Trumped up trickle-down: How hype clouds the tax issue

Photo: Actor and comedian Will Rogers on the set of “A Connecticut Yankee in King Arthur’s Court.” It was Rogers who first used the term “trickle down.”

Taxation, Macro 1.0

Part 1 in a 3-part series on tax reform

“Some folks are born, silver spoon in hand/Lord, don’t they help themselves
But when the tax man come to the door/Lord, the house look like a rummage sale – John Fogerty, “Fortunate Son””

“We fight for and against not men and things as they are, but for and against the caricatures we make of them. – J.A. Schumpeter”

By TATIANA PROPHET

A fool and his money are soon parted.  But the deceived and their political self-determination are parted over and over again. Often, it’s the self-deceived politicians who lead their deceived supporters around the same old problems. Especially when it comes to taxes – because the topic is so damn complicated.

Yet understanding the basic issues around taxes and the economy doesn’t have to be painful. Perhaps the first reality we must acknowledge is that economics – and taxes – are not a binary proposition: up/down, yes/no, good/bad. The mechanism involved in what we do every April 15 has many factors. Context is important. Omission can lead to confusion. And when we’re confused, we soldier on, convinced we aren’t going to be able to understand the issues well enough to make them any better.

But there is a better way to approach this debate. Understanding the context, components and history of our economy is our way forward – not as Democrats or Republicans, but as Americans.

Every time a new tax proposal is on the table, the debate comes down to catch phrases. Yet if there ever were an issue that was solved with a catch phrase – and it’s debatable – it would definitely not be taxes. Even our umbrella use of the term “taxes” is grossly oversimplified. We have excise taxes, of which the sales tax, the automobile tax, the coal tax and the estate tax are a part, as are gasoline, cable and telephone taxes. We have income tax, corporate tax and capital gains tax. We have a progressive tax and a flat tax. We have the alternative minimum tax, the pass-through tax and social security tax (FICA). We have tax penalties, tax breaks and tax credits. Then there are the all-important tax deductions that play such a big part in the actual income we declare. And don’t forget property taxes.

Last but not least, there are the taxes that employers pay on behalf of their employees (social security and Medicare), half of which the employee is required to pay. If you're self-employed, you must pay the entire amount yourself (currently 15.3 percent of your income). Also, there is unemployment tax (FUTA) based on how many employees a company has. Don't forget state worker's compensation taxes, either.

All of these taxes affect the economy in different ways – some of them expected and some of them not. If one kind of tax is higher, the tax that is lower will become a popular tax shelter. And after a couple decades, crack CPAs generally find loopholes so their clients – of all ideological stripes – pay as little tax as possible.

CONFUSION

The debate has raged almost since the moment income tax began in 1913. And it almost always comes down to a thumbs up or down based on a few things: “My political opponent likes greed. He doesn’t care about the poor.” Thumbs down. Or, “My political opponent likes to spend my money to help people who aren’t being encouraged to help themselves. Boo.” The clash of ideologies is never more obvious, or painful, as when it involves taxation. Conservatives cry: “Redistribution of wealth! The end is near! We’re going to the gulag!” Liberals cry: “You have no conscience. All you care about is your stock portfolio.”

Let’s begin by identifying the few things everyone can agree on. First of all, we largely have a progressive taxation system, which by definition is a redistribution of wealth -- as it should be. The rich pay a much higher percentage of their income in tax than the poor. In fact, the lowest income earners pay no income taxes, and many of them get the child tax credit. However, critics suggest that sales tax and other excise taxes, like the cigarette and gasoline tax, are regressive in that they hurt the poor. And payroll and employment taxes (there is a difference) could be seen as hurting the middle class and wage earners alike.

Second, wars and taxation go hand in hand. And third, the worst thing to happen to our economy in the last 50 years is that wages have stayed flat. Why? Along with payroll and employment taxes, that’s for another article.

In spite of these facts, our nation is locked in an endless partisan struggle over money and wealth. You would think members of each party lived on different planets for their lack of common ground. Much of the debate has been dominated, at least since the 1930s, with the phrase “trickle-down economics.” FDR used it. LBJ used it. Obama used it. Then he extended his predecessor's tax cuts. Even in the recent debates between Trump and Clinton, the Democratic nominee used a well-rehearsed twist on the phrase to shut down her opponent’s economic proposals: “Trumped-up trickle down.”

