Posts Tagged “taxes”

A little high level data/history here, and then we’ll jump into Myths related to taxes for the rich.  I will provide a logical plausible mechanism for why low taxes for the rich do not stimulate the economy.

1.  The GDP growth rates during times of high marginal tax rates on the rich have historically been better than when they were low. Understand?  Growth is BETTER when tax rates are high on the rich.

2.  If tax cuts for the rich were stimulative, we’d be in boom times right now, but we are not.  The Bush tax cuts were largely tax cuts for the rich.  They did not stimulate the economy when enacted, and now the argument is that if they are taken away the economy would be even worse?  Not true.

3.  There was one other time in our nation’s history where taxes on the rich were this low:  right before the Great Depression.

The funner, better question is why?  Why are high taxes on the rich better for the economy?

Myths about taxes and the rich:

More money for the rich creates jobs.

Really? How? Businesses create jobs, not rich people (unless you count their housekeepers).  Giving more money to the rich simply makes them richer.  More money for the rich does not make their businesses richer either (the money leaves the company when they pay themselves).

Payouts to the rich actually make businesses poorer, since that money is not available to fund new projects.  Low capital gains taxes can also produce this effect.  High taxes for the rich are stimulative because it encourages companies not to pay out that money, which the businesses can then use internally to make investments.

But, still, the rich have money, which they then spend, which creates jobs, right? No.  I do agree that demand for additional goods/services creates jobs.  But rich people do not create as much demand as others.  A rich person saves a good percentage of their money, which is a drain on the economy (since that money is not spent to create demand for additional goods/services).

To reiterate:  Extra money for the rich stimulates the economy less than extra money for the middle class because they save a good portion of their money.

But the rich use that savings to invest their money which is good for the economy, right?


The word “invest” is used too loosely.  I wish there were another word.

In economics, Investment is good for the economy.  It is defined as business expense (minus SG&A) and purchase of capital goods.  Businesses generally make investments.  They include purchase of machinery, expansion into a new line of business, improvements on a facility, even education of the workforce.

In finance, Investment is when you buy something and hope to sell it for more later.  This is just speculation.  That is what the rich are doing.  This does not help the economy (unless you work in finance).  Purchasing stock, bonds, mutual funds, etc. IS NOT INVESTMENT.  The underlying companies DO NOT GET ANY OF THAT MONEY (only at the initial sale does the company get money.  The entire stock market is a second hand market.)  The vast majority of business initiatives are funded through excess profit, not equity (or debt).  Even when the rich do spend money on IPOs where companies get the money, this is not a significant source of funding for new business ventures.

In short, the “investment” that the rich make with their excess savings does not help the economy. It encourages speculation or, more to the point, it IS speculation….which is incidentally exactly where we are right now with the financial crisis:  too much speculation.

Putting more money in people’s pockets through tax cuts is a good way to stimulate the economy.

No.  In most cases, taxes are neutral for the overall economy.

As covered earlier, tax cuts for the rich do not stimulate because they save more of their money.  Let’s say the rich spend 80% (which becomes someone else’s income) and save 20% (which goes largely into bank accounts or speculation and is not stimulative).

As an aside here, you may say “Well, then the 20% the rich have in bank accounts is then lent to allow businesses to pursue new initiatives.  It IS still sound economic investment in the end.”

Nope.  Banks don’t need deposits to lend; that money is good for nothing until spent.  Banks can always get the money they need to lend (meet their reserve requirement) through borrowing from the Federal Reserve, which has to lend to them by law (and creates money out of thin air so there is no natural limit).  Lending is limited only by the number of credit worthy people/projects, not by deposits.

If the government taxed away the rich’s extra money, the government would spend 100% of it, not 80% of it (since the government never saves).  So….the government taxing away the rich’s money is actually stimulative.

What about the rest of us (the non-rich)?  We spend almost all of our money.  If the government taxes away our money, it is a wash at an aggregate level….either they spend 100% of it or we spend 100% of it.

So, tax cuts in general don’t stimulate the economy.  What taxes do is allow the government to pick winners/losers.  The government simply takes the money from us and puts it elsewhere.  Sometimes we agree with where they put it (highways, education, etc.); sometimes we disagree (wars, etc.).

To reiterate, tax cuts do not generally stimulate the economy.  They are a neutral.

Although a bit more controversial, there is some data/history and a plausible mechanism to make the case that high taxes for the rich encourage growth, not low taxes.  With high taxes for the rich, the businesses are encouraged to keep the money and make investments to fund new initiatives and the rich  save more of their money (which does not help the economy).  With high taxes on corporate profit, business is also encouraged to spend the money on improvements/investments (which would be pre-tax) instead of taking the money as profit (which is taxed).  Excess profit does not create jobs or stimulate growth.  Demand for goods and services in excess of what the company can provide with current resources creates jobs and stimulates the economy.

To conclude, I do not understand the tax cut for the rich argument.  Data and history do not back it up and there is no logical plausible mechanism for it.

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