AR House 46: Two Daves Unsurprisingly Not Better Than One

84

I don’t know the exact number of times I’ve listened to Dave Elswick’s show, but it is certainly less than ten. Which is to say that Elswick has had a guest I was interested in hearing fewer than ten times, as there is no way I would listen to that show just to hear the host bloviate about topics on which he has no clue. (See, generally, everything.) Monday was no exception, in that I tuned in only because I knew BHR whipping boy David Meeks was going to be on, and I wanted to hear what obviously-lifted-from-a-conservative-website ideas he would put out there.

Rather than leave such things to chance, however, I decided to email Elswick ahead of time to offer some suggestions for show topics. I wrote:

Mr. Elswick,

I heard that David Meeks will be on your show today. I hope that you can ask him to explain his alternative “solutions” to the health care problem that would obviate the need for the health care reform bill entirely. Additionally, if time permits, I would be curious to hear why he thinks that “cutting spending” (without explaining what spending he would cut or offering any plan of substance) is a better answer than decades of evidence supporting the Keynesian economic theory that governments should spend in down economies and save in good economies.

Thank you,
Matt

Elswick replied promptly:

Thanks Matt….however the only evidence I’ve seen backing Keynesian theory are [sic] [from] those sold on it’s [sic] philosophy. There are just as many economists who believe quite the opposite of Keynesians. I’ll ask about the state budget and cuts there.

Dave

And I replied:

I appreciate the response. I happen to think that the evidence for Keynesian theory is far more extensive than that, but we’ll have to agree to disagree there, I suppose.1

As for Meeks, another question that I haven’t seen him realistically answer is how he intends to create jobs — any jobs — while simultaneously cutting government spending.

Well, it must have been a slow day for finding things to ask Davey about because Elswick wasted no time in going right to my questions. I’m paraphrasing here, but Elswick told Davey that he’d been reading about the candidate “in the blogs,” which he was able to find because Jason Tolbert at the Tolbert Report had other blogs listed on the side of his. (Note to Elswick: It’s called a “blogroll.”) Elswick then feigned ignorance, pretending like he didn’t know the correct name for Blue Hog Report (“Hog Blue or something?”), but Davey helped him out. Such a nice boy, that Davey. Elswick mentioned that I’d emailed — even got my name right! — and demonstrated that he was unfamiliar with the word “obviate” (“…that would…uh…obliviate the need…”) as he asked Davey the first question regarding health care solutions.

It was right around this point that Davey apparently forgot that he is running for STATE representative and not U.S. Congress, as he proposed removing state-line restrictions on the sale of insurance policies. Even assuming that this is a good plan, Davey would be in no position to effectuate such a change. Then he prattled on about “free market solutions,” again ignoring that there is no such thing as a free market for health care, and he offered insights about how the idea of a “free market solution” illustrated the difference between conservatives and progressives. Personally, I would say that it illustrates the difference between people who understand economics and those who don’t, but whatever.

Always the consummate journalist, Elswick then slipped into his sycophant fanboy costume to ask Davey the second question, prefacing it with “I know you’ll knock this one out of the park” before reading my question about jobs. And, you know what? Elswick was right … as long as we are counting foul balls as “knock[ing]…one out of the park.”

Broadly, Davey’s plan was “cut taxes” because, as a Republican who does not choose to think for himself, he is contractually obligated to say “cut taxes” as a solution to any and all problems that cannot be answered with “10th Amendment.”. More specifically, he suggested that we eliminate the capital gains tax. It’s not enough for Davey that Arkansas is one of only nine states (of the states that levy income taxes) to offer some sort of substantial tax break for capital gains. No, Davey is arguing, in effect, that we should remove all taxes from capital gains and allow companies to realize these profits on investments, which are currently only partially taxed as income, without paying any taxes on that money, which (he says) would encourage businesses to invest more in their business, which in turn (he says) would cause them to hire more people as their companies expanded. Sounds simple enough, right?

Too bad it’s completely wrong.

First of all, it might be helpful to review Arkansas’s capital gains tax structure under Arkansas Code Annotated § 26-51-815. For long-term holdings (greater than one year) that result in a capital gain, 30% of the gain is excluded from being taxed as regular income. With short-term holdings, 100% is subject to tax. Recall that, in Arkansas, $32,600 is the bottom of the highest tax bracket (7%), and it’s hard to fathom that someone who would have much in the way of capital gains would not already have $32,600 in net income, so it’s safe to assume long-term capital gains are basically 7% of 70% of the amount (i.e. $4.90 per $100 gain). If a person were to calculate the effective capital gains tax, however, it would be even lower than this number due to factors like, inter alia, the advantages from deferring the capital gains realization until some point in the future.

