Democrats Embrace Voodoo Economics

By Kevin Williamson

Approximately 99.44 percent of the time, it is a safe assumption that when you disagree with Thomas Sowell, you are wrong. But on the issue of the “trickle-down” theory of economics, Professor Sowell is in fact wrong to claim that “trickle-down” is a nonexistent theory, absent from “even the most voluminous and learned histories of economic theories.” Trickle-down is there — just not where its critics are looking for it.

Getting to the bottom of this will require a little background.

Professor Sowell is correct that trickle-down functions in our current discourse mainly as a caricature of certain conservative, supply-side, and/or free-market economic ideas, mostly pertaining to taxes: “Repeatedly, over the years,” he writes, 

the arguments of the proponents and opponents of tax rate reductions have been arguments about two fundamentally different things. Proponents of tax rate cuts base their arguments on anticipated changes in behavior by investors in response to reduced income tax rates. Opponents of tax cuts attribute to the proponents a desire to see higher income taxpayers have more after-tax income, so that their prosperity will somehow “trickle down” to others, which opponents of tax cuts deny will happen. One side is talking about behavioral changes that can change the total output of the economy, while the other side is talking about changing the direction of existing after-tax income flows among people of differing income levels at existing levels of output. These have been arguments about very different things, and the two arguments have largely gone past each other untouched.

What sort of “behavioral changes” do the tax-cutters expect? In Andrew Mellon’s day, tax cuts were intended to lure wealthy investors out of tax-free government securities, which Mellon had proposed abolishing, into more-productive private-sector investments, which he believed would raise overall economic output. As Professor Sowell points out, the aggregate reported income of those earning $300,000 a year or more in 1916, back when three hundred grand meant something, was cut in half by 1918, and it probably was not because Scrooge McMoneybags actually was earning less: The consensus is that the very rich shifted their investments into tax-free securities as taxes went up and tax shelters became more attractive. Most of a century later, billionaire presidential candidate Ross Perot would be criticized for keeping his copious loot in tax-free munis. The more things change . . . 

President Woodrow Wilson and others argued at the time that the combination of high taxes on income and zero taxes on certain government securities created a situation that discouraged private investment and encouraged profligate government spending, while lowering the tax burden on the wealthy and thus necessarily increasing the burden on everybody else. Presidents Calvin Coolidge and John Kennedy would make similar arguments.

The cartoon version of conservative economic thinking — that we should subsidize gazillionaires in order to create work opportunities for yacht painters, monocle polishers, and truffle graters — is fundamentally at odds with the facts. The supply-siders may have wrong economic ideas, but they do not have those wrong economic ideas. President Ronald Reagan, for example, loved to boast of the number of poor and modestly-off Americans his policies had removed from the federal tax rolls entirely. George W. Bush promised that he’d take the poorest fifth of taxpaying U.S. households off the federal tax rolls; Heritage estimates that he succeeded in doing so for about 10 million low-income households.

One of the perverse consequences of conservatives’ success in lowering the federal income-tax burdens of those on the left half of the earnings bell curve is that we have finally arrived at the point where our critics are partly correct: Most conservative plans for tax cuts at this point in history do disproportionately favor the wealthy and the high-income, for the mathematically unavoidable reason that they pay a steeply disproportionate share of federal income taxes, making it very difficult to design a tax-cut plan that does not disproportionately benefit them. It’s hard to cut taxes without cutting them for the taxpayers.

I myself am mostly neutral on the question of tax cuts, on the grounds that cutting taxes while the government is running significant deficits is not inadvisable but impossible — in that situation, taxes are not cut but merely deferred. All accounts must in the end be settled, so the real rate of taxation is the rate of spending.

The point of rehearsing this history is not to determine whether traditional supply-side thinking on economic policy is true or false, but rather to show that it is something fundamentally different from the trickle-down caricature offered by the progressives and others generally hostile to the idea of a smaller federal financial footprint. But that is not to say that “trickle-down” is an idea without adherents, a banner without partisans marching under it. Perversely, those advancing trickle-down ideas are mostly the same ideologues who denounce “trickle-down.” But they do not call it trickle-down — they call it “stimulus.”

