Left-wingers should be the real supply-siders

by on April 2, 2007 at 6:34 am in Economics | Permalink

This post is pure provocation, take it as you will.

The left often stresses how wealthy people have superior opportunities in life.  They can save more, avoid debt, buy better educations, they have a better chance to start a company, and so on.  Furthermore this is seen as unfair.  Right?

To put the point in simple quantitative terms, equity yields an average of about seven percent, while holding debt claims yields a bit over one percent.  Most poor people don’t hold much equity, or for that matter they tend to take out debt rather than hold it.  Smart rich people stock their portfolios with equity quite heavily.  So on average rich people get richer.  That is even more unfair.  Right?

OK, to oversimplifiy the numbers just a bit, rich people earn — at least — six to seven times more on their money than do poor people.  Many of the poor earn negative rates of return.

The contemporary left often seeks to remedy this unfairness, but in the meantime it is true true true.  Right?

So for each extra dollar we leave with rich people, the economy earns six or seven times more in net terms — at least — than if that dollar had been given to the poor.

"The rich people’s economy" doubles in size about every ten years or so.  "The poor people’s economy" doubles in size about every sixty years or so, at best.  After sixty years have passed, "the rich people’s economy" has done at least six times better, relative to its original starting point. 

Now trickle-down effects from rich people are possibly quite slight.  If a rich person creates a dollar’s worth of investment, the consumer surplus and wage-boosting effects from those investments won’t be more than 25 cents on the dollar, right?  That means poor people get…

Well, it depends upon your assumptions.  But how do you feel about this claim? 

"I favor redistribution from the rich to the poor.  It will make the poor better off for a few decades, but no more.  After that point, the poor are worse off, forever, and by more each year."

Um…oops. 

The more you emphasize the unfair differences between the capabilities of the rich and the poor, the more easily you fall into this trap.  Redistribution is good for the poor only in the short run, and we haven’t even considered the traditional negative incentive effects on the rich.

Supply-side economics doesn’t have to be about assuming unrealistically large elasticities of substitution on the part of the wealthy.  The real supply side story is about how different social classes use resources in different ways and to achieve different rates of return.

Right?

Ned April 2, 2007 at 7:31 am

Right!

Rob April 2, 2007 at 7:55 am

Perhaps by receiving redistributed money, the poor will stop being poor? This may then change their behavior if their behavior is caused by being poor and not the other way around.

judgement April 2, 2007 at 7:58 am

I’ll second what Mike Spenis said…

Doesn’t this sort of thinking assume there is no mobility between classes? Isn’t there at least some chance that dollars redistributed to a poor person will allow that person to climb out of poverty? And if so, they might eventually earn six to seven times more on all their money, not just on the dollar that was redistributed to them.

In other words, who says the relative numbers of rich and poor people are constant over time? Various folks might argue about the likelihood, but it seems at least theoretically possible that redistribution might have some effect on the number of poor in the future, and wouldn’t it benefit the overall economy quite a bit to decrease the number of people earning a low or negative rate of return?

An economy in which everyone is earning returns of seven percent, pie-in-the-sky fantasy though it may be, is certainly a stronger economy than one in which only half the people are earning seven percent.

Grumpy Old Economist April 2, 2007 at 8:00 am

The evidence suggests that the share of income accruing to the bottom quintile stays constant as the economy grows. See Dollar, D and A Kraay (2002) ‘Growth is good for the poor’, Journal of Economic Growth, vol 7, no 3, pp 195–225 at http://ideas.repec.org/p/wbk/wbrwps/2587.html. That makes your argument even stronger.

Chris Stiles April 2, 2007 at 8:15 am

I suspect the politics of envy – and the focus on relative levels of poverty by people outside a small group of left wing intellectuals – only gains appeal when both absolute inequality increases and when social mobility slows down.

anne April 2, 2007 at 8:22 am

Judgement:

No one ever got out of poverty through governmental programs of wealth redistribution.

I have heard of plenty of folks who financed a business or education through debt – credit cards, loans, and the like, but it seems as if we would have heard of someone taking that welfare check and starting a business with it…

ryan April 2, 2007 at 8:49 am

One response (and, incidentally, the one that Rawls would probably give) would focus on the political effects of such inequality. That is, how can one buttress the increased inequality from having a negative effect on other possible political reforms?

This is nothing like a full argument, but it strikes me as something like what a left response might be.

The bad thing about this site is the almost total lack of differences of opinion.

joan April 2, 2007 at 8:58 am

The argument depends on the assumption that economic growth depends on the growth of tangable assents not on the health and educational level of people (workers). This is contrary to the evidence that wages (marginal productivity of labor) are very dependent on education, and that ill health lowers income. The non-rich spend a large fraction of their income on their childern who will be the work force in 20 years. This is also investment.

josh April 2, 2007 at 9:23 am

Well duh.

