The real-world effects of tax policy are counter intuitive. They run exactly opposite the conventional wisdom. They defy what modern political conservatives call “common sense” and what conservative economists calls “the logic of the market”. Reality laughs at the Laffer Curve, calls Ronald Reagan wrong, and says Milton Friedman is a loon.
Here’s a reality check: High marginal tax rates correlate with economic growth. Examples include World War II and the Truman-Eisenhower years, when it was around 90 percent, and the
Why do high taxes create a stronger economy? I used to run a small business -- a technical training school for adults. Every time we took a dollar out as personal income, it instantly turned into 50 cents. If we didn't really need the money, that was an incentive to keep it in the company and to find ways to spend it that took it out of the taxable profit column but increased the value of the company.
Conversely, low taxes create an incentive for profit taking. One of the main problems of discussing politics and economics with non-historians is that it is easy to confuse profitability with wealth creation in the context of twentieth century American industrialization. They are not the same. President Eisenhower built the interstate highway system. There is no doubt that this gave the country an asset of great value, one that was very productive. It created great "wealth." But, aside from the construction companies that contracted the work, it was not profitable.
Selling subprime mortgages, trading in derivatives, packaging mortgage-backed securities and "flipping" condos were all very profitable but did not create wealth. The theory is that if the rich can keep their money, they will invest in businesses that create jobs, more businesses, more tax revenue and greater "wealth" for the nation. That sounds like logic and common sense. But is it, in practice, what happened? Once tax cutting began, the culture of business changed.
It was no longer enough for a business to be a reasonably good business, making steady, reliable profits. Indeed, that became a very bad condition for a business to be in. It made it a target for takeovers by people who were willing to milk them of their profits. Among the ways you can get more profit out of a going business are:
- Cutting the workforce (possibly sacrificing long-term productivity)
- Cutting salaries (who cares if the employees are unhappy? The balance sheet improves)
- Selling off assets (who cares what happens in 10 years? We can take the money now)
- Outsourcing (which sends the "wealth" somewhere else.)
A whole host of devices were developed to do all of the above: junk bonds, leveraged buyouts, hostile takeovers, greenmail and the like. Lots of money could be made that way for a small number of individuals. But it doesn't produce "wealth." An environment in which personal profit is incentivized and profit-taking is cheap creates the conditions for a bubble.
Once you've taken your profit, and you have the cash in hand, you look for a place where you can get profits quickly, then again and again. Instead of examining how sound a company is, how well it's run, its debt load and its long-term prospects, other things become important, such as the speed at which you can profit and the ease of entry. Instead of investing in business (which is difficult, slow and complicated) investors go into markets. They look for sectors that are hot. When investors find such an area, they flock to it. It heats up even more. People are seen making money, quickly and easily, simply by buying and selling, and they don't want to miss out. Then there's a bubble, which is followed by a crash.
Proponents of tax cuts take the position that taxes take money out of the economy. The problem with that position is that it’s not based on either reality or historical accuracy. Governments don't keep the money they collect; they spend it. It goes right back in. It just takes a different route. It goes to different places. The places that government puts money are important. More to the point, they are important for business. All infrastructure is an invisible subsidy for all business; It's easy to understand this when we're talking about roads. It doesn't matter if your business doesn't ship anything by truck or even by bicycle. The fact that you can get to your office quickly and easily, that your mailperson can get to you without traveling on the back of a mule, is a subsidy of your business.
It's a little harder to see that when we're talking about soft infrastructure.
- Laws, regulations and their enforcement
- Social Security, unemployment insurance, public health and welfare
- Education, research, support of sports, arts and culture
- Parks and playgrounds.All of them create a society that is safer, more stable, and more able to produce and consume. They produce a better place in which to do business.
Tax cut fundamentalists also claim (and I paraphrase the essence of the argument) that the money government gets disappears in wasteful stupidities. They might point out all sorts of cultural and scientific projects, like a museum for the Woodstock Festival, counting the fish in Waldon Pond, or studying the sex life of prairie dogs. I would point to the Star Wars missile defense shield, farm subsidies, the ethanol program, the privatized non-reconstruction of
In the mythical marketplace of Adam Smith, they should fail and suffer for their faults. In the real world, the arrogant fools who ran the place will walk away with millions, and the hundreds of thousands of people who worked for them and their suppliers, who offered services and goods to those in turn, will be the ones who suffer. The point is that relying on the magic of the marketplace is like relying on any other kind of magic.
There are things that are necessarily done for the common good. Clean water, sewer systems, garbage collection and public health initiatives create a healthy population, able to work and consume. Take those away, and we return to the plague years. Imagine what that does to business. Polluted air, toxins in the groundwater, viruses and bacteria jump the borders of even the wealthiest communities. Bad health created by lack of care for the common good becomes an economic drain on society. This is not to say that a full-out, state-run economy is better than capitalism. It's not. That produces different problems that are even worse.
It is not even meant to imply that all "sound" investments in "real" businesses stopped with tax cuts. They didn't. Start-up money and venture capital were relatively easy to come by. Lots of new and good businesses were built in low-tax environments. But low taxes produced great excesses of negative activity as well. There is a propensity in business, and as a nation, to hollow out our businesses, and mortgage and sell off our assets, in order to grab short-term profits. A sound economy is based on a mix of market and government actions; in fact, the most successful capitalist economies the world has ever seen have been Keynesian in nature.
What is certain is that tax cuts on the top brackets, and in particular on unearned income, do not produce healthy economic growth. Contrary to all expectations, tax hikes seem to produce the desired growth. All the explanations in the world, funded by all the right-wing anti-tax think tanks in the world, won't change that reality. As John Stewart once stated (in all of his truthiness), “Reality has a well-known liberal bias”.
