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 Originally Posted by wufwugy
Thank you so much for posting this. It provides a new avenue that we have not discussed here before, and something I didn't have that great of a grasp on just a month or so ago.
Also this post is a monster, but I only made it because it's all new stuff, no repeating of the same old argument.
Before we get started, this study does not find that wealth doesn't trickle down. What it finds is that when wealth goes to the rich and doesn't go to the poor, it is that way because, well, it is that way. There is no determination of causality. My explanation is probably much more confusing than it should be. The paper is looking at situations where capital acts a certain way and then says "hey look it is acting this way". It is essentially saying "when it doesn't trickle down, we don't see effects of trickle-down". Ho Lee Shit Batman!
Now onto the concept for why trickle-down is a thing. First off, "trickle-down" is a dysphemism. Economists talk about policies regarding supply, and the media has attached this misnomer. It doesn't help that a politician favorable to supply expansion reforms first coined the term. It isn't exactly off base, but it is just a metaphor that is honestly very misleading. I will refer to supply-side from now on instead of trickle-down.
Economic growth happens only when the nominal economy increases in size. It doesn't grow when any of just prosperity increases, real GDP increases, inflation increases, money supply increases, productivity increases, production increases, etc. It grows only when any combination and quantity of those things turn the nominal value of the economy into a bigger number than previous. This is important because supply-side reformers are concerned with growth specifically (I'll explain why later). Now, with this understanding of growth, what happens when we redistribute? Well, you could say the middle gets bigger and the top gets smaller. If true, the math still adds up to no growth. It is popular today to claim that this would spur growth by putting more resources into the hands of consumers. But this would only be true if it came from growth. If it didn't come from growth, we have just created magic and the only thing we need to make everybody as prosperous as humanly possible is to spend as much as possible. Clearly there is something wrong with this idea.
Hopefully we can agree that the economics profession agrees that growth is the focus and that we don't really have much mechanism to expand prosperity for any group except through growth. What they want is growth to be made up of is productivity and production (instead of something like hyperinflation), because those are the only known reasonable metrics by which to evaluate prosperity increases.
So let's assume you agree with this. You're probably still confused as to why reducing top tax rates are the preferred mechanism to achieve this growth. I mean, it honestly sounds ridiculous in common sense terms. But regardless of what it sounds like, there are specific technical things in play that entirely change the scenario. It's not unlike how quantum mechanics is as wrong as you can get when it comes to common sense, but it is still technically correct.
The technical concept behind this is margins, more specifically the marginal utility of each new dollar/product (or each tiny piece of new economic growth). Economic growth occurs on the margins. Always, with zero exceptions. Real economic growth also occurs only when production increases. This piece is more complex than that, but the bottom line is that if there is not more supply in an economy, it has not grown in real value.
Trickle-down is a narrow view of a much broader supply-side approach. The theory for it is that by reducing marginal tax rates, increased production is incentivized. This is to say that people who enter the marginal brackets, at lower tax rates, would have a greater incentive to work more, and thus this additional work would create more product and create economic growth. And it all "trickles down" because that's "just" how it works. Economists don't like that they don't better understand growth, but it is universally understood that real growth disperses throughout the entire economy. This is so universally understood that I'm pretty sure they have equations to back it up. I just don't know them.
Now a question may be "why not reduce tax rates for the middle instead". It is a reasonable point. You could technically incentivize the middle brackets to work more by reducing their penalties for production. But there are three problems with this (at least when we discuss trickle-down specifically): (1) the middle already works near or at its peak. Not that many people who already work full-time will choose to work more because of a reduce penalty. The incentive for them to work more at current tax rates is already really high, but also the incentive to not work beyond full-time is much higher. Leisure and family time has higher marginal utility to the middle class worker who already hits full-time.
(2) As a corollary to (1), the marginal utility of work to those in the top bracket is higher than those in the middle brackets because they don't work as much already. The utility of every new dollar achieved by work to the rich is lower than the utility of every new dollar achieved by work to the non-rich. This is sorta similar to what we had discussed a few weeks ago when Renton was looking at investment incentives. It's complex because incentives and utilities are always relative and always moving around. Like, the rich have lower marginal utility with each new dollar than the poor, but the poor have much higher marginal utility of leisure than the rich. All of this means that if we want to grow the economy through tax rates, we won't be able to do it much by increasing the marginal utility of work for the poor/middle, but we can do it by increasing the marginal utility of work of the rich.
Which brings us to (3): the marginal utility policy-wise and politically of reducing top tax rates is much higher than for middle/low rates. When comparing top rate cuts to middle rate cuts, the top rate cuts reduce total taxation by a much smaller percentage and achieve a higher percentage of production. Where middle bracket tax cuts would grow the economy if coupled with govt spending cuts and reduced regulations, they would not incentivize much in more hours worked. But rate cuts at the top spur growth with that one additional technical factor that the middle bracket doesn't have so much: marginal utility of extra production.
To wrap it up, economists, the wealthy, most politicians, and market-oriented voters do not support marginal tax rate cuts just because they want the rich to get richer. They want the economy to grow, and marginal rate cuts are among the easiest way to achieve them. Additionally, we have the last several decades of evidence to show that they're probably right. I'm sorry that I couldn't find it again (it's buried in Sumner's blog), but there is a ton of data showing that the US has outperformed Europe for the last approximately four decades. The primary correlation discovered is *cough* Reaganomics *cough* (also known for its primary focus of reducing marginal rates).
Thanks for listening. I hope this helps.
I haven't had time to read the paper, just an article on it in the guardian, but I find it interesting that it seems we all use it to confirm our polarised views.
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