The Great Supply Side Economic Experiment (Again)

January 4, 2018

Love him or loath him Trump’s tax package is yet another supply side economic experiment.  All other supply side experiments have ended quite well.  Both JFK in the early 1960s and Ronald Reagan in the early and mid 1980s slashed personal tax rates across the income spectrum and especially at the highest tax brackets.  The economy boomed in both cases.  There are many other examples.

 

Trump is doing for the corporation what JFK and Reagan did for the personal side.  And, at the same time, he is slashing onerous regulation.  Regulation is necessary, but regulation is cost.  Excess regulation is excess cost. 

 

It is important to understand that corporations do not pay tax.  Human beings pay tax.  Change in corporate tax affects human beings.  There are three groups of human beings associated with every corporation: owners, employees, and customers.  If rates go up or down, or if the rules change, at least one of the three groups is affected.  If tax rates increase and owners refuse to take less, either prices go up or expenses – labour is the greatest expense in any corporation – are cut.  In this example either customers or employees, or a combination of the two, are paying for the rate increase.  If this describes the company you work for, you may want to dust off your resume after a corporate tax rate increase.

 

Will the economy boom?  I believe yes.  The simple arithmetic is compelling.  Economics happens on the margins.  This means that all don’t need to alter behaviour to achieve positive or negative economic change.  An example helps.  Let’s say there are 10 people 60 years old and each earns $200,000.  The government decides to raise marginal tax rates by 10 percentage points on those earning $100,000 or more.  Each of the 10 now pays $10,000 (($200k- $100k) x 10%) more tax per year.  Two of the 10 decide to speed up retirement from 65 to 60.  There were many factors in this decision, but one factor is work for these 10 individuals became 10 percentage points more expensive.  The flip side is leisure time became 10 percentage points less expensive.  They lose less by not working.  Government revenue increases by 8 x $10,000 from the tax hike but is lowered by the tax not paid by the two retiring individuals.  The revenue from the two could plummet.  It depends on their income in retirement.  The tax rate increase changed the behaviour of two individuals.  Economics happens on the margin.  Eight of the 10 did not alter behaviour and two of the 10 did and it is difficult to determine whether the government achieved its goal of raising revenue.

 

Companies are constantly evaluating projects and new lines of business.  The evaluation phase is a stringent cost / benefit analysis.  Let’s say projects A, B, C, pass the cost / benefit analysis and are ordered by expected profitability, or best to worst.  Projects D, E, and F fail and are ordered from best to worse.  The government cuts corporate tax rates.  Instantly, and because of this one factor, project D may now pass the cost / benefit analysis.  If tax cuts spur some D projects to proceed, economic activity is happening to the positive from the tax cut.

 

A reduction in regulatory cost works the same as a tax cut.  More D projects pass the cost / benefit analysis.

 

The Trump administration has cut both regulatory costs and tax rates on the corporation.  This will be derided by many as "trickle down economics".  I've got news for these people.  All economic systems (that work) are trickle down.  Money trickles down from the talented and industrious to the dull and indolent.  Sorry, that is just the way it is. 

 

Yet another supply-side economic experiment that will end well: just like the others.

 

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