There are three main ways in which the federal government goes about trying to stimulate the economy. Traditionally, the most popular and most bipartisan method has been tax cuts. The popular if intellectually dodgy Keynesian analysis holds that during periods of economic weakness, there is a glut of underutilized productive capacity — capital and labor both — and that government can help clear it by increasing “aggregate demand,” i.e., stimulating consumption. As President Obama put it, “For businesses across the country, it would mean customers with more money in their pockets.” If you want Republicans on board, then the easiest way to put money in consumers’ pockets is with tax cuts, but you can achieve much the same thing with various kinds of welfare spending, the second form of stimulus, as seen with the bump in food-stamp and unemployment spending under President Obama’s American Recovery and Reinvestment Act. You can also sometimes forcibly deputize others to do some spending for you — in the speech above, President Obama was talking about raising the minimum wage.

The president and congressional Democrats treat tax cuts and spending as though they were the same thing, and from a federal accounting point of view, they are not entirely wrong: Cutting a $50,000-a-year household’s taxes by $1,000 a year is functionally identical to cutting them a check for $1,000 every year. Cutting an unemployed worker’s taxes by $1,000 a year is functionally the same thing as giving him an extra $1,000 in unemployment benefits. On the question of economic stimulus through tax cuts vs. through targeted social-welfare spending, the real dispute is about the method of targeting those distributions — and that’s about nothing but politics. Democrats do not want to do too much to establish the precedent that tax cuts might be good for the economy in some circumstances, lest it come back to bite them, and Republicans do not want to establish the precedent that some welfare spending might be good for the economy. 

For what it’s worth, I’m not convinced that either approach does much more than provide a short-term sugar rush at the expense of the economy’s long-term health, and the Congressional Budget Office shares that suspicion, estimating that in the long run the Recovery Act will decrease economic output for reasons that would have been familiar to Andrew Mellon back in his day: 

To the extent that people hold their wealth in government securities rather than in a form that can be used to finance private investment, the increased debt tends to reduce the stock of productive private capital. In the long run, each dollar of additional debt crowds out about a third of a dollar’s worth of private domestic capital, CBO estimates.

One of the problems with the traditional Keynesian view of stimulus is that it assumes that the increased aggregate demand in the economy will be matched by a mirror image of underutilized productive capacity. But we know from experience that this is not always the case. For example, we spent years around the turn of the century stimulating the economy with lower interest rates, tax cuts, and welfare spending, and the result wasn’t general prosperity — it was a housing bubble. These things tend to be unpredictable, and it is as likely that such efforts will deepen the misalignment between production and consumption as it is that they will mitigate it.

The third way that government attempts to stimulate the economy is through project spending, i.e. the so-called infrastructure investments that politicians always are nattering on about. From the politicians’ point of view, infrastructure spending has one important advantage over tax cuts or welfare outlays: They get to control what the money is spent on and where. Cut somebody’s taxes, and he might put the money toward his children’s college tuition — or he might put it toward a few lines of cocaine. Additional welfare dollars might find their way to the grocery store — or a casino. But if you spend a billion dollars on a bridge, you can be pretty sure that you’re going to get a bridge out of the deal, and a bridge right where you wanted one.

Needless to say, that’s not the same as building a bridge where a bridge is needed — but if we buy the traditional model of stimulus, that shouldn’t matter. Through the magic of the multiplier effect, $1 spent on a bridge works its way through the economy, creating $1.25, or $2, or $22 in value, depending on whom you ask. (All of which assumes that the multiplier generally is greater than 1, rather than less than 1, which has not been established, but never you mind. And if this looks to you like nothing other than the contemporary supply-siders’ self-financing tax cut in drag, then you’re on the right track.)