DK April 2, 2007 at 9:32 am

There is also a right-wing argument for redistribution. Assume you are a right-winger who believes that greed is good and that making the rich richer is your #1 goal. Also assume that free markets, free trade, and low taxes are good for growth.

But assume also that you pay attention to history. You’ll notice that income inequality frequently leads to the election of politicians committed not just to redistribution but to absurdly hamfisted and counterproductive ways of achieving redistribution. Not just farm subsidies and union rules, but nationalization of industries, trade protections for the least productive industries, wage and price control boards, and, in some countries, military coups. and that’s not to mention that income inequality can lead to higher security costs for the rich by increasing crime and rioting.

A good, rich-people-loving right-winger will therefore support a sufficient level of redistribution to preserve popular support for property rights and limited government. Furthermore, most large US corporations understand this, and that is why they often raise wages to preempt the formation of unions and why they embrace affirmative action.

In other words, the welfare state is the price Europe pays for not being Communist. And Chavez and Morales are the price Latin America pays for excessively fast economic liberalization.

spencer April 2, 2007 at 10:04 am

So let me see if I get this right, you are claiming that the past few years where the top few percentile of income get virtually all the gains and the great bulk of the middle class experience stagnating real incomes is the optimal economic outcome. While an era like the 1960s when everyone, including the wealthy and the middle class both experienced rapid real economic gains is a suboptimal economic environment.

That sounds about like I would expect from someone who always claims that anything that improve the returns to labor always makes the working poor worse off.

According to the WSJ even the top officials in the Republican party are coming to the realization that this is poor policy.

odograph April 2, 2007 at 10:14 am

Does anyone believe in redistribution of wealth, as a pure goal, anymore? I’m not a left-winger, but I think that stuff went out with the Berlin wall.

I think the more interesting arguments, the ones I’ve had sympathy with as a conservative, revolve around giving everyone a fair start in life, and an adequate safety net along the way.

We want (I think!) good enough public education (&etc.) to ensure mobility, and to prevent rigid wealth stratification.

We don’t want one’s ending lot in life to have been a birth-lottery from the beginning.

michael vassar April 2, 2007 at 10:22 am

I’m sincerely confused. Is this post a late April Fools joke? When people hold debt the returns *to them* are only 1% on average, but the debt that they hold is necessarily invested by someone. There is no reason to expect the returns to the economy from holding debt to exceed those from holding equity. Your proposal would result in more money flowing into equity from debt, an equity bubble, increased equity volatility in the long term, and potentially the eventual elimination of the equity premium, nothing more.

mickslam April 2, 2007 at 10:25 am

DK,

You are making my head hurt by focusing on reality rather than economic theory.

Something very under appreciated by any libertarian is the fact that essentially all of our increase in the standard of living in the last 100 years is the result of the focus on the living conditions of poor people.

Many things don’t make economic sense to build or make unless many millions of people use them. By building and making these things, you stumble on improvements that cannot occur on paper or theory, or on the first pass.

I’ve thought about this before in the context of trickle down economics. For example, you can give a rich guy $1M or 20 families $50K. Its the same amount of money in our economy. Who stimulates the economy more? It’s pretty clear when put in these terms. Who better incentivizes business owners to make products and create services that will raise our standard of living? Its pretty clear.

I think we are running into the difference between economic growth and increasing our standard of living. They are not the same, and many people confuse them.

Chris April 2, 2007 at 10:35 am

So, left-wingers should be the real right-wingers?

Not sure what that means right-wingers should be…

Daniel Klein April 2, 2007 at 10:49 am

Nice post. So what is it that really lies behind being a leftist?

Xanthippas April 2, 2007 at 11:30 am

The left often stresses how wealthy people have superior opportunities in life. They can save more, avoid debt, buy better educations, they have a better chance to start a company, and so on. Furthermore this is seen as unfair. Right?

Wrong. And it’s not a good sign to start your post with an inaccurate assumption about what people on the left believe. Many on the left (who are not “leftists” my dear Mr. Klein) are not appalled by the fact that people with more money do better in life. We are appalled by the fact that people without money have so little opportunity to better their own situation. No one on the left (and Marxists are not “the left”) belives that the solution to this is to take money from the hands of wealthy people and put it in the hands of poor people. We believe that the super-rich should be denied the ability to skew government in their favor (witness the Bush administration) and that government should largely be responsible for programs and services that give the poor or the disabled or the discriminated against a chance to better themselves and their families.

Only someone who is trapped in a world of theory can sincerely make the argument Cowen does here at the same time that we’ve watched inequality drastically worsen in the last six years.

Keith April 2, 2007 at 11:50 am

“For example, you can give a rich guy $1M or 20 families $50K. Its the same amount of money in our economy. Who stimulates the economy more?”

Asking the question that way does not actually yield a clear answer, and is a really stupid way of framing the question, anyway. After all, short-run stimulation does not yield as much (or maybe not any) long-term growth as capital formation. Saving is a key to growth.

