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Wednesday, December 29, 2010

Tax Cut Fallacy

There was a big controversy over "extending the Bush tax cuts". It wasn't really a tax cut. After adjusting for inflation, tax rates are higher than when the law was passed in 2000.

Tax brackets are either not indexed for inflation, or indexed via the CPI. The CPI understates true inflation. Due to inflation, everyone is pushed into a higher tax bracket every year.

Consider an example. Suppose the tax schedule is 20% on the first $50k of income, and 50% on income over $50k. Suppose your income is $50k. You owe $10k in taxes, a taxation rate of 20%.

Suppose there is 50% inflation, and your income keeps pace with inflation. Your income is now $75k. You owe $10k on the first $50k and $12.5k on the next $25k. You now pay a total of $22.5k, a taxation rate of 30%.

When you add 10 years of inflation, current taxation rates are *MUCH* higher now compared to 2000. Nominal tax rates are the same. Inflation plus progressive taxation means there's a tax hike every year, even if Congress does nothing.

When Congress first passed the tax cut law in 2000, they only made it last 10 years. That meant in "budget deficit projections", they went back to the old rates. They knew that in 2010, there would be a debate over extending the cuts. Now, Congressmen get to be the good guys, cutting taxes again. If you adjust for inflation properly, current tax rates are still higher than when the "tax cut" was first passed.

There is a progressive taxation schedule plus high inflation. That leads to a tax hike every year, even if nominal rates stay the same. By improperly indexing for inflation, Congress periodically passes a "tax cut law", while simultaneously raising taxes.

Restoring the 2000 tax rate schedule is actually a tax hike, when you consider inflation. The correct answer to the tax debate is "All taxation is theft." Politicians distract this issue, by debating who pays what. No matter what the taxation rate, most insiders are net negative taxpayers. Insiders receive more in government subsidies than the taxes they pay.

For example, suppose Lloyd Blankfein has income of $100M and pays $50M in taxes. He isn't a swell guy who paid $50M in taxes. The reality is that he stole $50M via State violence. Besides, most insiders use trusts and other tricks to lower their taxation rate.

When politicians cut taxes, they seem like good guys, but they're just stealing less. The mainstream media debates a tax hike/cut of a couple percent. They never mention "All taxation is theft".

1 comment:

Scott said...

Very interesting point about inflation, I may use that in discussions.

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