So in the spirit of understanding what the heck is really going on, let’s start by examining the term. What is it really saying?

PLAIN TALK

The first reference to “trickle down” economics was by none other than the comedian Will Rogers in his regular weekly column in the St. Petersburg Times on Nov. 26, 1932. Franklin Delano Roosevelt had just been elected President, knocking the Republicans out of the White House for the first time since 1920.

But Rogers wasn’t actually talking about taxation; he was talking about bad investments and big-bank bailouts. Sound familiar? The most heinous example of bad investments is still fresh in our memories from 2008, when well-respected investment banks and mortgage brokers lost their senses because they were making too much money on the home loans of people with bad credit, sliced up and monetized as securities.

It wouldn’t have been the first time. Loose credit and reckless lending standards go at least back to the Panic of 1837, when the booming cotton market collapsed with over-supply, and cotton producers couldn’t pay back the money they owed British banks – who had raised interest rates as a result of high debt-to-capital ratios. The British banks were never paid back by many a cotton-growing slave holder, causing friction for decades. Enslaved humans were caught in the middle and often used as collateral. The boom-bust cycle has been played out in our country ever since.

According to Will Rogers, the lie of trickle down, in his own words, referred to the banks and the corporations enacting “merger on top of merger.”

“Get two nonpaying things merged and then issue more stock to the public,” he wrote. “Consolidations and holding companies! Those are the ‘inventions’ that every voter that had bought during the “cuckoo” days was gunning for at this last election.”

And even before Will Rogers, William Jennings Bryan, who later was to argue against evolution in the famous Scopes monkey trial, came up with the idea of trickle-down, yet not in those exact words. And it had to do with his being pro-silver, and anti-gold, as a currency backer.

So if Rogers and Bryan weren’t talking about taxes, what actually happens when taxes are cut, and why do people do it? Obviously, if taxes are cut, the government makes less money, all things being equal. So what is the rationale? To make your rich friends richer? More on that later. To win elections? Perhaps.

TWO SANTAS

After the recession and inflation (stagflation) of the early 1970s, Americans were looking for new answers. In 1978, Jude Wanniski, a former associate editor at the Wall Street Journal, wrote a book called “The Way the World Works.” He is credited with coining the term “supply-side economics” to refer to economic growth through deregulation and lower taxes – an idea which eventually became Reaganomics. He also came up with the idea of Two Santa Clauses. If the Democrats could offer welfare to win elections, then the GOP could offer tax cuts, he cynically observed. Together with economist Arthur Laffer, Wanniski influenced conservative economic thought for decades. Always the outsider, Wanniski was an early critic of the Iraq War before he died in 2005.

As for Laffer, he designed an eponymous curve that swayed generations of politicians including Dick Cheney and Jack Kemp into believing that above a certain percent tax, federal tax revenue starts to go down. Essentially, the Laffer curve showed that there is a tax rate above which people will no longer be willing to pay their taxes. They will instead pay someone to find ways to avoid paying those taxes. Laffer himself gave credit to 14th Century Tunisian philosopher Ibn Khaldun, who wrote: “It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments.”

“Trickle-down” evokes such a visual that, once created, it has really stuck. It was used by FDR as he used fiscal spending and higher taxes to bring us out of the Great Depression. It was even used by President Lyndon Johnson, who ironically had pushed through his predecessor’s income tax cut in 1964.

Then, there was “voodoo economics,” a zinger coined by George Bush the elder when he was battling Reagan for the 1980 Republican nomination (actually he said “voodoo economic policy”).
 

But it was actually one of the faithful, Reagan’s first-term budget director, David Stockman, who pulled a Steve Bannon and "admitted" the GOP was merely pushing trickle-down economics, when he was famously quoted in The Atlantic as saying that the term “supply-side” was just a cover for “trickle-down” tax cuts for the rich. 

