In any event, the cost of production rises in all three cases and output falls, which means there is another downward force exerted on government revenues, once again upsetting Krugman's revenue estimates.
Raise taxes on capital, and the story is the same. Firms will produce and sell fewer goods and services at current prices. Less labor will be hired, and fewer inputs will be purchased.
Again, after all dynamic adjustments have rippled through the economy, tax revenues will not increase as much as Krugman might project. In fact, depending on the circumstances, revenues may actually decline from their pre-tax-increase level.
Increase the capital gains tax rate and you increase what economists call the hurdle rate for new ventures, namely the rate of return a new venture must yield to entice investors to put capital into the project. As the hurdle rate rises, fewer new projects can successfully get over it; fewer new ventures are undertaken, fewer jobs are created and revenues, in most cases, end up lower than they were before the capital gains tax was raised.
Krugman would call this voodoo economics, but listen to what his hero, John Maynard Keynes said, "Nor shall the argument seem strange, that taxation would be so high as to defeat its object and that given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. To take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price. And when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, he decides that prudence requires him to raise the price still more. And who, when at last, his account is balanced with naught on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss."
The evidence indicates that this is precisely what happened when President Bush convinced Congress to cut the tax rate on dividends and capital gains and to allow small businesses to recover their capital investments quicker by writing them off in a shorter period of time.
Revenues continue to pour into the U.S. Treasury so fast the Congressional Budget Office projects that if the tax cuts are left in place permanently, the budget will be balanced within a few years, and revenues as a share of Gross Domestic Product will remain pretty much where they have stayed since the end of World War II, right about 18.5 percent of GDP.