It’s not about deciding who gets the money, it’s about creating the right incentives for a good social order. That certainly includes some government intervention, but Tyler is right that redistributive leftists underthink the beneficial cumulative effects of capital formation, or at least discount those gains very highly.

“And aren’t you forgetting the proven high returns to human capital investment – i.e. the opportunity cost of NOT redistributing! ”

Actually, human capital investment and redistribution are two different things, and redistribution may actually lower human capital investment. There are useful government interventions in human capital formation, but they’re quite a bit more specific (and probably far more paternalistic) than straight-up redistribution.

Person April 2, 2007 at 12:35 pm

Timeout.

Tyler_Cowen, wouldn’t the lefty try to cut you off at your original premise? He would argue that the the
6+ percent earned in equities does not correspond to actual economic growth, but just taking a bigger share
from others without generating real advancement.

mk April 2, 2007 at 1:35 pm

A few more things:

- Someone else mentioned it already, but what about the ripple effects of giving a poor person money? Surely they pay for goods and services, right? Are those ripple effects believed to be less than in Tyler’s situation where we give the rich person the money?
- Would we achieve the same beneficial results that Tyler alludes to if we gave poor people their payouts in the form of shares of an S&P index fund? And let’s say we also say you’re only allowed to withdraw your money at a certain rate.

Dean Moriarty April 2, 2007 at 2:13 pm

I thought the main objection to supply-side economics is that it really doesn’t pay for itself, or that it is more a matter of favoring a progressive taxation system, not redistribution.

Unless I’m missing something, this post presumes redistribution is the only objection to supply-side.

Mike April 2, 2007 at 2:26 pm

Smart and responsible people have a tendency to marry other smart and responsible people who, generally, have smart and responsible children. Genetics and parenting skills are powerful variables.

First, if one is poor, responsible and smart, one wonders what barrier is preventing that person from making some gains overtime albeit slower than the average middle class fellow who strives for the same proverbial brass ring. Certainly with so many ubiquitous federal programs available one begins to wonder. Most people who are labeled as poor don’t remain in that group forever. So what is this guy’s problem? Why is he making that “rich/poor gap” grow bigger? He just chooses not to close the gap – too much work and effort for him – his “poor” American lifestyle covers his stunted ambition just fine. The left has to let go of this guy don’t ya think? My dad, like his dad, was poor, smart, and responsible. He succeeded without a government program. My father closed the gap.

Second, most of the time, dumb and irresponsible people have a tendency to marry or shack up with dumb and irresponsible people resulting in, most of the time, dumb and irresponsible children. Their lot in life is not determined by the omniscient economic theory of liberals, hard-ass conservatives, or bad luck – it’s their poverty of values that result in the same said gap turning into a hell-hole. These folks just can’t close the gap – no genetics or moral motivation. Just ask any first generation Asian or African legal immigrant in this country what barriers to success s/he faces in the United States – I’ll bet ya that the response is “the sky is the limit” when compared to what they left – but you won’t hear liberals talking about their achievements.

Third, the 12 million or so illegal immigrants, of which many are illiterate in their own language, increase the “rich/poor” gap artificially by increasing the numbers of people who don’t want to close the gap or just can’t. For those who close the gap, they have chosen to and many without a government program.

Finally, the angst of liberals is nothing more than a power play – to alarm the electorate in voting for them. During the eight years of the Clintons, poverty was rarely talked about – it was as if it disappeared. It returned, however, just like clock work when Bush was elected. If a Democrat is elected in 2008, the gap will be “closed” within one year only to return when a Republican is reelected.

mickslam April 2, 2007 at 2:57 pm

I do love this blog. Tyler, I can really imagine having some fun conversations with you and many of the posters here. I come across pretty harsh here, but in the real world, I joke much more and say things with much more empathy behind them.

Keith,

“It’s not about deciding who gets the money, it’s about creating the right incentives for a good social order”

This was one of my points. Many families spending money create the right incentives for a good social order, far more than one guy spending $1M, as I mostly think that people are good and spend with some amount of wisdom. In any case, bad actors will only be able to spend a fraction of this money on foolish purchases. This money being spent will incentivize business people to provide the products and services these families need.

Now do I believe in complete redistribution? No, but between the facts that completely free market economies tend to be overthrown by leftists and simply don’t grow that fast(see south america for this), then the fact that our economy has thrived dispite 50 years of rightist propraganda that we are on the road to surfdom, and that communist revolutions only happen when people think they are getting screwed, and that the increase in our standard of living is almost entirely due to inventions that benefit people that are not rich, well, I think there are serious reasons to tend to benefit middle class/poor people in the tax regime. The incentives formed by this tendency will form a good social order that maximizes the risk adjusted returns AND the absolute returns to our economy.

