Our esteemed representatives in Washington DC just passed another sweeping tax overhaul with the Fiscal Cliff Senate deal but as I see it, this is just another instance of our Federal Government playing in the margins and avoiding the much bigger spending issue.

There was a recent post in the Wall-Street Journal Blog that that shows a history of tax overhauls from Reagan to Obama.  You have to have a WSJ subscription to read the full story but I’ll summarize my key takeaway.

The article goes into details about the various changes to the Alternative Minimum Tax, deductions, corporate tax rates, ‘sin’ taxes (alcohol, tobacco, etc.) and adding/combining various tax brackets but there were two tax rates that all of the past 5 Presidents have changed – Top Individual Tax Rate (TITR) and Capital Gains Tax Rate on upper incomes (CGTR).

The graphs below show the changes that happened during each President from Reagan to Obama.

Notice anything about these graphs?  Let me put a trend line in both of these graphs and then see what you can conclude.

For the past 30+ years we’ve been moving these two tax rates above and below an average – TITR around 38% and a CGTR around 22%.  What has all the tweaking of these two tax rates meant for our Federal budget deficits?

I used this link to obtain the US government’s deficits by year and then averaged them for each President and used the metric deficit/GDP.  I’ll graph this metric versus TITR and CGTR for upper incomes to see if there is a correlation.  It should be pointed out that the budget deficits under Obama can’t be correlated to the new TITR and CGTR since these new tax rates were just passed a few days ago.

Let’s first see if there is a correlation between CGTR and deficit/GDP.

From this graph we see a correlation between lower CGTR and lower budget deficits – When CGTR goes down the deficit/GDP ratio also goes down!  From this data, we should be lowering the Capital Gains Tax Rate to 0%!  It makes sense that when you encourage investments in companies then more jobs are created and that creates more tax payers which will ultimately increase the tax revenue.  I’ll admit that the macroeconomic landscape is much more complex and I’d caution reading too much into the above graph, but still there seems to be a compelling argument from the data.

Now let’s look at how TITR is correlated with budget deficits.

It’s hard to see a correlation here but what happens if I invert the budget deficit/GDP ratio and re-plot the graph.

From this graph we see a correlation between TITR and lower budget deficits – When TITR goes up the deficit/GDP goes down!  From this data, we should raise the top marginal tax rate to 100%!

Of course, the Laffer Curve tells us this is nonsense and if wealthy people are taxed at 100% then they’ll avoid paying these taxes.  I’ve also shown that relying on the ‘soaking the rich’ theory is mathematically impossible to close our budget deficit without reigning in our spending addictions.

At best I can come to a conclusion that higher TITR and CGTR could’ve moved the needle when the US ran annual budget deficits in the $100-$200 billion range but with a $1.3 trillion budget deficit under Obama, we don’t have a prayer to close this gap with just playing in the margins.

We. Must. Address. Spending.