Tax Breaks for the Wealthy Do Boost Economy

Once again, tax policy is playing a central role in the election campaigns across the country. While almost all politicians appear to favor the extension of tax cuts for low- and middle-income households, a political fight has erupted over the fate of the top income tax bracket rate and the tax rate on dividends and capital gains. A host of arguments has been heard--some sensible and some less so. One particularly troubling idea that has emerged is summed up by a recent statement by President Obama, who argued, "These [high-income taxpayers] are folks who are less likely to spend the money, which is why economists don't think tax breaks for the wealthy would do much to boost the economy."

This increasingly popular narrative is based on the troubling implication that the only way to positively impact the economy is through changes in consumer spending. While this simplistic theory would strike any Economics 101 student as preposterous, the behavior of Washington in recent years aligns with this sentiment. It is alarming that the President and so many other politicians in Washington are disparaging saving. But Washington's culture of spending ever-increasing amounts of borrowed funds without any serious strategy to tackle our unsustainable fiscal outlook is reflected in political rhetoric that encourages our middle-class families to spend more, more and more. And the government's extensive web of safety-net programs leaves most families feeling little need to build their own rainy day fund or retirement nest egg. Lost is a culture of thrift, both in Washington and across the households of our country.

Deemphasizing the importance of saving--whether through taxing the returns to saving or through rhetoric that suggests that economic prosperity will result from more consumption--is dangerous.

Saving is not the practice of the wealthy stashing money under plump mattresses. Rather, when we save, we defer consumption to the future, allowing our savings to be invested in productive ways that lead to long-term economic growth. In short, my savings account is your investment fund. Our collective savings are the funds available for investing in stocks, bonds and other securities that allow businesses access to the capital they need to grow. Firms use these funds to start or expand businesses and to buy machinery and other physical capital.

The logic espoused by this spending-cult mentality denies the role of saving, or, at the very least, relegates it to the backseat. It also belittles the virtue of thrift. Future living standards depend in large part on the willingness of the current generation to save for the future. And the willingness of individuals across the income and demographic spectrums to save depends on the value placed on self-reliance and personal responsibility. Deemphasizing the importance of saving--whether through taxing the returns to saving or through rhetoric that suggests that economic prosperity will result from more consumption--is dangerous. Long-term, sustainable economic growth--the kind that comes from businesses and individuals saving, investing, hiring workers and growing businesses--must not be discarded in favor of increased consumer spending.

Because much of the savings that can drive investment and economic growth over time comes from the relatively small fraction of individuals in the top income tax bracket, permitting a tax increase on high-income earners would be a significant disincentive for savings. Our colleague Alan Viard recently cited Internal Revenue Service data for 2007 revealing that households with incomes above $200,000 received 47% of the taxable interest income, 60% of the dividends and a staggering 84% of the net capital gains reported on tax returns.

When Congress returns to Washington for the scheduled lame-duck session they may finally address the looming tax increases scheduled to take effect on Jan. 1, 2011. This decision will affect not only the near-term outlook for the economy but savings and investment decisions for the long-run as well. Consumer spending has its place, but it is not the answer to every economic question. By disparaging investment and in particular the taxpayers who account for most of that investment, Congress is biting the hand that feeds long-run economic growth.

Alex Brill is a research fellow and Chad Hill is a Jacobs Associate at AEI.

Photo Credit:iStockphoto/Brandon Rose

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