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Economic Growth Does Not Pay for Tax Cuts, and Tax Cuts do Not Increase Wages

Economic Growth Does Not Pay for Tax Cuts, and Tax Cuts do Not Increase Wages
Profile photo of Kel Kelly

moneyWith President Trump’s proposed tax cuts on the table, the conservatives are making their traditional argument that increased government revenues from increased economic growth will offset reduced tax receipts from lower tax rates, and will prevent the budget deficit from increasing. Tax cuts pay for themselves, they argue. Tax cuts do grow the economy, but they do not pay for themselves.

There is a virtual consensus among some commentators that this is a truism. For example, Treasury Secretary Steve Mnuchin stated that “the tax plan will pay for itself with economic growth.” The White House’s Council of Economic Advisers published a recent study showing that Trump’s proposed cut in the corporate tax rate would boost the typical family’s take-home pay by at least $4,000 per year. Tax experts at Boston University and MIT said in a recent paper that tax cuts would boost wages by 4% to 7%, after inflation.

Additionally, it is virtually universally undisputed that various types of tax cuts could increase nominal revenues. But in fact, they can’t. The notion that tax cuts could increase revenues, or wages, is a myth.

The idea that a growing economy will increase government revenues is most commonly expressed by the Laffer Curve, a graph which depicts a tradeoff between tax rates and government revenue, and implies that lower tax rates mean increased government revenue.

The problem with the Laffer Curve and the argument that revenues increase with economic growth is that they assume a growing economy results in greater monetary incomes that provide greater tax revenues. It does not—that is to misconceive what economic growth actually is.

The common assumption is that economic growth is manifest in companies and individuals receiving higher revenues and wages and therefore having higher incomes on which to pay higher taxes to the government. On the contrary, an economy grows by increasing the quantity of goods and services it produces—companies produce things; they do not produce money. Economic growth increases real incomes, not money incomes. Creating more goods does not create more money. Only the central bank creates money.

So the conservatives are wrong to argue that the increased economic growth generated by tax cuts would result in greater money incomes that, when taxed at the lowered rates, would result in government revenue that (at least) equals the revenue from the previously lower incomes taxed at higher rates. Instead, the economic growth the tax cuts would cause results in more goods and not in more money (the value of tax cuts is that they free up capital that would otherwise be taxed, so that it can be used for production instead of consumption). Therefore, there would not be higher money incomes to tax at the lowered tax rates. There would simply be the same money incomes taxed at lower rates, resulting in less government revenue. Thus, to prevent the budget deficit from increasing, tax cuts would need to be offset by spending cuts.

If economic growth doesn’t increase money incomes, how is it that our money incomes increase? Indeed, the confusing relationship between producing more goods (i.e., economic growth) and earning more money needs some explanation. The Federal Reserve or any central bank merely adds money to an economy as it grows. By adding to the amount of money in circulation the central bank  pushes up wages, prices and revenues; but that is a separate, if sometimes simultaneous, independent activity. More money can be added or not while economic growth is taking place, and economic growth may or may not take place when the money supply is increased (look around the world, and you’ll see that countries have different combinations of money growth and economic growth).

But it is not an increased amount of money that makes an economy grow; what makes an economy wealthier is instead the increased capital—from tax cuts, for example—that is used to increase the supply of goods and services per capita, which, in turn makes everything cost less. Therefore people can buy more with the money they have and are thus wealthier in real terms. When the money supply is increasing—and thereby causing prices to rise—at the same time that economic growth is occurring, the nominal price of goods increases, but more slowly than wages increase (because the supply of goods per person is increasing). Thus, real incomes increase because the things people buy cost less relative to their incomes, regardless of the monetary level of incomes and regardless of the amount of price inflation. It is real incomes that increase with economic growth and make us wealthier, not nominal money incomes.

The misconception that economic growth brings higher incomes derives from the habit of expressing economic growth in monetary terms, and losing sight of the actual production taking place. Conservatives can perhaps be forgiven for their confusion, as this misleading accounting practice is common, not least on Wall Street where analysts do measure and report economic growth in monetary terms. It is this accounting error anomaly that inclines analysts to believe that economic growth brings greater revenues and profits to companies, and makes stock prices go higher. In fact, however,  those increased incomes—as well as the higher stock prices—are the result not of increased production, but of increased money supply from the central bank  available in the economy.

Politicians, political analysts, and others on both or all sides misunderstand what economic growth actually is and how it is manifest in the economy. Therefore they fail to grasp that lower taxes do not result in higher incomes or increased government revenue, but instead in greater productivity. A better understanding of the true relationship between taxes and economic growth could result in better tax policy.

  • Gary marshall

    As usual, you have a number of unstated assumptions or ones that I cannot find.

    Is the economy running at full capacity?

