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 hy
is it that knowledgeable corporate leaders just don’t get it when
it comes to understanding the impact of supply-side tax cuts? Recently,
in a well known financial newspaper, I came across a critique of
President Bush’s tax-cut plan by a very successful entrepreneur,
one who should have a pretty good idea of how incentives work in
a free economy. His opinions encouraged me to provide a supply-side
perspective of the president’s tax cut — which seems all the
more important these days as Congress looks to stimulate the economy
at a time of war. In the following dialogue, I respond to "Mr. X."
Mr. X would
like the government “to bolster consumption by revising the recent
federal tax cut so that it gives more benefits to lower and middle
class people, who’d be more likely to spend the new found cash.”
Sorry Mr.
X, there is no such thing as “new found cash.” The tax cut in the
form of a rebate is a wealth transfer from one segment of the population
to another segment. Whether one economic group would spend more
or less of the rebate is conjecture especially since many consumers
in the lower- and middle-income brackets are currently over-leveraged
and may very well use the rebate to pay off debt rather than spend
it. A prominent supply-side economist, in a recent interview, stated
that the tax rebate could actually have negative economic consequences.
Mr. X:
“I am a high-income individual and I didn’t ask for a tax cut. I
didn’t want the tax cut.”
Rebates aren’t
tax cuts that have an economy-wide impact because, in total, their
economic impact is nebulous. They don’t affect behavior. It’s a
one-time event. On the other hand, the reduction in tax rates in
the President’s program is a key supply-side idea. So to the extent
that Mr. X was referring to the tax rate cuts, they weren’t meant
for him anyway. The reason for tax rate cuts is to increase
the incentives to engage in economic activity. Supply-siders have
never argued for higher after-tax returns for rich people. Such
a position would be ludicrous. The fact that some higher income
people benefit from tax rate cuts is a side effect of policies that
are designed to increase overall output by encouraging people to
work for a higher after-tax reward.
Mr. X:
“People of lesser means were eminently entitled to one (tax rebate)
because ethically it was the right thing to do, and economically
it would have put resources into people’s hands who were going to
spend it.”
The decision
about who is entitled to tax cuts is nebulous at best. From a supply-sider’s
perspective, each person’s tax rate should be the rate at which
that person’s output is highest. Experimenting with lower marginal
tax rates and subsequent tax revenues could go a long way at achieving
the right mix of tax rates to produce maximum growth.
Mr. X:
“I thought the tax cut was shockingly insensitive. It was pointless.
It was political. To be honest with you, I thought it was rude.
It was rude to the people who could have used it more thoughtfully
than I am going to use it.”
Can we therefore
assume that raising tax rates is sensitive? How do we measure sensitivity
from a macro economic perspective? Transferring wealth from one
who has it, or one who earns it, to one who doesn’t demonstrates
a sensitivity to the needs of the poor and disadvantaged. But this
process may also produce a reduction in output, making everyone
less well off.
Back in the
'80s, the Democrats learned this lesson the hard way. They decided
to impose an enormous luxury tax on the purchase of leisure yachts
thinking they were going to soak the rich and benefit the poor or
fund their spending programs — whichever the case might have
been. What actually happened was that the demand for yachts collapsed,
slowing economic growth. More importantly, over 120,000 workers
who were employed by the yacht companies lost their jobs. These
workers were likely to have been the same constituents of those
Democrats who tried to soak the rich and instead cost all those
skilled and unskilled craftsmen their jobs. Did you ever see that
movie Dumb and Dumber?
Tax rate cuts
increase output over time and reward those who participate in that
process. Assuming that we are not in a discussion about manners,
the accusation that the tax cut is uncivilized turns economics on
its head. The key is to understand how the tax rate cuts work in
a dynamic world and then provide an interpretation of the effects.
An overall increase in output is probably the most sensitive economic
policy. Obviously Mr. X was incapable of looking beyond his basic
love affair with wealth redistribution to figure out which economic
policies really help the poor.
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