The important point here is this: The argument that the government should spend on infrastructure because a certain piece of infrastructure is needed is one kind of argument; the argument that government should spend on infrastructure because doing so is good for the economy is a different kind of argument — specifically, it is a trickle-down argument. 

If you doubt that, ask yourself: What kind of firms get federal contracts? Do you think any of those unhappy people in Ferguson, Mo., own firms that are in line for Department of Defense or Department of Energy contracts? Do you think impoverished Appalachian pillbillies are in the running for upgrading Treasury’s computer networks? If so, I have a bridge I’d like to build you at a very reasonable price.

Federal contracting is dominated, as one would expect, by large firms, often the dreaded multinational corporations of angsty soy-latte-liberal legend. Call the roll: In first place, we have Lockheed Martin, followed by those poor, Dickensian waifs at Boeing, who would be bereft without the support of the Export-Import Bank. Then we have the plucky upstarts at Northrop Grumman, General Dynamics, and Raytheon. And, lest Wall Street feel left out, Cerberus Capital Management comes in at No. 11. Deloitte, Rolls-Royce, and our friends at the Kuwait Petroleum Corporation all make the list — because federal spending is all about Main Street, albeit Main Street in Abu Dhabi, where the national oil company does nearly $2 billion a year in business as a federal contractor. 

That’s a non-issue if your argument is that Uncle Stupid needs to build a spur on I-35 because it is having trouble getting trucks to Fort Sam Houston, or if you believe that it should buy its oil from whoever has the best price. Jim Bob’s Mom-and-Pop Interstate Highways, Aircraft Carriers, and Bait Shop (“No Job Too Small!”) is not a thing that exists.

But that is a big, hairy Gordian knot of an issue if your argument is that infrastructure spending, and other federal project outlays, are a desirable form of economic stimulus in and of themselves. If the latter is your argument, then you have to believe something far stronger than even the cartoon trickle-down version of supply-side tax cuts: You have to believe that having the federal government literally write enormous checks to gigantic international conglomerates and the rich guys who own and operate them will create prosperity by, forgive me for noticing, trickling down through the economy to the guys who spread asphalt and the guys who sell those guys work boots and burritos and bass boats. “Deep voodoo,” as Paul Krugman would put it in another context.

Inevitably, there are federal rules setting aside a portion of contracts and subcontracts — 23 percent, in fact — for small businesses. This works about as well as you’d expect: Large firms simply organize subsidiaries or make other arrangements to meet small-business rules — which are pretty flexible to begin with — or they fraudulently misrepresent themselves. And so “small business” awards to go firms with 150 employees and $400 million a year in revenue — or, in some cases, a hell of a lot more. By the American Small Business League’s count, 16 of the top 100 small-business contractors in 2013 were actually small businesses. It finds that many small-business contracts are in effect awarded to Apple, Bank of America, PepsiCo, General Electric, and all the usual suspects, through arrangements that made small businesses the names on the contracts while the majority of the revenues went to Fortune 500 companies.

But still, might this stimulate the economy, create jobs, raise wages? There is reason to be skeptical about that proposition. Under the Recovery Act, stimulus spending went to doomed firms such as Solyndra, Evergreen Solar, and SpectraWatt, all of which took the money and ran into bankruptcy. The Export-Import Bank’s defenders make a very conventional case that its subsidies stimulate the economy, but there is no evidence that they do. Even hard infrastructure projects are not always obviously good ideas: roads to nowhere, bridges to nowhere. Such projects likely are net losses for the economy once everything is accounted for: the opportunity cost of the labor and capital that went into them, their effect on the debt and interest expenses, long-term maintenance costs, etc.

If the federal government needs a nuclear submarine or an upgraded computer system, so be it. (Although maybe not the kind of information technology that the stimulus bill bought for the Veterans Administration.) But if you think that dumping another billion dollars into the pockets of General Electric or Raytheon is going to produce trickle-down prosperity for the general public, you’re subscribing to an economic theory that makes Arthur Laffer look like Chairman Mao.