Analysis: A Head-Banger Primer on Tax Cuts and Job Formation

This is a repost and enhancement of a portion of the Open Forum of December 9, 2005.

As part of a tax-cut bill now subject to reconciliation with a Senate version, the U.S. House of Representatives yesterday approved legislation to extend for an additional two years the "tax relief," originally set to expire in 2008, on capital gains and dividends that Republicans had enacted in 2003 with the blessing of the Bush Administration. The capital gains and dividends tax cut extension, part of a broader package now before the Congress, will cost an estimated $21 billion dollars of which the overwhelming percentage will accrue to those making over a million dollars a year. In fact, George Yin, chief of staff of the Joint Committee on Taxation, explicitly stated to the committee that extending the tax cuts on dividends and capital gains would "benefit predominantly higher-income people." One can imagine the Republicans thinking to themselves, "Well, duh!"

The theory of this kind of tax cut—painfully simplistic and dangerously misguided as that theory is—has to do with targeting fiscal stimulus on those people whose proclivities for the use of money are the most "productive" to economic growth. Rich people, according to this theory, will not only invest the tax savings, but they will also be more willing to move capital into investments that would otherwise be subject to taxation at unacceptably high rates. The capital thus flowing into productive investments will create jobs for average Americans, who will then earn more money, pay more taxes, spend more money, and thereby stimulate the economy. Essentially then, the rich will move benefits down the economic ladder, and those benefits will spread far and wide through the economy.

This is nonsense: it is predicated on several assumptions that tail off steeply in soundness, and it is to the credit of a thundering lack of economics training by the typical journalist that this silliness is actually taken as reasonable. It doesn't take much to expose these Creationists of economics to some withering scrutiny. Sadly, that scornful and rational eye is woefully lacking in its attention to the neo-conservative think-tank lifers and their Right-wing foundation grant-gobbling cousins in academia.

Let's hit three assumptions lurking behind the trickle-down drivel.

First, this old supply-side economics grind assumes that the marginal propensity of wealthy people to invest is high. That one's not too bad; but it makes facile use of the term "invest," and that's where the assumptive train starts down the long, greasy track to problems.

Second, trickle-down assumes that the investments the wealthy make will be primary capital investments. Just going out and buying stock is not an investment in the plant and equipment of a company; instead, it is an exercise in buying a security from someone else who's trying to unload it. Only if the money goes into a public or private offering of common stock, into a loan to a company (usually through the purchase of a bond the company is selling), or through some other investment vehicle by which a job-producing company then has more capital will the investment make business capable of offering new jobs on balance. Just throwing money "into the stock market" isn't going to create any jobs, much less will it induce broad economic activity to drive incomes up resulting in greater tax revenues flowing to the government. At best, wealthy people throwing money into the stock market will keep some stockbrokers current on their house payments and hypertension medications.

The supply-side chain of events that ends with federal tax revenues actually rising because of the economic stimulus of tax cuts was given diplomatic but roundly negative treatment by none other than the Congressional Budget Office as recently as late 2002 in the CBO document "Capital Gains Taxes and Federal Revenues". Not surprisingly, the soaring federal deficits since then, attended as they have been by round after round of tax cuts, are themselves a testament to the failure of the supply-side economics predictions that lowering tax rates would increase federal tax revenues. The Congressional Budget Office told Congress this, and Congress elected to ignore the analysis of its own, objective, professional analysts.

Now, even if an investor is putting money into primary capital market instruments, he or she could be providing funds to something other than a business enterprise. There are literally tens of thousand of government or quasi-government entities desperately howling for money: school districts that need to build new warehouses to minimally educate kids, municipalities suckered into thinking that a sports arena will really cause an inner-city Renaissance, and government-protected, corrupt, non-transparent mortgage re-sellers are but a few broad examples. But the biggest vacuum cleaner of available investment capital is the United States Treasury, which is sucking up money like it's going out of style from every corner of the Earth.

And the absurd part about capital invested in Treasury bills, notes, and bonds is that all the money flowing into the coffers of the federal government is simply replacing revenues the government has surrendered via tax cuts! And as the government goes deeper and deeper into debt, its appetite for money drives rational market participants to pump up the interest rates the government will have to pay. Uncle Sam will always pay whatever interest rate is necessary to obtain required funds, which means that, if businesses want to attract capital, they have to push the interest rates up that they're willing to pay. This makes it more and more painful for businesses to attract investors, and it drives businesses to abandon all projects but those that can clear a progressively higher hurdle rate for return on investment. Worse still, as the federal debt piles up, the service of it (the interest it must pay) becomes more and more onerous, thereby forcing the government to borrow at an accelerating rate to pay the interest on money it has borrowed in previous periods.

That spiral is, of course, exacerbated by further tax cuts that starve the government of even more tax revenues, which are the alternative to cash inflows from borrowed funds. Fortunately, a prudent government could cut spending, and the House of Representative—may God bless its responsible Members—is doing that to some extent. No, the black hole of endless and unproductive war will continue unabated; but the lower chamber of the federal legislature has approved spending cuts of as much as $50 billion, these savings to be made largely in programs like food stamps and other aid to poor families. Who says those Congressmen aren't responsible little heathen?

Returning to the assumptions underlying the theory of tax cuts for the rich, there's a third one, and it's a doozy, but it's a little more complex. Brace yourself, Hazel, we're taking the cargo elevator.

Even if an investor makes available to a corporation money by which the company can expand its operations, there is no reason to believe that such expansion will, in some lock-step fashion, create jobs; and in particular, there is no reason to believe that the expansion of production facilities will create jobs at living wages, or even that the jobs created will be offered in the United States. The extent to which labor is hired as production increases has to do with the relative scarcities of various factors of production, the production technology employed, the ability of the enterprise to locate the production facilities next to factors of production that give the most efficient (that is, the minimum-cost) factor mix, and numerous other considerations. Simply waiving a hand and claiming that money flowing to corporations creates "jobs" is baloney. The questions are actually pretty simple: how many jobs? at what wage rates? where? for how long? and to the detriment of what opportunities foregone by the placement of the capital where it has decided to land for the maximum return on investment?

What does all this mean? Clearly, it means that the Dark Wraith is the indispensible guide to learning why Right-wing and assorted other neo-cons who have come to befart our world are twits. They rely on appealing, simplistic declarations that the mainstream media cannot fathom as deeply flawed.

The bottom line is this: stick with the Dark Wraith, and you'll know a lot that you wouldn't have known otherwise. We're all still going to Hell: the greedy, corrupt, amateurish, war-mongering nerds of neo-conservative nonsense are resolutely at the helm of the Good Ship Iceberg Bait; but if you keep reading economics articles posted by the Dark Wraith, at least you'll understand that the sudden collision with the giant chunk of ice isn't the Happy Hour call for chilled margaritas.

Yes, good readers, we shall all go down with this economic ship, despite the spigot of Federal Reserve money pouring in at the top of the food chain to keep the deck chairs dry. And once the mixing of metaphors gives way to the inevitable sound of band instruments impersonating bubble machines, you'll know exactly what happened and why it happened.

Sadly, unlike during the Crash of '29 and the following depression, the rich won't go down with this ship. The capital markets have too many lifeboats for any but the stupidest of the wealthy to get nailed this time. But if it's any comfort to you, they'll still be a little sore at the neo-cons for inconveniencing them with a recession that'll make people want to elect unrepentent Democrats and assorted Socialists. Elections are getting so expensive to rig these days.


The Dark Wraith has brought some cheer to an otherwise dull and listless weekend.