It Seems So Simple

poorWhy do tax cuts lead, counter-intuitively, to industrial decline, stagnant wages, and finally financial collapse?

This was the question asked in a very interesting article at The Daily Kos by  David Cay Johnston titled Democrats struggle to understand how Bush Tax Cuts wiped out $6.6 trillion in personal income. Johnson wrote the book Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill), which sounds like pop-analysis but read the complete article and judge for yourself if his analysis is accurate.

If you look under the hood of the industrial economy, you easily see why there is this counter-intuitive relationship between tax rates and economic growth . With high taxes, the only way to retain the bulk of the wealth created by a business is by reinvesting it in the business — in plants, equipment, staff, research and development, new products and all the rest. But if tax rates are low, then there is more incentive to pull the wealth out, by declaring it as profits that are taxed at what turns out to be too low a rate. In other words, low taxes create an incentive for profit taking.

This in turn creates an incentive for short-term horizons in business planning. If you’re going to be taking all the profits out of a company, and take home a few million a year, why bother to reinvest anything in the business? You’re going to be rich, and never have to work again, even if the business goes bust. Or gets packed on a boat and shipped to China. Or goes “virtual” and lets all the hard work, like, you know, actually making something, be done by the lowest bidder. Employees? Don’t need them.

But employees are also customers. If enough businesses “take profits”, after some length of time, the former employees also become former customers. Meaning, they stop buying. The economy’s aggregate demand generation is crippled. From the three Republican tax cut experiments this past century, it appears the length of time for this to happen is five to seven years.

If tax rates are high enough to discourage profit taking – forcing wealth created by a business to be recycled back into the business – then businesses are pushed toward longer-term planning, as they invest in new plant and equipment that will be used for many years. And you do not get the absurd situation you have now, where companies are posting record breaking profits, but are not buying new equipment, nor hiring new employees.

Low tax rates encourage taking wealth out of industrial companies; the wealth taken out must then be “put to work.” That means more money chasing “investment” opportunities, leading to price increases in financial capital or real estate or some other asset. In other words, an asset bubble. The rise in prices of an asset bubble has nothing to do with the creation of real wealth. It all looks like prosperity – until the asset bubble bursts. That’s where we are now.

A recent poll concluded that a vast number of American voters do not know the simplest facts about the makeup of the Federal government: they have no idea who represents them in the legislative branch and many do not even know there is a legislative branch. This, it seems to me, is the basic truth that political strategists such as Karl Rove discovered and have been using to their advantage. The formula is simple: lie, lie again and again, ignore the truth, and blame the other guy for everything, even if they had nothing to do with it … fact is, most people are not going to know you are lying. Then the corporate mouthpiece called the media (older folks know it as The Press or The Fourth Estate) will either support your lies or befuddle the distinction with erroneous comparisons and meaningless analysis (the old “they all do it” when the fact is, they don’t all do it).

The President, in this case Barack Obama, being the one name these upstanding Americans remember, is then openly accused and vilified for all the ills of the country. If you doubt this pool of challenged Americans exists, look at the list of voters who put Louis Gohmert into office.

It’s so ironic that the root of all our problems and the biggest reason for the decline of the United States, internationally and in-country, is directly attributable to the idolized Ronald Reagan …  but this does help to explain why the Republicans are so Hell-Bent to destroy the country and the Democratic spirit of its citizens: it’s the Reagan plan and they’re just following it.

What are your thoughts on this?

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