💥 You say 'trickle-down economics,' I say 'net positive spillovers from cultivating upper-tail human capital'

A few thoughts on tax policy, Trussonomics, and Reaganomics

President Ronald Reagan signing the the Economic Recovery Tax Act of 1981

If you had told me a couple of years ago that I would be writing a newsletter about economic growth and barely mention tax policy, my skepticism level would have been pretty high. After all, taxes are an important lever of economic policy. That said, I’ve barely mentioned tax reform, especially versus subjects such as scientific research funding, environmental regulation, housing regulation, and education.

But today is the day for some tax talk, and for a couple of reasons. First, there’s been considerable kerfuffle — both among economists and in markets — about new UK Prime Minister Liz Truss’ intention to cut taxes, what some over there are calling her “Reagan dash for growth.” Then there’s this recent tweet from President Joe Biden:

President Biden @POTUS

I am sick and tired of trickle-down economics. It has never worked. We're building an economy from the bottom up and middle out.

I’m going to assume that what Biden means by “trickle-down economics” is economic policy, especially taxes, that supposedly favors wealthier Americans at the expense of middle-class and lower-income Americans.

Anyway, with taxes top of mind right now, I thought I would run through a few thoughts on several tax-related topics — all seen through a pro-growth, pro-progress lens:

1. Let’s quit freaking out over Trussonomics. Sometimes Mr. Market gets momentarily emotional and overreacts. It’s hard to see why tax cuts of around 1 percent of GDP (including scrapping the top income tax rate and reversing a planned rise in corporate taxes) justify the pound falling to a record low versus the dollar — not to mention all the heated commentary about their supposedly ruinous effects. The pound’s subsequent reversal is one bit of evidence for this. And that turnaround makes sense given Britain’s overall fiscal situation, which isn’t really that precarious. Goldman Sachs noted earlier this week that “the UK’s debt ratio remains lower than most other G7 economies and its average debt maturity is significantly higher.” The tax cuts aren’t going to cause a debt crisis. And unlike much of the news and social media commentary, GS mentions some potential upside to the tax changes:

   Some of the announced measures could lead to increased productivity; for example, the cut to the corporation tax may encourage business investment, lower national insurance contributions could lead to more hiring and investment in worker training, and the increased threshold for stamp duty reduces the costs of relocating and has the potential to lead to better worker-firm matches.

2. Taxes matter for economic growth. We should want a tax code that raises revenue in an economically efficient and in a way that the American public generally thinks is fair. But make no mistake, tax policy can both help and hinder economic growth. Policymakers need to take that reality into account when thinking about changes to the US tax code. Take corporate taxes. All else equal, reducing them should, over time, increase real investment in the US (because the tax cut lets companies keep more of the profits from those investments, making such investments more lucrative). And more investment should translate eventually into higher worker productivity and higher worker wages.

   That’s the theory. And it’s a theory backed by evidence. One example: In the July 2022 working paper, “Short-Term Tax Cuts, Long-Term Stimulus” by James Cloyne (University of California, Davis), Joseba Martinez (London Business School), Haroon Mumtaz, (University of Lond), and Paolo Surico (London Business School), the four researchers find “that corporate income tax changes generate persistent effects on R&D expenditure, productivity and output whereas personal income tax changes trigger large but short-lived responses of capital expenditure, productivity and output.” (That said, constantly tinkering with the code is hardly optimal.) Indeed, there’s good reason to mostly abolish the corporate income tax while shifting most of the tax burden to shareholders.