    Real income, not nominal income, rises with a tax cut for individuals. This results in greater demand pushing the demand curve higher. Companies may respond with greater production or higher prices or some combination, if the economy were not at full capacity, which partially leads to a rise in demand for labour and rise in nominal wage. This equates to a higher level of growth

    If at full capacity, then higher prices. With business profits rising with a tax cut for both individuals and businesses, either new investment results entailing greater productivity or enlarged production, both of which put pressure on the demand for labour, hence rising wages.

    There is also the impact of government and its varied social programs and costs. With rising economic activity, demand for and cost of those programs should decline, leaving more people available to work. Even in a booming economy, there are those who rather would collect a meager govt. cheque than work. Govt. has a profound impact on the size of the ‘unproductive’ element in the economy. Full capacity may in fact be a long way from true full capacity with this factor accounted.

    The former Soviet Union was not a particularly productive economy. Only a small fraction of the economy produced any of the goods valued by the nation. Same with North Korea and Venezuela today.

    You have some problems to clear up before you come to such a conclusion!

  • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

    The problem with your thesis is, the Fed does not add money to the economy, it can’t. What the Fed can do is manipulate interest rates to incentivise either an increase or decrease ‘borrowing’. Banks generate ‘loans’ as deposits which the ‘borrower’ gets to experience for a brief moment in time as a line of credit, then for a longer period of time, as debt. Most miseducated economists refer to this process as ‘money creation’. The residual of bank debt creation (profits, salaries, etc.) is held as deposit accounts, which are nothing more than bank managed records of legal claims held by account holders against the legal tender money (checkable deposits) that is supposed to be in the bank’s vault.

    Fiat Money
    MONEY

    • Joch C.

      There a no limit as to how much credit/debit I can easily and readily convert to legal US tender in the form of a cash withdrawal. The 2 are completely interchangeable. So I don’t really understand your distinction without a difference.

      • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

        OK Joch I’ll give you another shot: Explain how much legal tender money the banks currently have in their possession and how much the banks owe to deposit account holders. Explain how banks get legal tender money from the Fed and how the Fed gets legal tender money from the Treasury. Excluding Investopedia and Wikipedia as sources, demonstrate thorough your vast research and knowledge of the laws that govern the subject , how I am wrong. Prove to everyone that you are not just another idiot stalker.

        **While you’re at it explain how bank deposit accounts work. Also fractional reserve banking.

        • Joch C.

          None of that is germane to this discussion and only serves to muddy the waters. Same purpose the Fed reserve has. To confuse and obfuscate.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            Explain how the documented facts as I’ve stated are not germane to this discussion and how those facts only serve to obfuscate. Demonstrate to everyone that you’re not obfuscating and projecting your own ignorance into the subject.

          • Joch C.

            Explain to the world now, how there is a distinction between crebit and money without the quagmire of technicality’s and Fed propaganda.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            I’ve explained my position, now it’s your turn to explain yours. You’re the one insisting that I’m wrong, prove it or STFU and stop stalking me.

          • Joch C.

            You are making a logical fallacy called a distinction without a difference.

            List 5 ways that crebit does not have the exact same features of treasury money. Also prove how crebit is not fully interchangeable with money. The convertibility is exactly what drives demand for money. If not for people wanting to convert crebit into treasury dollars, there would be no treasury money. Man go study Elementary Algebra.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            If you know that there 5 ways in which credit is the same as the legal tender money it is denominated and payable in, then list them. Explain why you believe banks are 100% reserved, present proof. Explain why you believe ‘beliefs’ take precedent over facts. When the U.S.G. confiscated monetary gold, what were people, businesses and banks issued to replace it? Explain why you believe a study of “Elementary Algebra” is relevant or mitigates your continued display of stupidity.

    • waltduro

      Have been using the phrase, “the Fed creates money out of thin air” myownself for a few decades – since reading The Creature from Jekyll Island back around 1992. I think I see your perspective, Dwain D. So….the Fed lowers rates leading to an increase in demand for “borrowing”. So what is being borrowed ? Debt or Money – as expressed as a line of credit (zeroes and ones in a computer) ? Guess you need to count me a miseducated. Although clearly not an economist.

      • Joch C.

        Technically what is being borrowed is banker generated credit. Crebit. However this acts as money, is a market mover, constantly rearranges resources and can easily be redeemed for Dwains definition of money at any time, world wide. So this is a logical fallacy labeled distinction without a difference.

        The real question is simple. “What has become of our money?” This question and answer is to difficult for some sentimental individuals to process and it easier to construct a mental defense a built on technicality’s.

        My irrational faith in God and understanding of Satan’s deception allows me to accept how the show really operates.