Keeping that additional $4.90 per taxable $100 in capital gains is hardly a windfall for a company; the tax savings on $100 wouldn’t even cover one hour’s wages for a minimum wage employee. Even if we were to buy the incredibly specious argument that every dollar saved by eliminating the capital gains tax would be re-invested into labor, it would take $128 in gross capital gains for the tax savings to cover that one additional minimum-wage hour. Assuming we are trying to create full-time jobs, and without even accounting for employee benefits, an employer would have to realize $1,024 in capital gains for the tax savings to cover a single day of minimum wage labor. Want the tax savings to cover that worker for a whole work week? $5120 will get you there. A full year of labor? $266,240.

So, basically, Davey’s plan is to create four new minimum wage jobs for every MILLION DOLLARS in capital gains that a company makes, assuming they put 100% of their new-found tax savings back into the company in the form of additional labor. I can see the unemployment line shrinking already.

The relatively small amount of tax that Arkansas’s capital gains scheme imposes, however, is not the only reason why Davey’s plan is flawed. No, his mistake is much broader than that. Extensive research shows little to no connection between capital-gains rate changes and economic growth, especially long-term economic growth. The Congressional Budget Office has explained why this is so:

The sensitivity of realizations to gains tax rates raises the possibility that a cut in the rate could so increase realizations that revenue from capital gains taxes might rise as a consequence. Rising gains receipts in response to a rate cut are most likely to occur in the short run.

Postponing or advancing realizations by a year is relatively easy compared with doing so over much longer periods. In addition, a stock of accumulated gains may be realized shortly after the rate is cut, but once that accumulation is “unlocked,” the stock of accrued gains is smaller and realizations cannot continue at as fast a rate as they did initially. Thus, even though the responsiveness of realizations to a tax cut may not be enough to produce additional receipts over a long period, it may do so over a few years. The potentially large difference between the long- and short-term sensitivity of realizations to tax rates can mislead observers into assuming a greater permanent responsiveness than actually exists.

Because of the other influences on realizations, the relationship between them and tax rates can be hard to detect and easy to confuse with other phenomena. For example, a number of observers have attributed the rapid rise in realizations in the late 1990s to the 1997 cut in capital gains tax rates. But the 45 percent increase in realizations in 1996–before the cut–exceeded the 40 percent and 25 percent increases in 1997 and 1998 that followed it. Careful studies have failed to agree on how responsive gains realizations are to changes in tax rates, with estimates of that responsiveness varying widely.

(emphases added)

This is not mere theory: historical evidence bears it out, at least on a federal level. In November 1978, the top rate for capital gains was cut from 39% to 28%. From November 1977 to November 1978, the economy had grown 5.8%; in the next eighteen months, it fell one percentage point.

In August 1981, the rate was again cut from 28% to 20%. From August 1980 to August 1981, the economy had grown by 3.5%; From August 1981 to August 1982, it fell by 2.8%. Now, I am not the type of person who buys monocausation of phenomena on a macro level, so I fully grant the possibility that other factors could have been at play here. That said, Meeks and Co. like to argue that tax cuts/low taxes are overwhelmingly what drive business. If, however, some other factors can undermine this driving force of tax cuts qua business octane, then it seems pretty silly to suggest that tax cuts are the end-all, be-all, and should be adopted without looking at the other possible factors. (Which I guarantee you Meeks has not done.)

Besides, there is also evidence that capital gains increases have a positive effect on the economy. The tax was was raised in 1976, and economic growth jumped up from 3.6% in the previous two years to 5.2% in the next two years. Capital gains were also raised in 1986, undoing the August 1981 cuts and restoring the level from 20% to 28%, and economic growth rose from 2.2% in the previous twelve months to 3.8% over the next twenty-four months. Again, even if we reject the monocausal explanation, such movement suggests strongly that cutting the capital gains tax does nothing to improve the economy and, in fact, may hurt it.

Also, since Meeks offered this plan in response to my jobs question, I note that the effect of capital gains tax changes on unemployment is even more surprising. The unemployment rate rose after both the 1978 and 1981 capital gains tax cuts, yet it fell significantly after the 1976 and 1986 capital gains tax increases were passed.

