Horses and Sparrows: The myth of 'trickle down' economics

Posted Monday, July 30, 2012 in Analysis

Horses and Sparrows: The myth of 'trickle down' economics

Trickle down economics.  Any questions?

by Gina Hamilton

In the last 40 years, a "new" type of economic model arose known as the monetary model, which was later sold to the public as something called "supply-side economics".  To keep it as simple as possible, the idea of the monetary model was that the economy would grow ... and governmental income such as taxes along with it, if income tax and capital gains cuts were made to the top tier, what the new crop of politicians are calling the "job creators". 

The job creators would create jobs, because the model allows business owners to keep more of their income in the first few years that the business is a going concern.  In general, businesses do not become profitable for a number of years.  Employees are paid, expenses are paid, taxes are paid, suppliers are paid, before the business owner takes any money out of the business.

So far, this is perhaps a half truth.  It is difficult to launch a business, which is why we in the U.S. have a generous system of tax credits for new businesses, and allow businesses to deduct everything that has anything to do with the business, from wages to office supplies to shipping costs to health insurance to the expenses involved in using one's car or home for the business.  That all of these things can be deducted, and are, doesn't mean the business isn't bringing in income, indeed, many business owners take a salary that is taxed at a regular income tax rate, even if the business is not technically profitable.  So people are being hired, business is being conducted, suppliers are being paid, and money is being made ...  that isn't obviously being made on paper.

If the business runs in the red for an extended period of time, it might fall under the eye of the IRS, which might justifiably wonder why someone keeps throwing good money after bad, but audits are comparatively rare and young businesses are generally given the benefit of the doubt.  In the meantime, the owner and possibly his or her employees have an income, and other people are making money, too, by virtue of the fact that the business is operating.

For a small business, which we are constantly being told is the 'economic engine' of the nation, this is the most typical model.  The owner is not only putting his money in initially, he is also a very integral part of the business.  He is the first one in the shop in the morning and is the last one to turn out the lights at night.  She is the one who figures out which suppliers need to be paid each month, and is the one who writes the payroll checks and pays the employees' taxes and health care costs. 

But these small business "job creators" are not what supply-side economics had in mind.  Most of these businesses were built from nothing except a carefully husbanded nest egg, or with significant low-interest small-business loan help, much of which is federally guaranteed. 

They don't benefit from supply-sider economics.  Indeed, they benefit most when the people who make up their clientele have money in pocket, which is a completely different economic model.

Supply-side economics aren't really unique to the last quarter of the 20th century and beyond.  The model, known pejoratively as "trickle down" economics, had another name in the past.  This model, largely credited with the 1896 panic, was called "Horse and Sparrow" economics, on the theory that if one feeds the horses enough oats, eventually there will be something left behind for the sparrows.

No prizes for guessing who the sparrows are.  They are the mom and pop small business owners, and the rest of us who aren't millionaires to begin with. 

Giving people who have millions of dollars a tax cut in the hope that they'll do something socially useful with it may seem like a good idea, but let's look at the numbers in some historical context.  In the business cycle that began in 2001 and included all of the years of the Bush tax cuts that were enacted in 2003, job growth, while it occurred, was lackluster to put it kindly. The expansion lasted a while, but the number of jobs it created by comparison to other expansions fell far short.

Below, the Bush line is the pale turquoise at the bottom. 

The graph plots job growth over the latest three business expansions that have lasted at least 78 months (the length of the Bush cycle as of September 2007, before the economic collapse).  As the reader can see, job cycles in the post-supply-side world (which began in the 80s) are significantly weaker than job cycles in conditions in which the wealthy paid a higher percentage of their income in taxes.

Figure A

Of course, other issues also rose during the intervening four decades or so ... globalization and the resulting outsourcing of jobs to low-wage nations, for example.  And it is possible that many supply-siders, unconstrained by the American tax system, did in fact create jobs ... overseas.  But whatever the case, it seems incontrovertible that simply cutting the taxes of the wealthy does not lead to job creation in any meaningful sense.  Indeed, it is just the opposite.

Expansions create jobs when the middle class feels comfortable enough in its own position to spend its money.  When the middle class buys cars or televisions, goes on vacation, buys a slightly better cut of meat, or gets a pedicure, other middle class people have money in their pockets, too, and they in turn spend money on something other than subsistence too.  Kids get braces and new school clothes; people feel comfortable enough to buy that small sailboat or invest in a home-improvement project.  The dollars keep getting reinvested in the community and eventually, everyone benefits. 

This bottom-up model, Keynesian economics, provides public support for the neediest, which keeps "subsistence" funds in the general economy, for things like energy, food, shelter, and medicine.  But Keynesian economics is also concerned with expanding and raising up the broad middle class so that we can move beyond subsistence and into a gradually increasing standard of living.  The items we buy and the services we engage for ultimately expand the class into higher income brackets.  THESE are the people who will really become the job creators, and they'll do it even though they are paying a reasonable income tax to support the poor, infrastructure, defense, and all other government programs.

Will we still have nine million millionaires in the US? Maybe not.  Will we really care?

Perhaps that is the most important question.

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