The Changing Justification for Tax Cuts: From Efficiency to Fairness
Matt Yglesias has posted something interesting about the ongoing debate in the US about tax cuts for the wealthy. He notes that people on the right of the political spectrum traditionally defended tax cuts for the wealthy on the grounds that they would spur economic growth. In effect, they were asking voters to trade the principle of economic equality away for higher economic growth. The famous trickle-down metaphor said that the best way to help the poor was to invigorate the economy with a bit more inequality.
There is more and more empirical evidence that the Reaganite formula for economic growth (cut taxes and regulation) doesn’t actually work. Much of this evidence, I am proud to say, has come from the discipline of economic history. There is a great deal of evidence of the suggest that there isn’t necessarily at trade-off between growth and equity. For most of human history, massive inequality was a fact of life: there was a huge gap between the peasants and the wealthy in Elizabethan England, but this sure didn’t produce modern economic growth. Even during the British Industrial Revolution, the rate of economic growth in Britian was pretty slow by today’s standard, less than 1% per year. Really rapid economic growth only became common in the Western world at roughly the time these countries were starting to create welfare states. In the 30 years after 1945, when there was consensus in favour of fairly generous welfare states in the United States and other Western countries, economic growth was rapid. Income tax rates for the wealthy were sky high in 1950s America, but this didn’t keep the US from enjoying tremendous prosperity. Presumably there was enough inequality in Eisenhower’s America to encourage the Don Drapers of the world to work hard. The period since the late 1970s, which saw the erosion of the redistributive state in most Western countries (as represented by Reaganite tax cuts, Thatcher, Prop 13, etc.), also saw a slow-down in economic growth and technological progress.
So now that the economic argument in favour of cutting taxes for the rich has been shot to hell, the right’s justification for tax cuts has shifted from economic efficiency to equity: the right is now arguing in favour of tax cuts for the wealthy on the grounds of fairness.
Yglesias summarizing the new argument coming from right-wing figures such as Arthur Brooks, Yglesias writes:
It’s not that higher taxes on our Galtian Overlords would backfire and make us worse off. It’s just that it would be immoral of us to ask them to pay more taxes even if doing so would, in fact, improve overall human welfare.
Two days ago, the Center for American Progress in DC in hosted a public forum with leading economists and policy experts to discuss the proposition that a focus on equity and economic inclusion is necessary to grow the U.S. economy. In the companion framing paper titled “Is Equity the Superior Growth Model?” authors Sarah Treuhaft from PolicyLink and David Madland from American Progress discuss how economic growth has been slower and less broadly shared over the past several decades, leaving more and more families, even entire communities, behind with diminishing prospects for catching up. Let me quote from their excellent paper at length:
Economists have long considered the relationship between equity and economic growth. Early economic thinking was heavily shaped by Simon Kuznets, a Nobel Prizewinning economist, who argued that economic inequality increases while a country is developing, and then after a certain average income is attained, inequality begins to decrease. His explanation for this pattern was that shifting from agriculture to industry caused inequality to rise but further growth led to increased economic opportunities as well as equalizing government policies.
Kuznets Curve
This argument and its graphical representation—the inverted U-shaped Kuznets curve—suggested that inequity was good for economic growth, at least at the early stages of development. Alas, overwhelming evidence has accumulated that development does not quite work like Kuznets predicted.
Many countries have not become first less and then more equal as they develop. Instead, there have been a wide variety of development patterns, with some countries growing relatively equally at all points in their development and others growing unequally at all points in their development, and still others vacillating between relatively equal and unequal. South Korea, for example, has seen relatively equitable economic growth throughout the past 60 years as it developed from a relatively poor country to a middle-upper-income country. Brazil, historically one of the most inequitable countries, has in very recent years begun to grow more equally. And in the United States, from the 1940s to the 1970s, economic growth went with increased equality, but since the 1970s, additional growth has reduced equity.
The real world has not conformed to the Kuznets curve. Still, the idea that there is a tradeoff between growth and equity did not just go away. Instead, it remained influential, even for advanced countries, though the hypothesis was largely untested.
Read more here.
Update: Krugman has commented on Yglesias’s post. See here also.
The Past Speaks 