The other part of my point was that this money spent by families would benefit the standard of living of all of us more than $1M spent by a single person due to the improvement effects that I mentioned in my earlier response.

And I think my answer does yield a clear answer. Simply ask yourself how much growth that $1M in the hands of 20 families will provide vs. 8% from the equity returns. Thats probably 3-4 new cars a year, substantial improvement of an almost full block of homes, clothes for kids, retirment savings, probably a few business started, all of these things.

Xanthippas April 2, 2007 at 3:24 pm

Mike,

Genetics? You grossly misunderstand the function of our genes if you think that genes are why people who don’t plan for the future give birth to other people who don’t plan for the future. Parenting you’re right about, but the mention of genetics gives a whiff of…eugenics.

Secondly, everyone appreciates the anecdote about your dad and his dad, but in truth everybody can think of someone else who works just as hard and yet doesn’t succeed, because they get sick, because they’re laid off from a well-paying job, because they can’t afford an education, etc., etc. Anecdote begets anecdote.

Lastly, exactly why is it that legal immigrants work hard, but illegal immigrants don’t? First of all, illegal immigrants work just as hard as legal immigrants. But legal immigrants have considerably more opportunity, thanks to their legal status, which accords them the ability to take out business loans to open their own businesses. Your argument is basically one about race and class, and you make basic assumptions about both which can’t be borne out. I have a feeling that many illegal Mexican immigrants, if given the opportunity, would open their own businesses and increase the prosperity of their children. I could be wrong, but the current approach doesn’t appear to be working.

Also, you plainly ignore the fact that income inequality has increased considerably and at a faster rate during the Bush administration. So it’s not all just talk.

Lastly, it’s absurd to talk about the poor “closing the gap.” The poor, even if they race with all their might to better their positions, cannot keep up with the wealthy who are getting rich at a faster rate than ever before.

triticale April 2, 2007 at 3:33 pm

Spending welfare money with a thought to the future is usually prohibited under the terms of welfare. There was a case in Chicago some years back wherein a woman managed to squirrel away enough from her ADC check to send her daughter to college. When the government found out, the money was confiscated. Until the reforms the Gingrich congress pushed thru under Clinton, welfare was explicitly configured to sustain, not end, poverty.

Sandy P April 2, 2007 at 3:47 pm

At some point in time, we’re going to have to realize people making $120/yr or a little bit less isn’t “poor.”

There are 3 things one must do to stay out of poverty:

1. Finish HS.

2. Don’t get married until after age 20 – and stay married.

3. Don’t have a kid until after you’re married, and not due the next week.

Of course, I remember when we got the rebate wayyy back around 01-02, “the poor” spent theirs on tatoos, according to an article I read.

I bought a purse.

Mike April 2, 2007 at 6:00 pm

SandyP.,

You’re right, of course. It’s always the liberal who thinks teachers are underpaid.

When I tell people what I earn as income, many people respond, “Oh, I thought you people made like $10 per hour or something…”

Many “rich” liberals depend on the largess of government: grants, professorships, teachers, non-profits, etc. Like my former wife said, “I can’t imagine living on a teacher’s salary”.

How could she buy a 40″ plasma television, or a Blueberry on that? Healthcare or a big T.V.? Cigs or diagpers? Beer or books?

I’m mean, aren’t I?

tom s. April 2, 2007 at 7:30 pm

Without thinking this through carefully, isn’t there a fallacy of composition here? The argument applies to a marginal dollar. So if we (whoever this “we” is – I can never work that out) reassign one marginal dollar at a time repeatedly, we’ll end up being like Dennis Moore, stealing from the poor and giving to the rich (in their own best interests of course) over and over again until they’ve got nothing left except sub-prime loans. And any new money should go to the rich of course.

But policy decisions are not about the marginal dollar. The real question then becomes, does an equitable society generate growth as much as an inequitable society, and the answer is “sometimes, depending on lots of other things”.

Xanthippas April 2, 2007 at 9:12 pm

Matt,

My point is that genetics has nothing to do with it. Some people may be born stupid; that doesn’t mean they can’t work hard and progress in our society.

Actually, my intellectual being accepts perfectly that there are people who are satisfied with being poor and living off of welfare checks. It’s not un-liberal to think that some people are happy just skating by and taking advantage of whatever the system gives them. The point however, is that our current system does not provide opportunities to people who want to do otherwise. People who want to work hard but get sick don’t make it. People who want to work hard but can’t save don’t make it. People who work hard in a particular field and acquire experience and knowledge, but then get laid off, lose their 401k, their health insurance and their savings, don’t make it.

Actually no, I’m not under the impression that everyone wants to compete with the super-wealthy. Nor am I under the impression that everyone deserves to live as the super-wealthy do. But the fact that some people accumulate vast sums of wealth, then proceed to use that wealth to influence politicians to lower their tax burden, shelter their income overseas, invest in corporations that do the same, and basically do everything they can to acquire yet more wealth without necessarily benefitting society, while people who want to work hard get laid off, lose their health insurance and their savings, is quite frankly, obscene.

