Time For Tax Hikes?
OK here’s an interesting article brought to my attention today: Time For Tax Hikes | CommonDreams.org
Interesting thesis, and certainly controversial at the moment when we are all running around in a frenzy of Keynesian deficit spending.
Here’s my take:
I am not sure that higher taxes automatically means higher growth. The old adage ‘correlation is not causation’ has real meaning in this case. The fact that higher taxes seem to occur at times when growth is higher doesn’t mean that there was any cause and effect.
Having said that: it is absolutely clear that the ‘trickle down’ or “Laffer” curve theory is totally bogus. There is no evidence at all that lower taxes automatically increase growth. This is because lowering taxes usually only affects the well off who don’t then rush out and spend the extra money they now have, but rather they save it. So lower taxes has a low stimulative impact on the economy [remember that growth is an increase in spending and investment less net exports].
The Laffer theory was based on the notion that the money saved through lower taxes would go towards investment, which would then increase productivity which consequently increases wealth in the future [investment increases the capacity of an economy to generate wealth in the form of additional jobs etc]. In other words the cut taxes would ‘trickle’ through investment and end up as higher wages.
One of the problems of the past few years is that the investment went overseas and so created wealth elsewhere … it was more profitable to invest in low wage countries. But the main reason that investment supposedly flowing from the Bush tax cuts seems to have been ineffective is touched upon in the article: money flooded into non-productive areas like real estate. This provides a temporary stimulus only through construction jobs and subsequent furnishing purchases, but does not contribute to a more permanent productivity growth and hence future wage growth. This is one of the reasons wage growth was so poor over the past decades: investment was not going to productivity enhancement.
So the extra liquidity caused a bubble, not productive asset acquisition.
Raising taxes today would have a stimulative impact only if the government then went and spent the money on something. The Kennedy/Johnson tax increases were designed to offset the cost of the Vietnam war … wars always stimulate the economy because governments spend money on non-productive material like guns etc. In other words the economy was being stimulated by defense spending not the higher taxes per se.
Also bear in mind that any tax increase would reduce, potentially, spending by the wealthy so the increase in government spending could be offset by the reduction in private spending. Economists have measures for things like this. They measure the ripple effect of money being spent as it works its way through the system. As money is first spent, say in a store, it enables jobs to be created and therefore wages paid. those wages then get spent … and so on. The effect means that a single dollar spent provides more than one dollar’s worth of economic activity. The net effect is called the ‘multiplier effect’. Right now a good estimate is that one dollar of government spending has a multiplier effect of roughly 1.5. So a $1 billion of spending grows the economy by roughly $1.5 billion when all is said and done. Tax cuts are far less efficient, they have a multiplier of less than 1 and so are much less effective as a stimulus. One last thing on multiplier effects: the wealthy tend to spend less of their income as a percentage. This means that a tax increase on the wealthy has less of a drag on spending than a tax increase on the poor [who, for obvious reasons, spend most if not all their after tax income]. The thesis of the article relies heavily on this fact. The notion is that the wealthy would still spend even if their taxes went up, so the negative growth impact would be minimal.
For the thesis of this article to hold we would have to have large scale government spending on education, roads, rail etc [hopefully not a war]. Presumably these would be paid for by tax increases on the wealthy. But the various multiplied impacts suggest that the increase in growth from the government spending would be at least partially offset by the decrease in spending the wealthy [the data suggests that the wealthy are cutting back more than normal due to the reduction in their wealth held in the stock market and in real estate]. So it’s a pretty bad idea right now.
Ironically that is one reason not to get out of Iraq right now: the reduction in defense spending would adversely affect the economy just as we are trying to stimulate it!!
Lastly it probably is a bad idea to drain cash out of private hands at the moment: we need every penny we can get spent in stores to stimulate the economy. This is also why cutting taxes as part of a stimulus package makes no sense, people would simply save the cash rather than spend it.
In more regular times, and lets hope we get back to such times soon, a progressive tax code provides a balanced way to provide revenue for heavy government spending without causing a huge drag on growth. The article is correct in pointing out that high taxes and strong growth often occur together. There is no cause and effect there though. It is simply that during periods of strong economic performance the government has been able to raise taxes without causing a slowdown.
Nice try though.
Note:
Thanks go to Tom for sending the article!