Why don’t cuts in capital gains taxes lead to longterm growth? For a number of reasons, from the fact that they only go to the wealthiest families who are more likely to save that money in lean economic times rather than reinvest it (the primary observable failure of trickle-down economics), to the idea of tax independence (i.e. that as long as the capital gains tax isn’t 100%, businesses are going to make the same decisions regarding hiring and expanding regardless of the capital gains tax because some percentage is better than $0). Yet, for whatever reason, Republicans continue to ignore data, fact, and economic theory in favor of their own misguided, unfounded belief in the infallibility of the free market. Heck, they don’t even listen to people whose only job is to advise the government on the cost/benefit of various proposals. For example,

[i]n 2002, the Congressional Budget Office (CBO) evaluated the stimulative effect that several different approaches to cutting taxes might have. It found that “capital gains tax cuts would provide little fiscal stimulus,” since most of the benefits of such cuts would accrue to high-income households[…]. Indeed, the CBO determined that, of the range of approaches it examined, capital gains tax cuts were among the least effective. Similarly, but more recently, Mark Zandi, the Chief Economist of Moody’s economy.com, examined a set of proposals Congress could adopt to stimulate the economy in the wake of the credit crisis and the developing recession. He found that each dollar spent by the federal government in making President Bush’s dividend and capital gains tax cuts permanent would boost Gross Domestic Product (GDP) by just 38 cents.17 To put that in perspective, Zandi determined that each dollar dedicated to bolstering the food stamp program, extending Unemployment Insurance, or improving public infrastructure would yield over $1.50 in additional GDP.

And it gets even worse. There’s a strong argument to be made that even the 30% break in capital gains taxation that Arkansas gives to taxpayers is hurting the state longterm. In 2008 alone, Arkansas lost $45M in income tax revenue due to that 30% break, and 89% of that lost money stayed in the pockets of the top 5% of Arkansas incomes (73% stayed with the top 1%!). This is the breakdown one would expect in a state where 75% of the tax returns filed have adjusted gross incomes under $50,000 but only 9% of the capital gains reported were from that group. By way of comparison, AGIs over $200,000 accounted for only 2% of the returns filed … and 75% of the capital gains. Looking at the budget problems Arkansas has had over the last two years, can anyone in his right mind really think that an additional $90M wouldn’t have eased that burden a great deal?

Speaking of budget problems, therein lies the last flaw in Davey’s plan. As he likes to point out whenever he thinks it will work as some kind of rhetorical trump card, Arkansas is required to balance its budget. Using the 2008 numbers again, if there were no tax on capital gains whatsoever, Arkansas would have lost an additional $105M, which would have resulted either in further cutting of programs and services or in higher taxes elsewhere. Meeks and his ilk seem to be under the ridiculous impression that cutting taxes and increasing spending don’t have similar effects on the state’s budget. The only reason they ever give is that, with lower taxes, the economy will grow and the money will be made up through higher revenue under existing tax schemes. Except, like with pretty much everything else he ever says regarding economics, this is false. Capital gains tax cuts do not pay for themselves elsewhere. In an article in the Journal of Public Economics, N. Gregory Mankiw — former chairman of President Bush’s Council of Economic Advisers — and Matthew Weinzierl asked, “To what extent does a tax cut pay for itself?” Mankiw and Weinzierl concluded, “In almost all cases, tax cuts are partly self-financing.” Mankiw explained:

Matthew Weinzierl and I estimated that a broad-based income tax cut (applying to both capital and labor income) would recoup only about a quarter of the lost revenue through supply-side growth effects. For a cut in capital income taxes, the feedback is larger–about 50 percent–but still well under 100 percent.

50% payback, of course, also means 50% loss of money that will have to be made up elsewhere.

Look, maybe it’s just me, but, if I were David Meeks, I think I would just stay away from economic arguments altogether. Stick to the “God, Guns, and Gays” rhetoric that has proven successful for Republicans in the South, and leave your easily rebuttable attempts at arguing fiscal policy at the door. Or don’t and continue to give BHR fodder for the dog days of summer blogging. Your choice.

***

1 Actually, I was just being polite with the whole “agree to disagree” thing. Truth is, Elswick has no idea what he is talking about. While there are other minor schools of thought that wax and wane in popularity respective to one another — monetarists, neoclassicals, and laissez faire/Austrian school types primarily — the overwhelming majority of modern economists are some sort of Keynesian. What’s more, Elswick’s assertion that there’s just as much evidence against Keynesianism as there is in favor of it is ridiculous; the last decade has practically been a case study in Keynesian theory and has supported the Keynesian theories with real life proof. One would like to think that Elswick, as a journalist, would put fact above dogma, but one would apparently be mistaken.