Taxes, Stimulus, and Inequality

A time of controversy over tax policy provides apt occasion for recalling a few facts about the relations between wealth and income inequality on the one hand, financial fragility and economic slump on the other. Appreciation of these relations appears to be strangely lacking in much of the current discussion over the wisdom or otherwise of extending the Bush tax cuts for another two years or more. To be sure, some commentators do cite or allude to some of these relations. But the numbers, as a portion of all who are chattering right now, are depressingly small. And even the few explanations we hear are depressingly vague, particularly given how straightforward the relations in question are. So here's an attempt at a short and sweet explication. The first fact that bears noting, then, is the relation between wealth and income levels on the part of individuals on the one hand, and those individuals' expenditure patterns on the other. That relation is nicely captured by simple and empirically well established observation long ago made by Keynes. It is that as individuals' incomes and wealth rise, their 'marginal propensities to consume' diminish. In other words, as we come to earn and own more, we tend to devote a diminishing proportion of our earnings to consumption expenditure, and a correspondingly larger proportion to investment or, more problematically, 'speculative' expenditure. Now, it turns out that this fact, in turn, bears consequences both for the sustainability of healthy financial markets during perceived 'boom' times, and for the prospects of protracted slump during the 'gloom' times that tend to follow a crash. Those consequences, for their part, have been on display very graphically over the past decade or more. With respect to the first of those consequences, then, when earnings and wealth tend to accumulate disproportionately at the top of the distribution during good times, the sustainability of those good times' 'goodness' grows steadily more precarious. The reason is that, as wealth accumulates at the top, a diminishing share of national income goes to the purchase of goods and services supplied by firms. The longterm prospects of those firms' profitability and, in consequence, continued employment of labor accordingly diminish. Lower profits and lower employment begin to loom as very real prospects. At the same time that this process unfolds -- indeed, what is the flip side of this process itself -- those who disproportionately reap gains and refrain from spending them upon goods and services when wealth and incomes are skewed -- namely, those at the top of the skewed distribution -- tend to spend them upon something else: They spend them increasingly upon speculative investments. But more and more speculative money chasing proportionately fewer investment goods -- as must happen when demand for the goods and services, whose supply those investments finance, is diminishing as a proportion of national income -- of course leads eventually to inflated, even hyperinflated, prices among those investments. An asset price bubble is apt to form and to grow. But asset price bubbles, for their part, of course have an unfortunate habit of eventually bursting. When they do, even 'value' investment, as distinguished from 'speculative' investment, freezes up. People 'hoard' and hold back. Not only the economy's consumer expenditures, but indeed its aggregate expenditures, accordingly shrink. People become much more cautious about making money available to firms -- even to those that produce and supply real goods and services. Only those that supply goods and services apt to be actually PURCHASED will attract investment and keep people employed. That takes us to the second mentioned consequence of the diminishing marginal propensity to consume highlighted above -- the consequence implicated during 'gloom' times. By far the most, it not indeed the only, reliable way to 'jump start'an economy that has gone into slump is to boost purchases of those goods and services that firms produce for consumption. And the best -- the most efficient -- way to do that is to direct stimulus money toward those with higher marginal propensities to consume. It is most efficient, that is, to put stimulus money into the hands of those who are not at the top end of the distribution. One receives much more 'bang for the buck' in that way. One in effect 'levers' the stimulus much more effectively in such case. To employ the canonical Keynes/Kahn jargon, 'the multipliers' are higher in such cases. It seems to me that the lessons that these simple observations offer for current tax policy are plain. If we're looking to stimulate an economy in slump, while also doing minimal additional harm to the nation's federal budget position, we should be seeking the maximal 'bang' for the tax cut 'buck.' And that is at the lower end of the distribution -- it's with middle class earners and lower. By the same token, if we wish to minimize the risk of occasioning yet another asset price bubble and burst with our stimulus, we should be chary indeed of directing more moneys toward those whose expenditures already go disproportionately toward speculative investments -- and did so in such way as fueled those very bubbles after whose bursting we're now cleaning up.