Do tax cuts stimulate job growth?

Cecil's Columns/Staff Reports
1

Cecil, if you were a student in my econ course and you answered an exam question the way you answered this reader question, I would give you at best a C-.

You hopelessly muddled three different concepts:
[ol]
[li]Trickle-down economics[/li][li]Supply-side economics[/li][li]Tax cuts to stimulate job growth[/li][/ol]
Virtually any economist worth his salt will tell you that, other things equal (including spending), cutting taxes stimulates economic activity, and therefore jobs, by increasing aggregate demand (unless we’re already at full employment, in which case it just causes inflation). This is because the recipients of the tax cut spend at least some of the money that would otherwise be taxed away. This is true regardless of who gets the tax cut – wealthy, middle-class, poor – so long as they don’t simply save it all (fat chance of that!). This is the answer to today’s question. It is also, incidentally, the theory that undergirded the Kennedy administration’s hugely successful tax cut in 1963.

Trickle-down economics says (as, to give you credit, you noted) that giving money to wealthy people leads them to increase investment, thereby creating more jobs. This theory also operates through aggregate demand, but via a very different channel – investment, rather than consumer demand. It relies on the assumption that wealthy people make investment decisions on the basis of their personal income. In fact, most investment decisions (real investment in plant and equipment, which is what matters, not buying and selling stocks) are made on the basis of corporate earnings and product demand.

Supply-side economics is a whole different beast. Arthur Laffer’s argument was that the effects of high marginal tax rates on incentives (e.g., work disincentives, investment disincentives) were so strong that if you lowered tax rates you would “unleash” economic forces that would generate economic growth so strong that the increase in income would actually lead to higher tax revenue than the govt had previously received with the higher tax rates. This argument has nothing to do with aggregate demand, only with the disincentive effects of taxes. There is a grain of truth to this argument – the 92% marginal rates of the 1950s probably caused a lot of inefficiency and income loss, as rich people shifted their income and investments around to avoid taxes. But at today’s rates (or even the rates in the 80s) these effects are almost certainly small. As the great former OMB Director Charlie Shultz once remarked, “There is nothing wrong with supply-side economics that division by 50 wouldn’t cure”.

That’s the straight dope on tax rates and jobs, Cecil. If you don’t believe it, send Una out to cut somebody’s taxes (mine, for example).

LINK TO COLUMN: Does cutting taxes create jobs? - The Straight Dope

2

How about some empirical data to back up those claims? Tax rates were high during the 50s, was there a commensurate increase in unemployment?

3

@Kibitzer:

Thank you for that intelligent, articulate, informed, and timely response to Cecil’s off-base blather on the subject of tax cuts. Sometimes I wonder where this guy gets off giving the “straight dope” on anything. (He also seems to think he’s got the last word on several other controversial issues of our day, which I won’t go into here.)

He’s got some nerve calling tax cuts a “con.” I’ve never understood the “mantra” (as his questioner put it) that tax cuts benefit “the rich.” Even to the extent that were true, Cecil himself notes that the topmost portion of income earners pay an overwhelming share of the taxes. So it naturally stands to reason, then, that they’d be the first beneficiaries of a reduction in rates.

I wish Cecil had included the other pertinent fact in this discussion - that the bottom 50% has no net federal income tax liability at all, thanks to a laundry list of various credits, subsidies, and social programs designed to help low-income individuals. (I happen to think this state of affairs is a travesty, and that these people have no business voting on how public monies are spent…but that is a discussion for another day.)

But, as you noted, cutting tax rates does indeed “trickle down” to lower income groups. Leaving the higher-income groups with more money in their pockets means that money can be spent on investments - growing their businesses (which means more workers hired), making capital improvements (buying equipment, which also creates jobs), or putting it in stocks/bonds where corporations can use it to grow, or into bank accounts where banks can loan it to other business owners for their expansion…creating…you guessed it - more jobs!

The one thing that wouldn’t do lower income groups any good is if “the rich” drew that extra money out of their bank accounts as currency and physically crammed it under a mattress. But why would they do that? Remember, the rich want to get richer. They’re going to put there money someplace where A) it is safe from burglars and B) where it can earn interest or some other positive return on their investment.

