But are they accurate? Let's look at the idea that higher tax rates will be harmful for economic growth. I would argue that for businesses and individuals the greatest factor impacting their economic actions, and the economy as a whole, is the year-to-year uncertainty of tax rates. With greater clarity comes higher economic confidence, and often more productive use of time, energy and resources. However, beyond the short-term, what is more important than federal tax rates is whether or not the government is able to balance its budget. Just as any family or business knows, one can not continue running a deficit for long. One can borrow money to take care of short-term expenses, but in the long-term one cannot continually spend more than they make. Eventually, an individual or a business will have to either increase the income that comes in or decrease expenses.
In the case of the federal government, right now their stated revenues (nearly all from taxes) are a bit less than $2.5 trillion per year. At the same time, their yearly spending is above $3.5 trillion. Assuming the government is unwilling to cut expenses significantly (based on past history, a pretty safe assumption), individuals and businesses intuitively know that this income shortfall will have to eventually be paid by higher taxes. In the short-term the government is simply borrowing the money, but eventually that debt will have to be repaid. In fact, if their debt rises too high, there will come a point at which further borrowing will become impossible, or only by having to pay significantly higher interest rates. As this point approaches, higher taxes will be demanded.
Hastening the approach of this day of reckoning is the increasing financial challenges that the federal government is facing. More individuals are aging and health care costs are rising, increasing demands on Social Security, Medicare and Medicaid. And with the generally deteriorating finances of state and local governments, more and more of their budgets have been supported by federal dollars, unsustainable in the long-term. Already, federal and state governments have massive debts they are responsible for paying in the coming years.
Americans know this. And they know that they will be responsible for paying these debts. So don't expect the continuation of modest federal tax rates to supercharge the American economy. Individuals and businesses know that whether it's in a year, two or ten, higher taxes will be coming. And the longer it is until we see higher taxes, the higher those taxes will be.
Ironically, whether tax rates go up or down, it doesn't have that much effect on government revenues. Studies have shown that over the past century, during times of very high tax rates and much lower tax rates, federal tax revenues consistently amount to about 19% of the size of the American economy (as measured by the Gross Domestic Product). America is a dynamic economy and people and businesses change their behavior depending on tax rates. When tax rates go up, more income is pushed "underground" and more efforts are made to shelter and avoid paying those taxes, and effort to increase earnings declines. Conversely, when income tax rates go down, more income makes its way into the open economy, there is less emphasis on avoiding taxes, and increased entrepreneurial activity increases government revenues. As a result, the revenues going into the federal government is remarkably consistent. Whether tax rates double, or are cut in half, government income won't change much. However, despite this fact, when government debt becomes too weighty we can be sure that politicians will substantially raise tax rates on taxpayers in an effort to try to increase tax revenue.
For now, politicians want Americans to focus on the relatively low federal tax rates they are paying while obfuscating high government spending. But Americans are not that easily fooled. Americans and businesses need to see government spending constrained, at the local, state and federal level, until they can be confident that their tax rates will also stay constrained. Only then will businesses feel freer to invest and grow. Only then will individuals feel more confident about saving, investing and spending. And only then will the real wealth that accumulates lead to a sustained period of real economic growth. Until then, politicians can and will argue about the tax rates that Americans pay, but Americans will look, correctly, at how the politicians are spending their money: not only the current taxes they pay, but those they will be paying in the future.