Tax cuts are just another type of government spending

| September 2, 2008 | 5 Replies

Republicans like tax cuts, probably because the vast majority of tax cuts go to rich people, most of whom are Republicans. Of course, they can’t admit that this is the reason why they like tax cuts so, instead, they declare that tax cuts will “stimulate the economy.” Simultaneously, they condemn Democrats, whom they criticize for supporting “wasteful government spending.” To see the hidden lie in this Republican argument, consider the following thought experiment.

Imagine you are a doctor paying an income tax of $500,000 per year. Imagine that Republicans write budget legislation that will give you a 10% tax cut, equal to $50,000 per year. Republicans declare that this tax cut is a wonderful idea for the country because it will “stimulate the economy.” Meanwhile, Democrats also draft budget legislation, but their plan provides nation-wide healthcare coverage for all Americans. Coincidentally, this healthcare coverage will also pay you $50,000 per year, but you will need to earn this money by providing medical care to poor people. Although the amount of money you receive is the same under both budget plans and, thus, the amount of government spending is the same under both budget plans, Republicans will condemn the Democrat’s proposed legislation as “wasteful government spending that will cripple the American economy.”

Do you see the lie?

Now, let’s revise our thought experiment. Instead of imagining that you are a doctor, imagine you are a construction worker, and imagine that Republicans want to give you a $5,000 tax cut, while Democrats want to hire you to build part of a new bridge that would also pay you $5,000. Although the government spending is the same, and although the Democrats’ plan would result in a bridge being built while the Republican plan would not, Republicans would again condemn the Democrats’ plan as wasteful.

You can repeat this thought experiment as many times as you wish. Pick whatever type of job you want, imagine that a Democrat budget plan would give you a government contract to do it and that a Republican budget plan would give you a tax cut to not do it, and then explain why the Republican plan would “stimulate the economy” while the Democrat plan would be a “crippling economic disaster.” Better yet, ask a Republican you know to explain it.

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About the Author ()

Grumpypilgrim is a writer and management consultant living in Madison, WI. He has several scientific degrees, including a recent master’s degree from MIT. He has also held several professional career positions, none of which has been in a field in which he ever took a university course. Grumps is an avid cyclist and, for many years now, has traveled more annual miles by bicycle than by car…and he wishes more people (for the health of both themselves and our planet) would do the same. Grumps is an enthusiastic advocate of life-long learning, healthy living and political awareness. He is single, and provides a loving home for abused and abandoned bicycles. Grumpy’s email: grumpypilgrim(AT)@gmail(DOT).com [Erich’s note: Grumpy asked that his email be encrypted this way to deter spam. If you want to write to him, drop out the parentheticals in the above address].

Comments (5)

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  1. Susan says:

    If I am understanding you correctly, there are in fact two important differences between the two scenarios – in the first, the doctor will need to work for his or her $50,000 and the tax office will need to collect and distribute this money (that is, more medical services will be provided and both Government revenue and expenditure will be higher by $50,000). There are genuine issues around Governments' capacity to efficiently collect and distribute taxes. Which is not to say that I support tax cuts for the rich – I don't and given the current dire fiscal position of the US, tax cuts of any variety seem madness.

    In my view, the more compelling logical fallacy in relation to tax cuts is the argument that tax cuts for the wealthy will stimulate them to work harder (rather than work less for the same amount) while for the poor the opposite is held to be true – very high marginal effective tax rates which result from means tests are needed to ensure that they work hard enough.

    I have seen a number of articles where the very rich claim that it is not the money that is important to them. If this was the case, then economists' arguments about dead weight loss would have no merit, but the use of tax havens etc suggest the rich are not being entirely honest with themselves on this point and they are very much motivated by the money (or possibly aversion to anyone else benefitting from their good fortune).

    There is, of course, the other argument that we should tax this group much more heavily on the altruistic grounds that they would then work less and have a happier life as a result. Not to mention that the world might be improved if the activities by which some of the very rich make their money were curtailed – complex financial instruments, lawsuits, etc.

  2. Edgar Montrose says:

    While I agree with the fundamental idea, there are some logical holes in the argument.

