Tax relief involves more than simple arithmetic

Raymond Keating
Raymond Keating

It’s as predictable as the sun rising in the east and setting in the west. What am I referencing? The response of the left, various elected officials and much of the media to proposals to cut taxes, especially when it comes to tax relief including upper-income earners and businesses.

Whether it’s due to bias or not, they seem either unwilling or unable to think through the full effects of tax relief.

For these groups, cutting taxes is about a very narrow, simplistic take on arithmetic. According to this view, reducing taxes on upper-income earners means only they benefit. And these groups will come up with some amount of that benefit based on what income levels are now.

The same goes for reducing the tax burden on businesses. That is, only those businesses benefit, and the calculation of how much they benefit is based on current earnings. It follows, of course, that since low- and middle-income earners make less than wealthier individuals — and therefore pay less in taxes — then across-the-board tax relief overwhelmingly benefits upper-income earners with little left for low- and middle-income earners.

Got that? Well, now toss it out the window, because that’s not how the economy and tax relief actually work.

Thinking about the economics of any subject, including tax relief, requires more than an adding machine. It requires an understanding of behavior, incentives, grasping that economic activity is dynamic and not static and an ability to think through all of the effects.

Consider what happens when income and capital gains tax rates are reduced.

First, incentives are changed in a positive way. Specifically, incentives are enhanced for working, saving, investing, starting and building a business, using resources more efficiently and effectively and substituting productive income-generating activity for undertakings based solely on tax deductibility.

Second, these incentives then translate into greater business creation and growth beyond where they would have been otherwise. Also, the resulting enhanced investment, innovation and efficiencies generate improved productivity. Such activities translate into higher incomes and expanded employment opportunities. Therefore, the effects of substantive tax relief reach far and wide, beyond the simplistic view it’s only about upper-income earners and businesses.

Third, given that both labor and capital are increasingly mobile, lower income and capital gains tax rates for both individuals and businesses provide a competitive advantage that helps to attract entrepreneurs, investments and skilled professionals, with commensurate benefits, again, flowing throughout the economy.

To the extent one understands how an economy grows — that is, through greater risk taking, namely, entrepreneurship and investment — then it becomes clear reducing the costs of such risk taking through tax relief is a positive that affects the entire economy, boosting growth, productivity, incomes and employment.

Of course, economic decisions and growth are affected by many other factors, including, on the policy front, regulatory burdens, property rights, the size of government, trade policies and monetary policy. And to the extent each of these areas is pointed in the right direction — that is, reducing burdens on and removing obstacles to entrepreneurship and investment — the greater the benefits across the entire economy.

But to say that tax relief for upper- income earners and businesses only benefits those particular individuals and businesses exhibits a gross misunderstanding of how the economy works.