Another Tax Cut

I don’t know if you’ve been following the national news regarding the latest in tax cuts, but if not, there’s a new one and you can read about it here until CNN takes the story down. Now, I know this blog is supposed to be about business and not politics, but this particular bit of political nonsense is based on a faulty business premise, and that brings it into my area of expertise. I can’t really comment on whether or not this is an astute political move, or on whether or not it constitutes good governance on the part of the President and his advisors; I only know that our current President’s own father once referred to this type of tax cut as “voodoo economics” – and he was right…

The basic idea behind any tax cut – especially a “tax rebate” like the one being proposed this week – is that the people who receive the money will spend it on new houses, major appliances, new cars, and other major purchases, which will benefit large companies that produce consumer products. These companies will then pay their suppliers and hire more workers to handle the increased demand, and the suppliers will also need to purchase more materials and hire more people, thus creating even more jobs. In economics, this basic concept is called the Multiplier Effect, and the general idea is that by injecting money into the economy through the increased purchase of goods and services, the money gets spent many times over (as opposed to just giving the money to one person or organization, who may just keep it).

This is the basic idea behind the Supply-Side Economics so beloved of the Reagan Administration in the 1980s. Massive tax cuts were given to the very wealthy, who were expected to take the money and invest in new factories, purchase masses of consumer goods, and generally stimulate the economy. These economic benefits would therefore “trickle down” to the people who owned the factories, supplied the factories, and worked in the factories, thus indirectly benefiting everyone who worked for a living in the United States.

It’s a pleasant enough idea, but ultimately nonsense. If you suddenly discover that your tax bill for this year has dropped by $800 it’s always possible that you’ll apply that amount to a new stove or a new refrigerator – assuming that you can find one for that amount, or that you have the extra to cover the cost of something you’d actually want. It’s more likely, however, that you’ll just have to pull 800 fewer dollars from your savings to cover the cost of the tax hit. Or borrow 800 fewer dollars to keep your household afloat. But since almost none of these “tax rebate” dollars will be given to people making between $25,000 and $40,000 per year (which is to say, almost 40% of the country!), it’s unlikely that this tax break will mean very much to anyone who gets it.

The fact is, it really doesn’t do anyone earning $40,000 per year much good if people richer than them get to spend less on their taxes, and it does no one any good if the people in the top 1% in incomes get to buy large estates in the country – except for those 1% of the people, who can almost always be relied upon to donate money to the political campaigns of the party that enabled them to buy their large estates in the country. Which is really the point I’m driving at here. I realize that the richest people in the country also account for the majority of the income taxes paid, and I understand that any potential tax break will have to be made proportionally, which means those same richest people will be the ones who will benefit the most from the tax cuts. But anyone who has spent even a few minutes learning how economics actually works will already know that the idea that this sort of tax cut program will actually stimulate the economy is nonsense. Or, in the words of Harvard economist James Tobin, “The idea that tax cuts would actually increase revenues turned out to deserve the ridicule..."