Economics of Taxes

One aspect of universal healthcare that few people want to talk about is the cost. How will the government pay for this coverage? That is something that should be central to any public discourse in universal healthcare(UHC). The government is already spending more then tax revenues provide for. On top of that people want to pile on what would be the costliest entitlement program in the history of the United States. Obama is one of the biggest proponents of UHC. He says that he will pay for it by rolling back the tax cuts that President Bush put in place for the wealthiest classes. He also says that he will increase taxes on capital gains, dividends and estate taxes famously called death taxes. Since these ideas seem to be very popular as a means of providing UHC I thought that it would be a good idea to get out there some reasoning as to why this is economically bad advise.



One of the most basic tools for measuring economic growth is called GDP. This is the Gross Domestic Product. It is the sum of all income earned in the US. It is also the sum of all output in the US. Either way it gives us a hard number for how much business is going on. Anyone who has taken a basic macroeconomics class should remember that there is a formula used to figure the GDP. It is GDP=C+I+G+(X-M) where C=consumption, I=investment, G=government spending and X-M=exports - imports. There are 2 key factors that need to be looked at when discussing taxes. Consumption is the money that we as a populace and also firms spend on stuff. Food, materials, cars and all that jazz. When taxes are added to the equation then C=Income(1-tax rate). This is important. If taxes are 0 then C=Income(1-0) which equals Income. If taxes are 50% then C=Income (1-.5) which means that consumption is half of income. So the more taxes increase the less consumers have to spend. It is important to note that consumption is around 70% if GDP. When consumption goes down then less money is spent by consumers. This lowers profits for firms trying to sell to these consumers. As profits go down firms lower production and often start reducing employment. This leads to lower or even negative growth in GDP. This is not just the crackpot ideas of some neocons. This economics 101. If you look at many of the European economies with these higher taxes you will also see that they have higher unemployment and lower GDP growth. Interestingly, if you look back in history you will usually see that tax cuts eventually lead to higher GDP which will usually lead to higher tax revenue for the government. So if the government wants more money then they should boost domestic growth as much as possible by returning as much money as they can to consumers and then allowing the following economic growth to increase their revenues. There is a tipping point in this idea of tax cuts equals increased revenues. However, we have not reached that point yet. That should be our goal.