Nathan Scandella (personal)

Trickle-Down Economics

So, as the presidential campaign winds down, John McCain has resorted to the good old Republican playbook. He's trying to scare people about Obama's position on taxes, doing everything he can to imply that Obama is a socialist, while confidently proclaiming that his own plan will cut taxes and grow the economy as a result.

Wouldn't it be nice if we could all pay less taxes, and still have a steadily growing economy? The best of both worlds. Unfortunately, life on planet earth has some eventualities, and one of them is taxes. We need taxes to pay for the services we rely on government to provide. We need taxes to ensure that our government doesn't ring up even bigger deficits, which will ultimately result in inflation, that will erode the value of all the money we make, or have made. And sometimes, we need taxes to allow the government to stimulate the economy in specific ways that private individuals wouldn't think to stimulate it themselves.

The first simple rebuttal to the McCain-Palin interpretation of economics is that Obama is cutting taxes for the majority of the country, and in some tax brackets, cutting them significantly more than McCain would. If you make more than $250k, then your taxes will go up. McCain and Palin like to interpret that very specific threshold as a tax increase on "small businesses and families"; a small fraction of small businesses and families, but let's not get hung up on their inability to tell the difference.

McCain still sees this $250k and up crowd as the key to the economy. You increase their taxes, and you kill economic growth. But, if this fighter-pilot-suddenly-turned-economist actually bothered to do any research, he would realize that there's no data to support this idea, that giving the wealthy tax breaks leads to economic success for all of us. This isn't the cure for cancer, the human genome, or the Big Bang. This is simple stuff. Look it up.

First of all, the amount of tax paid by the wealthy in this country has changed quite a bit over the years. Here you can find the amount of tax paid by the highest tax bracket in the US during recent history. It has varied from over 90% to under 30%. Now, let's look at GDP history. Can you see any correlation, whatsoever, between marginal tax rate and GDP? I can't. I seriously doubt you can either.

The intuitive argument is that the rich, who own the businesses (large and small), are the ones who hire the rest of us. If you take money out of their pockets, they can hire fewer workers, and everybody loses. I admit, there's some hint of logic there. But, if that was the dominant factor, why wouldn't the data show a growing economy after tax cuts, and a slowing one after tax hikes? There's other factors at play. As Obama said eloquently in his talk with Joe the Plumber, if the bulk of the population (say, 95%) pays less in tax, then they'll have more money to spend on goods and services. This means more business for the small business owner. Even if some of that extra business is "lost" because the owner has to pay more taxes, we don't see a slowdown in the economy, or a loss in jobs. Because the rich make so much more money, you can have a revenue-neutral shift in taxes from poor to rich where a small number of people get their taxes raised, and a vastly larger number of people get their taxes cut. Trickle-Down Economics ignores this effect.

There's another effect. In the economy, things work well when we "pass the buck". Literally. I think I saw something that a dollar bill changes hands 7 times in its first year of life. The economy does well when we all keep spending money as fast as we can make it. Our income gets passed around like a hot potato. Americans, on the whole, are not savers. We're spenders. And that's actually one reason why our economy has grown so much over the years (compared to a country of savers, like China). When the middle class makes money, they spend it. When the poor make money, they spend it. And when we give the government our money via taxes, they spend it, too - right back into the same economy we work in. The only place where the buck actually stops is with the rich. The rich in this country are about the only ones who do any significant saving. Now, most of that saving is investing, and that does have benefits for the economy. But, some of it is taken out of the system and stuck in safe places where it can't continue to change hands so quickly. This is another reason why letting the rich keep more doesn't necessarily make the economy go any faster.

If you look again at this chart,



we see that another (possibly counterintuitive) result is that changing the tax rate on the rich doesn't seem to affect the overall tax rate for society-at-large. Of course, it can probably be assumed that many changes in top-bracket tax rates have been accompanied by opposing changes in the lower brackets (which is what Obama's plan does). There's also the separate issue of tax avoidance, via IRS loopholes. Nevertheless, the data shows somewhat of an indifference to marginal tax rate in the total tax revenue. So, does it even matter what rate we tax the rich at?

It does matter. For one, there is the issue of fairness. When times are tough, the rich only feel it when they login to their investment accounts. The poor, and middle class, suffer tangible losses. Therefore, a redistribution of wealth is appropriate based on need. The rich may not like it, but I have news for them: they already pay vastly more than their "fair share", so if they haven't gotten over that yet, now would be a good time. I can't buy the implied McCain-Palin argument that somewhere between 36% and 39% tax rates lies the boundary between capitalism and socialism.

One interesting thing to note ... this issue of taxation, and rich vs. poor, is a common theme amongst Democrats and Republicans. We've shown above that the tax rate on the rich in fact does not have much of an effect on the economy, as Trickle-Down Economics suggests. However, we can see here that the unemployment rate in this country has, unlike average tax revenues, varied quite a bit. Notice that since 1950, every Democratic president has either reduced unemployment, or in one case, kept it the same. Every Republican president has increased unemployment, with the one exception of Ronald Reagan, who kept it the same. So, while Trickle-Down Economics may not be real in terms of the effect it's purported to have on the economy as a whole, it certainly seems to be a bad deal for those at the bottom of the totem pole.

The record has been set straight.

Posted at 11:20PM Oct 27, 2008 by Nathan in Economics  |  Comments[1]