Why Trickle-Down Economics Won’t Work

I’ve gotten a little blog writing advice – stick to one topic per post. Good idea. Most of the following is from my last post, but it’s less cluttered here.

In his economic working paper “Tax Cuts For Whom? Heterogeneous Effects Of Income Tax Changes On Growth And Employment,” Dr. Owen M. Zidar reports that tax cuts or increases for the top 10% earners in the U.S. have no impact on job growth over the following two years. Tax changes for the bottom 90%, however, have a substantial impact. For every 1% change in tax burden as measured by percent of a state’s gross domestic product (GDP), there is a 5% change in job creation over the following two years.

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.

Some warn of capital flight from high tax states to low tax states – that is, the wealthy moving residence to pay less state income tax. There is no evidence of this in the U.S. (See:http://news.stanford.edu/news/2012/november/millionaire-migration-myth-110212.html.)

Others argue that the wealthy do stimulate the economy following tax cuts because they invest in capitalist institutions – businesses, real estate & stocks, for example. Let’s take these separately.

Business Ventures: If the wealthy take their income tax savings and start businesses, that will stimulate the economy. No question. According to Dr. Zidar, that doesn’t happen within the first two years, so tax cuts for the wealthy are not a good strategy for a quick economic stimulus.

Real Estate: The wealthy are investing in real estate and some of the properties they purchase are from people with less wealth. This is a good example of successful trickle-down economics. The less wealthy will spend their real estate windfall and stimulate the economy.

There’s an area of concern though. Rents and property values in most cities have increased at a much higher rate than inflation. Some people with less wealth are forced into selling because they can no longer afford the real estate taxes and an ever increasing percentage of residential housing is owned by the wealthy. High rents mean that the poor and lower middle class can no longer live near their jobs and they have to spend a higher percentage of their time and income on transportation, rent, and perhaps childcare. This will act like a tax on the bottom 90% and Dr. Zidar’s work shows that it will be a drag on the economy.

This is trickle-up economics, not trickle-down.

Stocks: Stock purchases do not stimulate the economy unless they are 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.

So why did trickle-down economics work during the Reagan administration? 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 spent a lot of money – 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 increased 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. Because the current tax rates are much lower than those when Reagan took office, there’s less to work with. 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 in stocks (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 economic hardship.

About tonyj126

I'm a 50+ married man who always seems to have a large backlog of work to do, but also a lot of flexibility in my schedule. Much of the work I do is volunteer or taking care of extended family members. I suffer from, as my priest calls it, "the sin of self-sufficiency," which means I can figure out how to do most things myself, and consequently, reduce the need for community to solve problems. As a logical extention (at least to me), I find myself called to comtemplate the country's and the world's woes and offer my observations. I hope someone out there will find them useful.
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