To take this to another level, the fact of the matter is that I’m not at all interested in living in a country where a tiny percentage of Americans control a significant percentage of the wealthy in this country, and the only time it “trickles down” is when they deign to use it to provide jobs to Americans as opposed to people living overseas. I’m also not interested in living in a society where people who work hard can find themselves bankrupted by medical expenses at any point in life, including in retirement, or find themselves unable to find another job for want of an education they can’t afford, etc., etc. I respect the integrity of your argument, but in fact I think recent events indicate most Americans agree more with me.

Success in life is partly a moral issue, yes, so I understand your point in general that people should work hard and earn their success. But it’s not only a moral issue for those who must work to succeed. It is a moral issue for our country to provide those who want to succeed with opportunity, and it is a moral failing when we do not. Simple as that.

mike_tchk April 2, 2007 at 10:50 pm

let’s take it a bit further: take everything (literally, until they starve to death) from poor, and let the remaining rich build the super economy!

TJIT April 3, 2007 at 12:02 am

One other point.

The leveling influence of technolgy and increased buying power is chronically ignored or not understood by those who maintain income inequality as one of their primary policy concerns.

Money does not matter as much as it used to

peter jackson April 3, 2007 at 1:09 am

Doesn’t this sort of thinking assume there is no mobility between classes? Isn’t there at least some chance that dollars redistributed to a poor person will allow that person to climb out of poverty? And if so, they might eventually earn six to seven times more on all their money, not just on the dollar that was redistributed to them.

For some reason I never bookmark the page with these stats on Census Bureau’s website, so you’ll just have to trust me. Or not. But the percentage of folks of folks who manage to move out of the lowest income group (quintiles I think) and highest income group from census to census has been the same for the last several decades, about 85% (e.g., in 1990 it was 86% of the lowest and 84% of the highest). At the same time the percentage of households that fall below the poverty line has been steady at about 14%. So when we’re talking about the persistently poor—those who remain in the lowest income group from one census to the next—is 14% of 14%, or just under 2% of our population. This does not a “class” make.

To my mind, this level of churn between incrome groups over time means that speaking of “the rich” or “the poor” as some type of static class of people is, at best, sophism. The individual reality of poverty cannot be usefully studied in the aggregate because there is no aggregate, no static group of people persistently identifiable as “the poor” or “the rich.”

I think everyone would be better off if

1. More attention was focused on improving the financial knowledge and life skills of the less well off so they would be better able to have a decent quality of life and become more well off.

I want to start a political party that does just that, that goes out into communities teaching personal financial management and entrepreneurship. Very ethical and non-political with no selling. Give a man a fish and he’ll vote for you once. Teach a man to fish and he’ll vote for you forever.

yours/
peter.

perianwyr April 3, 2007 at 1:22 am

Money does not matter as much as it used to

Power’s still in vogue.

Trieu Truong April 3, 2007 at 1:44 am

No one on the American political spectrum cares about the poor. When was the last time a candidate won an election based upon a platform of helping the needy? The left champions the middle class, not the poor.

bob April 3, 2007 at 3:13 am

I’m fairly well off. Most of my money doesn’t go back into the economy very directly at all. I buy stocks and bonds, a little gold, etc. Some of those investments aren’t even in this country. I bought some rental property some years back, so I put some money into the economy when I pay for painting and plumbers and so on. A relatively small percentage of my net worth goes into the economy in the form of buying goods and services. I’m not extravagant and as my net worth has increased faster, my spending hasn’t come close to keeping pace.

It’s been a long time since I was a member of the “working poor,” putting myself through college and eating a lot of ramen and peanut butter and so on. But back then, every last cent that came into my pocket was spent very quickly on the goods and services I needed.

For those reasons, the argument about “trickle down” effects makes little sense to me.

Furthermore, the rate at which I’m taxed is lower than that of some of my middle-class relatives. A lot of the increase in my net worth is cap gains and dividends, not only taxed at a lower rate but not taxed at all until the gains are realized. And the bulk of that is from assets I never intend to sell and don’t anticipate having any need to sell, so if the estate tax isn’t reinstated I’ll be able to pass those assets on to my children without those gains *ever* having been taxed.

You’ll understand then if I don’t join in on the whining about “redistribution of wealth.”

Kevin Spires April 3, 2007 at 10:00 am

Wrong.

I think this article and the discussion below are off point for three main reasons. First the returns of 7% for equities and 1% for debt are not realistic (Actually I think they are completely bogus). Secondly, the discussion of supply-side economics is severly lacking (if not non-existent). Lastly, I think the whole framing of income distribution in static class terms is misleading.

