By now you know that Congress passed The Tax Reform and Jobs Act reducing taxes on most Americans and corporations. The bill’s passage led to mass hysteria on both sides of the political aisle with the conservative Wall Street Journal questioning the bill’s focus on tax breaks for the wealthy and The Federalist, an even more conservative publication, defending it. Forbes, another conservative publication, gave its 2017 “Lump of Coal Award” to the bill! And if conservatives are this conflicted about the law you can imagine the melodramatic Democratic response!
The truth is that nobody can forecast the law’s ultimate outcome. I highly doubt it will be as great as the Republicans claim or as bad as the Democrats predict. I obviously hope the new tax law is successful and that all Americans will benefit, but I’m not optimistic.
You probably know that the bill may add at least $1 trillion, possibly $1.5 trillion, to the national debt. This from conservatives who are, at least in theory, against adding to the debt by running deficits. The reason they voted against their consciences is actually pretty simple; their donors threatened to stop future contributions if Congress didn’t reduce their taxes. At least that is the standard pattern in DC these days.
Since I cannot predict how this law will affect the economy over time I want to instead focus on “trickle down” or “supply side” economics, the theory used by Republicans to defend the law.
I have to admit that the two economics classes I took in college were the absolute worst and I learned less from them than from any other classes. However, grand economic theories such as the ones being used to support the tax bill don’t really require much academic understanding (although understanding the details certainly would). I’ll make this brief because I can already imagine your eyes glazing over and your mind wandering (much as mine did in two semesters of ECON classes).
As I said, the Republican tax reform is based on an economic theory referred to as “supply-side” economics which is closely related to “trickle down” economics (although there are subtle differences I’ll refer to them synonymously).
The argument is very simple; cut taxes on those earning the most (including corporations) and the tax savings will trickle down to those in the middle and lower classes. The wealthy will invest their tax savings in such a way that new products will be developed, jobs for lower and middle classes will be created, and the economy will prosper, again leading to new jobs, higher wages, and better benefits for workers. So under this notion corporate taxes and capital gains taxes, those most often enjoyed by the wealthy, are reduced and tax credits are increased for investment. Importantly, this theory expects government to reduce regulations on business (this is either good or bad depending on one’s political leanings).
OK. Sorry. That was boring but I hope you will bear with me. I’ll try to get to the good part shortly. You can read much more about supply-side theories here.
By the way, the opposite of supply side economics is “demand side” or Keynesian economics and is based on the idea that the workers should have more money in their pockets to spur economic growth. Under this theory corporations and the wealthy are taxed at higher rates and those tax benefits are redistributed to those at lower economic levels.
I’ll only focus on trickle down theories since that is what we are currently facing. When liberals/Democrats eventually regain control I’ll probably wind up criticizing demand-side economics as well (assuming I live that long).
How does trickle-down economics work in the real world? As my friend and colleague the Economics Professor says, “it doesn’t”.
Those defending trickle-down theories often point to “Reaganomics”, President Reagan’s massive tax cuts and the coincidental economic turnaround. What they ignore, however, is the fact that President Reagan also increased government spending significantly (about 2.5% per year) which is actually a Keynesian or “demand side” policy, tripling the federal debt by increasing government spending. So we cannot really use Reaganomics as an indicator of success. And remember that George Bush called Reaganomics “voodoo” economics and said it was nonsense.
President George W. Bush reduced income taxes early in his presidency and the recession came to an end, but unemployment spiked as well. So the recession ended but more people became dependent on government programs. Research following these tax cuts found that only 17 cents of every dollar in income tax reduction and 50 cents of every corporate tax dollar reduced actually find their way back in to the economy. In other words very little of the amount individuals and corporations save via tax reduction actually does what supply siders say it will.
In 2012 the State of Kansas drastically reduced taxes in an attempt to promote economic growth. This attempt at stimulating the economy via supply-side policies didn’t work. The State’s economy lagged behind the economies of other states, growth didn’t occur, and tax revenues dropped to the point that the Republican legislature actually reversed the policy and raised taxes.
There are few foreign examples of what my have been successful trickle-down policies, but those almost always occurred in countries with dismal economic conditions unlike anything comparable to the US. And those policies were much different than those passed by Congress.
Numerous academic studies also conclude that trickle down policies rarely work. They conclude that those who benefit most from the policies (the wealthy) shelter the saved money in tax havens, the tax breaks are almost never offset by improved economies, and corporate tax cuts favor shareholders and CEOs rather than workers. The U.S. Treasury Department does conclude that a tax reduction almost always provides a temporary boost to the economy IF the economy is weak (and ours isn’t) but long term boosts are rare.
Finally, trickle down policies lead to increased income inequality, and increased inequality has a number of consequences other than, you know, inequality! Most important is the fact that if wealth becomes increasingly concentrated in the hands of a few (the 1%) the economy will stagnate because those of us in the working and middle classes have less to spend on stuff we need and want, and spending is what stimulates the economy.
OK. That’s enough. I’ve gone WAY above the level of my college ECON courses.
The bottom line is that the economic theory used to justify the tax reduction law is flawed. In all likelihood the economy will get a short term boost that will not be sustained, over the next ten years the rich will become richer, and the gap between America’s rich and poor will grow. None of these outcomes are good for America.
Again, I obviously hope I’m wrong. To hope otherwise would be unpatriotic.
Thanks for this one professor.
Thank you for reading, Doug!