On top of that, it ignores the fact that tax policy in the US has been abused and misused for a long time. Taxes have only one purpose - to obtain money that government needs for things. Period. (I won’t even go into how many current federal programs are blatantly unConstitutional and shouldn’t even exist.) The “con” is the way tax policy is used, by government, to reward certain economic behavior by individuals and businesses…and punish other behaviors. This should not be happening.

This entire country, I think, is long overdue for a refresher course on basic economics. It would run this trend of creeping socialism out of our country, at the end of a sharp stick. If people knew the truth, they’d stop voting for politicians that want to impose confiscatory tax rates.

The reader who asked Cecil the original question also gets an F, as far as I’m concerned. The phrasing of his question indicated that he wasn’t a student seeking truth (“the mantra of tax cuts”) but as a partisan seeking validation for his preconceived agenda. Sadly, Cecil was all too happy to give him validation.

Coming next week on The Straight Dope: Why Chicago politicians really are the best choice for the White House.

4

This doesn’t directly address your question about unemployment rates during the 50’s, but it will shed some light anyway:

http://larrymwalkerjr.blogspot.com/2011/08/are-taxes-really-lower-than-1950s.html

Bear in mind that during the first part of the 1950s, the US experienced a postwar economic boom, as soldiers were returning from World War II and starting businesses. Many of today’s big-name corporations (Burger King, for instance) had their genesis during this period. Those same ex-GI’s also started families during those years, and that in turn generated a huge demand for houses, cars, and all manner of consumer goods. (Incidentally, very little of this postwar benefit occurred in the rest of the world; the US homeland was comparatively unscathed, and all of the other combatants in the conflict had exhausted themselves fighting the war. They had to physically rebuild as well as recover economically.)

Finally, bear in mind that the Cold War was just getting underway, and the US government was pumping huge amounts of money into defense both at home and abroad, trying to make sure the Soviets didn’t establish a foothold in any of the defeated Axis countries. Those who worked for the military or defense-related industries during the 1950s benefited from that spending.

And finally, let’s not forget that the space program also started during that time and eventually fueled an explosion of new technologies that eventually led to all sorts of additional economic benefits.

So it’s not quite fair to assert that the low taxes = more jobs argument is invalid, simply because the 1950s had high tax rates coupled with low unemployment. Looking at the graphs in the link above for another decade - the 1970s, for instance - should put the lie to that one pretty quickly.

5

Creeping trend of socialism, eh? What did Hazlitt say about government employment for no purpose? Lower levels of unemployment, GDP growth, more federal programs, increasing quality of life (though it wasn’t until the late 60s that the US caught up with the USSR in quality of life).

6

Any of you geniuses care to add a link to the column at issue?

And Cylar certainly doesn’t hide his opinion of democracy:

7

That’s not surprising. The business model is essentially feudalistic: those at the top make money for themselves and their friends, appointing those that serve them. When one is indoctrinated to believe that such a hierarchy is a necessity, other forms of government appear inferior unless they explicitly serve the feudalistic system.

Some apologists even claim that free markets are inherently democratic as one votes with one’s money, but that’s no different from now: those with the most money control public policy. Plutocracy: or a meritocracy, if one holds that Paris Hilton’s opinions are worth substantially more than Lew Rockwell’s or Hans-Herman Hoppe’s merely because she has more money than them.

8

I was quite surprised by Cecil’s comment that the top 10% of filers shoulder 70% of the burden. I have always been under the impression that those considered in the “middle class” pay the bulk of taxes, simply due to the fact that there’s a lot more of them. Not that I have any sources to back me up.

So I’d be curious, does anyone know of any relatively reliable sources that would support Cecil’s comment?

9

It depends – are you arbitarily restricting the question to federal income taxes (in which case it might be approximately correct) or are you asking about taxes generally (in whcih case, nope, not even close).

10

Linky!

If I’m not too mistaken Margret Thatcher was very much influenced by these ideas and let me just mention this: I was a regular visitor to England during her time as PM and it seemed to me that the number of homeless people and panhandlers grew almost exponentially during that period.

