Probably the most persistent and pernicious economic lie of the last 40 years is that tax cuts aimed at upper-income people and businesses will "pay for themselves through economic growth."
There are circumstances under which the net effect of a tax cut is so stimulative of the economy that tax receipts actually increase. As usual, however, the devil is in the details, and those details are a lot more complex than can be understood in the amount of time most people have time to learn about and consider them.But we can try, anyway.
The aggregate health of our economy is best understood in terms of the total number of dollars that are spent for goods and services in the country by all actors in the economy. This is similar to, but not the same as, the "gross domestic product," which is a measure instead of the goods and services produced. Production is important to the economy, but merely producing a thing does not mean that it is an economic good unless there is someone willing and able to buy it. For example, we produce a lot of garbage, but that doesn't mean an economy devoted to producing garbage would be a healthy one.
What matters is spending, because an exchange--the fundamental unit of economic activity--can only take place when there are willing, able purchasers for goods and services.
One way to induce more spending is to put more discretionary dollars in the hands of people and entities. One way of putting more discretionary dollars in people's hands is to reduce taxation. It's superficially easy to assume, then, that any tax cut will result in more spending.
It's also wrong.
Some tax cuts will result in more spending, and some will not. To understand why, a couple of scenarios:
Imagine for a moment that your income over the last few years has been such that you've been able to live the lifestyle you want to live, buying all of the things that you want to buy, and in the process you've been able to set aside another $500,000 in savings for retirement, emergencies, and so forth. (Perhaps you don't have to imagine it.) Imagine also that your job is reasonably secure.
(This puts you in perhaps the top 2% of incomes, by the way.)
Then, one day, Congress passes a revision to the tax code that results in a year-over-year cut in your taxes of $50,000. What will you do with that extra money?
Imagine, now, that your income over the last few years has lagged well behind the pace of inflation, and you're living from paycheck to paycheck and carrying fairly heavy credit card debt, and it's a struggle to get by most of the time. You live in constant fear of losing your job or having your hours cut. It's been years since you took a real vacation. Your retirement fund is a joke.
Then, one day, Congress passes a revision to the tax code that results in a year-over-year cut in your taxes of $1,000. What will you do with the extra money?
Now, these two scenarios are very different in terms of how the protagonist views his financial position and even the value of money. I don't think we can say with certainty that Person 1 will behave in one way and Person 2 will behave in another way, because people don't always make choices that conform with our expectations.But, in the aggregate, we can make some generalizations that are fairly likely to hold true over time.
Person 1 might spend some of that money, but let's don't forget that Person 1 already has enough current income to buy everything he wants to buy. An extra $50,000 in that person's hands is much more likely to go into savings, because it doesn't give that person a license to spend something he wouldn't have spent previously. And the thing about savings is that while it's a good thing to have on a private level, it doesn't necessarily do anything for the economy. In fact, if that money goes into a tax-deferred retirement fund that's invested in the stock market, it will probably only work to drive up stock prices a bit--not to stimulate any other spending. In other words, there will not be any beneficial exchanges made possible by that tax cut. It's certainly not going to increase tax revenue--certainly not by the amount of the cut.
By contrast, Person 2 is likely to spend every bit of that $1,000, because an extra $1,000 in the hands of someone who is struggling is going to be used to alleviate some of that struggle. Perhaps it will go for a new refrigerator or washer-dryer to replace the one that's broken down. Maybe they'll take a small vacation to try to relax and recharge from years of constant work. Maybe they'll buy new clothes to replace the ones that have been worn hard for several years and are starting to show more than a little wear. It's also possible that they will pay down a credit card, or put the money in an emergency fund. Those activities aren't the kinds of economic exchanges that we're looking to stimulate--but they do facilitate later exchanges, and those later exchanges are much more likely to occur. After all, people who are in a marginal financial condition are much more likely to need to dip into savings or re-borrow on credit cards in a financial emergency.
Over the last 40 years, we've been sold this lie, that tax cuts always result in more spending that stimulates the economy. In fact, whether tax cuts stimulate spending or not is highly dependent upon the initial conditions, and we're not in a set of conditions where a tax cut directed at upper incomes would stimulate the economy.
For example, in 1961, the top marginal personal income tax rate stood at 91%. (Yes, it was really that high.) When the top rate is that high, people whose incomes are high enough to reach that rate lose a significant part of the incentive to make more money--or, at least, they will put their effort into making and spending money in ways that avoid taxation at that rate. The tendency was to lock up that money in investments that would not produce taxable income--and it happened at a rate that was significant enough that the economy had stagnated because of a lack of capital available for use in ways that would produce taxable income. So JFK proposed--and got Congress to agree--to reduce the top rate to 70%. That stimulated people with money to move their investments into new vehicles that would produce greater economic activity and greater tax receipts, and the result was that the new tax receipts offset the loss to the Treasury from the tax cut.
Today, however, the top rate isn't 91% or even 70%. It's actually 39%. And at that rate, taxes are not a disincentive to invest in income-producing activities. Cutting taxes on high incomes today is very unlikely to stimulate growth. It will simply stuff more money into the retirement accounts and savings of wealthy individuals. And with income inequality at historical highs, the credit markets are very tight, so even the availability of cash to lend doesn't mean we can rely on consumer borrowing for stimulus.
Cutting taxes on high incomes today isn't going to stimulate the economy. It will simply exacerbate the difference between the haves and the have-nots--and that is the fundamental economic problem facing the country today.
If you want to stimulate the economy, create jobs, and raise incomes, you need to put more money in the hands of the people who are closer to Scenario 2 above, who will likely spend it. And, frankly, we need to increase tax rates on top incomes. If I were in charge, I would impose a top rate of 50% on family incomes above $250,000; I would also tax dividends and capital gains as regular income. Finally, I would establish a Universal Basic Income--we would end all forms of welfare and replace it with a monthly check sent to every American, regardless of income, equal at least to the amount of the federal poverty line. More on that in a later post.