Has anyone challenged the 7% return for equities and 1% return for bonds? What time period were these returns earned? Are those returns going to persist going forward? Those numbers don’t pass my personal sniff test. In fact, current investment practice is to expect long term risk-adjusted returns for different investments to be equal. If one sector has a higher expected return when adjusted for risk then the price of those assets will be bid higher, bringing expected return down until it is the same on balance when adjusted for return as other possible investments. In the example above, bonds could return 1% but only have 1% annual volatility while stocks could return 7% but have 7% annual volatility. If that was not the case, one of the thousands of hedge funds out there would use leverage and the ability to go short one asset class or the other to make a better risk adjusted return. This idea of a return on capital to a “class” of people tells me more about the author than anything about investing.

Also, the whole point of supply side economics is that lower marginal tax rates on capital and income lead to higher supplies of both. Higher supplies of capital lead to higher marginal productivity of labor and higher wages. Higher supplies of labor lead to higher marginal productivity of capital. This is a virtuous cycle that leads to greater real growth, higher incomes and faster capital/wealth accumulation. The greater the capital accumulation of an economy, the greater the average income. This is supply side economics.

As an interesting aside, one reason for the stagnation of real incomes in the lower quintiles could be the massive illegal immigration from lower capital countries. Think about it, you have 20 million immigrants coming to this country with little or no savings (capital). They compete for low skill jobs which drives down wages in those jobs/industries because for the existing stock of capital the supply of labor has increased dramatically.

Income distribution is a hot button issue. I don’t think Tyler’s post makes the issue any less hot. Left wingers – if they actually cared about the citizens at the bottom of the income distribution – should be supply-siders. If wages at the lower end of the economic spectrum are determined by the amount of capital stock available then left wingers should be behind proposals to lower taxes on capital. Remember the maxim – Tax something and you get less of it. But left-wingers always want to punish capital accumulation. Oil companies earning outsized profits – the left winger says take it from them. Drug companies making money on a blockbuster cholesterol drug – raise their taxes. Who then will invest in these sectors or any other hot sector if they think the government will just confiscate their returns? Where will the money come from to invest in shale oil or tar sands? Who will invest in deep water drilling?

Many comments were made about upward mobility through education, or through hard work and thrift. I think these comments are spot on. Distributing citizens into “classes” does not actually capture the dynamics at work when discussing how income is distributed among the competing factors in the economy. Most people start out near the bottom of the income ladder and climb upwards as they gather skills and experience. How do we make the process of skill accumulation proceed more efficiently without destroying incentives for savings/capital accumulation? How can we create incentives for greater capital accumulation so the average real wage rate can increase? In other words, how do we make the pie bigger so everyone gets a bigger slice, versus fighting over the pie and having much of it get ground underfoot in the scrum.

Tyler’s post was very dissappointing on many levels. Better luck next time.

Kevin Spires
Houston, TX

Dirk April 3, 2007 at 11:54 am

This explains how reducing tax rates increases tax revenues, reduces wealth concentration, improves family life, improves the entrepreneurial climate and lowers demand for government social services.

If the tax rate on Monday was 100% and the tax rate on Tuesday was 10% would you report for work on Monday? Would you work harder on Tuesday? What tax rate would make you show up for work on Wednesday, Thursday and Friday? Will your tax rate at which you are willing to work be the same as everyone else’s? If you would stay home Monday and would go to work on Tuesday you understand Voodoo economics.
Voodoo economics says tax revenues increase when tax rates go down. How does this happen? It happens because high tax rates cause a decrease in economic activity. Rewards for taking business risks are lower under high tax rates. Lower tax rates stimulate economic activity. Rewards for taking business risks are higher when tax rates are lower.
This concept can be demonstrated graphically. The basic concept is taken from the Laffer curve. The horizontal axis is tax rate, zero to one hundred percent and the vertical axis is tax revenues. Tax revenues are derived from the tax rate times the tax base. At zero tax rate tax revenues are zero. At 100 percent tax rate tax revenues are again zero. No one can afford to go to work if all their compensation is forfeited to taxes. There is no economic activity to tax, so no tax receipts.
However we do have a point where we have tax revenue and a tax rate greater than zero and less than 100%. So the question is what is the shape of the curve that connects the three points? For the sake of the illustration assume the current tax rate is about 30% and the revenues are about 1/4 the height of the vertical axis. There are three possible basic revenue curve shapes, depending on the slope of the line through this non zero revenue point. The slope can be positive, negative or zero. Proponents of raising tax rates to increase tax revenues say the slope is positive, proponents of Voodoo economics say the slope is negative. No one makes a case the slope is at zero.
What does real world experience reveal of the true shape of the revenue curve? Empirically tax rate reductions have yielded growing economies, In the 1920′s low tax rates stimulated the economy. In the depths of the 1930’s depression tax rate increases to 99% on incomes greater than $60,000 increased the unemployment rate from 25% to 35%. In the early 1960’s John Kennedy stimulated economic growth with tax rate cuts. Gerald Ford lowered tax rates and the stock market boomed. In the 1980’s Ronald Reagan lowered tax rates from previous levels and the economy again boomed. George H. W. Bush raised tax rates and was rewarded with a recession that cost him his reelection. In the 1990’s Republicans forced Bill Clinton to reduce tax rates on capital gains and the economy boomed again. (note that income will be taken at the lowest tax rate possible) George W. Bush pushed for tax rate decreases that have pulled a 9-11 shocked economy back into growth. Tax receipts have recently reached record levels, and in some recent months even exceeded expenditures. These examples suggest that the correct shape of the curve is negative slope at our current tax rate.
Examples can be seen in other countries, low flat tax rate Estonia is booming after suffering decades under Soviet communism. Ireland has gone from being the poorest country in Western Europe (with a high tax rate) to one of the richest (with a low tax rate) Why? low tax rates have attracted investment. Russia itself has seen tax revenues jump after implementing a low rate flat tax after high tax rates failed to provide revenues. Many other countries from the former Eastern block have implemented low flat taxes and these countries economies are showing far better growth than the Western Europe high tax rate economies that are mired in low growth and high unemployment. Recently it has been pointed out the US has created over 50 million new jobs since the 1980′s (when tax rates were lowered) where high tax rate (and larger population) Western Europe has created only 4 million new jobs, and most of these are government jobs.
The following graphs show the three slope possibilities at a tax rate of 30%, with the added reciprocal curve above the revenue curve being the size of the tax base, ie the size of the economy. Note that with all slope scenarios the slope of the economy is negative, that is, the higher the tax rate the less economic activity there is to tax.

