Tuesday, September 20, 2011

Taxing the Wealthy

President Obama's proposal to impose higher taxes on those earning more than $1 million each year (which would certainly qualify as "wealthy" by anyone's definition) in order to insure that the wealthy pay at least the same rate of tax as middle income Americans, has produced the usual claims that higher taxes on the wealthy will hurt economic growth.

Claims which are absolute nonsense (to put it politely).

Economic growth generally comes from increasing demand for goods and services, and demand comes from four areas:

  1. Domestic consumer spending (including housing);
  2. Investments by businesses in plant and equipment;
  3. Exports (i.e., sales to other countries); and
  4. Government spending on goods and services.

Increasing taxes on the wealthy would have no effect on exports, and would allow more spending by the government (which is expansionary), so increasing taxes on high-income Americans would reduce only the first and second types of demand, if its going to reduce anything.

Almost by definition, wealthy people earn more than they spend on themselves. Someone who earns $1 million each year is not going to be spending that $1 million, but is going to be saving or reinvesting most of it. So increasing taxes on the wealthy is not going to reduce consumer spending.

Increasing taxes on the wealthy might affect business investments, because wealthy people who invest in stocks and corporate bonds help those businesses raise capital for investments in new plant and equipment. But that's not what's happening right now.

  • Because demand is down, businesses currently have excess capacity, meaning that they have plants and equipment that they are not using to full capacity and have no need to invest in more.
  • As a result, businesses are currently holding hundreds of billions of dollars of uninvested cash.
  • Because businesses don't need cash to invest and aren't looking for capital or loans, investors are putting their money into federal securities, which is driving interest rates on federal securities down to record lows. (At the August 31 auction of inflation-protected bonds, four-year bonds actually sold at a negative yield, meaning that investors were willing to pay the United States to hold their money for them as long as they got back money with the same value.)
What that means is that, if you let a wealthy person keep more of their income, they are going to take that money and buy more government securities and not invest the money in the economy.

Right now, the best way to expand the economy is through increased government spending that will put more money in the hands of consumers, and that means tax breaks for middle-income taxpayer and more government spending on construction, which provides more employment.

Which is what President Obama is proposing.

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