        On Edit: Just think of the Federal Reserve as the master bank. The Fed creates all the rules that govern smaller banks and how much crebit they issue, even if only in a round about way. The Fed Reserve is part of the US government. The Fed Reserve is controlled by Congress, The President, The Fed Board and The Fed owners. Also any shadows. The treasury is only here to serve the Fed and is a integral part of the Feds mechanics. Taxes serve an equally important function, if only a mop. Also behavior control.

        Evey Nation has a similar structure. We are a Crebit based people.

        • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

          And for some people, such as yourself, it’s easier to hide from the fact and truth by simply ignoring it and making shit up.

          • Joch C.

            The fact is, crebit has taken control of what you define as money. Money as you understand it, is dead and gone. Put on your big boy boots and deal with it.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            That’s your ignorance talking, you haven’t a clue and it doesn’t change the facts as I’ve stated and were made manifest during the 2008 Financial Collapse.

          • Joch C.

            The collapse is proof of how it really operates.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            That’s assbackwards, the collapse is validation of the fact that it doesn’t work and the only reason it continues is out of miseducated or wilful ignorance.

          • Joch C.

            Work is the wrong term because it is dysfunctional to the core but it is what it is. You get my point, now you are being difficult and tedious as usual.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            And you’re proving yourself to be what you’ve always been, a idiot asshat and a stalker.

          • Joch C.

            And 1 more thing, just because the face value of your dollars did not change during the collapse of 2008, the purchasing power and wealth it represents sure did.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            Legal tender dollars had nothing to do with the 2008 collapse, you may as well be blaming unicorn farts.

          • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

            Adding to your comments after a response has been made illustrates what an uncouth POS you are and declaring something to be a “logical fallacy” just because you are incapable of understanding it, doesn’t make it so. You are a stalker, a looser and you’ve repeatedly proven that you don’t know the subject; I’m going back to blocking your ignorant comments so if you have any other ignorant comments to make, I don’t care. Bye looser.

      • http://carl-random-thoughts.blogspot.com/ Dwain Dibley

        “the Creature from Jekyll Island” went off the rails when Griffin misinterpreted the word “issue” in Section 16, Paragraph 1 of the Federal Reserve Act to mean “create” the nation’s money supply and asserted that Congress had surrendered the Federal Government’s sovereign right to coin/print the money to the Fed, which is wrong. Neither the Fed or the banks possess the legal authority to create U.S. money in the form of accounting entries, or in any other form. The reason the U.S.G. uses FRNs instead of USNs is because there is a U.S. law limiting USNs to a total issue of 300-million, whereas FRNs are unlimited. Plus, if people believe that FRNs are a product of the Fed and a part of their debt/credit operations, Congress can point the fingers at the Fed and blame them when it all goes south, as it did in 2008 when people were made to suffer simply because there wasn’t enough legal tender money in circulation to keep their debt/credit system from collapsing, or at least mitigate millions of people unnecessarily suffering.

        The Great Depression was the result of a cascading collapse of bank generated debt/credit being used as if it were money. People were made to suffer, a few million died of starvation, for a lack of money. That’s why understanding the difference between bank generated debt/credit and ‘money’ is important. Money doesn’t !POOF! out of existence when a bank fails.

        • waltduro

          Perhaps you are correct. Price inflation 40% since 2000.

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  • Andrea Iravani

    Excellent and honest analysis, in part, however, failing to diagnose the cause of the debt disease which is guaranteed to keep getting worse, NO MATTER WHAT! Unless we end the Fed!

    Stop the Charade!The Economy is FUBAR SQUARED and everyone knows it!

    https://rebel0007com.wordpress.com/2018/01/08/stop-the-charade-economy-is-fubar-squared-everyone-knows/

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  • James_R

    “Therefore they fail to grasp that lower taxes do not result in higher incomes or increased government revenue, but instead in greater productivity.”……..That’s assuming companies reinvest those untaxed dollars in new and innovative ventures which increase productivity. What we’ve been seeing for a number of years now is corporations using their cash and borrowing power to buyback stock or payout dividends to drive stock prices and valuations up. They simply see there is a less risky way to make money with larger returns. Financial returns which will result in job destruction. As evidence look at the $2.4T of excess reserves at the US Federal Reserves and the bloated cash presently on corporate balance sheets.

  • Blindfolded

    \The Times 03/Jan/2009 Chancellor on brink of second bailout for banks//

    https://uploads.disquscdn.com/images/b480fd69809d57784607b15f93cfa8091d689b47560b5359df3a6bdfcf898e09.jpg

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Profile photo of Kel Kelly

Kel Kelly has spent over 13 years as a Wall Street trader, a corporate finance analyst, and a research director for a Fortune 500 management consulting firm. Results of his financial analyses have been presented on CNBC Europe and in the online editions of CNN, Forbes, BusinessWeek, and the Wall Street Journal. Kel holds a degree in economics from the University of Tennessee, an MBA from the University of Hartford, and an MS in economics from Florida State University. He lives in Atlanta.

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