I have a friend who knows a lot of stuff. I’m generally a glass-half-full kind of guy, but every now and then I rail against some injustice or stupidity; it’s the stupid things that bother me the most. But sometimes, I can’t enjoy the pleasure of my indignation because my friend informs me of the reason why the thing I’m annoyed at is the way it is. To take a quote from the movie Airplane, “What a pisser.”

Here’s an example. The cleaning cycle discharge from the water softener in our basement was placed off-center over the drain in the floor and the salty water foams up and pits the concrete. After six years of this, the drain cover corroded and the salty discharge tube was loosed. It sprayed the control panel on our hot water heater and destroyed it. Because of this off-center placement, we had to replace our hot water heater. I was indignant.

My friend, on the other hand, calmly stated that off-center positioning was required to prevent contamination of the house’s fresh water supply should the sewer back up. Know-it-all!

There have been other cases when I have been bothered by one thing or another and my friend has straightened me out. These generally involve car or home maintenance topics – I’ve never been a car guy, and he replaces engines and rebuilds transmissions in his spare time. Lately, however, our discussions have a lot to do with politics and macroeconomics, and we’ve spent a fair amount of time discussing the issues.

One of his observations is that our experiment with capitalism may be coming to an end and serfdom may be returning. He’s considering guest writing a post about it so I don’t want to give too much away here, but he and I had completely different ideas about about what the new serfdom would mean.

I though he meant that the widening income and wealth gap and the shrinking middle class means that the very rich will be the new lords and everyone else will be dependent on what they provide by way of employment and charity. My friend, who comes from a more conservative background, meant that the government is the new lord and everyone will be dependent on what the government provides. How’s that for extremes.

One of the followers of my blog is Shray Srivastava at https://shreysfinanceblog.com. Shray is an economically conservative 15 year old from the U.K. who writes posts on economic issues, many directed toward the U.S.

I would like to write a counterpoint to one of his posts. In “Why trickle-down economics works” from October 8, 2015, Shray argues that:
1. High taxes leads to capital flight;
2. “Do not be fooled by socialist propaganda telling the lie that it is the normal person, the average Joe, that fuels the economy of America, or any country, in fact, because it isn’t.”
3. “It is the rich and famous that encourage growth and economic expansion….”
4. “…the only place the rich will put the extra money that they have is into other economic industries, meaning that the money they save will always be reinvested….”

I purchased an economic working paper a few months ago which evaluated job growth and economic expansion or contraction in the U.S. in the two years following tax cuts or increases (TAX CUTS FOR WHOM? HETEROGENEOUS EFFECTS OF INCOME TAX CHANGES ON GROWTH AND EMPLOYMENT, by Owen M. Zidar).

Dr. Zidar determined that there was statistically no impact on economic growth or contraction following tax changes for the top 10% earners (slope of the graph: -0.1%). For the bottom 90% earners, on the other hand, there was a 5% economic expansion or contraction for every 1% of state GDP change in tax burden.

These data clearly state that the wealthy save their money and tax cuts do not trickle-down. Those who earn less spend a higher percentage of their total income and that provides significant economic stimulation following a tax cut and equally significant economic drag following a tax increase.

To address Shray’s points that I noted above:
1. High taxes may lead to capital flight in the EU because of open borders and duty-free commerce, but the same is not true in the U.S. The U.S. equivalent would be movement from a high tax state to a low tax state following the implementation of a “Millionaire Tax.” Stanford researchers found no evidence of capital flight following such tax changes (http://news.stanford.edu/news/2012/november/millionaire-migration-myth-110212.html);
2. As noted above, Dr. Zidar’s paper refutes this;
3. Ditto;
4. The wealthy more often invest in stocks than in starting new businesses. Stock purchases do not stimulate the economy unless they are actually stocks awarded in exchange for start-up capital. The vast majority of stock purchases are from one shareholder to another and the company receives no capital from such transactions.

I fear the same is starting to happen with real estate in major cities. The wealthy are purchasing the apartment buildings and high rents are acting like a tax on the poor. The rent goes to the wealthy and there’s less left over to drive the economy. It’s not quite the same as stock purchases because some manpower is required to run the rental businesses, but it’s less labor intensive than operating a factory or trucking company, for example.

So why did trickle-down economics work during the Reagan administration? Pretty simple actually. Taxes were reduced for almost every taxpayer in the country so those extra funds received by the bottom 90% earners led to increased consumer spending. In addition, the federal government expanded the policy of deficit spending – much of it on the military – and government spending is a large driver of economic growth.

Before the Economic Recovery Tax Act of 1981, there were sixteen tax brackets topping off at 70%. When Reagan left office, there were two tax brackets, 15% and 28%. Revenues decreased the first two years after the tax changes, but increase during the rest of Reagan’s term. Unfortunately, spending increased at a faster pace and the annual deficits averaged $192 billion vs. a high prior to Reagan of $73 billion.

The U.S. currently has seven tax brackets topping off at 39.6% for taxable income greater than $450,000 for married filing jointly. The top 1% earners pay somewhere between 25% and about 35% of their income in taxes. Unlike the situation that existed when Reagan took office, there is much less to work with that would stimulate the economy if, in fact, cutting taxes for the wealthy promoted economic growth.

I’ve written about this economic reality several times now, but I keep coming back to it because I’m worried that our leaders will reduce taxes on the wealthy and increase taxes on the poor in an attempt to stimulate the economy. If they take such action, it will backfire.

I am convinced the road to economic prosperity for the country is to get our deficits under control, set up a consistent, simplified tax code for businesses and high income earners to remove uncertainty, and eliminate the capital gains tax rate incentive for money sitting on the sidelines (Jeb Bush’s idea).

If we make decisions based on trickle-down economic policy when we already have high deficits, moderate tax rates, and little opportunity to cut spending with 10,000 Baby Boomers retiring every day, we’re going to cause more economic hardship. If so, we may end up with a modern day serfdom, whichever form it takes.