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Effect of Taxes on the Economy

Lower rates of taxation will stimulate economic activity and so raise the levels of personal and corporate income as to yield within a few years an increased – not a reduced – flow of revenues to the federal government. — John F. Kennedy, Jan. 17, 1963, annual budget message to the Congress, fiscal year 1964

I stumbled upon an interesting tidbit today: 103 US companies have announced special dividend to their shareholders. Obviously these companies are paying out this dividend to their shareholders to avoid imminent tax increase in the capital gains from 15% to 30%.

This news is a precursor to what may happen to the state of our economy if both personal and capital gains taxes go up. This news also reveals the unintended consequences of raising capital gains taxes. Most seniors will end up paying more taxes as a result of the increase in the capital gains tax rate on their dividend income.

The political gridlock in Washington has made it clear that the battle between raising taxes on the upper income families vs spending cut has taken the center stage.

Choice is clear and distinct for those of us who believe that living within your means is far more important than to increase income as no income is suffice for those who live beyond their means.

While political parties are fighting their holy war to avoid the looming fiscal cliff, I decided to explore history to find the effect of taxes on our economy and federal revenue.

It’s apparent that federal revenue has gone up for the past four years despite the great recession of 2008. On the same token, federal budget deficit has gone up from $9 trillion to $16 trillion in the past four years. No one denies that our federal government is in dire need of raising its revenue.

It’s worth knowing that federal revenue went up by 86% between 1964 and 1970 after Congress passed the Kennedy tax cuts. Revenue went up by 57% between 1982 and 1990 after President Reagan slashed the top marginal rate from 70% to 28%, and the history repeated again when President Bush cut taxes in 2001.

Government spending is at 24% of GDP. This shows that while it is important to raise federal revenue, it’s even more important to limit the runaway spending in the midst of the slow economic growth of our economy. That shifts focus back to spur job growth in the private sector.

Time and again, it has been proven that when taxpayers get more tax savings, they make prudent decision about the best way to invest and/or spend their own income.

The biggest folly is to believe and buy into notion that government knows how to spend our money better than we do ourselves.

If you are not convinced that raising revenue(AKA taxes) can do more harm to our economy, I have narrated some interesting thoughts for you to ponder about.

1.  Imagine that you are in debt up to your eyeballs. It’s time for your family to make some tough decisions about your personal finances. You have lot to pay in credit card debt. The good news is that you have some equity in your home. Is it a good idea to pay credit card debt by raiding equity in your home? I don’t think so. Most people who borrow money from their equity line to pay for their credit card debt end up revisiting same painful dilemma by raking up their credit card debt again. Why? They don’t address their Achilles hill — their hedonic spending problem.

In every second of 2011, for example, the government spent $114,253—even though it was only taking in $73,043 in revenue. According to Face the Facts, that means the federal government spent $41,210 every second that it didn’t actually have. – US News

Unless our government can address runaway spending spree, taxing every rich person won’t reduce our national fiscal woes; on the contrary, effect of taxes may cripple our economic growth.

2.  Imagine that you own a small business. You are selling widgets to your local customers. All of sudden, you have a conundrum to solve — your are only 30 days away from losing your business as your business is burning cash at a faster rate than your annual revenue. What would you do as a CEO? I don’t think you would contemplate charging more to your most profitable customers in order to raise your revenue. You would instead take some painful steps to cut spending drastically all the while focusing more on superior service to all of your customers.

Our federal government is one of the largest enterprises on the planet with revenue of $2.2 trillion in 2010. Since President Woodraw Wilson used 16th amendment to enact income taxes in 1913, personal income tax has become major source of government revenue. No private business can survive hundred years with growing revenue without controlling its costs.

3.  Imagine that you are a salesman for a major corporation. You also have a friend who is a stellar salesman in your organization. Obviously, he makes lot more than you with his hard work and skills. Will you gain anything if your boss informs you that your friend has been forced to let go some of his bonus to raise revenue for the corporation? Absolutely not. If anything, it will stop you from working hard to become a stellar salesman.

While our nation is at the brink of facing a daunting task of reducing national deficit, common sense approach would be to foster economic growth by helping small businesses grow — as they are the engine of growth and prosperity for this nation — to create more jobs and thus more revenue for our federal government.

Those of us who have replaced ‘more’ with ‘enough’ in our lexicon, it is time to let our leaders know that — sometimes — even our government has to learn some painful lessons of personal finance. Do you agree?

Elsewhere:

Black Coffee: The Death and Tax Edition @ LenPenzo

We’re Ignorant Idiots! Please Tell Us Why A Flat Tax Is Not Fair @ FinancialSamurai

Tax Implications of Running a Blog @ Modest Money

 

Photo by: Picturetakingone

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Comments (17)

I agree.

It is the GREATEST irony that the government cannot even balance its own budget by raining in spending while telling us what to do.

It’s a travesty, which is why I’m against the ROTH and any vehicle which allows people to pay MORE taxes up front. I’m also against tax increases if not everybody contributes something.

S

Biggest folly of the progressive tax system is to tax someone more for his or her hard work to justify insane spending.

A tax hike of a few percentage points won’t hurt the rich, but might cripple the poor.

When the world’s richest pay less in taxes than the average American, something isn’t right.

That’s the problem with progressive tax system. I think middle-class and poor people will benefit more if we adopt fair tax.

You still don’t get it. The rich DON’T pay less in taxes than the average American. Research this on your own instead of listening to the mainstream media and you will discover this. Most Americans either pay nothing at all in Federal income taxes or pay between 10-15%. Most rich people pay between 40-50% not including state income taxes.

[...] Effect of Taxes on the Economy on Street Smart Finance [...]

Until there is some recourse, there will be no lessons learned. We elected the same people, and the other candidates didn’t seem to have better solutions anyway. I wouldn’t mind taxes so much if I felt the government was doing it’s part. As it stands, small businesses are the only ones that know what time of day it is and we just keep getting more penalties.

Well said, Kim!!

Taxes will be going higher sooner or later. Increasing taxes is a very bad idea. Government is big enough as it is.

Absolutely!

In each of the examples in those graphs highlighting when tax cuts occured, the US economy was also emerging from a recession. You could argue this had more of an effect on the increase in revenue than anything.

Like today’s economy…assume a deal is made, the fiscal cliff is avoided and the President gets his way to raise taxes 2-3% on the top bracket. It’s a certainty that that tax revenue increases over the next 4 years just due to the continued economic recovery.

I believe that you can make better decision about your hard-earned than our government. Those who want to increase tax rate on so-called wealthy(anyone making over $250K a year) have not yet articulated how much will that bring more in revenue to our beloved government. It won’t even pay for more than a month or two of runaway, reckless spending.

Shilpan,

Wecome back! Hope you had a great trip.

Re: Taxes and the economy.

Every time I hear some gfovernment offcial use the euphanism “Raise Revenue” for increase tax rates, I want to puke. Why they can not simply look at the numbers to see that tax rate increases do NOT automatically translate into revenue increases, I can not understand….. wait, there can be only one reason;

That way they can keep up their class warfare, tax the rich (pay their “fair share”) politics to which they seem so addicted.

Playing devil’s advocate:

If lowering taxes on the populace increases revenue for the government and stimulates the economy, at what rate should taxes be set? If the economy slows at this rate (as we will never be immune to recessions), how much lower do you go to “stimulate” the economy? Once the rate has been lowered and the economy stimulated, do you leave the rate there and then go lower still at the next slowdown/recession? What happens when you hit 0%? Can you raise taxes again so you have something to lower the next time?

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