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What does this decreasing size of economy with increased tax rates mean to you? It means little or no job creation, and certainly lower overall employment. There must be economic activity to have jobs and the level of economic activity can be a good proxy for the number of jobs in the economy. The following graph uses the size of the economy as a proxy for the number of jobs.
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Compare the number of jobs in the economy with the size of the available workforce. The size of the available workforce remains basically constant independent of the number of jobs available. Where there are more available workers than available jobs, as under high tax rates, there is downward pressure on wages paid to workers. Where there are more jobs available than workers in the workforce employers must pay more to attract workers, wages are bid upwards. So would you rather look for work under high tax rates or low tax rates?
Another overlooked effect of high tax rates is wealth concentration. High tax rates are said to be needed to tax from the rich and give to the poor to redistribute incomes. But high tax rates actually concentrate wealth. How? Under high tax rates jobs are few, workers plentiful, and compensation is low. The employer can pay far less than the value of the workers contributions and pocket the difference between the compensation paid and the value the worker generates for the employer. With large numbers of employees getting paid far less than the value of their contributions the employer can still profit greatly even if the tax rate is high, the net after taxes is still large.
Under low tax rates jobs are plentiful and employers must pay more to retain valuable employees. Because employers are forced to pay a higher percentage of the value of the employees’ contributions to the employee there is less wealth concentration. Wealth created by the business enterprise will be more evenly spread among the creators of the wealth. Employers will earn less from each employee, but will pay a lower tax rate and may not suffer as much damage to their net as one might expect.

There are a variety of other effects of higher wages stimulated by low tax rates.
1. Capital investments will be made to increase productivity. Productivity increases correlate strongly with increased living standards. Productivity growth also moderates inflation.
2. Low paying jobs often lead to two income earner families which expands the active workforce. With each worker earning more, fewer families will need two income earners. More families will have a single income earner with a stay at home parent. This could have a cascade effect on the job market in that this will reduce the active labor force, potentially forcing wages even higher. And a stay at home parent usually means good things for children.
3. More jobs = less government assistance needed. With more jobs available, the whole of the work force that wants to work should be able to find a job, the chronically poor and last hired minorities could find a job. This should reduce the demands on a variety of governmental assistance programs, including unemployment programs, welfare, medicaid, social security.
4. Workers with more disposable income can accumulate wealth and join the investor class or start their own businesses.

So the big question is where are we on the tax curve now? Most certainly we are on a point on the negative slope and decreasing tax rates will increase revenues and increase the size of the economy. How far should tax rates be reduced? Should they be reduced to the zero slope point (the highest point on the revenue curve) on the curve? This would maximize revenue to the government, but this is not the point where standards of living would be the highest, or where the fewest people would require governmental assistance. The goal should not be to maximize government, but to maximize the standards of living for the population of the country. This would indicate lower tax rates, to the left of the zero slope point, where economic activity is highest are desired.

Mike April 3, 2007 at 7:15 pm

Mr. Wu,

I would suspect that your parents aren’t idiots – genetics are powerful – unless, of course, you have an idiot savant uncle somewhere in your lineage, but I doubt that. My opinion is buttressed by facts; you just don’t like the implication of them. The nurture vs. genes debate turned in my favor a long time ago. Naturally, smart people fail all the time because of the same reasons that not so bright people fail but that’s not the point.