    First, the 10% tax cut will be applied to the amount of tax, not the amount of income. So that doctor who earns $500,000 in taxable income will see a reduction of 10% of the $190,000 she paid in taxes (assuming that she is in the 38% bracket), or $19,000. Now, the idea is that she will take that extra $19,000 and spend it on something, or invest it in something, either of which will ultimately benefit the economy. However, I assert that someone earning that much money will probably invest it in some tax-sheltered account, which really won't benefit the economy.

    Second, if the amount of the tax cut were instead earned by our doctor because of the nationwide health care program, it would also be taxable. So the doctor would have to work extra to get her $19,000, which would then be reduced by 38% because of income tax. There is really no incentive for the doctor to do this, especially in comparison with just getting a "free" $19,000 for doing nothing.

    Finally, if the example $5,000 is used to help build a bridge, the positive indirect effects can be much greater than the $5,000 investment. If the bridge opens up a new commercial or residential corridor, then there are tax benefits. If the bridge reduces commuting distance by a significant amount, then there are environmental benefits. This all assumes, of course, that these potential benefits are the justification for building the bridge in the first place, and that they are actually realized. If it is a "bridge to nowhere", then it truly is wasteful because the economy does not benefit at all.

  3. grumpypilgrim says:

    Further to Edgar's comment, the first item was a typographical oversight on my part, now corrected. The second item could be easily avoided by making the doctor's income from a national healthcare program tax-free. The final item was tangential to my post, which merely used the bridge example to illustrate the point that tax cuts are just another type of government spending. Fans of tax cuts would claim that tax cuts likewise have trickle-down benefits, just as does a bridge, though I do agree that it is better for the nation if the government gets something tangible for its spending.

  4. grumpypilgrim says:

    Further to Susan's comment, my post was not an attempt to debate the merits of giving tax cuts to the wealthy, it was merely to point out that tax cuts do not "stimulate the economy" any more or less than do other types of government spending, even though Republicans like to claim that they do. Republicans also like to claim that giving tax cuts to the wealthy will stimulate the economy more than will giving tax cuts to the poor, but, of course, this is also a lie. In the short term, injecting money into the economy in any form — even in the form of military spending — will stimulate the economy. What matters more than anything (and what Edgar points out in his third item above) is whether the money is spent as investment or consumption. Investment spending (e.g., building a bridge or other infrastructure) can provide long-term economic returns; consumption spending (e.g., the military occupation of a foreign country) often just drains the federal treasury in the long-term in exchange for a short-term economic jump-start.

  5. Niklaus Pfirsig says:

    I've often said that the main difference between Democrats and Republican on the government finance is that the Democrats pay cash and the Republicans use a credit card.

    I often hear some devout Republican talk of "Tax and spend Democrats" while they believe the Republican lawmakers are stimulating the economy with their "Borrow and spend" mentality.

    The fallacy in this is that for the economy to be well, the money must circulate. Every successful business person knows the motto "Watch cash flow", but it seems that most law-makers don't understand the concept.

    The example is not as simple as it sounds. The effect on the economy is determined largely by how the money is spent. In the example of the Doctor, she could use the extra money for a European vacation, in which case that money stimulates the economies of a few European countries. She could invest the money in stocks and bonds, which, due to the fact that most corporations are outsourcing to offshore labor, would provide more jobs in India and Sri Lanka, but do little for the US economy. She could invest it in paying off the business loans on her clinic, which might allow her clinic to reduce it overhead and reduce office fees which would make the health care more affordable for the less wealthy patients, increasing business, and profits.

    Now look at the construction worker. This guy is paying most of his money on the basics of life. He gets some work on the bridge construction, and the addition income goes to catching up some bills and buying a bunch of cheap Chinese made crapola from Walmart, which stimulates the Chinese economy, but doesn't help the US economy.

    All the money being pumped out of the economy reduces the international exchange value of the dollar, which adds to inflation. The problem is not so much the taxes or the tax burden, but the nation debt and the trade deficit, and I have not seen any Republican politician that even begins to understand this.

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