Last week in Paul Ryanomics I wrote the following:

Ryan advocates a simpler tax code. Any changes in the tax code mean there will be “winners” and “losers.” But the tax code is not static. Every change, no matter how small, also means a large number of people will behave differently. The Congressional Budget Office (CBO) is legally not permitted to consider these behavioral changes when it estimates how budget changes will impact revenue. Thus figures from the CBO are as useless as ignoring the principles of supply and demand.

For example, if you asked the CBO, “How much revenue would you collect if the tax rate were set to 100%?” they would have to answer, “You would collect the entire $15 trillion gross domestic product (GDP).” They are not allowed to take into account that none of us would work if the government took all our money. Similarly, they are not permitted to compute how much more productivity would be generated if tax rates were lowered.

I’ve since learned that it is the Joint Committee on Taxation which is not allowed by Congress to consider how tax and spending policy would through behavioral changes alter the size of the macro economy. I had the wrong congressional office because the CBO works heavily with Congress and the Joint Committee on Taxation to produce these numbers. Also, there is no law preventing the CBO from doing such an analysis. The CBO stands ready to do such an economic forcast or analysis any time Congress has the wisdom to ask. <grimace>

It is Congress that stipulates that such analysis shall not be done. It would have been more accurate to say, “The Joint Committee on Taxation by agreement with congress is required to limit their analysis to a fixed GDP assumption.”

Here is how I corrected the article:

Ryan advocates a simpler tax code. Any changes in the tax code mean there will be “winners” and “losers.” But the tax code is not static. Every change, no matter how small, also means a large number of people will behave differently. The Joint Committee on Taxation by agreement with congress is not allowed to consider these behavioral changes when it estimates how budget changes will impact revenue. Thus figures from the The Joint Committee on Taxation are as useless as ignoring the principles of supply and demand.

For example, if you asked the The Joint Committee on Taxation, “How much revenue would you collect if the tax rate were set to 100%?” they would have to answer, “You would collect the entire $15 trillion gross domestic product (GDP).” They fail to take into account that none of us would work if the government took all our money. Similarly, they ignore how much more productivity would be generated if tax rates were lowered.

When the Joint Committee on Taxation looks at raising the capital gains tax rate or taxing dividends as ordinary income they use a simplistic model.

The CBO, it turns out, understands that these changes will result in behavioral changes. First people defer the realization of capital gains.

As an example, I was looking at a piece of property here in Charlottesville. It was an old broken down gas station where the building is falling apart. It’s been this way for a while. The owner is an elderly woman who would like to sell the property. She doesn’t need the money, but it isn’t producing any revenue. The problem is that it is highly appreciated. She doesn’t want to pay 15% in capital gains taxes. So she is holding the property so that her heirs will get a step up in cost basis on her death and owe no tax. In this case death is certain, but taxes are not.

She can’t sell it without paying the tax. But no one will lease it and build improvements on land they don’t own. She doesn’t want to sink a large sum of money into improvements. Buyers want to buy it. She wants to sell it. But even a 15% tax by the government prevents the transaction. So the land sits idle waiting for this poor women to die.

Liberals tend to get mean-spirited about cases like this. Just because she has a piece of capital they have an attitude of “Serves her right!” I’ve come to see that liberals tend to use the term ‘rich’ as an economic slur within their own culture. I’ve tried to argue that there are at least three better phrases to use rather than using rich as a slur:

1. the most productive (high income)
2. wealthy (high net worth)
3. living rich (lavish life-style consumption)

The reason why I think these are better terms is because they more accurately describe three very different groups of people. Small business owners most often fall into the first category, and yet we use social arguments against them as though they are in the second or third category. That these three are the same group has not been my experience.

The second result from a rise in capital gains taxes is that it would change the return on investment which would lower the overall rate of saving and investing and as a consequence lower the overall capital investment which in turn would lower GDP growth and expansion. It is this effect that the Joint Committee on Taxation by agreement with congress is required to ignore.

I’ve seen this effect at work as well. A few years ago, the rules for capital gains changed: you now owe capital gains on the pro-rated number of years you aren’t living in a property. Since then, fewer people have been willing to buy second homes or rental properties. With capital gains rates going up in 2013 and the Obama Care tax applying to rental income, owning properties will become even less attractive.

Who wants to own property when the government induces inflation and then taxes investors on it?