The Dubious Logic Behind Tax-Cutting
Over the years, the Republican party has offered a number of justifications for tax cuts that largely favor the wealthiest Americans. When we were running a temporary budget surplus in 2000, for instance, President Bush argued that his proposed cut was essentially a refund, and that it was only fair that those who pay the most taxes get the biggest refund. By far the most common Republican argument, however, is that tax cuts for the rich benefit everyone by stimulating the economy, creating jobs, etc. This is the notion of trickle-down economics, or as it is more commonly referred to these days, supply-side economics.
The basic logic behind this argument is pretty simple, that tax rates affect people's incentives to work. If taxes are high, the argument goes, people keep less of what they earn and therefore have less incentive to work hard. When taxes are lower, people know they will get to keep more of what they earn, so they work harder. Lower tax rates, therefore, lead to higher economic productivity and a stronger economy. Everyone wins. The most zealous proponents of this theory go as far as arguing that the money the government loses by lowering tax rates will be fully offset by the increased tax revenue resulting from increased productivity. This is the argument that the Elder Bush once dismissed as "voodoo economics."
Now, at first blush, this argument makes some sense. But there are a number of objections that can be made. First, it's not entirely obvious that the incentives run the way the supply-siders suggest. One could argue, for instance, that increasing taxes would increase productivity because people would have to work longer to take home the same amount of money. Conversely, lowering taxes might decrease worker productivity because people will then be able to maintain the same standard of living while working less hours. The point here is that people react to incentives differently and there is no firm empirical evidence that, in the aggregate, people respond to tax cuts the way that supply-siders suggest.
Moreover, there are a number of dubious assumptions at work here. First, the theory assumes that people do not get their money's worth out the taxes they pay. If for instance, people pay higher tax rates in exchange for free health care and college tuition, as is the case in many European countries, it is not at all clear that cutting taxes (and therefore eliminating those services) will in any way alter incentives. People will not be "keeping" more of their money because they will now have to pay for something that was previously free. If the government can cover a cost more efficiently than the market (which is certainly the case with health care), the tax/service cut will actually result in people having to pay more for that same service.
Supply-side theory also assumes that workers are always rewarded for increased productivity with hirer wages. It's as if we're all doctors who can moonlight to earn a few extra bucks whenever we feel like it. The fact is that many workers (myself included) earn a fixed salary, meaning that no matter how productive we are, we get paid the same. Even workers who are paid by the hour are often limited to a certain number of hours per week. Not all jobs come with opportunities to work overtime, and many people (for example, working parents) have responsibilities that prevent them from working overtime even if they otherwise could. For all these workers, changes in the tax rate will have no effect whatsoever on productivity.
And there's a simple common sense objection. We aren't computers. People don't respond to minor changes in income tax rates the way an economist's graph might suggest. Assuming I have the sort of job where productivity precisely corresponds to pay, is it realistic to think that lowering my marginal tax rate by a percentage point or two will result in increased productivity? Will the knowledge that I now get to keep 72 cents for every dollar earned instead of 70 cents really cause me to suddenly work harder? Perhaps if they lowered taxes from 90% to 30%, it would affect my behavior, but that's not what we're talking about. American tax rates are already rock bottom compared to the rest of the world. To suggest that minor tinkering with tax rates will alter people's incentives to work in any significant way strikes me as somewhat divorced from everyday experience.
Finally, it's worth noting that the wealthiest Americans make the majority of their income from investments, not from wages. Therefore, even assuming the supply-siders are right about the relationship between tax rates and productivity, the wealthy are the least likely to be affected by such incentives. Yet, inevitably, Republican tax cut proposals disproportionately benefit the rich.
The basic logic behind this argument is pretty simple, that tax rates affect people's incentives to work. If taxes are high, the argument goes, people keep less of what they earn and therefore have less incentive to work hard. When taxes are lower, people know they will get to keep more of what they earn, so they work harder. Lower tax rates, therefore, lead to higher economic productivity and a stronger economy. Everyone wins. The most zealous proponents of this theory go as far as arguing that the money the government loses by lowering tax rates will be fully offset by the increased tax revenue resulting from increased productivity. This is the argument that the Elder Bush once dismissed as "voodoo economics."
Now, at first blush, this argument makes some sense. But there are a number of objections that can be made. First, it's not entirely obvious that the incentives run the way the supply-siders suggest. One could argue, for instance, that increasing taxes would increase productivity because people would have to work longer to take home the same amount of money. Conversely, lowering taxes might decrease worker productivity because people will then be able to maintain the same standard of living while working less hours. The point here is that people react to incentives differently and there is no firm empirical evidence that, in the aggregate, people respond to tax cuts the way that supply-siders suggest.
Moreover, there are a number of dubious assumptions at work here. First, the theory assumes that people do not get their money's worth out the taxes they pay. If for instance, people pay higher tax rates in exchange for free health care and college tuition, as is the case in many European countries, it is not at all clear that cutting taxes (and therefore eliminating those services) will in any way alter incentives. People will not be "keeping" more of their money because they will now have to pay for something that was previously free. If the government can cover a cost more efficiently than the market (which is certainly the case with health care), the tax/service cut will actually result in people having to pay more for that same service.
Supply-side theory also assumes that workers are always rewarded for increased productivity with hirer wages. It's as if we're all doctors who can moonlight to earn a few extra bucks whenever we feel like it. The fact is that many workers (myself included) earn a fixed salary, meaning that no matter how productive we are, we get paid the same. Even workers who are paid by the hour are often limited to a certain number of hours per week. Not all jobs come with opportunities to work overtime, and many people (for example, working parents) have responsibilities that prevent them from working overtime even if they otherwise could. For all these workers, changes in the tax rate will have no effect whatsoever on productivity.
And there's a simple common sense objection. We aren't computers. People don't respond to minor changes in income tax rates the way an economist's graph might suggest. Assuming I have the sort of job where productivity precisely corresponds to pay, is it realistic to think that lowering my marginal tax rate by a percentage point or two will result in increased productivity? Will the knowledge that I now get to keep 72 cents for every dollar earned instead of 70 cents really cause me to suddenly work harder? Perhaps if they lowered taxes from 90% to 30%, it would affect my behavior, but that's not what we're talking about. American tax rates are already rock bottom compared to the rest of the world. To suggest that minor tinkering with tax rates will alter people's incentives to work in any significant way strikes me as somewhat divorced from everyday experience.
Finally, it's worth noting that the wealthiest Americans make the majority of their income from investments, not from wages. Therefore, even assuming the supply-siders are right about the relationship between tax rates and productivity, the wealthy are the least likely to be affected by such incentives. Yet, inevitably, Republican tax cut proposals disproportionately benefit the rich.
posted by A.L. at 11:01 PM
2 Comments:
Also their arguments don't address the reality of the deficits. All tax cuts really do is raise taxes in the future. They put off the bill (while adding interest costs.)
Short term the borrowing is stimulative. Longer term they are going to be terribly destructive. How ARE we going to pay off the trillions we owe?
It similar to the price of gasoline. It doesn't reflect the cost of the carbon it is putting into the air. But this will be a tremendous cost.
These Republicans are like teenagers who have just discovered credit cards.
That's a great point, one I was planning on addressing in a future post. Democrats need to learn a lot about framing issues. If, for instance, they consistently characterized Republican tax cut proposals as "tax deferals," they could help make this point clearer to the public.
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