A protracted congressional consideration of tax reform looms menacingly in our near future. This is a prudent time, before the predictable partisan bombast begins, to take an analytical nonpartisan look at exactly what a tax cut means and what it accomplishes. Especially, we need to anticipate the familiar clarion call for the most misleading “axiom” you’re about to hear: a tax cut to stimulate the economy.
From a strict benefit/cost perspective, who is helped and who is hurt? Technically, a tax cut is merely a transfer of spending power from public hands to private hands. Thus, it means that the expenditure of those dollars will be controlled by private “former” tax payers, and not by those who control the public budget. Private spending replaces public spending.
An important proviso must be mentioned. The analysis assumes that public spending will be reduced by the amount of the tax cut, or in other words it is deficit neutral. Of course, we all realize that this is rarely the case in practice, which is ironic in that those who usually argue for tax cuts and less public spending also tend to abhor the government deficit. However, cutting taxes and simultaneously reducing spending by more than the amount of the tax cut is both a skill our political system is yet to master and potentially devastating economically. Whether possible or desirable or not, it is virtually impossible in the modern political climate.
Any discussion of economic impact depends squarely on the concept of a multiplier. When anyone receives additional income, they spend a portion of it, thus creating additional income for the recipient of that expenditure – and so on. The more that income is spent and re-spent, the higher the multiplier, which merely quantifies the ultimate result of this hand-to-hand process. The higher the multiplier, the more beneficial to the economy overall of having the money in a particular use. Dollars go farther.
Over the years there have been many studies of expenditure patterns of people in various income categories. Such research is necessary to create a realistic Consumer Price Index, which supports the monitoring of inflation, among other important measures. This research has indicated that multipliers for public sector expenditures exceed those for private sector by at least .3 of a point.
It is simple logic that people with lower incomes spend a substantially higher percentage of their income on needed goods and services than do higher income people. Additional discretionary income to wealthier former taxpayers is more likely to be saved or invested, or possibly spent on a service or luxury item. This creates economic “leakages” and lowers multipliers. Consequently, multipliers are higher if spending power is in the hands of lower income earners, who immediately re-inject it into the core economy.
These results depend on the statistical fact that average incomes on the part of tax cut recipients are considerably higher than incomes created by government spending. Salaries of public employees are moderate, and clearly the income of the average recipient of direct aid almost by definition will be among the lowest in the system.
All this has nothing to do with ideology. It is a statistical conclusion backed by hard empirical data. Arguments about growing inequality or the merits of some public program all belong elsewhere in more value-based analysis. Channel purchasing power to public rather than private entities and, all other things equal, your economy will thrive.
To conclude otherwise is to come down firmly in the camp of the widely discredited trickle-down economics – the notion that we help the masses by bestowing purchasing power on the corporate rich, and the ways in which they spend it will create jobs for all of us. Trickle down is the idea that the best way to nurture the little birds foraging in the pasture is to overfeed the horses — and, well, you get the idea…