Friday, May 18, 2012

Trickle or Drought?

One of the criticisms you often hear about supply-side economics is that it is “trickle down” economics. This conjures up the image of a bunch of rich people living it up on some elevated platform and some of the wealth they are enjoying spills or falls through cracks in the platform and masses of middle class and poor people underneath scramble to pick them up.

If you think about it too much, it gives you a headache. Is this wealth in the form of dollar bills? If so, shouldn’t it be called “flutter down” economics? “Trickle down” implies that the wealth is liquid, perhaps expensive French wine that is being spilled, which means the poor devils down below must be trying to catch the errant drops in their mouths. No matter how you try to think of it, it doesn’t work.

The problem with the metaphor is not just visual. What it implies is the problem is one of wealth transfer and the question is, what is the fairest way to do the transfer? But trying to think of fair ways to movie money around misses the whole point. That falls into the trap of thinking of the economy as dollar bills instead of human activity. As I asserted in a previous post, the basic economic question is how to get the most people making or doing things that most people want or need. To be sure, taxing some people and passing that money on to other people can encourage some economic activity. People who receive money from the government will definitely spend it or maybe even put it toward starting their own business, although realistically that won’t be true of most people. And just because beneficiaries of government programs have more money in their pockets that doesn’t mean that other people will necessarily start up new businesses to meet their consumer needs and wants.

Tax cuts, on the other hand, don’t involve a transfer of money from one group of people to another. Instead, they leave money in the pockets of the very people who are most likely to start or expand businesses and, consequently, hiring people. And that gets more people involved in the economy.

To be sure, transferring money to people who are unemployed or otherwise in need is a compassionate thing to do. And it can seem unfair to see one group of people who are comfortable and can afford to pay more in taxes not doing so when people are in need. But it only seems that way when we focus on how much money everyone has instead of whether they are gainfully employed. While compassionate, unemployment and other benefits are, in the end, a disincentive to participate in the economy. That doesn’t mean we, as a society, shouldn’t pay them. But we need to be aware that, like any medicine, too much can be unhealthy or even fatal.

So, if a good economy is simply a matter of low taxes, how come the economy has been so bad for the past four years during a period of relatively low tax rates? First of all, that’s an oversimplification. It really isn’t the precise tax rate that matters so much as the percentage of the nation’s economy that is diverted from the free market by the government. But to answer the question, the economy has been bad in spite of low taxes because the employer class has been severely hit by two severe blows. The financial crisis made it difficult to impossible to borrow money, a requirement for business startups and expansion. Then potential employers were hit by a massive amount of uncertainty that has made business planning extremely difficult. One aspect of this uncertainty stems from a massive overhaul of the healthcare system, which will clearly increase the costs of health care in general and the hiring of employees specifically. Another aspect of the uncertainty is the administration’s oft stated desire and/or intention to raise taxes. Any prudent businessman would tend to wait until things look more certain before investing money in starting up or expanding. And government subsidies for new businesses, such as those in so-called “green energy,” are not filling the gap by a long shot.

If we look back at the best economic periods in recent history, at the top of the list would be the Clinton administration. Democrats like to point out that taxes were higher then than they were under Bush and (so far) under Obama. But remember that under Clinton the government actually managed to balance the budget, which is a good indicator that taxes were not too high for the state of the economy at that time. Compare that to Obama’s record high deficits which, no matter how you make the comparison, are by far the highest in history. The next best economy would be the one under Reagan. The growth during that period has been derided by critics as an “era of greed” and “trickle down economics.”

But I would wager that most working people today would gladly trade that economy for the one the country is living through now. You can call it “trickle down” if you want, but the reality was that those economic policies enabled a lot more people to participate in the economy, leading Reagan to win his re-election by a landslide. How good are the current president’s election chances by comparison?

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