The Idolatry of Ideology
Why Tax Cuts Hurt the Economy
by Russ Beaton
Never have so many been fooled for so long by an idea so totally lacking in economic logic, facts and theory. I am speaking of the religiously held and seldom questioned premise that (are you ready?): TAX CUTS STIMULATE THE AMERICAN ECONOMY.
Im fully aware that I risk excommunication from the Church of Economic Science when I argue exactly the opposite: Tax cuts actually hurt the economy. It isnt just that they dont help, or that theyre ineffectiveTHEY REALLY HURT!
I can hear you thinking (even if your values bias makes you otherwise eager to agree): Here comes the bleeding heart liberal, anti-trickle down, do something for humanity mantra. No, indeed. Im talking data herenumbers and empirical evidence. Check your values at the door and come on in.
Lets start by examining conventional wisdom. You know the drillCut taxes. Leave the money in the hands of the people rather than the depraved clutches of the government. That way the people, being good red-blooded (Visa) card-carrying Americans, will dutifully spend the money. This stimulates economic activity, creates jobs and well all live happily ever after. Why, the activity thus stimulated may be so vigorous that collection of taxes on this newly stimulated activity will soon exceed the amount of the original tax cuts! Its the economic version of perpetual motion.
But lets get real here, starting with some basic facts. First: tax cuts put more money in the hands of people who (used to) pay taxes. In any data-based analysis of the impacts, the starting point must be the fact that money that would have been spent by the government is now spent by private individuals.
So lets follow the money.
Propensity to Consume
It is virtually always the case (especially with this President) that a tax cut returns money to high income people disproportionate to the middle or lower income taxpayer. This makes understanding the spending patterns of the rich critical to analyzing the economic impacts of a tax cut. Thus, the question becomes: What kinds of things do higher income folks spend additional money on, compared to moderate and lower income people?
There is both a quantity and a quality dimension to the evidence on this question. Economists call the percentage of an additional dollar received that will be spent (as opposed to saved) the Marginal Propensity to Consume (MPC). On the quantity question, both the data and common sense support the fact that less wealthy people have a higher MPCtheyll re-spend it all. They have to, theyre poor. Higher income people will save (or invest?) more, and therefore show a lower MPC. (If you consume only half your income, you have an MPC of .5. If you are at subsistence and cant save anything, your MPC is 1.)
The essence of economic impact is the hand-to-hand re-spending of dollars. That is called the multiplier. A high MPC leads to a high multiplier, and that means a certain amount of spending will go farther in stimulating the economy by being multiplied more times within the economy and creating more incomes before the impact dies out like a ripple on a pond. That is the essence of the quantity elementput the money in the hands of people who will re-spend it (moderate & lower income) and the economic stimulus will be more pronounced per dollar provided.
On the quality side, it matters what you buy. Consumer behavior data consistently show that low and moderate income people tend to spend money on goods and services that are more likely to result directly in jobs and incomes in the community (that is, to continue multiplying on a secondary or tertiary basis). Higher income people tend more to take a trip or buy some good or service produced elsewhere and set in motion an earlier leakage to their local economy, thus lessening the multiplier.
Of course, trickle-down economics rests on the now widely discredited assumption that wealthier people immediately invest this extra money productively, causing growth in the economy and putting everyone to work. (Good grief, George, even Ronald Reagan gave that one up!) This is equivalent to providing for the welfare of birds by overfeeding the horses, and then encouraging the birds to forage over whats left in the corral.
It is increasingly the case, beginning with mergermania in the 1980s, that the well-to-do have found a great many unproductive (to the general economy) ways to use their extra cash. Most of these ways increase disparity between rich & poor further (a subject Ill consider in a few more paragraphs, so be patient).
So there we have it. If you want to promote economic well-being through tax policy, dont give it to the rich. They lower economic multipliers by not re-spending as much in the first place, and then by tending to spend it on the wrong things when they do. You want economic health? Increase taxes and balance public budgets by having government re-spend the money. Let government put the money in the hands of two types of individuals: people who work for the government (generally of middle or modest means); and, people who receive the benefits of direct payments (such direct recipients of social services tend to be our lowest income types).The lower the income of the person you can get it to the bettertheyll re-spend it all!
As promised, this hasnt involved valuesjust data (and a few cheap shots). But this analysis wouldnt be complete without some observations of the income and wealth distributional effects of all of this. I knowI promised an ideology free case for the negative effects of tax cuts, but even traditional economists occasionally allow themselves to speak about income disparity. (They just dont DO anything about it
Much of my argument has derived from the fact that people who pay taxes normally have higher incomes than people who do not. That goes for normal people, of course. If youre really rich, or a corporation, you might get out of paying taxes altogetherbut thats a different story. Of course, avoidance of taxes by the super-rich is a lose/lose for all the rest of us (the welfare class, the working poor, the middle class, the upper middle classthe whole bunch of us) since those elite occupants of the high income tax havens are really getting double subsidies. One is a systemic tax structural subsidy, and the other is a government expenditure subsidy.
What are these things? First, anyone who has enough wealth and flexibility can often avoid paying taxes through a bewildering variety of features within the tax code and state-of-the-art accounting practices. Thats a built-in structural subsidy not available to us mere mortals. If you dont believe me, go get your own oil depletion allowanceor buy Rockefeller Center for the rapid depreciation write-off. Then well talk.
The second type of subsidy derives from taking advantage of direct government programs. For instance, Archer Daniels Midland (Supermarket to the World) is rumored to collect about half a billion dollars each year for a methanol fuels project that no one ever derives fuel from. (Or is it ethanol? No matterthey grow a lot of corn.) You just have to know where to look and how to apply. It also helps to have important friends and lobbyists in Washington and all the state capitols to help write the enabling laws and keep the programs funded. Homeless people or those on food stamps should be so well connected.
Do you suppose George Bush has ended this and other shameless slopping at the public trough in righteous indignation? No point even asking.
So finally, what is the justification for the almost religious adherence to the idea that tax cuts stimulate the economy? In my humble opinion, we must once and for all leave the land of data and logic, and enter the never-never world of ideology, which can roughly be defined as the willingness to believe whatever the hell you want to believe no matter what logic or scientific evidence might suggest.
As near as I can tell, it comes down to people wanting to keep their money rather than see it go somewhere else.
I hear you thinking: Of courseso do I! No awesome insight to understand this point, just self interest, greed, looking out for Number One. We can all identify with those feelings. They form the foundation for this market-oriented capitalist culture that we inhabit.
But a problem arises when a few people can manipulate the tax code and the markets to gain advantage, and the rest of us cannot. Thats precisely our problem: the rich can and do control the actions of lawmakers, and also the rhetoric we hear from the media about what makes this country great
. That is not the level playing field glorified in the myths about the marketplace.
You dont like it? Tough. Go buy your own president.
Russ Beaton is Professor of Economics at Willamette University in Salem, Oregon specializing in environmental economy, urban land economy and energy economy.
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