Stockman went on to write a book titled “The Triumph of Politics: Why the Reagan Revolution Failed,” in which he blamed congressional Republicans for failing to rein in fiscal spending to counterbalance the Reagan tax cuts.

ARMAGEDDON

Taxes go up? Democrats are happy. “This is the way we take care of the less fortunate, and provide opportunity for all.” But Republicans predict doom.  “Higher taxes are a job killer.”

Taxes go down? Republicans are happy. “More money, more investment, more jobs.” Now Democrats predict doom. “Trickle-down economics doesn’t work. It never worked before, but Republicans keep trying it so they can stay rich and get richer.” This year, Nancy Pelosi went as far as saying “this is Armageddon.”

Tax reform does not happen in a vacuum; other factors affect the outcome. And despite these sound bites, the reality of our government shows our elected leaders behaving in unpredictable ways.

John F. Kennedy, a Democrat, cut taxes in the middle of a recession caused mainly by the Fed raising the funds rate sharply (they were concerned about inflation as GDP growth in 1959 had been 6.9 percent).

Pundits of both parties seize on JFK’s actions as evidence to bolster their positions. See sidebar: “What happened when JFK lowered taxes,” Back to Facts, Dec. 31, 2017.  It just so happens that after the Kennedy tax cuts, tax revenue grew and GDP increased.

UPDATE: The economic outlook has changed drastically since early 2020 due to the coronavirus pandemic. Tax revenue from individuals — which makes up the bulk of government revenue, were higher than ever before, as GDP rose, unemployment dropped and Americans were earning more. But corporate taxes, which are mistakenly thought of as a larger chunk of revenue than they actually are, did jump in the second year after the 2017 Trump tax cuts — an amazing thing since the corporate rate went from 35 percent to 21 percent. This is the same measurement that was used to gauge the effect of the JFK corporate tax cut — a two-year spread. Left-leaning think tanks warned, however, that the benefits would not be sustainable. Because of the pandemic, we may never know the true effects of the Trump tax cuts. And the IRS is still in a legal batttle with giant corporations as to the actual taxes owed during the years they had moved their headquarters to Dublin (12.5% corporate tax rate at that time).

George Bush the elder, a Republican, raised taxes and lowered the deficit by $500 billion over the coming five years. A recession followed shortly after, causing lower tax revenue. The New York Times weighed in, saying the luxury tax on yachts had hurt the boat building industry.

Bill Clinton, a Democrat, both raised and cut taxes. In his first term, he raised income taxes modestly on the wealthy, and also on transportation and fuel. Tax revenue increased by $90 billion per year and the deficit went down, but wages were flat. In his second term, though, Clinton lowered the capital gains tax from 28 percent to 20 percent – thus giving birth to the famous disparity between Warren Buffet and his secretary, and how much they pay in taxes. And the economy boomed – buoyed by the newborn Internet and the dot-com bubble.

Barack Obama spoke out against “trickle-down economics,” but then in 2012, he renewed the tax cuts of his predecessor, George W. Bush, and made most of them permanent.

FAT CATS AND TAX CUTS

Oh, it’s easy to say the Republicans caused the Great Depression when they got into office in 1920 and lowered taxes. In fact, that’s exactly what historian Robert S. McElvaine argued in an opinion piece in the Washington Post on Nov. 30.

“The crash followed a decade of Republican control of the federal government during which trickle-down policies, including massive tax cuts for the rich, produced the greatest concentration of income in the accounts of the richest 0.01 percent at any time between World War I and 2007 (when trickle-down economics, tax cuts for the hyper-rich, and deregulation again resulted in another economic collapse).

“Yet the plain fact that the trickle-down approach has never worked leaves Republicans unfazed.”

The professor is a Depression historian, so he is an expert. Then why does he not discuss the conditions leading up to the tax cut?

Andrew Mellon served under three Republican presidents: Warren Harding, who died in 1923; Calvin Coolidge; and Herbert Hoover. None of the four men could escape the taint of the Great Depression on their watch.

In 1916, under Democrat Woodrow Wilson, the top income tax rate was 15 percent. By 1918, the top income tax rate was hiked to 77 percent to help pay for World War I. Much of this was due to an excess profits tax designed to prevent war profiteering (since Gross Domestic Product tens to skyrocket during war).

