Hillary Clinton’s economic sophistry

Printed from: https://newbostonpost.com/2016/10/13/hillary-clintons-economic-sophistry/

Second only to lawyers, economists are the subject of frequent jokes. For example: “If all the economists were laid end to end, they would never reach a conclusion.” The follow-up joke is that “if all economists were laid end to end, that would be a good thing.” Yes, economists can disagree. Yet, they can agree, as well.

We, along with three co-authors, recently finished a series of studies of the Trump and Clinton tax plans. We all signed off on the methodology and the findings. You can see these studies at www.beaconhill.org.

Here are the principal features of Trump’s plan:

— Reduce the number of non-zero tax rates from seven to three (12%, 25%, and 33%);

— Abolish the Alternative Minimum Tax;

— Cut the business tax to a flat rate of 15%;

— Abolishes the estate tax;

— Increase the standard deduction to $20,000 for single filers and $40,000 for married couples filing jointly; and

— Introduce a child care tax deduction.

Here are the principal features of Clinton’s plan:

1.    Add a surcharge of 4% on adjusted gross annual income above $5 million;

2.    Limit the value of deductions (except for contributions to charity) to no more than 28% of their value;

3.     Ensure that all taxpayers with a modified adjusted gross income of $1 million or more would pay at least 30% of their income in taxes (the “Buffett Rule”);

4.    Increase the tax rates applicable to capital gains for those in the top income tax bracket;

5.    Repeal carried interest, which is a provision that allows general partners in some businesses to book most of their earnings as (low-taxed) capital gains rather than earned income; and

6.    Increase the estate tax.

In our studies, we agreed that the two plans would have very different effects on the economy. The two of us did not agree, however, on which plan was better. In conversation over our findings, one of us favored Trump’s plan, the other Clinton’s.

How is this possible, considering that we agreed on a very wide range of economic effects? The answer is that economics, like any science, utilizes theoretical models that work by showing how changes that take place outside a model (e.g., tax policy changes) affect variables that are determined inside the model (e.g., investment and employment). The alternative tax plans we considered called for very different changes in current tax policy and thus yielded very different results, making it difficult to agree on which results would be better for the country.

So we agreed to disagree. Here is David Tuerck’s opinion of the two plans. For Jonathan Haughton’s, read HERE.

Hillary Clinton’s economic sophistry

In a recent column in the Wall Street Journal, Daniel Henninger suggested that the one sound bite to come out of the first presidential debate was Hillary Clinton’s “trumped-up trickle down,” meaning her characterization of Trump’s version of what the Left likes to call “trickle-down economics.” There are conflicting stories about the origin of this term, one that traces it all the back to William Jennings Bryan and his populist rhetoric. The idea is that the poor should not oppose tax cuts that benefit the rich because they will benefit too. Some of the benefits will “trickle down” to them. Or, to switch metaphors, the poor, like hungry dogs, will get some of the crumbs that drop off the table.

The only problem is that no economist would ever support a tax policy based on this idea. Indeed, the only people who use the term “trickle-down economics” are people who want to advance the belief that some tax policy or another depends on an argument no one schooled in economics would ever make. The trickle-down argument is pure economic sophistry.

Clinton is aiming her sophistry at the Trump proposal to cut the tax rate on business income to 15%. Because business owners, including stockholders in corporations, are at the upper end of the income scale, Trump must be trying to fool voters when he argues that his tax proposal would benefit the economy.

Now let’s consider a defense of the Trump proposal that is based on economic logic rather than sophistry. Consider a corporation that wants to raise $100 million to expand its plant. The corporation decides to raise the money by issuing stock. In order sell its stock, however, prospective stockholders have to believe that they will get a sufficiently high return to justify putting their money into the corporation’s stock rather than some other use, say opening a bank account or buying a vacation home. One reason not to buy the stock is that the government will tax income received by the corporation for investing the $100 million dollars and then tax the stockholder on whatever income that he might receive in the form of dividends once the corporation pays its taxes.

