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Trickle Down or Bubble Up?

By James H. Nolt

The recent passage by Congress of the Republican Tax Cuts and Jobs Act of 2017 brings back the age-old argument about whether most people benefit from policies that further enrich the rich. Conservatives say yes, while leftists and most liberals say no. The conservative argument, the foundation of the campaign for this latest tax act, is that rich people and corporations are the wisest stewards of wealth. If they gain wealth, then they are sure to grow the economy for the benefit of everyone. Wealth naturally trickles down. The ancient basis of this belief is that the rich constitute an aristocracy (literally “rule by the good”) because they are superior people. In recent decades this conservative idea has been reinforced by the teachings of economics.

Economics is a doctrine for aristocratic rule, since it claims that under free-market conditions, all people and corporations receive what they deserve. Economists argue to what extent the modern economy approximates a free market ideal and whether some who hold power receive uneconomic (and perhaps undeserved) quasi-rents, but most economists broadly justify the way “markets” distribute income. Therefore, decisions about how to invest, employ, and price are “good” decisions. “The market” is virtuous rule by a fair and efficient aristocracy of corporate and private wealth. Thus taxing this virtuous elite is not only an imposition on the elite, but also disadvantageous to everyone. Economics is conservatism. “Liberal economist” means to me only “guilt-ridden conservative.”

Economics sustains its aristocratic myths only by massively mischaracterizing how our economy functions. Once these conceptual errors are corrected, it is much easier understand why enriching the rich may not only further exacerbate a staggeringly unequal distribution of wealth and power, but also intensify economic instability. Most liberals understand how the current tax bill favors the rich. But the negative implications of cutting taxes on corporations and the rich may be even worse than most liberals imagine, because their habits of thought are also largely conditioned by the mainstream economic doctrine of an inherently stable and self-equilibrating market economy. Our political economy is polarized, however, so concentrating wealth also accelerates and magnifies economic crises. Not only may the tax cuts fail to grow the economy—they could help crash it.

The optimistic prognosis about the tax bill is rooted in the standard textbook argument that the rich, like anyone else, can do only two things with their income: consume or save. If they consume, jobs are created making the stuff they consume. If they save, their money is automatically recycled by financial intermediaries (banks) toward new investments in productive plant and equipment, which also creates jobs. No matter what the rich do, they cannot help being great job creators—if only this simplistic economic doctrine were true.

These assumptions are flawed, however. First, the rich are far more likely to consume products and services made abroad, since they travel more and have more cosmopolitan tastes. Their consumption is more likely to create foreign jobs that do not “make American great again.” That is a simple if not obvious point. If the same tax cut were granted instead to millions of ordinary folks, the domestic job creation would certainly be greater and the social benefit more widely distributed as well. That makes the case for tax cuts for the poorest, not corporations and the rich.

The only real argument for upper-income tax cuts is that corporations and the rich know better than ordinary folks do how to invest money in ways that grow the economy. After all, if they were not good at business, how did they get rich in the first place? It helps, of course, to start at the top, as an established corporation or a mogul like Trump who inherited the wealth. However, as Rousseau argued so well centuries ago, the fact that one’s ancestors (or corporate founders) may have been clever at business is no guarantee for the later generations. This is a potent argument to retain or increase the inheritance tax, which was gutted by this bill.

Beyond this, there is a huge error of omission in the standard economic models that exclude options other than consumption or productive investment. Perhaps the simplest one is that anyone (but wealthy folks more intensively) may spend on assets produced in the past, such as existing Manhattan real estate or a Leonardo Da Vinci painting (one sold recently fetched $450 million). If the rich spend on such existing assets, few new jobs are created since nothing new is produced, nor is the productive capacity of the economy expanded, as would happen if a new factory were built. Often wealth increases simply by increasing the relative value of existing assets like these. Real estate developers like Trump depend on this.

Beyond real assets like art, antiques, and real estate, corporations and the rich can also park their wealth in financial assets like stocks, bonds, derivatives, and now BitCoin. Economists pretend that buying a bond means lending your money to someone who is (hopefully) investing productively or spending the money on consumption. But that can only be true of a newly issued bond, and even then there is no guarantee. Income lavished on the rich and corporations can circulate from one asset to another for some time—perhaps indefinitely—without creating a single job, not even in finance, since many such trades are now automated. Purchasing power circulating among existing assets tends mostly to inflate asset values, making rich owners even richer, allowing them to claim more from the rest of us in the form of higher rents and other jacked-up prices, say on medicine or insurance. No wonder the series of upper-income tax cuts since the Reagan years has coincided with the rapidly rising share of wealth owned by the top 1 percent! It has also coincided with the increasing volatility of the economy as the business cycle intensifies.

This Christmas tax gift to the rich and powerful merely expands their financial toy chest. As I have often argued, such a proliferation of financial playthings expands the polarization between bears interested in curtailing, if not crashing, credit expansion and asset price inflation and bulls profiting from expanding credit and the resulting asset price inflation. The boom-and-bust financial cycle increases insecurity and hurts most Americans at every crash, but the more capital there is circulating among the volatile virtual assets of the rich, the more likely we accelerate to onset of the next financial crisis. The tax cut could have a downside risk even more severe than the mere giveaway of public wealth to the very rich: another asset-price bubble to burst in another great financial crash.

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James H. Nolt is a senior fellow at the World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of Images Money]

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