Trickle Down, Again??

Ok, one of the new tax bills that is going through Congress at the moment of this writing seeks to provide some temporary tax cuts for some Americans while giving permanent cuts to corporations. It is the main goal that President Trump has had since he was elected. Tax reform. It sounds like a relatively innocuous policy. Taxes are complicated, and paying them hurts you economically; so they need to be reformed, right?

Let’s set aside for the moment the fact that Trump himself has been touting a strong economy since he was elected. The stock market is hitting record highs. Unemployment is pretty much back at pre-recession levels. While some groups are not seeing these benefits, the wealthier half of Americans (those making over the around $53k per year in household income that is the median in the U.S.) are doing fine. We might ask why the economy needs a boost at all?

But let’s just grant that boosting the economy is always good. Is this the right way to do it? No. It isn’t.

The reason why is very simple. The tax bill being proposed is strongly slanted toward the wealthier Americans that I just showed are doing fine already. Here is the CBO’s analysis of what the after tax incomes of Americans will look like in 2019 and 2027 under the proposed plan:

As you can see, the short-term benefits go to Americans making more than $30k per year, and those cuts expire in 2027, which is why the chart shows that starting that year, only those making $75k or more will see benefits under this plan. Why do the cuts expire, you might wonder? That’s by design. It’s meant to provide an infusion to the economy without permanently blowing up the deficient. But it will still blow up the deficit.

The tax bill will raise the deficit by $1.5 trillion over the next ten years. That’s an odd result given that the party proposing it literally threatened to shut down the government when Obama was President because of growing deficits. However, the proponents of the bill claim that the tax cuts will grow the economy and thus offset these losses by increasing earnings overall, which in turn will raise taxes.

This is the magic of so-called ‘trickle down economics’. The idea is pretty simple. If you cut taxes on corporations and high-income earners, they will be able to start more businesses and hire more people. Unfortunately, there is almost no historical evidence that this is the case, even though it’s been tried off and on since the 1980s, and plenty of evidence that it does not work. Even in particular states, such as Kansas, it has had disastrous results.

But let’s set aside the numbers and history for a moment and just think about why this is a bad idea in principle. It’s very simple, so simple that you might suspect the people proposing these policies know they don’t work and thus have other motives for cutting taxes on the wealthy.

Suppose you own a business. You make something simple, like ice cream cones. In the Summer you have better sales, of course, because people buy more ice cream in the Summer. In other words, there is more demand; so, you make more money. You know that, which means you make more cones in the Summer. You may even hire extra people to make your product. Now, suppose one January you get a tax cut due to legislation. Will you hire more people with the extra money?

Of course not! You hire people because of demand, not because of how much money you have on hand. If cone sales are down, hiring more people would just raise your costs and eliminate the money you got from the tax break. Well, maybe you could open another business, selling a product that is popular in winter? Maybe….but again, whether you do that or not depends on whether you have the ability to run that business and whether there is a spot in the market for it. In other words, it doesn’t really depend on cash on hand. In fact, most people start businesses using business loans, so they don’t have to risk their own money on it. The corporate status protects their personal assets.

In other words, where does more money from tax cuts go when wealthy people receive it? In their pockets mostly. But what about spending it on goods, you might ask? Wealthy people can already buy all the goods they want. Giving them more money doesn’t increase their spending. In fact, once you hit the top 20% or so of American households (which is $120k per year or more), spending tends to plateau a bit. We can only eat so much food and buy so many cars.

Growing the economy is complicated, and there is some truth in the idea that over taxation can curtail spending. However, we are nowhere near being overtaxed right now. Tax rates in the U.S. are very low, especially on top earners. Lowering them even more is unlikely to have any significant effects, and trickle down approaches to growing the economy won’t work for one simple reason. Economies grow based on demand, not supplies. If it were as easy as making tons of product, Atari wouldn’t have filled a dump with ET cartridges in the 80s.

This is a bad bill. But don’t take it from me. Ask Forbes magazine, the pro business mag.

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