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.

Trickle-Up Economics

I suffer from a certain amount of cognitive dissonance every time I hear a conservative politician or pundit talk about the need for tax cuts for the wealthiest 2% of Americans in order to stimulate the economy. What I hear on the news almost every night is that the biggest factor driving the economy is consumer spending, and that they economy is not recovering because consumer spending remains weak.

So, if lack of consumer spending is the problem, the solution should be policies that give consumers more income to spend, right?

No, the mantra from the right is that we need more money in the hands of wealthy individuals and businesses. Of course, the very meaning of "wealthy" is having more income than you need to spend, which means that increasing the disposable income of the wealthy does not increase consumer spending but simply makes the wealthy wealthier. Investments in plants and equipment would also help the economy, but businesses are investing now because the economy is so bad (the kind of self-reinforcing behavior that makes "boom and bust" cycles work), and most investors are not putting their money into new businesses creating new jobs but into government securities, which is why interest rates are so low.

During the Reagan years, the belief that reducing taxes for the rich would stimulate the economy was called "trickle-down economics." But if consumer spending is the issue, then what we really need is trickle-UP economics. We need to adopt policies and programs that put more money into the hands of the lower economic levels where it will translate into consumer spending and economic growth for the entire economy.

The following chart presents empirical evidence of this truth also. This chart was originally published by Slate and it shows the income growth of different income levels during Republican administrations and Democratic administrations based on data compiled by Princeton political science professor Larry M. Bartels.



The chart obviously shows what it was intended to show, which is that the policies of Democratic presidents cause greater economic growth among the lower income levels, while the policies of Republican presidents promote more growth at the higher levels and less growth at the lower levels. But there's another inference which can be derived from the chart, which is that everyone does better when the lowest income levels are rising. For the top 5%, the income growth might be pretty much the same either way, but for everyone else, there is a correlation between income growth at the lowest levels and income growth at all levels.

So it's not necessarily a zero-sum game, and the "class warfare" that conservatives complain about might not be necessary, because policies that benefit the working class are going to benefit the wealthy, but policies that benefit the wealthy don't seem to benefit wage earners.

Panaceas

There are an increasing number of "solutions" that Republicans and conservatives seem to want to apply regardless of the problem.

Tax cuts are one. If the economy is going well, tax cuts are needed to sustain economic growth. If the economy falters, tax cuts are needed to stimulate the economy. If the federal deficit gets too big, then tax cuts are needed to stimulate the economy in order to produce higher tax revenues. Tax cuts are the remedy to every economic problem.

Keeping our troops in Iraq is also the conclusion no matter what happens. If things are going badly, then we need to maintain troop levels in order to avoid losing. If things improve, we still need to maintain troop levels because we're winning. No matter what happens in Iraq, the solution is military.

Imprisonment is also a "solution" that seems to have gotten out of control. We now have 1% of our population in prison, which is the highest incarceration rate in our history and the highest incarceration rate in the world. Imprisonment is applied not just to violent crimes but to social crimes such as drug addiction, gambling, and prostitution. And if people who are released from prison commit another crime, make the prison sentences longer. It doesn't make any difference what the crime was, or whether crime rates are going up even as prison terms are getting longer, the solution is still to make the prison sentences longer still.

Fed Rates Redux

Fearing recession, the Federal Reserve Board has dramatically lowered interest rates in order to make it easier to borrow (and spend) money.

One of the causes of the feared recession is the bursting of the housing bubble, which was caused by low interest rates leading to excessive borrowing (and spending) on housing.

So the current problem is caused by too much borrowing, and the "solution" offered by the Fed is to encourage more borrowing?

Does anyone else see a possible problem here?