The Fallacy of Modern Day Trickle Down Economics

A few weeks ago, I wrote an article on the path I hope the Republican party takes in the coming years. The piece was pretty broad and touched on a lot of issues, making it difficult to get very granular on any one particular subject. One thing I mentioned was the need for the Republican Party to understand that in order to once again achieve the success they enjoyed as a party during the Reagan days, they were going to have to look forward rather than backwards. In other words, Republicans must stop clinging to policies that were enacted 35 years ago and thinking that they would work today.

 

When you ask one of us Republicans the first association they make with the Ronald Reagan presidency, many of us would quickly reply “Reaganomics”, in reference to the Reagan fiscal policy agenda that called for tax cuts and business friendly regulation. Additionally, if you asked that same individual how they would like our current economy to be handled, they would more than likely call for policies similar to those put in place by Reagan. One of the first definitions you learn in an economics class is the Latin phrase “ceteris paribus”, meaning all other factors are equal. So while it is a fact that the United States enjoyed economic growth throughout Reagan’s eight years, it is foolish to assume a condition of “ceteris paribus” applies today. The United States, and its economic climate, are fundamentally different now than they were in the 1980s. Below are a few graphs that will be explained as we move forward:

 

 

 

 

 

When Ronald Reagan was elected, the US economy had been in decline for two years, and was suffering inflation levels of over 13% (see inflation level on top graph for the year 1980). For comparison, a 2-3% inflation level is generally considered acceptable. In order to get this number down, the Federal Reserve, headed by Paul Volcker, needed to dramatically raise interest rates (interest rates and inflation generally have an inverse relationship). These massive interest rate increases were a necessary evil, and it was widely understood that they would initially make things worse in order to make them better. Enter Reaganomics.

 

With high inflation and interest rates, businesses everywhere needed to catch a break, and that literally what Ronald Reagan gave them: a tax break. Shortly after the Federal Reserve began raising the interest rates, Ronald Reagan passed sizeable tax reductions intended to help the economic healing. Although it took a few years, it finally began to work in 1983. Inflation fell from roughly 7% to about 2%, and with a more stable economy, the 10.3% unemployment rate (shown on the bottom right graph) began descending as well. This growth can largely be attributed to the fiscal and monetary policy instituted by the US government, and although Ronald Reagan’s presidency was quite far from ideal for many (a large increase in national debt, accused negligence of minorities and homosexuals), the argument in favor of his business friendly policies is strong.

 

In summary, supply side, or “trickle down”, economics postulates that rolling back taxes and barriers to entry will lead to increased profits for businesses, which will then “trickle down” to the common worker. The argument for it is laid out above, but If you want to learn a little more before continuing, feel free to do a quick Google search. You’ll be an expert in no time! But now that we have a general idea of supply-side economics, let’s see if it is an appropriate policy option for this day and age.

 

Let’s take a snapshot of the US economy as is. As shown by the bottom left graph above, we have a 4.3% unemployment rate, which is essentially full employment. Every healthy economy should have an unemployment rate around 5%, it means that technologies are advancing and different, more advanced skill sets are needed to fill new positions. As a small consequence, a portion of the population will be left without a job for a period of time until they can find a new job or develop new skills. Additionally, the US economy has steadily been adding jobs for quite some time now, indicating a steadily recovering economy that is finally on the other side of the 2008 recession. The biggest difference between our needs now and then can be summarized like this:

In the 1980s, our economy was suffering from incredibly high levels of inflation and rising unemployment levels, which is more easily controlled by policy decisions. Today, both unemployment and inflation are at healthy levels. So let’s revisit the question at hand, will supply-side economics work in this case?

 

In order to answer this, let’s take a look at some of the positions the current administration has taken in order to defend its tax policy. For one, if you click this link, you’ll see that the White House website literally has a page for “getting Americans back to work”: https://www.whitehouse.gov/the-press-office/2017/02/04/getting-americans-back-work.

This sounds great, who doesn’t want to see more Americans get back to work? But in reality, what Americans is this referring to? Our unemployment level is below the natural unemployment rate, and once again, this can be seen in the bottom left graph a few scrolls up. Yes the labor force participation rate has been dropping for over a decade, and that largely has to do with the high number of recent retirees. In fact, within the next 15 years or so, the amount of individuals retiring will create a massive demand for labor, so writing fiscal policy with the singular goal of increasing the demand for labor is hardly time well spent.

 

But all of this theoretical talk is probably boring, don’t you wish we had a real life example of what happens when you enact a supply-side agenda during times of economic expansion. Good thing we do! Look no further than Governor Sam Brownback of Kansas! Elected in 2012 by a 30% margin, Brownback promised to cut taxes and bring tens of thousands of jobs back to Kansas, which had been hit quite hard during the recession. It was Brownbacks calculation that cutting taxes and government expenditures would empower the average worker in Kansas and turbocharge their economy. His tax cuts include slashes to the personal state income tax, state business tax and more. How exactly has that worked out?

