A Deeper Insight into Taxation: An Economic Approach
The issue of tax cuts is an incredibly controversial topic in the US today. The Trump tax deduction that was put in place recently has caused even more controversy than usual because people worry that it will create a larger deficit and that the rich will not have to pay their fair share. In the past, however, tax deductions have proven to be economically successful. For example, Reagan decreased taxes because a 70% tax bracket was destroying innovation and jobs, and accelerating inflation in the US. The tax cut was meant to reduce unemployment and inflation and stimulate the economic growth of the US. The data shows that the tax cuts caused the unemployment rate to reduce from 11% in 1982 to 5% in 1989, and inflation from 10% in 1980 to 4% in 1988. The opposing side supports the plan of increasing taxes, which is the mainstream view held by the Democratic party and practiced during the recent Obama administration. Obama levied a 2.3% surtax on investment income, capital gains and dividends, owed by households making at least $250,000 or individuals earning $200,000. He also increased the payroll tax from 4.2% to 6.2% in 2013. This was the first time the payroll tax had increased since 1990. The notion that current taxes in the US were low in 2016 at the end of the Obama administration, and that the tax cuts from the Trump administration were not needed could not be further from the truth. This is clear when taking into consideration that the US corporate tax rate was 11 points higher than the average of the countries in the OECD (Organisation for Economic Co-operation and Development). The Trump tax reform was designed to act as a counter policy to the negative consequences that the Obama administration generated in terms of wage stagnation and foreign investment. Under the Trump reform, there has been less wage stagnation and more foreign investment. This topic is controversial and probably the most divisive topic in American society regarding economics. According to the main sources that argue for tax cuts, articles by David Boaz and Justin Wolfers, low taxes are an essential requirement for the country to progress because wealth does not just happen but has to be produced. On the other hand, Ehrenfreud and Nicole Lewis, demonstrate the appeal of decreasing the amount of revenue that could be used for public benefit. They claim that inequality would increase and this would lead to big social catastrophes. I will argue that there is substantial evidence that can prove that when economic liberty is increased in a country in the form of a tax deduction, there is usually more economic progress in that area. This trend of economic progress in the US will continue with the recent tax reform by Trump.
Synthesis
The health and growth of a national economy depends on the driving force of tax reductions for several reasons. First, tax reductions increase the incentive to invest. A lower corporate tax rate gives investors in a new factory a larger share of the income that factory generates. In turn, more investment project to pass the cost-benefit test that informs a company whether the project is a worthy investment in the first place. A company will not invest in building a factory if the benefit does not outweigh the cost. Tax reductions increase the benefits companies can gain from investing, so they are much more likely to invest in the first place. This incentive effect drives most economic models of investment, and few economists debate its underlying logic. Lewis explains, “The positive effect that the tax cut is going to have can be more easily observed with what occurred when Reagan signed the Economic Recovery Tax Act in 1981” (Lewis, 2017). He says that Reagan’s tax reductions created “14 million jobs, incomes grew by over 22 percent, and gross domestic product, the broadest measure of the economy, grew by more than 3.5 percent on average” (Lewis, 2017). The economic growth following the tax reduction generated more profit for businesses and finally led to a decrease in unemployment because businesses had more capital to invest in both their companies and their employees’ wages. Reagan was successful because he recognized the necessity of removing barriers to investment. He reduced tax rates and eliminated useless and needless government taxes on productivity, which encouraged companies to invest and therefore generate more capital to stimulate the economy. Trump’s tax reduction is based on this exact logic.
The Trump economic team’s main was motivated to cut taxes because the effective corporate tax rate was 35%. This was more negative than positive for the economy due to a lack of incentives to make the US appealing for foreign investment. Foreign businesses invested 15% less in the United States just from 2015 to 2016, falling to 374.3 billion 2016 from 439.6 in the prior year. The new Trump tax bill has just been one year in effect, however its effects are already visible. “The foreign direct investment in the United States position increased $319.1 billion to $4.34 trillion at the end of 2018 from $4.03 trillion at the end of 2017. The increase mainly reflected a $226.1 billion increase. By industry, affiliates in manufacturing, retail trade, and real estate accounted for the largest increases” (Bureau of Economic Analysis, 2019). This has caused an overall 3% GDP growth for 2018 and wages have increased in some multinational companies like Amazon because they could afford more money devoted for wages.
