The Limit Of Tax Revenues

July 31, 2012

Free Market Foundation

“Hauser’s Law” (named after W. Kurt Hauser of the Hoover Institution) states that there has been a close proportionality between revenue and gross domestic product (GDP) since World War II, despite big changes in marginal tax rates in both directions. The law states that there is a kind of capacity ceiling for federal tax receipts of about 19 per cent of GDP.

In short, Hauser’s Law provides a simple basis for testing the validity of any government’s revenue projections, says David Ranson, president and director of research of H.C. Wainwright & Co. Economics:

Today, since the U.S. economy already suffers from a large output gap that is expected to take many years to close, 18.3 per cent must be a realistic upper limit on the ratio of budget revenues to GDP for years to come.

Any major tax increase will reduce GDP and therefore revenues too.

How long does it take to fire up the economy once capital is more readily available? The answer is: Longer than it takes to close it down.

According to Congressional Budget Office (CBO) projections based on the current budget:

The revenue-to-GDP ratio could reach 18.3 per cent as early as 2013 and rise to 19.6 per cent in 2020.

Such numbers implicitly assume that the U.S. labour market will get back to sustainable “full employment” by 2013 and that GDP will exceed its potential thereafter.

However, when the projections are tempered by the constraints of Hauser’s Law, it is clear that deficit spending will grow faster than the official estimates show, says Ranson.

For budget planning, it is wiser and safer to assume that tax receipts will remain at a historically realistic ratio to GDP no matter how tax rates are manipulated. That leads to the conclusion that current projections of federal revenue are, once again, unrealistically high, says Ranson.

Source: David Ranson, The Limit of Tax Revenues, National Center for Policy Analysis, August 4, 2010.

For text: http://www.ncpa.org/pub/ba716

For more on Taxes: http://www.ncpa.org/sub/dpd/index.php?Article_Category=20

First published by the National Center for Policy Analysis, United States

FMF Policy Bulletin/ 10 August 2010