would have to purchase an additional $1.10 in bonds in order to cover the increase in debt.  This would require them to sell off 10 cents worth of business investment to purchase the bond.

This is a point that is commonly missed by both sides.  The right points out that redistribution has a negative impact on growth because it discourages or otherwise reduces investment.  The left points to empirical studies that show a different connection between taxation and growth than the right's theories predict.  The problem isn't that the theory are wrong, it is just that it doesn't apply to the case at hand.  If the government maintained a balanced budget, I suspect that the theory would work just fine.