In the fall of 2011 several stories arose regarding the 2013 tax cliff. Those stories are once again appearing in the media and will likely accelerate as we come closer and closer to 2013. What is the tax cliff? Basically the tax cliff is the massive acceleration in taxes come 2013 and going forward:
(1) Bush era reduced tax rates expire,
(2) temporary tax holiday regarding payroll tax expire,
(3) proposed increase in marginal tax rates proposed in the so called “Obama Jobs Plan” come into effect,
(4) the laundry list of tax increases associated with ObamaCare come into effect,
(5) proposed “Buffet Rule” taxes.
Hence the tax cliff is depicted as a massive acceleration in taxes and the consequential depressing effect on economic activity [when you tax something you get less of it, if you tax it more, you get even less of it]. (1) (2)
Few take the position of those at the bottom of the gorge looking up at the tax cliff. That is, those proponents of such massive tax increases who believe the massive accelerated tax increase will generate a bounty of government revenue. Yes, those at the bottom of the gorge looking up at the tax cliff.
Three items one needs to consider regarding those awaiting in the gorge:
(1) government spending, more succinctly politico spending through the mechanism of government, has accelerate in the last twelve years accentuated by a massive spending increase in the last four years,
(2) this new spending level, the summation of the last twelve years with special focus on the last four years, is now politically framed as “necessary, needed, required” [albeit no empirical evidence is forth coming, the level is merely argued from the notional proposition of “the way things ought to be“],
(3) the new politically framed “necessary, needed, required” spending level must then be, as the political argument goes, matched by a revenue level that matches the supposed “necessary, needed, required”.
A problem looming for the gorge dwellers is Hauser‘s Law. What is Hauser's Law? Hauser's Law states regardless of the mix of tax and tax preferences, tax will yield revenue just under 19% of GDP. That is:
"Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."
Over this period there have been more than 30 major changes in the tax code including personal income tax rates, corporate tax rates, capital gains taxes, dividend taxes, investment tax credits, depreciation schedules, Social Security taxes, and the number of tax brackets among others. Yet during this period, federal government tax collections as a share of GDP have moved within a narrow band of just under 19% of GDP." (3)
Hence the new politically framed “necessary, needed, required” spending level mantra of the gorge dwellers amounts to approximately 24% of GDP. Therefore 19% does not match 24% and moreover in a depressed economy the tax cliff may well generate well below the 19% “average” explained by Hauser’s Law.