Tuesday, 12 April 2016

More about the obscene lie of "trickle-down" economics

     I've written before about how trickle-down economics is mislabeled, because it mixes metaphors with inconsistent gravitational fields. The term will not die, though; just the other day I found myself in an argument with a business owner who insisted that if only his taxes were lower, he could afford to hire more people and let that wealth trickle on down.
     Inadvertently, he formulated his claim in such a way as to make the absurdity of the theory so clear to me I felt compelled to blog about it here. Think about this: What he's saying is that unemployment happens because rich people don't have enough money to hire anybody.

     Seriously, that is what the whole tax-cuts-for-the-rich, trickle-down ideology really boils down to. If only the rich could get a break on their taxes, they could afford to hire some of those unemployed people and create jobs and wealth for everyone. Our economic ills are, apparently, due to the rich not being rich enough.

     Now, if you have any sympathy for the idea of the rich being job-creators, you'll probably be suspecting at this point that I've unfairly stated the theory in the most absurd way possible, and I'm ignoring the subtle genius of Reagan's brilliant insight. After all, the fellow I was arguing with seemed pretty sure that it was his hefty tax bill that kept him from expanding, and shouldn't he know better than I the details of his own business? Doesn't it make sense that, if the state confiscates too much of the proceeds of productive enterprise, there will be nothing left to finance the further growth of that enterprise?
     Of course it sounds plausible, and all the more so because it has been so enthusiastically promoted as wise economic insight for nearly four decades now. But that plausibility begins to fall apart if you look a little closer at it.

     For example, if you've ever done your own taxes, you're probably aware that you can deduct expenses from your gross income. The basic principle is that if you need to spend money to make money, the money you had to spend is not counted as income when you recover it. Think of it this way: If you buy $100 of materials, and turn them into finished goods which I buy for $120, your income is $20, not $120. So our tax system is set up to tax you on your $20 gain, not the $120 in gross revenue.
     Now, if you run a business in which you hire people to work for you, their wages are classified as an expense for your business. This means they're not taxed (though your employees may have to pay income tax on it, minus their own deductible expenses -- the same rules apply to them). So what this means is that in fact, you can't actually blame taxes on your profits for not leaving you with enough  money to hire more workers; if you just went ahead and hired those workers from your business' pre-tax revenues, you wouldn't pay taxes on the portion of revenue used to pay their wages.

     The point here is that if a business isn't hiring new people, it's simply wrong to blame that on their taxes being too high. And the same is true for capital investment and other forms of expansion: our tax system is carefully designed to have all sorts of exemptions and deductions to encourage growth, which only makes sense, because the more money you make, the more taxes there are to collect. The taxman's interests are actually aligned with yours here. Sure, tax policies can be made smarter, but that's not a synonym for "lower".

     The other thing that's disastrously wrong about trickle-down theory is that it applies an extremely simplistic model of investment. To be fair, it's the model that most of us learn through school and which is reinforced in ordinary household economics and even in games like Minecraft: You need to save up a surplus pool of resources to build stuff. If you haven't punched enough trees or gathered enough vespene gas or saved up enough coins in your piggy bank, you can't start your project.
     This makes good intuitive sense, and it is a prudent way to manage your affairs. But it is almost shockingly naive to assume that entrepreneurs and job-creators are limited to this approach, and all the more so when you consider that the richest of the rich made their fortunes either in or at least in large part with the assistance of the finance industry.
     You see, entrepreneurs do not start out rich, and then decide they finally have enough money to trickle it down to everyone else. They start out by seeing an opportunity to get rich, a way to provide something that people will pay them for. Of course, as mentioned above, it often takes money to make money, so they have to come up with the capital to get started, to build a factory and to buy materials and hire and train staff, and in so doing they create jobs and growth. But here's the thing: they don't need to have all the resources to do that themselves up front.  They can get a business loan from a bank. They can incorporate a corporation and sell shares. This is why we even have a finance industry: to raise the capital to finance the exploitation of profitable opportunities!

