Every tax cut in recent decades has been denigrated as a trickle-down fraud (whose family tree also includes “voodoo” and even “déjà voodoo” economics) benefiting the rich at the expense of the rest. President Trump’s corporate tax rate cuts were just the most recent illustration. But with next year’s election getting ever closer, such attacks are picking up again.
Are Tax Cuts Fraudulent?
Those attacks, however, are built on several faulty premises. They rely on a zero-sum view of the world in which gains to some are taken to mean harm to others. They assume corporation owners capture virtually all the benefits of corporate tax cuts. And they rely on highly skewed data to make their case.
The zero-sum view ignores that voluntary market arrangements benefit all participants. Consequently, increasing mutually beneficial trade, as with reduced taxation, benefits both buyers and sellers. In contrast, punishing sellers with higher taxes also induces them to do less with their resources in the service of others.
Lower corporate taxes increase rewards for improving techniques, technology, and increasing capital investments, which increase worker productivity and earnings. They expand rewards for risk-taking and entrepreneurship in service of consumers. They reduce the substantial distortions caused by the tax. And those changes benefit others, such as workers and consumers.
The trickle-down, politics of envy approach also errs in assuming that corporate taxes are borne largely, if not exclusively, by owners of capital. Since higher-income people hold the greater part of current financial assets, this assumption virtually guarantees corporate tax reductions will be derided as just “tax cuts for the rich.”
This assumption is sometimes traced back to “The Incidence of the Corporation Income Tax” by Arnold Harberger in the 1962 Journal of Political Economy, which found essentially all the corporate tax burden was borne by capital owners. That result followed from assuming a closed domestic economy that prevents capital owners from dodging burdens by going elsewhere.
The Reality of Tax Cuts
But Harberger revisited his seminal analysis in 1995 (“The ABCs of Corporation Income Taxation,” in American Council for Capital Formation, Tax Policy and Economic Growth, Washington, D.C., (1995), pp. 51-73) and 2008 (“The Incidence of the Corporation Income Tax Revisited,” National Tax Journal (2008): pp. 303-12), which reversed his conclusions. He considered an open rather than a closed economy, due to capital’s increasing international mobility, given time to adjust. That means owners of capital can better dodge unduly burdensome corporate taxes, but that dodging would result in substantially reducing the productivity-enhancing tools American workers employ, reducing their real incomes.
Consequently, once capital has fully reacted to changed incentives, workers will bear essentially all the burdens. Further, he incorporated the distortions that make the corporate income tax among the most inefficient sources of tax revenue, concluding that workers “must end up bearing more than the full burden of the tax.”
Incorporating consideration of more mobile international capital reverses “tax cuts for the rich” conclusions. But tax cut critics ignore that. Instead, they distort reality further due to a serious but largely ignored measurement issue.
Critics want to divert attention from the positive long-run effects of corporate tax cuts for workers. So they focus on the short run, allowing them to hide such gains from public awareness and still generate misleading “tax cuts for the rich” conclusions.
Short- vs. Long-Term Effects
When an asset’s tax burden is reduced, this causes an immediate increase in its price, capitalizing the expected increased after-tax profits over the foreseeable future. Since most financial resources are owned by those with higher wealth at the time, the gains are measured as huge current gains to “the rich.” But there is no similar measure of the effects on American workers.
Higher after-tax returns lead to greater investment and a larger capital stock incorporating better technology, increasing worker productivity and earnings. But that takes time. So the immediate effects on workers can be small, even when the cumulative effects are very large. And unlike stocks and other financial assets, workers’ higher future earnings do not get capitalized into a current asset price increase. So when people focus on the short run, it triggers a comparison of current gains to “the rich,” which actually capitalize benefits that are anticipated well into the future, against virtually none of the gains for workers because they have not yet occurred, and no market price reveals those future effects now.
In sum, opponents of lower corporate taxes focus on the wrong issue—measured effects on incomes of “the rich” rather than benefits produced for others. They focus on the wrong time period—short-run rather than long-run effects. They rely on wrong premises that are massively misleading for an open economy—that capital owners rather than workers bear the vast majority of corporate tax burdens. And they use biased measures—comparing the capitalized future effects on financial assets with the effects on workers for whom there is no similar capitalization mechanism. That makes it hard to take their conclusions seriously for anything other than reinforcing the answer you want.
Gary M. Galles
Gary M. Galles is a professor of economics at Pepperdine University. His recent books include Faulty Premises, Faulty Policies (2014) and Apostle of Peace (2013). He is a member of the FEE Faculty Network.
This article was originally published on FEE.org. Read the original article.
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