Although I have stated that the corporate taxes have been reduced and directly and positively affected the economic wellbeing of US citizens, it is also important to notice that personal taxes were also reduced. As a result of the tax deductions we can see that about 69% of people with household income of $30,000 to $50,000 got a tax cut, nearly 82% of those in the $50,000 to $75,000 got a tax cut, 86.6% of households making $75,000 to $100,000 saw a tax cut, and 89.5 percent of those in the $100,000 or more bracket saw a tax cut. Tax cuts have been among all the socioeconomic spectrums; this has greatly increased the acquisitive power of the average American. It is important to empathize with every economic group because a tax cut can be really beneficial to a $30,000 to 50,000 household income. For them, it can help with important payments like rent or electricity bills. For the two middle brackets ( $50,000-$75,000 and $75,000 to $100,000) those extra dollars in their pockets will be of more use to create a small business. They will start with a higher capital to compete in the market and be able to incur less debt if the start-up does not do as well as they would like. It could also allow them to provide a better education for their kids, helping their posterity prospectively secure a more financially stable future. For the final bracket, the money they save because of the tax cut will be of utility by being able to hire more people for their businesses, donate more money for charity or creating new projects that will do a common good for society, like a hospital or a recreational green space in a community.
High taxes cause a frustration in the individual who may feel that the social mobility ladder is just a myth. There was a clear stagnation in wages during the Obama administration. There was a clear stagnation of middle-class wages and in some cases even a decline in middle-class wealth. Even though the tax increase created more public services, like Obamacare and other noble and charitable governmental causes, there was a clear dissatisfaction expressed by the average American. Democrats might have hoped that their charitability, the expansion of health insurance coverage and affordable health care, would tug on the heartstrings of Americans and win them over. However, in reality, Americans were frustrated because many of these movements did not directly affect them other than diminishing their own pocketbooks. This was one of the main reasons that in the 2016 election the electoral college voted Republican more than Democrat. High taxes discourage work and investment. Taxes create a “wedge” between what the employer pays and what the employee receives, so some jobs do not get created and tend to do more harm than good in the long run. The people’s votes in 2016 illustrate this public sentiment well.
Tax cuts are also good for the people for deep moral reasons. Boaz explains, “In a free country, money belongs to the people who earn it” (Boaz, 2001). The government has no moral right to rob its citizens of the money they rightfully earned for themselves. If people are continually forced to relinquish the hard-earned fruits of their labor to the government who seemingly gives it away for nothing, they will only grow more and more frustrated and bitter. Boaz continues, “The most fundamental reason to cut taxes is an understanding that wealth doesn’t just happen, it has to be produced. And those who produce it have a right to keep it” (Boaz, 2011). It is important to understand that the economy is not a pie that needs to be divided equally among society, rather it is a pie that can get bigger and bigger as the economy of a country becomes more advanced and healthier. Boaz qualifies the uses that citizen money may have when given to the government: “We may agree to give up a portion of the wealth we create in order to pay for such public goods as national defense and a system of justice. But we don’t give the government an unlimited claim on our money to use as it sees fit” (Boaz, 2001). Giving the government more money equates to giving them more power. There has to be a limit on the power that the state has over us, and this includes the power of taxation over its citizens; government should be minimal to provide basic services in a more efficient form. Lower taxes are the only real check on the expanding size and scope of the federal government. If we want smaller government, our best strategy is to reduce the amount of money Congress has to play with.
On the other hand, there are a series of sound arguments in favor of increasing taxes. The main argument posed by the left is that a better redistribution of wealth will enhance its relationship with economic prosperity. Growing inequality, paired with labor automation, could put a quarter of the U.S workforce out of a job by the end of the next decade, according to management consulting firm Bain&Co. This argument is backed by a circular logic. Rich people presumably hold most of the capital in a society, but they do not spend it. They hold onto it so that they can maintain their status as the upper class. Unfortunately for the lower class, however, when the rich do not spend their money, companies that hire members of the lower classes do not make as much money. This leads to the lowering of wages of lower class people, and even to firing them. By redistributing the wealth, the rich will still have some money with which to live, but the poorer classes will also have money to keep them from living in complete poverty. They argue that inequality prohibits growth in the economy.
