Why Bush's Tax Cuts Don't Work as Intended
If you apply a Keynesian view to this question, it is spending that you want to drive up aggregate demand. Savings are funds that are channeled through the banking system and equity markets for businesses to invest in capital goods and equipment as well as labor in anticipation of demand. With insufficient demand, inventories build up and there is ultimately a slack in the labor and factory utilization rates.
The logic of the tax cuts was to afford people monies so they will spend to stimulate domestic demand. However, historically low interest rates and inflation, increasing productivity rates, coupled with high GDP growth and output means we have plenty (even a glut) of investment capital that is churning out goods and services against a shrinking labor force. In addition, a large number of workers have left the job market or have given up searching for jobs, poor and middle-class households (HH's) are heavily in debt over leveraged with their home equity lines, who collectively cannot afford to continue bearing the brunt of sustaining aggregate demand.
In other words, a supply glut of goods and capital coupled with insufficient new jobs created to even keep pace with population growth ultimately leads to stagnant demand (plus existing HH’s are clearly overextended more than they’ve ever been). To stimulate job growth via tax cuts, a majority percentage of each tax cut dollar should be spent versus saved, which if saved in this day and age of free capital flows, is essentially a domestic sieve that in part redirects those dollars to global, especially emerging, markets (particularly China) in seek of higher returns with little immediate benefit to the U.S. – with my Far East ETFs blazing hot in the last 7 months to prove it.
Why It Disproportioanately Benefits Those Who Need It Least
Providing the rich who make more than 200K a year with tax cuts - which probably includes a few reading this (whether one feels rich or not), and if one can put aside pure self interest and few thousand dollars refund checks for a minute - is not a wise policy criteria since folks in the top 2/5 income quintiles have a much greater tendency to save a higher percentage of each tax cut dollar received.
Since more consumption driving up aggregate demand is what’s desired, not savings, the poor and middle-class would do more with each tax cut dollar they receive since a significantly greater percentage of it would be spent. Take the Japanese as a case and point – huge savings and capital pool, low interest rate coupled to gluttonous and undisciplined lending, and extremely weak consumer demand, all have led to a deflationary economy for more than a decade of stagnant growth. Like it or not, we are all Keynesians now; supply-side economics doesn’t work in theory or in practice.
The Numbers Behind It All
According to the Bureau of Labor Statistics' Consumer Expenditure Survey, or CEX, and Federal Reserve data, the top 2/5 quintile, folks who make more than an average of $85K/yr, to the top 1/5 who on average make $203K/yr, have an average 30-40% savings rate. The top 1% make on average $1.5 million/yr and save more than half their income. This is in contrast to the bottom 3/5 quintile of income-holders who make on average $56K/yr and less who have a dissavings rate between -5% to -120% (dissavings rate is the degree by which a HH consumes more than they earn and/or save).
And these tax cuts aren’t free. Foreign investors finance it via our treasuries and bond issues that have significant interest costs. In addition, a noticeable portion of it flows to equities markets for domestic and increasingly overseas investment, which is doubly negative for the economy. The trend is readily apparent: In 2001 we had a surplus of $100,000,000,000 whereas now in 2004 we’re have a $400,000,000,000 deficit, with tax cuts making up a 1/3 of the red, and Iraq is at $200,000,000,000 with no end in sight.
And fully one-third of President Bush's tax cuts in the last three years have gone to people with the top 1 percent of income, who have earned an average of $1.2 million/yr. Since they will also receive an average tax cut of $78,460 this year, with a saving rate on average of 45% and more, it means unfortunately, at least half of that almost $80K refund will not be spent, and so will fail to stimulate sufficient aggregate demand and not contribute directly to economic growth.
All this and more is why Bush’s massive tax cuts haven’t worked to stimulate significant demand and employment (last month’s anemic 32K new jobs vs. the expected 300K new jobs being a case and point), yet has done a great job for business growth and GDP.
Instead of the 1/3 of tax cuts going to the top 1% income earners who need it the least, it can be shifted to a middle class one and/or become transfer payments to the 40 million poor and lower middle-class Americans who need and do not have access to health care (totalling almost 20% of all Americans; I can't think of another G-7 nation with 20% of its population that have no health care rights).
This would not be investing dollars subsidizing big pharma and HMOs to do as they wish to fatten their income statement or increase margins. Rather, it provides a direct economic mechanism to pool and increase the levarage afforded to disenfranchised citizens who can then vote with their feet for those providers that deliver the best health care competitively in the marketplace.
This will take tax cut monies away from those top 1% of HH's making over $1 million who forfeit an 80K refund to those who do need it (though, according to the Daily Press, consider what President Bush said on August 9th: "The really rich people figure out how to dodge taxes anyway", on why high taxes on the rich don't work). It will also reduce the health care cost burdens for the majority of Americans who now have to pay for those that cannot.
Clarification: The most recent CEX data shows the bottom 1/5 to bottom 2/5 have a dissavings rate of -30 and -120%, respectively. The middle 20 have a -5% dissavings rate. The top 2/5 saves 35% and the top 1/5 saves 45%.