Sat, 11 Oct 2003

Tax cuts for the wealthy

Numerous people are decrying tax cuts for the wealthy. Google points to many of them. They are misled, or seek to mislead, for one primary reason: the wealthy are more likely to invest the money. They would have the tax cuts be uneven: weighted towards the middle-class. The thought is that middle-class people will spend the money immediately. This will result in more economic activity and more jobs. Simple, right? No, simple, wrong. It's not that obvious.

Why do people spend, or not spend money? Simply enough, because they prefer money to the goods that money would buy. Money is just another good, and a person can have a desire for money itself beyond what they can trade for it. Why can this be? Because money is the "universal good" which can be traded for all other goods. A primary reason for preferring money to goods is because of uncertainty over which good to buy. If you're not sure what you'll need money for in the future, you won't spend your money now. The middle-class doesn't automatically spend every dollar it gets its hand on. One thing you can count on is that the people have a better handle on their own interests than the pundits do.

The assumption here is that the wealthy already have "enough", and won't spend their tax cut. Instead they'll spend some and the rest they'll dump in the bank or the stock market or bonds. That's probably true, but it's not true enough (it doesn't elucide, it obscures).

Money that is invested rather than being spent does not disappear. It does not become unavailable to the economy. Even if the money is held as cash in a mattress, the economy will react to its absence and increase the value of the remaining money. Realistically, a LOT of cash would have to be stored in mattresses for this effect to be noticeable. Even though it's hard to measure, pulling cash out of the economy will result in everyone's cash becoming more valuable.

Money that is invested in a bank goes two places. A fraction of it (the fractional reserve) is kept on the chance that the account holder will want his money back. The rest of it becomes available to customers of the bank. The bank takes deposits and loans them out at a profit. That's how the bank pays for its expenses. What do the customers do? Without fail, they spend the money. When a wealthy person deposits their tax cut in their bank account, it gets spent, probably within a day or two.

Money that is invested in the stock market, the bond market, a mutual fund, or privately also results in spending. The reason a company sells stock is to raise capital. They trade a portion of the ownership of their company for money. They spend that money (or put it in a bank account; see previous paragraph). They do so with the full intention of being able to recover that money and more to pay back the investor and make a profit.

So far, these examples are ignoring the effect of new investment dollars. What happens when money becomes available to banks, or companies, or the bond market? You have more supply. Increase the supply of something, and what happens to the price? It falls. Capital becomes cheaper, which serves as a signal. Entrepreneurs see that people are dissatisfied with the current mix of goods they could purchase, and that they want different goods. They use this cheaper capital to create new products and new jobs.

The existing tax cuts just cut taxes evenly. Everyone who objects to tax cuts for the wealthy are really asking for taxes to be lowered for everyone BUT the wealthy. This just serves to force the wealthy to subsidize other people. Historically, that's what they've done (Google for Carnegie library) anyway. What moral benefit is to be had from forcing them to?

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