Sunday, July 10, 2011

"The Death of a Tax Collector" and Other Republican Bedtime Stories

You don’t have to be an economist to know that tax cuts, especially for the wealthy and for corporations, can only produce a small short-term benefit to the economy, if any benefit at all. It’s actually common sense, but sometimes common sense takes a back seat to the back pocket, and public good to personal greed.

Taxes are good and necessary

Taxes Concept
Taxes are the primary means for a government to obtain funding. Taxes can take two basic forms: continuous taxes on items you own (e.g. property taxes, vehicle title/registration, etc.), and taxes that draw out of economic transactions (e.g. income and sales taxes). From the perspective of the government, property taxes are mostly going to be consistent year-to-year, as long as someone owns a taxed item. Transactional taxes, however, are dependent on economic activity: in general, the more money that is being transferred from one person to another, the more money the government takes in.

If you are like many Republicans, you might think this is unfair, that the government is “stealing our money”. But these taxes should be (and to a large extent are) used by the government to provide services, infrastructure, and laws that facilitate economic activity, maintain a stable environment, and allow the participants to trust each other. It is possible to tax too little.

Income taxes largely do not affect overall economic activity

As I described above, the amount of money the government takes in is directly dependent on the amount of economic activity. In general, this economic activity would be happening regardless of the amount of taxation, as long as it wasn’t some obscene amount (say 50% or higher). If you’re paying more in taxes this year than last year, your net income is still higher than it was the year before. And as long as the taxes are being put back into the economy or spent on things that support the economy, there is no net loss of money from the system. It is only when there is a change in the tax rate that there may be an effect due to the change, but that effect is only temporary.

Tax cuts may only provide a temporary boost

It is always nice to have a little more money in your pocket, whether you are a person or a business, and it is true that for a business some of that extra money could be used for an extra job or two. But a substantial part of the effect of a tax cut is psychological. That little extra isn’t actually something extra.

A slow economy means income is shrinking over time. Since tax cuts only give back a little bit of that shrinking pie, the most it can do is stall the effects of the decline to the group receiving the cut, and we can only cut taxes so far before we run out of taxes to cut and lose the ability to carry out those functions necessary to sustain the economy, resulting in an economic death spiral. And since tax revenue is directly dependent on economic activity, cutting taxes at the same time as a shrinking economy hurts the government twice as much as either alone.
Cutting taxes may dampen the effects of a shrinking economy for people who receive them, but only an increase of income will truly help.

The economy is really about demand, not supply

Tax cuts are the cornerstone of the heralded Regan philosophy of supply-side, trickle-down economics. But they make zero economic sense. There are very few situations where supply drives demand—the iPad would be one of them in a sense—but in most circumstances, demand is what drives the economy. When demand is weak, the economy will be weak, no matter what happens to the supply. The weak demand will mean businesses won't need to create new jobs, even if they had the resources to do so. To save the economy, it should then be clear that any actions taken must increase the demand side of the equation, to increase the income going into businesses and consequently their need for employees.

And the data bears this out:
Bar graph showing the economic impact of a dollar of spending on various programs
The most stimulative actions that can be taken are those that increase demand. Food stamps free up money for poor people to spend elsewhere. Unemployment benefits allow people without a job to continue participating in the economy while they look for a job, rather than hoarding what they already have. Infrastructure allows people to travel more freely and goods to be transported more cheaply. States will spend money on projects that help local economies. Payroll tax holidays and a refundable tax rebate which would give money to people even if they didn’t make enough money to owe taxes, giving a larger chunk of net income to the people who are most likely to spend it.

Note that although some of these act effectively like tax cuts, they are deliberately temporary.

Irresponsible fixation on tax rates

If you don’t think about it too hard, tax cuts seem like a good idea because people are getting more money. But that doesn’t mean it’s a good idea for the long term. Of course, this also belies the real objective: an attempt to force spending cuts by driving the government (further) into debt. And now there’s serious talk of not raising the debt ceiling and letting the government default on its debts, with reports that the Republicans will not accept any deal that increases taxes for anyone.

This is completely irresponsible. There is no reason we can’t work to reduce spending over time while still guaranteeing we will pay our debts. And tax increases have to be considered as part of balancing the budget—and they’ll be absolutely necessary if we want to decrease the $14.3 trillion national debt. Ask any personal finance expert and they will tell you that you need to be paying more than the minimum payment in order to actually pay off your debts. We would have to massively cut annual government spending to even match current revenue, let alone start getting enough revenue to pay down the national debt.

To do as the Republicans have done and talk about income as if it were completely divorced from the reason we have a budget deficit is senseless and transparent political posturing. Indeed, this focus on tax cuts is exactly how we got into such a bad situation in the first place: taking the budget surplus of the Clinton years and then squandering it as tax cuts to the richest Americans. Of course, it didn’t help that those cuts were followed by massive new spending for Homeland Security and the invasions of Iraq and Afghanistan.

A good start

  1. Create a new stimulus package focused on the demand-side and infrastructure. This should include temporary jobs programs as a partial replacement for unemployment benefits. Instead of simply supporting people while they look for a new job, why don’t we put them to good use improving the country while they wait for the job market to improve?
  2. Wind down our military involvements in Iraq and Afghanistan.
  3. Allow the Bush tax cuts to expire, finally.
  4. Shut down subsidies to industries (like oil) that really don’t need it, close tax loopholes (including the hedge fund manager loophole) that allow rich people and wealthy corporations to owe no/low income taxes, and add new tax brackets above $250,000. Ironically perhaps, closing loopholes and ending subsidies may actually allow for an overall reduction on tax rates from current levels.
Our primary goals should be to fix the economy and stop hemorrhaging so much money. Once we slow the bleeding from the biggest and most recent wounds, then we can talk about how to fix older, more festering problems (including too much spending in, for instance, the military-industrial complex) so that we can start paying down our national debt.


  1. It's a temporary boost for the economy lobbied mostly with political motivations in tow.

  2. "The economy is really about demand, not supply"- I agree with you.