We have a regulation problem, not a revenue problem

Pace my colleague Jazz Shaw, who on 6 July defends the proposition that we have a revenue problem, I say we don’t.  Our problem today is a regulation problem, and until we fix that, tinkering with tax rates will only make things worse.

It should go without saying, but I’ll say it again, that increasing tax rates does not produce a commensurate increase in revenues.  The truth about tax rates is that raising them produces a less-than-proportional increase in revenues, whereas lowering them produces a greater-than-proportional increase in revenues.  Tax rate changes do not produce a one-for-one change in revenue levels, period.  Arguments are usually made as if they do, but history demonstrates otherwise.  You cannot solve a public debt problem by raising tax rates.

The chief reason for this is that people change their economic behavior when tax rates change.  An excellent way to discern this effect is through the tool falsely referred to as a “tax subsidy.”  There is no such thing as a “tax subsidy.”  There is only a “tax break.”  Oil companies get tax breaks on drilling leases; they do not receive subsidies.  It is important to understand this and not to buy into the false proposition that a tax break is a subsidy.  And an important aspect of that reality is that the imposition of a tax is a cost added to production from outside the intrinsic production process – and it is passed on to the customer.

When government imposes a tax, it makes the product cost more, and the customer therefore has to pay more.  When government gives producers a break on the tax, that reduces the cost of the product, and the customer pays less for it.

Eliminating the tax breaks for drilling leases will cause the price of gas at the pump to go up.  It will also cause the prices of everything else made from a barrel of oil to go up.  This in turn will depress the economic activity that would have been more robust at the lower price point – and that depresses revenues for the government.

A similar principle is in operation with regulation.  The more there is, the greater the costs added to all economic activity.  All regulation imposes a cost.  There is no such thing as regulating without increasing the cost of a process.  We consider some amount of regulation to be necessary; there may be libertarian arguments against using a priori regulation to achieve the effects we desire, like unpolluted rivers and clean air, but in general, our society has agreed to the proposition of a priori regulation (rather than, for example, leaving all such issues to lawsuits among property owners).

But whether we favor specific regulations or oppose them, they all add costs.  In many cases, they go further and prohibit outright certain kinds of economic activity.  The overall effect of regulation is to discourage economic activity.  No argument can be made that regulation has any encouraging effect on the economic activities on which everything else hinges:  production, transportation, and sales.  Regulation serves in every case – every case – to make it cost more to produce, transport, and sell.

If a government wants revenues to increase, its best option by far is to let production, transportation, and sales increase, and the people prosper.  To a limited extent, government can encourage production, transportation, and sales by arranging for infrastructure like roads and sewage, which private individuals and businesses use in common.  If government is functioning properly, the reliable maintenance of law and order, respect for property, and a national defense ensures against obstacles to commerce.  But government’s main effect on commerce is routinely a discouraging one, because governments are so prone to enlarging the scope of regulation.

It ought to be obvious to us today that regulation is depressing commerce, and therefore revenues for the government.  There are wildly obvious examples like the hundreds of miles of coastline off which we prohibit drilling for oil and gas.  There are less obvious examples like the effects of freon licensing (minor) and disabled-access regulations (major) on small businesses.  Even when such regulations don’t drive small proprietors out of business, they force price increases – and they slice into profits and investment, and therefore depress the prospects for revenue.  They also increase the entry price for small businesses, guaranteeing that fewer will get started, fewer will make a go of it, and more sectors of the economy will be less subject to competition and innovation – the mighty engines of revenue generation.

What we need today is a regulatory version of what Reagan did with taxes.  (Reagan also lifted some important regulatory restrictions, of course.)  California, for example, could close much of its budgetary gap with breathtaking speed and efficiency if it merely did three things:  opened up its coast for offshore drilling; eliminated its alternative-energy policies; and favored delivering water for human use over actively preventing its delivery.  Even California’s mind-blowing pension obligations could be met if the state would also change its litigation environment, its posture on workplace regulation, and its practice of implementing virtually all regulatory policies by enthusiastically imposing costs on business.  The average person in California doesn’t even know that 90-plus % of regulations have been imposed; all he knows is that things keep costing more and more, and businesses keep pulling up stakes and moving elsewhere.

Across America, regulatory policies are actively inhibiting the economic activity that produces revenues for the government.  The only way to change that is to lift the burden of regulation.  Raising tax rates will merely exert an upward pressure on consumer prices, and drive private money away from the taxable categories that strengthen the economy.  Lightening the burden of regulation, however, will unleash the economy to produce, sell, and deliver significantly increased revenues to the government – without raising tax rates.  Oh, and it will also reduce government spending.  Regulating less means government spending less, on regulators and their infrastructure.

J.E. Dyer’s articles have appeared at The Green Room, Commentary’s “contentions,Patheos, The Weekly Standard online, and her own blog, The Optimistic Conservative.