Tax policy

Emily Messner, who runs "The Debate" blog for washingtonpost.com, recently took on the issue of supply-side/trickle-down economics. While expressing skepticism over its benefits Messner says she's "interested in hearing from Debaters who can make a good case that the benefits of supply side economics are more substantial than the benefits of demand side."

Allow me to step up to the plate. I'd like to start by addressing some of the statements in her column:

Why would the ruling party cut taxes for the wealthy instead of, say, providing childcare for the poor, or making sure the District of Columbia has enough money for every student to get his own textbooks?

The answer lies in trickle down economics. Fans of the theory don't like to use that term because it astutely describes the phenomenon -- the economic benefit flows downstream until it's just a trickle. Yes, if the wealthy pay out less in taxes, they will invest more and hire more (and go on vacation to Europe more) but they'll hire at a minimum wage that, at the moment, puts a full-time worker with a family well below the poverty line. Besides, the wealthy (and corporations in particular) are notorious for exploiting loopholes in the tax code, so one wonders just how high a tax rate they're really paying.

There are at least a few problems with this passage, starting with the first paragraph. Poor children already receive funding through Medicaid and the reason D.C. schoolchildren lack textbooks is not due to money but the poor administration of its government. Indeed, this is one reason tax cuts are preferable to increased government expenditures -- money spent by the private sector is more likely to be put to good use than that spent by government. It's key to remember that simply spending money does not mean a problem is being alleviated. If it did every student in this country would already be receiving a first class education and homeland security would be airtight.

The second paragraph is equally flawed, with Messner resorting to a strawman argument -- that any new hires will be at minimum wage. What is the evidence for this? And why would you start a family if you're only making minimum wage? She does make a good point by noting the existence of tax loopholes that greatly reduce the effective rate paid by the wealthy since they can hire expensive accountants and lawyers. This, however, is an argument for closing those loopholes -- such as through a flat tax -- not against supply-side tax cuts.

Moving on, Messner says:

Ultimately, is everyone helped under such a system? Quite possibly. But the people at the top are helped disproportionately to the people at the bottom -- particularly when need is factored in -- resulting in an ever increasing wealth disparity and cycles of poverty that aren't broken simply by growing the GDP. Plus, there's the general concern citizens of a democracy should feel when too much wealth is concentrated into the hands of a powerful few. (Think Russia's oligarchs.)

This is an argument that almost makes my head explode. The measurement of welfare should primarily be from an absolute, not relative, perspective. Think about it: If my boss gets a $50,000 raise and I get a $10,000 raise is that less preferable to my boss getting a $2,000 raise and me getting a $1,000 raise? Of course not. Frankly, as far as I'm concerned, the improvement in welfare should only be evaluated from an absolute standpoint.

Messner concludes:

My skepticism should not be construed as a blanket condemnation of the Reagan tax cuts. Surely we can agree that a top tax bracket of 70 percent is outlandish and it was a good move to get that figure down significantly.

With the recent extension of the tax cuts for capital gains and dividends (cuts that help only those who can afford to invest) and the ongoing push for a permanent repeal of the estate tax (a tax that also hits only the wealthiest), we're back in the mode of supply-side economics -- the idea that with more money in their pockets, the country's elite will invest that money back into the economy, spurring growth.

On the flip side (demand-side) leaving more money in the pockets of those living paycheck to paycheck virtually guarantees that it will be rapidly recycled into the economy as they make necessary purchases at local stores. Choosing to save the money for a larger purchase, like a home, would also be an economic good.

So now we're back to the heart of the argument: is supply-side preferable to demand-side growth? Well, yes. For starters supply-side growth is less likely to cause inflation. Inflation, let us recall, occurs when too much money is chasing too few goods. But when you have more goods (the expansion of "supply" in supply-side) that effect is reduced.

Further, with expanded employment and lowered taxes people have more money in their pockets so you also receive many of the demand-side benefits.

Now, a few points. There are frequent claims that supply-side tax cuts actually boost tax revenue. Well, that depends on the original level of taxation. If you're being taxed at 80% and taxes are cut to, say, 40%, I can almost guarantee you that tax receipts will go up due to expanded economic activity. If, on the other hand, taxes are 40% and you cut them to 20% the impact is going to be less profound with revenue far more likely to decrease. I will say, however, that under that scenario that while revenue will decline it is unlikely it will be by exactly half, with expanded economic activity offsetting it somewhat. But you're certainly not going to get more than what you started with.

That is largely why I am skeptical as to the value of further tax cuts at this point. While there is certainly benefit to cutting current rates the marginal economic activity generated is probably unlikely to be very significant, or at least significant enough to make it worthwhile. What the government should really focus on at this point -- and there are some signs it will -- is tax reform. The current tax code is a monstrosity that is badly in need of reform. Closing loopholes and making the code flatter should be a far higher priority that further marginal rate cuts.

That, along with spending cuts and expanded deregulation, are all I want for Christmas.