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Do Tax Cuts for the Wealthy Stimulate the Economy?
July 14, 2005
The centerpiece of the Bush administration's economic policy has been large federal income tax cuts aimed mainly at top earners. These tax cuts account for much of the $2 trillion increase in the national debt projected to occur during the Bush presidency. They prompted a large group of Nobel laureates in economics to issue a statement last year condemning the administration's "reckless and extreme course that endangers the long-term economic health of our nation."

This from a recent article by an economist from Cornell University, Robert Frank.

In it he oulines the logic behind Bush's tax cuts for the wealthy. In particular, Frank dismantles the flawed logic that states that just by putting money in the pockets of rich people (and/or small businesses), they will go out and hire workers.

Wrong. From Frank's essay:

The basic hiring criterion, found in every introductory textbook (including those written by the president's own economic advisers), is straightforward: If the output of additional workers can be sold for at least enough to cover their salaries, they should be hired; otherwise not. If this criterion is met, hiring extra workers makes economic sense, no matter how poor a business owner might be. Conversely, if the criterion is not satisfied, hiring makes no economic sense, even for billionaire owners. The after-tax personal incomes of business owners are irrelevant for hiring decisions.

He goes on further:

Owners who used their tax cuts to finance the initial costs of new hiring would be acting, in effect, as their own bankers, lending money to themselves in the hope of future returns. The test for whether such internal loans make economic sense is exactly the same as the test for external loans.

A loan from a bank makes sense if the firm's ultimate gain from hiring extra workers is enough to cover not only their salaries but also repayment of the loan plus interest. Internal loans must meet the same standard. They are justified only if the firm's gain from hiring extra workers is enough to cover their salaries and repayment of the loan, including the interest that owners could have earned had they left their tax cuts in the bank. In hiring decisions, the implicit costs of internal loans have exactly the same economic standing as the explicit costs of external loans.

In brief, the president's claim that tax cuts to the owners of small businesses will stimulate them to hire more workers flies in the face of bedrock principles outlined in every introductory economics textbook.

Basic economic textbook logic turned upside down.

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