Tax Rates (%) X Tax Base = Tax Revenue ($)

An endless source of confusion seems to exist regarding the frequently used term "raising taxes" (e.g., do a Google search for "raising taxes on the rich" and you'll find almost 3 million results), which usually refers to a proposal to raise tax rates in an attempt to raise tax revenues.  Not so fast.  It doesn't always work that way, and frequently works in reverse - higher tax rates result in lower, not higher, tax revenue collected.  Here's the relevant formula:

TAX RATE (%) X THE TAX BASE = TAX REVENUE ($)

One explanation for the confusion is that the word "tax" appears in all three relevant terms in the equation, so it's easy to conflate the terms "raising taxes," "raising tax rates" and "raising tax revenues."  What we know for sure is that higher tax rates create disincentives for the activity being taxed (income, capital gain, consumption), which will cause the "tax base" to shrink.  Depending on how much the tax base shrinks in response to higher tax rates, tax revenue could increase, decrease or stay the same.  

Any discussion about "raising or lowering taxes" is always incomplete without considering how changes in "tax rates" will affect the "tax base," which then determines how the amount of tax revenue actually collected with change.  

Thomas Sowell addresses this issue masterfully in his column today, here are some excerpts:

"History has shown repeatedly, under administrations of both political parties, that there is no automatic correlation between tax rates and tax revenues.

When the tax rate on the highest incomes was 73 percent in 1921, that brought in less tax revenue than after the tax rate was cut to 24 percent in 1925. Why? Because high tax rates that people don't actually pay do not bring in as much hard cash as lower tax rates that they do pay. That's not rocket science.

Time and again, at both state and federal levels, in the country and in other countries, tax rates and tax revenue have moved in opposite directions many times. After Maryland raised its tax rates on people making a million dollars a year, there were fewer such people living in Maryland-- and less tax revenue was collected from them.

There is no automatic correlation between the direction in which tax rates move and the direction in which tax revenues move. Nor is this a new discovery."