Congress just donated another $70 billion in investment tax cuts to rich taxpayers. Last month, David Cay Johnston of the New York Times summed up the debate: (Big Gain for Rich Seen in Tax Cuts for Investments)
“Stephen J. Entin, president of the Institute for Research on the Economics of Taxation, a Washington organization, and other supporters of the cuts said they did not go far enough because the more money the wealthiest had to invest, the more would go to investments that produce jobs. For investment income, Mr. Entin said, “the proper tax rate would be zero.”
Opponents say the cuts are too generous to those who already have plenty. Representative Charles B. Rangel of New York, the senior Democrat on the House Ways and Means Committee, said after seeing the new figures that “these tax cuts are beyond irresponsible” when “we’re in a war; we haven’t fixed Social Security or Medicare; we’ve got record deficits.””
Republicans promise growth and jobs; Democrats just grumble. Yet in fact, the Republican claim depends on two false assumptions: first that the tax cuts will improve incentives to invest and create jobs, and second that tax cuts should go to the rich because the rich save and invest more.
Incentives.
If we cut taxes for the rich, either A) we raise other taxes or B) we increase debt or C) we cut spending. A), B) and C) have incentive effects too; we must consider net incentives.
A tax cut for the rich has minimal incentive effect. That’s because much income at the top is “passive.” Corporate shareowners can’t increase their capital gains if tax rates fall–though they may change their tax accounting.
What about incentive effects of A), B) and C)? A) At the Federal level, an increase in other taxes means higher payroll and income taxes. These taxes drive a “wedge” between employers and employees, penalizing job creation. B) An increase in debt eventually drives up interest rates, to the benefit of capital-owners–major corporations and wealthy individuals–and the detriment of capital-borrowers–small businesses and poorer individuals. Small businesses provide far more employment per dollar of assets than do large businesses. C) As for cutting spending, a cut in military and other pork would surely goose the economy, but that’s not what Republicans have in mind. Cutting spending on health and education and pensions reduces middle and lower income citizens’ ability and willingness to build the economy by working and investing.
Net effect: cutting taxes on the wealthy reduces incentives for investing and creating jobs.
Savings and Investment.
The rich supposedly save and invest a higher share of income, so that a transfer of income from poor to rich should increase net saving and investment in the economy. Now unquestionably the rich save and invest proportionally more through the markets, that is, by purchasing financial instruments like stocks and bonds and money market funds. These days, they’re lucky to earn 3 to 7% on such investments.
But people also “self” save and invest. A young person goes to school, effectively saving the income he or she could have earned in order to invest it in learning valuable skills. The immigrant shopkeeper works day and night, living on crumbs, to grow her little venture. She’s building “sweat equity.” So are the customers of Home Depot. Since we can’t easily measure “self” saving and investment we can’t be sure that the rich truly save and invest a higher share.
However–and here’s the key point–poorer people get a higher return on their investment! That may seem surprising, given that they can’t afford fancy investment advisors. But “self” investments like an education, or a small shop, or a do-it-yourself bathroom renovation, can yield very high returns–precisely because poorer investors find capital scarce and expensive. “Human capital” guru Gary Becker once estimated the return on a college education at 11% to 13%. Estimates of return on high school education run around 18%; over 40% for an 8th grade education. The investments of the shopkeeper and the bathroom renovator must at least repay the 20% interest on a credit card.
So, does poorer people’s higher return on investment outweigh a (possibly) lower savings rate? Absolutely. Fifty years ago, Asian “tigers” like South Korea and Taiwan were poor, very unequal, war-damaged agrarian economies. But unlike poor, unequal, backward countries in Latin America, the “tigers” redistributed land to the peasants, and invested massively in public health and education. Overnight they created a middle class, and set off rapid economic growth. Throughout the world, countries with a large middle class grow faster than very unequal countries.
A Message:
Tax cuts for the rich neither improve incentives nor increase saving and investment–quite the opposite. Our hard-working heavy-investing middle class built this country. We can have fair tax policies that also create jobs and growth.
