Ignatieff Announcement: We will earn less and spend more!

Liberal Economist

Michael Ignatieff wants to increase corporate tax rates to fund more liberal social spending.

His theory, apparently, is that income is completely unrelated to the rate of income tax - that increases in tax, have no impact on income rates. 

While Michael is a "Harvard Man" and all, he has a pretty simplistic view of the world, which most economists agree is, well, just wrong.

This was pointed out in the article I commented on last week from the Globe and Mail by Stephen Gordon about how Michael Ignatieff was simply wrong in suggesting a raise in corporate tax rates would fund new Liberal spending. 

But I'm a curious sort.  So, while I agreed with Gordon's explanation of the theory of why Ignatieff was wrong - I was interested in whether there are any "real world" examples to make that point.

And I discovered there in fact are, in an excellent analysis of the relationship between taxation and revenue generation, "The Laffer Curve: Understanding the Relationship Between Tax Rates, Taxable Income, and Tax Revenue", by Daniel J. Mitchell.

In the U.S., the highest marginal tax rate in 1980 was 70% for incomes over $200,000.00, based upon the typical liberal notion that a steep progressive tax rate is "fairest".

Ronald Reagan disagreed with that theory, however, and in 1988, he dropped the highest marginal tax rate in the U.S. to 28%.

Now. 

According to Michael Ignatieff, what we should expect from this move is a reduction in government revenue collection of 60%.  If we have 60% less tax, Michael assumes we'll collect 60% less revenue.  Problem is, revenue is not static in response to taxation levels.  People are more productive, actually, when they pay less tax.

And the Reagan experiment bears this out.  What happened?  Well, this diagram shows what happened:

Take a second to look at this.  What do we see?  That total taxes collected from people earning over $200,000.00 increased by over $90 million.  That tax revenue generated from these income earners increased by 500%.

Now.

Some will say, "well, the economy improved, inflation raised income rates.." and some of that is true. I would prefer not to be as simplistic as Michael Ignatieff.

So let's look elsewhere.

Say, Ireland.

In 1985 Ireland's corporate tax rate was 50%.  Between 1985 and 2000, the corporate tax rate was lowered to 12.5%.   Again, using Michael Ignatieff's theory of economic response to taxation, one would expect government revenue to drop by 75%.

Did that happen?

Nope.

In fact, this chart demonstrates the impact of lower taxes on government revenue:

Again, take a good look at this. The result of a 75% drop in corporate tax rates - to rates significantly lower, by the way, that current Canadian corporate tax rates?  As rates dropped, we saw a corresponding, and significant increase in the relative share of tax collected as a percentage of the country's Gross Domestic Product.  Government collected a bigger slice of a bigger pie.  Lower taxes resulted in higher tax revenue.. because it increased the incentive to earn more and increased available capital for increased investment.

Are there examples of the opposite effect?  Where increased taxes resulted in lower government revenue?  Well, in fact - there is.  As reported in the Baltimore Sun, in 2008, the State of Maryland brought forth an increased tax targeting those with incomes over $1 million - a 6.5% tax on top of the federal tax.  The intention was to increase state revenue by $100 million.  Based upon Ignatieff-type assumptions that if we increase tax, income will remain static, and government revenue will increase.

The result?  A drop in tax revenue by $100 million by May of 2009, with reports of government reductions in services being required as a result.

So.

Welcome to Michael Ignatieff's bold new plan.

We increase corporate taxes, potentially drop total government revenue, and then increase expenditures on social programs.

Lower revenue/Higher Spending.

Sounds like a great idea, Michael.