     (It's true today, of course, that a large amount of entrepreneurial activity is dependent on billionaire investors, but that's largely because we have concentrated so much wealth in the hands of billionaires; the institutions of finance and banking would work just as well with millions of small investors as they do with a few huge ones. Indeed, billionaire investors are the old-fashioned, pre-finance way of doing things. Back in the day, you had to go to the king or some other extremely wealthy noble to get your bright idea funded, and there was little incentive to do so since His Majesty would own it all. Also, he only had so much time to divide among all the clever people pitching ideas, and would probably rather be hunting anyway. This is why the emergence of financial markets, publicly traded companies, credit and other innovations in the Renaissance led to such unprecedented economic growth as we've seen in the last few centuries. It's also, I submit, why that growth is slowing down as we concentrate the money again in the hands of a few billionaires.)

    So this is why I say that trickle down theory is so preposterously backwards. Despite its superficially plausible rhetoric, it really does boil down to the claim that our economic malaise is due to rich people not being rich enough, and that if only they had all the money, we would all be much better off. And that is an obscene lie.


  1. Why do you think Donald Trump is winning in America?

    1. I don't think he's winning. He has, to be sure, secured the Republican nomination, which means he's won that particular contest, but the Republican Party has long ago ceased to even try to represent anything close to a majority of Americans, and I suspect (and hope) this will become stunningly evident in November. It's very important to him to be SEEN as a "winner", which part of why he spends so much time calling other people losers, but we have no obligation to amplify and validate his message.

      Unless, of course, you mean he's winning in the sense of being a beneficiary of the trickle-down ideology?

  2. I saw that argument and enjoyed it much. Yet while not trying to protect that particular business owner or his logic, I would still like to try and play devil's advocate in a sense.
    While you are correct in saying that only profits are being taxed and therefore taxes are not to be blamed for lack of desire to hire people, taxes are still a part of PnL equation. Higher tax would mean that more profits would need to be made to retain the same amount of money, which means less income spent on expenses, specifically salaries. Granted, it has more to do with the will to retain more profits than will to pay taxes, but people seem to cling to that sort of thing..
    The other argument goes as following: adding workers or increasing their salary is always seen as a discrete increment (regardless of your profits or income, your expenses will always increase by Xk dollars a year), which may tip the PnL equation over the balance for quite some time, until the worker gets up to speed and start pulling his worth. While it is obvious to me that it has nothing to do with taxes or trickling down of any sort, that transitional period is what I am pretty sure a lot of business owners refer to when saying that they cannot afford to hire new people. My problem here is how to properly separate the necessary risk of expanding your workforce from hiding from that risk behind "high tax" or "trickle down" reasoning.
    I am writing these down here not in order to protect their logic but to find arguments against it myself, as I am afraid I fail to see the proper response to these arguments so far. Your help will be much appreciated.

    1. Thank you for your comment. You're right, of course, that taxes do still figure into the profit/loss analysis, though arithmetically they're supposed to do so by reducing positive profit only; they're not supposed to push one from profit into loss territory. And yes, that will certainly factor into the cost-benefit analysis of whether it's worthwhile to go through the effort of hiring someone new.

      I'm not trying to argue that taxes are just peachy keen and don't have negative effects. Low taxes are in many ways better than high taxes. But the problem here seems to be that people are so personally invested in THEIR tax bill, and so motivated to seize absolutely any old argument that seems to support lowering taxes, that they will glom onto sloppy math (i.e. not understanding that taxes are on PROFITS, not revenue), or overly simplistic economics (I for one welcome our new job-creators) that fail to take into account that on the system level, money isn't a scarce resource that must be carefully allocated between government and private use, but a fluid that flows THROUGH the economy; the health of the economy has nothing to do with how many dollars there are, but how they're circulating.

      I have been thinking of a way to formulate this argument more clearly, but I haven't got it yet. I'd say to expect a blog post on the subject soon, but I really have no idea how soon.

    2. Looks like EI argument all over to me. The way you approach it, it is not about the way government rules or community works but narrow-mindedness of those who argue, who prefer to concentrate on personal gain as an end game. That and seeing economy as a zero-sum game. These people just managed to get ahead and now see those behind as a dead weight, or the competitors for "thy nookie". So out of narrow mindedness they look for ways to get rid of the "freeloading scum" completely ignoring really big players that are being helped in the process. Or even worse, helping them on purpose, hoping to get some token of appreciation in return or maybe even chance to join their ranks (hard earned, for sure). So like John Oliver said "Yup, I can clearly see this game is rigged, which is what is going to make so sweet when I win this thing."
      Sounds rather ominous. Will be waiting for your post.