11

According to one political survey, 19% of Republican voters believe they are among the top 1% of American income earners. It explains a lot.

12

They also earn 46% of the income. Here is alink Of course this doesn’t include payroll, sales and other taxes which hit the lower and middle classes much harder.

13

“(I happen to think this state of affairs is a travesty, and that these people have no business voting on how public monies are spent…but that is a discussion for another day.)”

Okay, let’s disqualify everyone who benefits from government spending from voting. What happens?

We save a lot of money on elections, because there wouldn’t be anyone to vote.

Back to the debate, there is no good evidence that tax policy affects jobs. The economy boomed in the 50s but stagnated in the 70s, boomed in the 90s but stagnated in the 2000s. Pleading special circumstances in the 50s or 2000s is useless–there are always special circumstances. MAYBE tax policy affects job growth, but there’s no way to know, and therefore tax policy (i.e., taxes on personal income) should not be set with an eye on promoting job growth.

14

This is a serious question, and not an attempt at socialism; why does it matter who spends the money, the people (or corporations) who earned it or the government who taxed it away from those people?

I know, in almost all cases the government spends the money anyway whether they receive it as taxes or are forced to borrow it, so in most cases government spending (via borrowing) + tax-relief-recipient spending is going to be a greater stimulus than just plain government spending from the taxes. So, in effect, cutting the taxes puts more money into circulation because the government borrows (to maintain spending levels) and the tax-relief-recipients spend more because they have more after taxes.

How much would economic activity have been stimulated by tax cuts if the cuts weren’t matched by increased government borrowing? I’m sure there are cases where that’s happened.

And, if Congress was disciplined and matched spending reductions to tax cuts, would the stimulus of tax cuts (and increased spending by the recipients) be greater than the stimulus if the government had just spent the taxed money as they originally planned?

I think any arguments about government spending being “wasteful” but personal/corporate spending being “good investment” are probably pretty specious, because in all cases it’s going to depend on the details of the spending.

15

Ah! Thank you, Echoreply – a serious question, at last. Several, actually. And here are the answers:

Why does it matter who spends the money? It doesn’t (at least from the standpoint of job creation). But in the case I was talking about – tax cuts unmatched by spending cuts – there is MORE total spending, hence more job creation, than in the absence of the tax cut.

What if Congress matched the tax cuts with spending cuts? That would actually REDUCE spending and eliminate jobs. Why? Because some of the money Congress gives back to the taxpayers won’t be spent (i.e., it will be saved). So the taxpayers will spend less of the tax cut than the govt would have, and aggregate demand will be lower. That is why the demands for reductions in govt spending to balance the budget are so misguided in an economy with 8%+ unemployment.

16

That’s just not true. Economists have studied this issue for 80 years and have compiled compelling evidence on the relationship between taxes, govt spending, and the level of economic activity. But it is not a simple relationship – you can’t just look at the level of federal income tax rates and the rate of unemployment. You have to construct a very complex econometric model (a set of equations estimated from historical data), as the Federal Reserve, CBO and a bunch of other public and private organizations have done. These models predict economic activity in the short-run (the next year or so) remarkably well, and they can be used to predict the effects of tax and spending policy. They all show that tax cuts unmatched by spending cuts is stimulative, and that spending cuts unmatched by tax cuts is contractionary.

By the way, I want to be clear that neither here nor in my original comment am I saying that we necessarily need to cut taxes right now or, if we do, whose taxes should be cut. Cuts for low- or middle-income familiies are just as effective a way to increase aggregate demand as cuts for the wealthy. Whose taxes get cut is a question of distributional equity that is quite independent of the question of how much tax revenue the federal govt should be bringing in. (I AM saying that cutting spending right now is a terrible idea.)

17

I am glad you are back **kibitzer. You have made claims that are just not true also: **

The wealthy do not spend their tax cuts the same way low and middle class earners spend tax cuts, and in fact, the rich actually do save their tax cuts rather than providing stimulus to the economy:

Rich Americans Save Tax Cuts Instead of Spending, Moody’s Says

If you have economists that contradict Moody’s, I would like to see some cites. Otherwise, I call shenanigans.

