I wanted to elaborate a bit on some of the ideas in yesterday’s post on why continuing Bush-era tax policies won’t boost savings, investment, and long-term growth.
For starters, it’s important to distinguish the idea that tax policy can boost growth by bolstering savings from the idea that economic “stimulus” is good or that “it’s never a good idea to raise taxes in a recession.” These ideas are almost the reverse of one another. The way the savings point works is this. Every time you earn a dollar that you don’t spend on consumption goods, you’re saving a dollar. If you just let those dollars pile up in your sock drawer, nothing happens. But assuming you do something with it — even just leaving it in a checking account — then the financial system turns that dollar of saving into a dollar of investment. And those investments can drive long-term economic growth by increasing society’s ability to produce goods and services. Lower-income people have a higher marginal propensity to consume, so there’s a case to be made that a regressive tax cut will do more to boost long-term growth.
Stimulus is the opposite of this. The idea behind stimulus is that sometimes even though your country can produce $X of goods and services, in reality it’s only producing $X-Y worth. Hence, lots of people sitting around unemployed, lots of vacant offices, lots of idle machinery, lots of factories with canceled shifts, etc. The idea here is to come up with ways to decrease the savings rate in hopes that this will generate a higher rate of utilization of existing productive capacity. Normally we accomplish this by having the central bank try to manipulate interest rates so as to make borrowing more attractive and saving less attractive. But the government can also simply engage in its own dissaving.
Conservatives like to equivocate between these two rationales for their preferred tax policy. But it’s important to see that these are not mutually reinforcing rationales for tax cuts. Instead, the two ideas are in direct tension to one another. The same policy move can’t be designed to both increase and decrease savings.
So why the equivocation? In many instances it’s simply because the person you hear talking doesn’t understand what he’s talking about. One consequence of the cushiness of the conservative echo chamber is that people can go far in their careers by simply echoing widely agreed upon notions (“taxes should be lower”) without ever being pushed to understand why they’re saying that. But the equivocation is actually critical to the conservative worldview, because it’s only by unscrupulously merging the two lines of argument that the right can generate its preference for regressive debt-financed tax cuts.
Only the “boost savings” argument generates the desired conclusion about regressivity. Rich people really do save & invest more, so cutting their taxes really does boost saving and investment. But this only works if you offset the entire cost with spending cuts or middle class tax hikes. You can’t increase the saving rate by borrowing money. But if you paired a tax cut for rich people with offsetting spending cuts, it would become politically toxic. Hence the appeal of demand-side arguments that justify cutting taxes in the absence of offsets. The problem here, however, is that if you’re trying to boost demand then cutting taxes on the rich accomplishes very little — rich people, as argued above, tend to save a large proportion of any additional income.
Long story short, there are circumstances in which a debt-financed tax cut aimed at the low end can boost growth and there are circumstances in which an offset tax cut aimed at the rich can boost growth, but the debt-financed tax cut for the rich that is the hallmark of post-Reagan conservatism is just an exercise in upward redistribution of wealth.