The wife and I the other day went down to Mt. St Helen’s. This is about a 3-hour drive from where we live.
The city of Seattle is heavily Democratic (capital D). Yet once you get out of the city and drive in any direction for an hour, the political orientation changes. There are lots of Trump supporters.
Along the way down, we saw a big billboard (privately owned, I think) that said “Higher taxes create jobs how?” The unstated argument is that raising taxes is bad for the economy and doesn’t create jobs, and lower taxes is a good idea and creates prosperity.
So I thought I’d take a stab at answering this question.
First of all, nobody who wants higher taxes wants them at 100%
So let’s throw that away. Everyone knows that if the tax rate is too high, the economy stops because no one will work.
Second, it’s a matter of who is being targeted with the higher taxes
In any economy, there is the poor, the working class, the professional class, and the rich. We’re not just talking about the 1% who have incomes starting over $450,000, but the highest sliver of that whose incomes are over $5 million per year. That’s usually who is being targeted for higher taxes although typically it applies to earners over $450,000.
Third, it has to do with increasing consumer spending
The United States’ economy, and most western economies, is built upon consumer spending. Someone has to sell stuff, and someone has to buy the stuff that’s being made. If I build 10,000 widgets, but nobody buys them, that’s bad. It puts no more money in my pocket, and if nobody can afford my widgets, then they can’t take advantage of my widgets’ awesomeness.
The theory behind tax increases
The idea being tax increases is that you take some money from the wealthy and give it to the poor, working class, and professional class. This could be in the form of a direct transfer payment, but usually it’s in the form of services. So, a government might take the additional revenue from taxes and spend it on improving public transit, or on roads, or on daycare, or on health care.
The result is that a poor, working class, or professional class person that normally would have spent an extra $5 on a subway ride, or $1000/month on day care, has extra money in their pocket. They decide to spend it on something else, be it goods that are necessary (household items) or luxury goods (mid-to-upper end vehicles).
The net result is that because people are spending less on one area because the government is subsidizing it, they get to spend more on another area. That means the people that sell stuff have more customers to buy their stuff.
The theory behind tax cuts
Tax cuts have to go to the wealthiest people. The belief is that a wealthy person will take the money they receive in tax cuts and invest it to start new business and generate more wealth for everyone – new jobs, new innovation, new spending on business.
A poor, working class, or professional person doesn’t get enough back in taxes to be able to invest it. For the poor and working class, any new additional income is likely to be spent on consumer goods and services. For a professional person, the money will either be spent, saved, or invested in the markets depending their financial situation. This is similar to a tax increase on the rich in that both are intended to be stimulative. But in these cases, the tax cut money has not gone to creating more wealth in the economy by starting a new business.
No, only a wealthy person who gets a big tax cut can take it and invest directly in the economy. For you see, a wealthy person already has all (or nearly all) of their needs and luxury items. This is because of the decreasing utility of money. All of us need a certain amount of money to buy food, shelter, transportation, cat food, and other requirements. Then we all buy some luxury items. But eventually that tapers off and additional money doesn’t make us happier, that is, we don’t spend it. But given enough additional money, and then maybe a wealthy person decides to take a risk and start a business to grow the economy. It takes a certain amount of money to get started, running a business isn’t cheap. It’s difficult and requires a cushion.
That’s why you have to give tax cuts to the rich if you want them to grow the economy.
Which one is better?
Economists have measured both of these. Both are intended to stimulate the economy. A tax cut does put additional money into everyone’s pocket, and they spend it – but not equally.
The poor and working class spend their extra money. The professional class frequently does, and the wealthy sometimes do, but sometimes they save it. If someone wants to save their extra money, that’s fine. It’s a smart thing to do, Americans don’t save enough. But from macro-economic perspective, it’s bad. Our economy is built on consumer spending, not consumer saving.
If the government now suffers a reduction in revenue, it either has to cut services or run deficits. If it cuts services, then the poor and working class who were using them now have to use the small bit of money from tax cuts to spend on those cut services whose fees have increased. They have no additional money. So the government has to run a deficit and sells bonds in order to finance itself, but as the deficit grows, it can increase inflation. That, too, can erode the buying power of consumers whose incomes have to grow fast enough to keep up with inflation. In 2017, that’s happening for the professional class, but not the poor and working class.
So, if you compare the two:
- A tax increase on the wealthy that results in the government providing more services for the middle class gives us more consumers who can spend money. Because of the marginal utility of money, the wealthy don’t experience a noticeable degradation of their lifestyle
- A tax cut on the wealthy does not necessarily result in the wealthy creating more jobs. Much of the time, they save it which is good for them but not for the economy as a whole. The middle class does notice a degradation of their lifestyle as they now have to spend more money on services that they previously didn’t have to spend on
Therefore, as long as it is done right and the rates are not too high, a tax increase on the wealthy does more to stimulate the economy than a tax cut for the wealthy.
And that’s how I would answer the billboard’s question.
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