Taxation and Debt

DEFICIT vs. DEBT

There is a lot of talk about our federal deficit and our national debt, and it’s important to understand the difference between the two words.


The deficit is the difference between how much the federal government spends and how much it collects in one year. If the government “earns” $2 trillion in taxes in one year, but spends $3 trillion, that's a deficit of $1 trillion. In order to pay for the difference, the government has to borrow money from itself, American citizens, foreign countries, and other sources.

The federal budget deficit for 2009 was a record-breaking $1.42 trillion and estimates suggest that 2010’s budget deficit will be $1.6 trillion.

The national debt, on the other hand, is the total amount we owe. Every year that we borrow more money, the debt grows larger.

The difference between the deficit and the debt is especially important because when politicians talk about reducing the deficit, all that really means is that our debt isn’t growing as fast. It does not mean we’re getting out of debt.

In more personal terms: If you have an income of $50,000 per year, and you spend $60,000, that’s a deficit of $10,000. You would need to borrow that $10,000 from someone, maybe with a credit card or a home equity loan. If you reduce your spending the following year, to $55,000, you have “halved the deficit”, but you’re still spending $5,000 more than you’re earning, and going further and further into debt. After two years, despite halving your "deficit spending," you’re $15,000 in debt .

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THE LAFFER CURVE


Named after Arthur B. Laffer, it illustrates the relationship between taxes and revenue. Revenue being the amount of monies the government receives from taxation. What the curve shows is there is a point in taxation where revenues are maximized. There are two effects of tax changes on taxes and tax revenue. The mathematical and the economic. The mathematical effect would be the first, and unfortunately, in most cases the only effect some people think of. Lower taxes and revenue is decreased by that amount, raise taxes and revenue is increased by that amount.

The economic effect is not so simple. It recognizes the positive and negative effects of taxation on work, output, and employment, or the tax base. Putting it simply people work for themselves, for the monies they receive after taxation. When taxes are lowered they receive more money to spend, invest, to hire. Less taxes are an incentive to increase the activates that create taxes. Raising taxes has the opposite effect by giving people less money to spend, to invest, and to hire. What happens is that the mathematical effect works the opposite of the economic effects.

It would be obvious to say if the government taxed 0% then there would be no revenue. It is just as obvious to say that if they taxed 100% then there would be no revenue because nobody would work if all of their money went to the government. Between these two extremes there are two tax rates that will collect the same amount of revenue: a high tax rate on a small tax base and a low tax rate on a large tax base.

The problem with a high tax on a small base (taxing the rich) approach by government is that these are the people that not only spend but invest and hire. More taxation on these people means less expansion of business and less hiring creating more unemployment. More unemployment means more government entitlement programs therefore the need to tax even more and it becomes a destructive circle on the overall economy. Does this sound familiar?

A small tax on a large base, as shown in the Laffer curve, brings in the same amount of revenue because business's have more money to invest, grow, produce, and hire. New business will also start and again more people are hired. Revenue is increased because there are more people paying taxes plus the government reduces the amount of entitlement funds they pay. The more people employed means the more people buy. The more people buy the more businesses need to produce. The more businesses need to produce the more they need to hire. This is the opposite of the destructive circle created by the tax the rich mentality.

Below is a three part video about The Laffer Curve presented by The Center for Freedom and Prosperity.  There is also a link on the home page to The Center which has a wealth of information. I would urge you to go watch many of these very enlightening videos.