Fair warning – this is going to annoy a few people. There is not a lot of agreement among economists on how tax cuts stimulate the economy or tax increases dampen it. But it is also a political and ideological issue. There are clear examples in which research that contradicts a person’s beliefs is discounted and attempts are made to discredit the research with attacks meant to confuse the public. I haven’t checked, but I would bet good money that a confused public is more likely to forget about an issue than try to clarify the situation.
I’ll give two examples – one economic and one not.
On January 16, 2015, NSAA released a NOAA report which declared that 2014 was the warmest year in recorded history (134 years of data). The average temperature was 0.69°C above the 20th century average which broke the previous annually-averaged global temperature record set in 2005 and 2010 by 0.04°C. The report, however, did not contain information on the standard deviation of the data collection. When released, that 0.09°C standard deviation could mean that either 2005 or 2010 may be the warmest year in modern history, but 2014 was slightly more likely and was certainly in the top three.
With the release of the standard deviation information, climate change deniers went to work. The first I heard about the controversy was from a friend who generally gets his information from conservative news sources. He stated that NASA and NOAA attempted to pull a fast one, and with the release of the standard deviation, 2014 may not even be in the top 10 warmest years. This simply is not true, and if you step back and look at the bigger picture, all fifteen years of this century are represented in the top 16 list of warmest years. Still, climate deniers attempted to confuse the public and they achieved their goals. Not only did they successfully sow confusion in those who got their news from conservative sources, they sowed a greater distrust in information that comes from government agencies. A Win-Win, you could say.
Now for the economic example. On April 20, 2015, the Wall Street Journal reported on a working paper published by the National Bureau of Economic Research in which the data show that tax cuts for the top 10% of income earners had almost no effect on job growth (“Tax Cuts Boost Jobs, Just Not When Targeted at Rich”). Tim Worstall criticized the Wall Street Journal for misrepresenting the paper’s conclusions in a commentary published on http://www.forbes.com a couple days later (“Tax Cuts Do Increase Employment, Do Create Jobs, The Science Is In”).
Mr. Worstall included the paper’s abstract in his piece and then used a somewhat confusing line of reasoning to suggest that abstract didn’t necessarily mean what the Wall Street Journal said it did. He, however, did not quote from the paper’s conclusion or any of the findings which would support or contradict his assumptions, just the abstract. His plan for this piece, it seems, was to confuse the readers so they would fall back on their long-held beliefs that tax cuts for the wealthy stimulate the economy. It didn’t quite work on me though – I forked over $5 and downloaded the paper.
The paper is “Tax Cuts for Whom? Heterogeneous Effects on Income Tax Changes on Growth and Employment” by Owen M. Zidar (http://www.nber.org/papers/w21035). The math is beyond me, but Dr. Zidar used post-World War II individual tax return data, 2-year job growth information by state, and percentage of high income earners by state to determine the effect that tax changes for various income groups had on job growth. He concluded that a tax cut for the top 10% income earners generated no job growth statistically, while a 1% of GDP tax cut for the bottom 90% resulted in a roughly 5% increase in employment over the following two years. If I read the graphs correctly, a 1% of GDP tax cut for the bottom 50% generates an employment growth rate of 9.5%. Keep in mind that to cut taxes for lower and middle class workers by 1% of GDP would require a very large tax rate cut because their income is so much lower that the top 10%.
A quote from the paper’s conclusion: “In particular, I find that the stimulative effects of income tax cuts are largely driven by tax cuts for the bottom 90% and that the empirical link between employment growth and tax changes for upper-income earners is weak to negligible over a business cycle frequency. These effects hold at both the state and federal levels, and are not confounded by changes in progressive spending, state trends, or prior economic conditions.”
This makes perfect sense. Wealthier people save much more of their income that less wealthy people. The high-income earners are referred to as “job creators” by presidential candidates – and many are – but unlike the impression presented by the candidates, they don’t just go out and build a factory and hire a bunch of people just because they have some extra money in their paychecks each month. Many of these high earners are doctors, lawyers and farmers who put the extra money away for retirement, unexpected expenses or perhaps purchase a vacation home. That doesn’t generate a lot of jobs.
The poor and middle class, on the other hand spend that extra money. Lower income individuals often don’t have enough money for what the rest of us consider necessities – food, clean water, reliable transportation. If they have $100 extra each month, it will be spent, and that spending stimulates the economy. Middle class individuals and families have a few more options, but they are not the best at saving for college or retirement. When employer-provided pension plans were the norm, companies put aside an average of 6% of total wages toward their employees’ retirement. Once the plans switched over to 401(k)’s, that percentage changed.
At two jobs in my past, I had the option of putting away 10% of my salary into my 401(k) and those companies matched the first 5%. I was saving 15% toward retirement, but I am not typical. The national average of employees’ wages that are placed into 401(k)’s is 1.4% – considerably lower than the 6% average for traditional pension plans. Additionally, mutual fund and 401(k) management fees, plus bad decisions by many account holders have led to poor investment performance for the vast majority of 401(k) account holders. So, in short, the middle class also spends more than they save.
So, there’s pretty good evidence to show that tax cuts for the top 10% income earners get saved and don’t stimulate the economy, while tax cuts for the lower and middle income earners lead to increased spending and job creation.
What about tax hikes on the wealthy. There’s not much evidence here, but there’s some – 1983 and 2013. The Omnibus Budget Reconciliation Act of 1993 raised tax rates on families (married filing jointly) with taxable incomes greater than $140,000. The tax rates were unchanged for those with less taxable income. Tax rates for wealthier individuals and families went from 31% to 36% and 39.6%.
Congress and the Clinton Administration anticipated an increase of $16 billion in taxes paid by the higher earners in 1993, but the increase was only $5 billion. Many fiscal conservatives point to this as an example of tax policy that changes behavior and negatively impacts economic growth, but that was not the case. Because of Clinton’s election, the wealthy shifted their capital gains and whatever other compensation they could to 1992 rather than wait until 1993 when they expected higher tax rates. Treasury Department studies suggests that about $20 billion of income was paid or realized in 1992 that would normally have been 1993 income. More importantly, the economy boomed in 1993-1994 and grew at a solid 2.8% rate in the 1992-1996 period. While there is a lot of negative news that the current economic recovery is less robust than has been the case following other recessions, there has been unimpeded economic and job growth, and a large increase in wealth concentrated at the top, following the 2013 tax rate increase on the highest earners.
There are plenty of sources that claim job cuts for the wealthy stimulate the economy. Just Google “Do tax cuts create jobs” and you will find many more sites than Mr. Worstall’s commentary noted above. The sources I trust the most are nonpartisan and have a function to fairly evaluate the variables – university economic research papers, the Congressional Research Service and the Congressional Budget Office. I tend to be skeptical of reports in sources which I feel have an agenda – National Review, Huffington Post. I sometimes think of Forbes that way, but then I saw a piece by Joseph Thorndike published two days after Mr. Worstall’s commentary. Check out “Tax Cuts For The Rich Don’t Create Many Jobs, But What About Tax Hikes?” It’s worth the read.
Next Time: Part III-D: How are Revenues Effected by the Presidential Candidates Tax Plans (America Great Series; Taxes, Economy & Jobs)