The greater this combined tax burden, the less attractive the stock. The less attractive the stock, the less likely it is that the corporation will make the investment and create the jobs that go with it.

This is not a problem faced only by corporations. The owners of unincorporated businesses have to pay taxes on their profits, too, and, like people who hold stock in corporations, these business owners have to determine whether it’s worth committing their personal funds to a capital project, the income on which they, too, will pay taxes.

The United States has the highest corporate tax rate in the world. When federal, state and local corporate taxes are added up, U.S. corporations pay, on average, a tax of 39.5% on every incremental dollar of income. (And Clinton wonders why so many corporations want to squirrel away their profits in foreign banks!) On average, the tax is 48.5% across all businesses, corporate and non-corporate.

I would invite Clinton and her redistributionist fellow travelers to consider the graph that follows.

Source: Federal Reserve Bank of St. Louis and BHI calculations.

Source: Federal Reserve Bank of St. Louis and BHI calculations.

The graph illustrates a feature that has characterized the U.S. economy since President Obama took office, namely a pronounced slowdown in economic growth. The recession that Obama inherited in January 2009 ended in June of that year, yet the slowdown in economic growth that coincided with that recession continues full tilt today. If we examine data provided by the Federal Reserve Bank (FRB) of St. Louis, we find that the annual growth rate of the U.S. capital stock from 1995 to 2008 was 3.0% but has since been 1.2%. Extrapolating from the latest data (2014) provided by the FRB to 2016, the capital stock is currently $7.9 trillion less than what it would be, had growth not fallen as it did.

The trickle-down mindset cannot come to grips with data like these. In the Clinton world view, almost $8 trillion in missing plant and equipment cannot be the issue and a plan to incentivize investment cannot be the cure. Rather, the issue is the economically distressed middle class and the cure is a higher minimum wage and mandatory paid family leave, along with even higher taxes on capital income.

It is, however, a fact, agreed to by almost all economists and certainly the economists on our study team, that cutting the federal tax on business profits would incentivize investment. Indeed, there is hardly any other remedy for slowing capital growth that is available to federal policy makers. In our study, Professor Haughton and I found that, when combined with the other tax cuts Trump proposes, his cut in the tax on business profits would immediately increase business investment by $191 billion, or 7.16%, and, moreover, create three million new jobs and add almost a trillion dollars to real, inflation-adjusted gross domestic product. The effects would become even larger over time. A trillion-dollar increase in real GDP would close the gap between actual GDP and the GDP we would have, but for the Obama-era economic slowdown.

Is there a downside to the Trump plan? Absolutely. We find that his plan would add $8.4 trillion to the federal deficit by 2026, whereas Clinton’s plan would reduce the deficit by $615 billion. And that does not account for Trump’s plan to increase infrastructure and defense spending. So Trump could not deliver on his promise to cut almost everyone’s taxes while leaving entitlements unchanged. And that’s to say nothing of his own economic sophistry when it comes to trade policy, a reality that I have addressed in this publication and in another study.

We must keep our eye on the prize, however. The principal domestic issue facing the United States today is the slowdown in economic growth that has characterized the economy for going on eight years now. We cannot reverse that slowdown with redistributionist policies and government interventions that will make the slowdown even worse.

What Clinton offers is an opportunity to give low-income families a bigger slice of a shrinking economic pie, and what Trump offers is a chance to make the pie bigger. From my point of view, that makes the choice between their competing policies an easy one to make. Trump’s plan would expand the capital stock. Clinton’s would contract it. His plan would thus increase real GDP. Hers would shrink it. Clinton cannot wash away those realities by her sophistic appeal to class envy.

David G. Tuerck

David G. Tuerck

David G. Tuerck is Professor of Economics at Suffolk and Executive Director at the Beacon Hill Institute. Tuerck is also a fellow at the National Center for Policy Analysis, which funded BHI’s work on tax policy. Read his past columns here.