I was around in my late twenties when Reagan was around and read extensively on the real effects of his tax policies – for and against – it worked. You either have a selective memory or reading list.

The economy grew despite Clinton’s tax hike – and remember, the Republicans controlled both houses shortly thereafter. Republicans mitigated much of Clinton’s exigencies. Reagan did not have that luxury, of course, and the economy grew despite the Democrats. In fact, the economy grew despite the Democrats in both cases. That is not prima facie evidence for your argument against supply-side economics.

Good luck!

Mike Alexander April 4, 2007 at 9:11 am

The argument made here is not correct. Return to equity has average just under 7% over the long run. But this doesn’t mean that national wealth or GDP has grown by anything like that. Over the long run per capita GDP in the US has grown by about 2%. Capital accumulation in the S&P500 index (defined as accumulated retained earnings in constant dollars) has also run about 2%. Earnings yield (defined as the reciprocal of P/E) has averaged about 7% over the long run. Not surprisingly total return to equity is roughly equal to earnings yield. Growth in *wealth* is the increase in the *value* of the equity (the real stock index value) and has run at about 2% in real terms. Not surprising, growth in the value of equity is roughly equal to the rate at which earnings are retained. That is, capital accumulation reflects the rate at which capital is retained (not distributed to investors as dividends).

Supply side economics argue that if you give more money to investors you will get more wealth accumulation. This is nonsense. Wealth accumulation is fixed by the rate at which economic development takes place (new innovations are developed and implemented) and this seems to follow a 2% speed limit over the long run in advanced economies like the US. If investors have more money they will simply bid up the price (P/E) of equity–reducing the long-term return to equity. Since Reaganomics began return to equity has fallen from 10-12% to about 5%. Return to debt will also fall (from 4-5% in the early 1980′s to about 2% now). With returns to equity and debt falling we should expect other asset classes returns to fall as a result of rising price. A good example is real estate.

The effect of supply side policies is not to increase wealth accumulation or economic growth, but rather to produce asset bubbles. There have been three times when capital gains taxes were reduced to 20% or lower: in the early 1920′s, the early 1980′s and the lat 1990′s. Following each a speculative equity bubble formed which was followed by a spectacular market collapse. If supply side type policies continue we should expect to see increased financial instability, possibly leading to something like the Great Depression.

Wealth redistribution from rich to poor for a few decades will boost returns to equity, reduce debt levels and promote economic stability.

Mike April 4, 2007 at 11:28 am

“…from the poor”? Please, tell me who the “poor” are? I’m a teacher. Am I poor in your world? I thought this conversation was about the bottom 20 – 15%%. What do you mean by debt here?

My wife stays at home with our 3 kids; we own a house valued by the market @ $350k; we have over $100k in retirement so far; I put in 11% of my income in a self-directed 401a with another $150/month in another investment, two cars, etc. BUT – we have “good” debt! Please, enlighten me about what poor is in this country. If you are poor in this country, you’ve got a problem that goes beyond supply-side economics.

You liberals need to write an extra check with your tax returns. Don’t wait for me!

Policy Watcher April 7, 2007 at 4:38 am

“Growth is the key to welfare in the long run. Right?

China is growing the most rapidly of any large nation. Right?

Therefore, we should adopt all of China’s policies. Obvious, right?”

China’s national savings rate is at a whopping 47% too, despite the fact that many of the mainland provinces are extremely poor and lack basic necessitites such as clean drinking water. Meanwhile the US, which is about 5% of the world population and consumes 25% of the world’s goods and services, has a negative national savings rate.

The thing you have to remember is that China is an industrializing nation, whereas the US is already industrialized and is currently sending many companies overseas. In the global economy, we are transitioning towards a R&D nation now. Wealth isn’t trickling down, it’s trickling out and being redistributed globally, not nationally, via jobs. The problem is that we’re lagging in education (no offense to educators- it’s a policy thing) and failing to equip our nation’s workforce for the R&D movement.

Most higher ed. programs geared toward the working poor (WIA, Voc. Rehab., etc.) guide students toward short-term technical/certificate programs in order to get them back into the workforce ASAP, usually at a very modest income level. It’s a band-aid on a recurring wound. Instead, we should be offering incentives and support for those who take the long road towards fields such as Engineering or Finance or Medicine. THAT would be a redistribution of wealth. However, those options are only available to the working poor if they’re willing to quit working (most can’t afford to concentrate solely on education), or accumulate massive student debt; and so we’re back to square one.

Me April 28, 2007 at 6:05 pm

Relative poverty is not important.

I’m poorer than the average, and yet I want more money to me, not less money for the rich, that would not make me better off, and even the rich people are human beings, I want nothing bad to them.

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