They also claim that the distribution of wealth is equal to distribution of justice. The fact that the difference in wealth is not so big generates a healthier, more solid, and more peaceful society. Inequality generates a bigger social disintegration and more conflict between different economic classes. Social cohesion is also a means that enables citizens to live in societies where they enjoy a sense of belonging and trust. Due to this analysis of social and economic reasons the logical policy to do would be to implement a high tax on wealthy individuals and corporations, and distribute that revenue among the lower and middle lower social classes. Ehrenfreud explains, “The main point of the Obama administration through the tax increases was to finance the Affordable Care Act and in that manner reduced inequality, and with that all the problems that inequality causes. Because of the policy 20 million more Americans have health insurance, gains that have reduced the uninsured rate to the lowest level on record” (Ehrenfreud, 2016). The law sharply reduced inequality by age, race, and income. The financial assistance that made this coverage expansion possible also reduced inequality in after tax incomes . The distribution of income before taxes also matters the 2009 Recovery Act and other fiscal stimulus measures, along with a forceful response to stabilize financial and housing markets, prevented a deep recession from turning into another Great Depression. The most important lesson to grasp from this is that without the stronger social safety net enforced by the Obama administration the US would have been in a total social and economic chaos.
The final argument for increasing taxation is that the government is going to raise more revenue. Raising more revenue is good because with the extra revenue that the government raises they can distribute more to each area in change of government (i.e education, infrastructure, security etc.) or focalize more revenue in a particular area in which that country has the most problems. For instance, a way in which most of European countries that have more egalitarian policies than the US (like Denmark) spend around 19% in social safety to guarantee a minimum living standard even from the less fortunate people in their society.
Closing remarks
On this account, it is fair to say that according to the economic analysis lower taxes will guarantee a better standard of living for a country. The empirical and scientific evidence available for us tends to show higher GDP growth rates. The moral part of taxation is also essential to reaffirm that taxes should be as low as possible. At first glance the arguments of the left of reducing inequality and raising more revenue can be appealing, however, it is better to have a better functioning society with higher inequality but greater prosperity because in the long run, although there is going to be more inequality, everyone is going to be better off than in the first model of society. Comparing the US and Cuba, it is simple to confirm this. The US a society that has a decent amount of inequality but overall their citizens are better off economically and in every other sense. Cuba, on the other hand, is a very equal society but with appalling economic conditions of life for its citizens. Therefore we can argue that every bill that implies taxes on different socioeconomic brackets is ultimately the most beneficial option for society, and we should focus on shifting the political spectrum in that direction, making every tax increase an unacceptable policy to impose on a country.
References
Foreign direct investment in the United States (FDIUS). Bureau of Economic Analysis. (2018). BEA 19-34. Retrieved from https://www.bea.gov/international/di1fdiop
Nicole Lewis. (2017, November 8). Did Ronald Reagan tax cuts supercharge the economy. The Washington Post. Retrieved from https://www.washingtonpost.com/news/fact-checker/wp/2017/11/08/did-ronald-reagans-1981-tax-cut-supercharge-the-economy/
David Boaz. (2001, February 28). One bad and eight good reasons to cut taxes. The Cato Institute. Retrived from https://www.cato.org/publications/commentary/one-bad-eight-good-reasons-cut-taxes
Max Ehrenfreud. (2016, June 9.) Here’s the proof president Obama really did reduce inequality. The Washington Post. Retrieved from https://www.washingtonpost.com/news/wonk/wp/2016/06/09/obama-really-did-sock-it-to-the-rich-bad/
Justin Wolfers. (2018, March 15 ). How to think about corporate tax cuts. The New York Times. Retrieved from https://www.nytimes.com/2018/03/30/business/how-to-think-about-corporate-tax-cuts.html
Carlos Cerna Reichmann 