18

And communist systems don’t have hierarchies? All systems have hierarchies. But capitalism is not feudalistic which means largely the mediaeval classic feudal system.

19

[QUOTE=kibitzer]
Why does it matter who spends the money? It doesn’t (at least from the standpoint of job creation).
[/QUOTE]

It makes a huge difference who spends the money. Spending money, by itself, is not economic activity. Real economic activity only comes from spending money well, that is, spending it in a way that maximizes human happiness. Spending money well turns out to be surprisingly difficult, and businessmen are far better at it than politicians.

Suppose that you love to cook, and you want to open a restaurant. You start with a big pile of money. Your goal is to turn that pile of money into specific goods and services that will together make up a successful restaurant. But unless you’re a professional restauranteur, you probably won’t do a very good job of purchasing those goods and services. Maybe you’ll rent the wrong building. Maybe you’ll pay too much for ingredients or equipment. Maybe you’ll hire employees who are lazy or dishonest. Maybe your prices will be too high or too low. If you’re starting a new restaurant, there are hundreds of decisions to make, and screwing up any one of them could doom the whole operation.

And if the business fails, that means the money is simply wasted. The restaurant sits empty. Employees show up for work and have nothing to do. The cooking equipment sits unused. The decor goes unappreciated. The food spoils and must be thrown away. The pile of money is mostly gone, and there’s nothing to show for it. No one was made happy by the spending of the money. And when all the money is gone, then the jobs are gone, too.

It’s true that the dollars still exist. They’ve moved on to suppliers and employees. And we hope that the owners of those dollars will find something more useful to do with them than the previous owner. But economic activity is about more than dollars simply changing hands. Economic activity is about people making each other happy.

Suppose that I decide to throw a party in my neighborhood, and you decide to throw a party in your neighborhood. I buy $100 worth of steaks, and you buy $100 worth of steaks. But let’s suppose that you’re really good at grilling steaks, and I’m terrible at grilling steaks. We both spend several hours standing at our grills cooking steaks for our neighbors. When you’re done, you have a pile of juicy delicious steaks that all your neighbors enjoy. When I’m done, I have a pile of overcooked, ruined, leathery steaks that no one will eat.

You could say that the grocery store received the same $100 in each case, but that misses the point. $100 worth of juicy delicious steaks is not the same as $100 in ruined steaks. And a trillion dollars of tax money spent by politicians on pork projects is not the same as a trillion dollars of private capital in the hands of people whose livelihoods depend on spending that money in a way that makes customers happy.

20

This is the salient point. Government does not allocate resources as efficiently as the private sector does. In fact - other than providing national defense and maintaining a handful of infrastructure items, there is NOTHING government does more efficiently than does the private sector.

There is a reason that the Soviet Union went bankrupt, and why China has embraced market reforms. Central planning simply doesn’t work. The reason is simple - a handful of politicians, elected or otherwise - even hundreds of them - simply cannot know all of the details and information that is known collectively by millions of other people out in the private sector.

By the way, Igor70, thanks for taking my quote out of context. I didn’t say that people who “benefit from federal spending” shouldn’t be allowed to vote. I said that people who don’t have a net federal tax liability shouldn’t vote. And instead of simply limiting suffrage, I have a better idea - reform the tax system so that everyone has some skin in the game. Everyone pays something, even if it’s only a dollar.

Do you allow other people to tell you what to do with money you’ve earned and items you’ve purchased with that money? No? So why would it be any different with resources that were confiscated from the productive and paid into a pool collected by our elected officials & their appointees?

I’m beginning to see why our country is so bitterly divided, not just over social issues but also fiscal ones. The hatred and envy of “the rich” is deep, having been planted by generations of government propaganda in the school system and further reinforced by the media. No wonder we have an “Occupy” movement out there clamoring for what amounts to communism. You demand verification of even the most minor points, unwilling to grant even that which is obvious from casual observation and common sense, and from history that most of us are old enough to remember.