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Trick(led) or Treat

December 30, 2017

A look at tax reform and trickle-down economics.

 

Current Situation

 

Just before Christmas, Congress passed its new Tax Bill. The legislation will lower individual tax rates (though the individual tax cuts will expire in 2025). In addition, the standard deduction will nearly double, but personal exemptions will be eliminated. Mortgage tax deductions will be reduced and all itemized deductions will be eliminated. The estate tax threshold will double and pass through income tax rates will drastically be reduced so generational wealth will be subject to little or no taxation. Furthermore, corporate tax rates and investment rates as well as business credits will be changed to the benefit of corporations and small businesses.

 

What is Trickle-Down Economics?

 

The 2017 tax bill is an example of what is commonly referred to as trickle-down economics, which is a form of supply-side economics that gained popularity in the late 1970s and early 1980s. Prior to its emergence, the prominent economic theories were the invisible hand theory of free markets advocated by Adam Smith and later Keynesian economics which advocated for the use of fiscal and monetary policy to influence growth.

 

In layman terms trickle-down economics suggests that reducing taxes will spur economic growth by putting more money into the hands of the wealthy and having that money filter down to all classes through increased investment and spending by the wealthy. In short, more money for the top will “trickle-down” to the bottom and will then cycle and flow throughout the entire economy.

 

Does Trickle-Down Economics work?

 

The short answer is no. This form of tax reform was first enacted in the 1980s under Ronald Regan who signed the Economic Recovery Tax Act of 1981, which lowered the top marginal tax bracket from 70% to 50% and the lowest bracket from 14% to 11%. This act slashed estate taxes and trimmed taxes paid by business corporations by $150 billion over a five-year period. The end result of these policies was the U.S. moving from the world's largest international creditor to the world's largest debtor nation. Reagan described the new debt as the "greatest disappointment" of his presidency.

 

Many of you who were around in the late 1980s and 1990s will recall that in 1988 Reagan’s successor George H.W. Bush ran on a platform of “read my lips, no new taxes.” However in his 1990 budget, Bush approved tax increases to attempt to cut into the growing national debt.

 

Need further evidence? From 2012 to 2017 the state of Kansas ran a “real-live” experiment of pure trickle-down economics according to its Republican Governor Sam Brownback. Kansas behind its Republican led state legislature slashed the state’s tax rates, eliminated state income tax for most owner-operated businesses and reduced vital government services. Brownback pledged this approach would deliver a shot of “adrenaline into the heart of the Kansas economy.”

 

The result? Kansas’ growth rates lagged behind that of neighboring states as well as the nation as a whole. Kansas’ state deficit mounted to unsustainable levels whilst providing fewer and fewer state services for its people. This summer, the legislature — still controlled by Republicans — overrode Brownback’s veto of legislation restoring taxation to sane levels. The experiment failed, miserably.

 

Counter-examples

 

On the flip side both California and Minnesota have turned their state economies around for the better by raising taxes – in direct contradiction to trickle-down economics. In 2011 Minnesota had a $6.2 billion budget deficit and a 7% unemployment rate. It raised taxes on the wealthy and increased the minimum wage. As a result Minnesota reduced its deficit by more than $2 billion and added 172,000 new jobs, giving Minnesota the fifth-lowest unemployment rate in the U.S., as well as a median income that is $8,000 above the U.S. average.

 

Conclusion

 

The trickle-down approach put forth by the latest tax bill is projected to result in a trillion dollar increase in the national debt whilst failing to grow GDP a sufficient enough sum to cover that debt. For more information on how the budget and tax math works check out my previous post called Axe the Tax.

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