Why Raising Taxes Decreases Revenue in the United States

If you know the rules, you can play the game. This concept holds true for the sea of rules imposed by the IRS. A good tax advisor is going to seek out loopholes or effective strategies to keep more money in your pocket. When you feel that you are paying more than your fair share, you find creative ways to reduce your burden. This is precisely why an increase in taxes often yields less tax revenue.Remember the yacht or luxury tax? The idea was to tax the very wealthy on their extravagant purchase thus increasing tax revenue. What happened? The rich bought less luxury items in the United States. They bought their luxury items in other markets. The United States shipyards that built and sold yachts suffered with decrease sales and many had to lay off workers and go out of business. The laid off workforce now had less revenue while they were unemployed which further reduced tax revenue. In short, it backfired!

This phenomenon is well documented by Arthur Laffer and a concept was published called the Laffer Curve. The theory was developed by exploring the extremes and then postulating a hypothesis that there is a maximum taxable rate the public will tolerate. The extremes are Zero Percent and One Hundred percent. If the tax rate was zero, there would be no tax revenue generated. Likewise, if the tax rate were 100 percent, there would be no incentive to work. Why would anyone work if they were going to give 100 percent back to the government? Therefore the theory states there must be an optimum tax rate.

I know a lot of individuals and business owners that would be considered wealthy yet pay very little in taxes. Why? Because these people are savvy and know how to play the tax game and win. They form S- Corps, Limited Liability Companies and engage in tax friendly investment strategies. The higher taxes create a behavior of seeking aggressive tax strategies. It also has the effect of motivating others to adopt tax saving strategies that they were otherwise content paying.

Think about it this way. Let’s say you could really use an extra $2,000 this year. You could get another job and probably find you do not have the time and energy to commit to another job while paying even more in taxes. You could ask for a raise. Or, you could get more aggressive on legitimate tax deductions and have less money withheld from your paycheck.