 

Kansas is currently facing a $350,000,000 shortfall in state revenues this year, and if the current tax structure is maintained through 2019, that number will move towards $1,100,000,000. In order to defend these tax cuts, Brownback used the popular defense of supply side economics, the general explanation goes something like this:

“We’re going to cut wasteful government spending, and the economic growth these tax cuts will produce is actually going to grow the tax base, resulting in more revenues”.

 

Cutting government spending is one of my favorite points to discuss, as everybody seems to think it’s so easy. I’ve written about our need to cut government spending and I’m a big advocate of it, I think most everybody is, but it’s important to realize that a lot of what the government does is really really important- and thus the size of your tax cut must be roughly equal to what you can safely cut from the budget. In Kansas, this has not been the case, and Brownback’s cuts have severely hampered Kansas’ educational system, amongst other things. In order to pay for these cuts, Sam Brownback has eliminated $225,000,000 from the state’s K-12 education budget, disability services have been slashed by $25,000,000, the budget for the University of Kansas has had their budget decrease by $9,000,000, and there are plenty more examples of cuts like this having been enacted in order to pay for a decrease in taxes. The most important question regarding tax policy is one of tradeoffs. Do the benefits from these tax cuts outweigh the cut in public services? That is the question most worth asking whenever you hear about tax reform.

 

Rather than drawing a conclusion on this matter myself, I want to give you some of the relevant information and allow you to formulate an opinion with me. The following is a list of 3 important economic statistics:

 

Unemployment (Kansas/US): 6% when Brownback was elected, 3.7% now (16/50)

 

Economic growth (Kansas/US): 35/50

 

Wage Growth- 1.6% compared to the US average of 1.7%

 

So, the statistics above don’t exactly spell out the tale economic horror that most liberal pundits would have you believe. Is their economy a shining example for the rest of the country? Absolutely not, but conversely,  it isn’t as if the state of Kansas is on the verge of economic collapse. But, we now have to take these facts and put them against the facts previously laid out.

 

Are these numbers worth creating a budget gap of $1,100,000,000 that must be paid for by cutting government programs?

 

Probably not.

 

Should the Federal Government take similar steps?

 

Once again, probably not.

 

It is important to understand that the premise of supply-side economics assumes that a hefty majority of the tax relief will be reinvested into business expansion, and that the money generated by this reinvestment will be dispersed evenly throughout the economy. However, history has shown us over and over that many of these benefits go back to ownership, which doesn’t do too much for society as a whole. Furthermore, when you consider the fact that the three statistics laid out above put Kansas in the middle of the pack with the rest of the nation, you may come to the conclusion that Governor Brownback’s tax plan did not accomplish what he would have hoped.

 

With all that being said, it becomes pretty clear that the United States economy, and its needs, are different than they were in 1980. Our economy rebounded relatively nicely from the 2008 recession, and it is important not to be impatient with this recovery. Many people will accredit our slower than usual economic growth on high taxes and crippling regulation. While I support a minor rollback of both of these things, I am not under the impression that our economic growth is correlated to the size of the next tax cut we get. There are many opinions on why economic growth is where it is right now, and if you’d indulge I’d like to share with you my personal opinion:

 

I do not believe that tax laws are what drive economic growth. Sure, they are an important factor in assisting growth, but they are not the main engine. Rather, the main engine of economic growth is innovation. Throughout the history of the world, the largest economic booms that brought about the most prosperity didn’t spring into existence because somebody cut taxes, they came about from innovation. Think about the industrial revolution or the creation of the automobile; can you opine on tax policies during those times? Me neither.

 

Periods of innovation are almost akin to waves crashing onto a beach. There is a wave, then a trough, and then another wave. So, the reason our economic growth has been modest is because we are currently between waves. This is the fault of no one man, and is part of the age old cycle of innovation. While this idea is disappointing, the good news is that we are probably within 15 years of another massive wave of innovation, and this time it will be caused by clean energy and technology. Think about all the growth that will soon occur when the electric car industry finally economizes and becomes competitive with traditional automobiles. Think about how the demand for solar panels will soon skyrocket when their installation cost begin to even out. To that point, according to the Solar Energy Industry Association, the cost of installing solar panels has decreased by 70% since 2010, and most of society doesn’t even use them yet. These are truly momentous innovations that are already beginning to take shape, at this point it is only a matter of time until they directly impact the way you and I live our lives.

 

Taking a step back and looking at the big picture can be helpful in any situation. I will never claim that my stances and views or interpretations of informations are perfect, and I welcome criticism. However, I did a good job of explaining my views on supply side economics by tying together various different pieces of data and information in this 2,000 word piece.

 

 

 

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