Tax Cuts for the Rich Hurt the Middle Class

One of the rationalizations often given for reducing taxes on upper incomes is to promote investment. That investment would then “stimulate economic growth and create jobs.” This, however, is arguing in a vacuum. Two points immediately come to mind:

1. Lack of capital for investment (until the last few weeks) has not been a problem for quite awhile. Many companies (such as MS, GE, Google, and until a couple of years ago even GM!) have been sitting on billions of dollars in cash (equivalents). Venture Capitalists were also sitting on hundreds of millions of dollars that they needed to invest. In 2005-2007 many companies began returning money to shareholders through large dividends and stock buybacks (I’m sure that the effect this had on the executive’s stock options was merely coincidental). The problem all these firms faced was that there was little in the way of promising investments. There were, and are, many promising ideas waiting for funding, but investors did not believe there to be sufficient demand for the potential product or service. This brings we to my second point.
   
2. Cutting tax rates on high incomes places moderate and low income groups at a disadvantage that reduces overall consumption. The rich, by definition, have more than enough to meet all their needs, and also more than enough to meet most (or all, depending on how voracious their appetites) of their wants. Cutting taxes on the rich has little effect on their consumption, so does little to affect aggregate demand or boost the overall economy. For the rich, tax cuts end up as investments (possibly after a trip to Europe or some other treat); this is a point on which the Right is actually... correct. But this is where the problem creeps in. People make investment decisions based on where they expect the largest (and surest) return. To a large extent, this turns out to be real estate. Both the Reagan and Bush terms were times with large run-ups in real estate investing*. The rich bought larger houses, and second houses. The increased demand for housing drove up both housing and construction costs. This squeezed the moderate and low income demographics by raising their housing costs, and as a result, low and moderate income groups had less disposable income, which the nation observed as a weakening in aggregate demand. A cascading effect was to make investments in goods and service producing industries less attractive and real estate more attractive, creating a vicious feedback loop.
   

*Rising real estate values during the Bush years were further fueled by Greenspan’s free money policies at the Fed.

The point is that investments are productive only if there is a market for the product in which the investment is made. The problem with supply-side tax cuts is not that the investment incentive is wrong, it is that the tax cuts (on the top marginal rates) weaken demand and destroy the rationale for investing.