As part of a multi-year tax-reduction package, Republicans did lower taxes under Treasury Secretary Andrew Mellon (who along with Herbert Hoover was blamed for not doing more after the crash of 1929 to stave off the Great Depression).

In his own words, Mellon’s main concern was paying down the national debt, which had ballooned from $5.7 billion in 1917 to $27.4 billion in 1919.

With the highest tax rate of 77 percent, it was his belief that the wealthy were doing all they could to avoid paying taxes, including putting their income into tax-free municipal bonds.

Writes Thomas Sowell, libertarian economist at Stanford University: “Secretary Mellon repeatedly sought to get Congress to end tax exemptions for municipal bonds and other securities, pointing out the inefficiencies in the economy that such securities created. He also found it “repugnant” in a democracy that there should be “a class in the community which cannot be reached for tax purposes.” Secretary Mellon said: “It is incredible that a system of taxation which permits a man with an income of $1,000,000 a year to pay not one cent to the support of his Government should remain unaltered.”

Thomas Sowell, senior fellow at the Hoover Institution at Stanford University.

By 1930, the national debt was paid down from $27.4 billion a decade earlier to $16.2 billion. Mellon had accomplished his goal, but neither he nor President Herbert Hoover had foreseen the causes of the Crash of 1929 or the ensuing Great Depression. Nor had liberal economist John Kenneth Galbraith, who lost out with the crash like everybody else.

Finally, we're getting somewhere. Obviously, lower taxes in a vacuum bring lower tax revenue. But the goal of most tax cut plans is not to play Santa Claus for the rich, or even temporarily for the middle class; rather it’s to bring money out of tax shelters, and encourage corporations to expand. Whether they actually do expand, hire more people, or raise wages, is for another article.

CAUSES OF COLLAPSE

John Kenneth Galbraith, economist and adviser to many Democratic administrations.

If we all knew exactly what caused economic collapse, we would be able to avoid it. But even as recently as 2008, we were not. Real people lost real jobs, and real companies went bust overnight. The reason things weren’t as bad in 2008 as in the Great Depression is also up for debate; but it’s safe to say we learn a little bit more each time. We have the FDIC now, preventing the old fashioned run on the bank (as in "It's a Wonderful Life); but in 2008 we also paid a huge price to bail out the holders of toxic mortgage securities, in billions added to our national debt.

For the Crash of 1929, experts still do not completely agree, but several factors can be listed: 
1) Federal reserve raising the discount rate
2) Too many people buying stocks on margin (with debt financing)
3) Public utility stocks overvalued
4) Gloomy articles in the financial press, including the New York Times and Washington Post.

According to Galbraith in his book “The Great Crash of 1929,” the economy was strong and things were going well in the 1920s. The main problem, he said, was too many people wanting to get rich with very little effort. Land speculation in Florida, for example, was an epidemic. And vast numbers of people were getting into the stock market on credit (buying on margin).

In other words, like so many panics and collapses before, people wanted to believe that “les bons temps” would “roulez” forever. Moreover, the Federal Reserve made things worse by raising the funds rate to slow down lending and speculation (which was still rampant). Then there was the Smoot Hawley Tariff of 1930, which killed foreign trade. No one knew just how deep the downturn, bank panic, and depression would cut. 

Rather than blame the other party for economic collapse, perhaps we need to look into our national soul and expectations. Entrepreneurialism is at the heart of the American spirit; and as a nation we have produced and exported some of the greatest innovation the world has known. Yet all along, we have also exported American speculation, entitlement, privilege, selfishness, greed, even thievery throughout the nation and the rest of the world. It is time to cast off the superficial catch phrases and memes, to examine the facts and context, and to finally learn from our past economic tragedies – for the good of all our citizens as well as the peace and prosperity of the planet.

Next:
Macro 2.0: Do tax cuts increase economic growth and wages?
Micro 1.0: How does the 2017 tax plan affect taxpayers? How does it affect the poor, middle class and the wealthy?

Thank you for reading Back to Facts. To continue reading journalism that seeks to advance the dialogue through context and balance, please subscribe below.