Tax Analysts Blog

Tax Cuts for the Rich Don’t Create Many Jobs, but What About Tax Hikes?

Posted on Apr 22, 2015

Want to create some jobs? Then cut some taxes. But make sure you cut them for the right people. According to Owen Zidar, an economist at the University of Chicago Booth School of Business, you’ll get the biggest bang for the buck by focusing your tax relief on the poor and middle class.

For decades, Republicans have touted tax cuts as the linchpin of prosperity. And they may be on to something, as long as those tax cuts don’t go to the wrong people. Cutting taxes for “job creators” might seem sensible, but reductions for “job takers” are actually more powerful. As Zidar reports:

      the positive relationship between tax cuts and employment growth is largely driven by tax cuts
      for lower-income groups and [the fact] that the effect of tax cuts for the top 10% on employment
      growth is small.
The problem (if you can call it that) is that rich people tend to save a lot. That’s good for some purposes, but not when you’re trying to create jobs. By contrast, less-than-rich people tend to spend most of their income. That makes tax cuts for the poor and middle class more effective, at least over the short term. Or as Zidar says:
      Overall, tax cuts for the bottom 90% tend to result in more output, employment, consumption,
      and investment growth than equivalently sized tax cuts for the top 10% over a business cycle frequency.

This is an important insight -- but not a new one. Supply-side theorists have been arguing for decades that high-end tax cuts are a powerful tool for boosting the economy. But their argument is actually a reaction to an even older tradition of economic thinking—one that emphasized the expansionary effects of low-end tax cuts.

Way back in the 1930s, economists spent a lot of time debating the macroeconomic payoff of various tax changes, giving special attention to the propensity to save. New Dealers and their academic allies generally viewed tax cuts for the rich as inefficient, or at least ineffective.

As I noted in a 2009 paper for Law and Contemporary Problems, a blue-ribbon academic panel insisted in 1934 that cutting taxes for the rich “would serve largely to pour public funds into private hoards.” Better to cut taxes for the poor, thereby boosting both consumption and the economy.

Some economists went even further, arguing that tax increases on the rich might actually be expansionary. A Robin Hood approach to fiscal policy – taking more from the rich and spending more on the poor – would shift money from those with a low propensity to spend to those inclined to spend every dollar they earned. The end result in a demand-starved economy? Faster economic growth.

“We must increase the incomes of those who desire to consume, and reduce the incomes of the very wealthy,” advised one economic thinker in 1932. “We can do that through higher taxes upon incomes in the upper brackets, through higher taxes upon profits, through very much higher taxes upon inheritances.”

Tax experts were inclined to agree. “The income tax is like the human heart,” observed New York lawyer Charles A. Roberts in 1931. “Business depression represents a stoppage or sluggishness of the two streams which are the lifeblood of commerce. The tax draws in the moneys which have become stagnant, and pumps them into forcible circulation in the stream of general buying power, restoring the vigor of our commercial life.”

Not many economists are willing to make that sort of argument nowadays; we don’t hear a lot of talk about “hordes” and “stagnant moneys” anymore, let alone using tax hikes to encourage recovery.

But as Zidar’s study confirms, saving propensities matter. Maybe those crazy New Dealers weren’t so crazy after all.

Read Comments (1)

mr. sal s.Apr 23, 2015

I'm glad someone has the guts to call out wrong-headed Republican or
conservative thinking on tax cuts for the wealthy.

To them, I say it's not about class warfare (i.e. "sticking it to the rich")
or, God Forbid, Socialism (or their common misnomer, "Communism"), it's about
reality backed up by hard numbers.

Mr. Thorndike's piece hits the nail on the head.

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