Horse And Sparrow Economics

As concerns about the  federal budget deficit heighten, and the year’s end draws ever nearer, increasing talk has been of the looming fiscal cliff. 

Unless Congress can agree on a solution by the end of the year, $600 million in tax hikes and automatic spending cuts will be enacted, and likely push the country back into recession.

One particularly bitter struggle has been whether or not to expire the Bush Era Tax Cuts, which would restore top marginal income taxes to 39.6%.

To preface, as someone who pays virtually no income taxes (a real rate of about 2%), on a personal moral level, it is difficult to cast stones at those who object to seeing their marginal tax rates increase if the Bush era tax cuts expire. 

At this point, I should also clarify a point for the reader.  I recognize that these tax rates I am comparing are not the same things.  As most of you probably know, a marginal tax means that different tax rates are applied to successively higher levels of income, not overall income. Currently, for someone who makes $500,000 dollars a year, the rate would not be 35% over the entire amount. Rather, this highest tax rate is only be applied on the amount over $379,149, or approximately $120,851.

So, like poor  graduate students, the wealthy pay overall lower income taxes than their highest marginal rates, hence the term marginal.

Still, giving 39.6% of any part of one’s income seems offensive to many who have, presumably, worked hard to get their money.

But, for these budding Ayn Rand disciples, a little perspective is in order.

Historically, the marginal tax rate on upper incomes in the United States has been much higher than it is today. The Eisenhower administration saw rates as high as 91% on the highest wage earners.  In fact, it is interesting to note that taxes for the highest income bracket did not dip below 70% until 1982.

That being said, it stands to reason that the ones who suggest raising taxes on the rich are not rich themselves

Or are they?

Warren Buffett, the well know billionaire investor and heralded “Oracle of Omaha” made headlines last year when he reported that he paid an effective tax rate of 11%. This is because most of his income comes from investments, that are taxed a much lower rate.

He surprised a lot of people when he said that he thought the rich, like him, should be paying more.

President Obama, emboldened by this endorsement has suggested a Buffett Rule, which will raise taxes to 30% on all income over $ 2 million dollars.

Like efforts to expire Bush Era tax cuts, his plan has met some opposition.

The reluctance of Republican lawmakers, and some Democrats to raise taxes on the wealthy is based on a belief that increasing taxes on the rich will diminish disposable income for investment, which is needed for growth.

Without growth it is feared we will plummet back into economic recession.  This is the argument of supply side economics, which sees investment, rather than demand, as the primary driver of economic growth. 

This theory suggests that increased investment will fuel economic output, creating jobs that will benefit the middle and lower classes.

This is a compelling theory, and one that has seen much support from Ronald Reagan and other conservatives over the years. But, for it to be effective, one would have to see the lower and middle class getting richer too, particularly since the early 1980s, when large tax cuts on the wealthy were introduced.

The rich are definitely getting richer. In the last thirty years, the wealthiest 1 percent has doubled its share of national income, from 10% of the nation’s income to 20%. The top tenth of one percent has tripled its share, and the richest 400 Americans own more than the bottom 150 million put together.

For this same time period, however, median wages have failed to keep pace with such wealth gains, increasing only 11%.  

Part of the problem with this theory is that tax cuts don’t always equal investment, because saving, or leakages don't equal injections.  Also, though profits and productivity at many companies are soaring, gains in growth do not necessarily translate to higher wages or increased jobs.

It's worth noting that before supply side economics was coined “trickle down” economics, it had a different name.  

Coined in 1896, it was called “Horse and Sparrow Theory.”

If you feed a horse enough oats, some of it will “pass through” to the road, giving food for the sparrows. 

An apt and demonstrative analogy for much of the “trickle-down” rhetoric of the past thirty years,
and I will leave my commentary at that.