POLITICS SEPTEMBER 22, 2010
One idea that has gained oddly wide currency, especially among Republicans and moderate Democrats, is that a recession is an especially bad time to raise taxes on the rich. “If the priority is to get people back to work, is to start growing this economy again, then you don’t want to make it more expensive for job creators,” asserts GOP House Whip Eric Cantor. The plight of the rich is never far from the minds of the political establishment, and the state of the economy has given fresh urgency to the cause of sparing the very prosperous from the horrors of Clinton-era taxation.
The notion that it’s especially damaging to raise taxes on the rich during a recession—call it the Donald Trump Emergency Theory—is nonsense of a special type. You have your essentially wrong economic theories, like monetarism. Then you have pseudo-economic theories, like supply-side economics. But the notion that you shouldn’t raise taxes on the rich during a recession does not even rise to the level of pseudo-economics. It’s a talking point dressed up as economics.
What gives this dressed-up talking point a veneer of plausibility is that it weaves together two different strands of economic thought. Economists believe, to varying degrees, that marginal tax rates on the rich matter. If you set those rates too high, the rich will have less incentive to create wealth and will arrange their financial affairs to avoid taxes rather than to follow the signals of the market.
Almost everybody agrees that this dynamic exists to some extent, with some disagreement centering on how significant the dynamic is. (The mainstream, persuasive view is that the Clinton-era tax levels President Obama proposes to restore would have minimal impact on incentives.) Now, you can find some conservative economists who believe that even Clinton-era marginal tax rates would have a significant impact. And then, further on the fringe and mostly outside the economics profession, you have supply-siders, who believe that marginal tax rates on the rich single-handedly determine the fate of the economy.
The thing to keep in mind about this aspect of economic theory is that it has nothing to do with whether the economy is in a recession. Whatever the relative merits of reducing upper-income tax rates, they apply equally during any economic conditions. This policy concerns increasing the long-term productivity of the economy, not putting people to work during a recession.
There is an economic theory that holds that the timing of tax or spending policies matters a lot. That theory goes under the rubric of Keynesian economics and holds that the government should counteract recessions through deficit spending. The broad contours of Keynesian theory are widely accepted.
The thing to keep in mind about Keynesian theory is that it’s all about increasing consumer demand. It has nothing to do with the incentive structure of rich people or business owners. The purpose of deficit spending is to get people to spend more money. And the economic consensus holds that tax cuts for the rich are a terrible way to get people to spend more money. Everybody wants to save money during a recession (that’s why the government has to inject spending). Still, if you reduce taxes for people of modest means, they’re likely to spend the extra money rather than save it, because they’re struggling to maintain their basic needs. That’s not the case with rich people, who are far less likely than middle-class or poor people to spend an additional dollar in tax cuts.
The typical formula holds that upper-income tax cuts provide roughly $0.25 worth of economic stimulus for every dollar of deficit spending (as opposed to, say, extending unemployment benefits, which provide about $1.60 in economic stimulus). To be sure, some conservative economists reject those formulas, arguing that people respond to government deficit spending by reducing their own spending. If you believe that, though, you also reject the argument for marginal-tax-rate cuts as a recession cure.
Conversely, it’s possible to be such a strong believer in the need for Keynesian stimulus that you’re willing to support even a wildly ineffective measure like temporary tax cuts for the rich. Trouble is, advocates of extending upper-level tax cuts also happen to be the staunchest opponents of Keynesian stimulus. The selfsame Eric Cantor, quoted above pleading for the Donald Trump Emergency Theory, had this to say earlier in the year on the subject of fiscal stimulus:
We will continue to reject the Keynesian notion that somehow you can actually create sustainable jobs by government spending. Let’s face it. There is no such thing as a free lunch. Every dollar spent must come out of the private sector.
That is a coherent worldview, albeit a radical one. It holds that any dollar of deficit spending by the government causes an equal and opposite reaction by consumers, cancelling out any benefit. That worldview utterly rejects the case for deficit-financed tax cuts as a palliative for the recession.
How is it that conservatives have been able to toggle between two extreme, mutually exclusive economic theories? They have undertaken a clever framing exercise. When presented with policies designed as economic stimulus, they have talked as though the entire problem is the national debt. To wit, John Boehner: “We’re broke. Our debt is now on track to exceed the size of our entire economy in the next two years. And the government has no plan in place for paying this debt back.”
And when the subject turns to policies with minimal stimulative impact but high impact upon the long-term budget, they have talked as if the entire problem is the recession. (Boehner again: “Listen, you can’t raise taxes in the middle of a weak economy without risking the double-dip in this recession.”) And thus they have arrived at a position with no theoretical support whatsoever.
The actual purpose of the Donald Trump Emergency Theory is not to inject a fantastically inefficient stimulus into the economy, but to increase the chances of making the upper-income Bush tax cuts permanent. First you extend them into 2012. Then, in 2012, if the economy is still weak, that weakness becomes the reason to extend the tax cuts once more. If the economy has recovered, you credit the tax cuts with sparking the recovery. Foolish consistency and all that.
Jonathan Chait is a senior editor of The New Republic. This article will run in the October 14, 2010, issue of the magazine.