Keynesians talk about a drop in aggregate demand as a big problem in the economy. Okay fine, we’ll stipulate that this is an accurate description of at least some downturns. It’s the prescription—government spending—that is the problem.
But then, there’s an even simpler way of looking at this. If aggregate demand is too low, could it possibly be that government is taking too much money?
Forget the rich—this is the middle class we’re talking about:
A middle-class taxpayer’s income is subject to a 25 percent federal income tax. Then there is the federal Social Security and Medicare payroll tax of 13.3 percent in 2012—5.65 percent of that is removed from the employee’s paycheck, and the remaining 7.65 percent is paid by the employer. (In reality, the employee pays the entire 13.3 percent, because the employer’s portion of the tax does not affect the cost of labor: The employer would pay the employee 7.65 percent more if there were no employer’s portion of the payroll tax.)
So the 25 percent federal income tax plus 13.3 Social Security and Medicare payroll taxes equals 38.3 percent going to federal taxes in 2012.
And then there are state taxes. According to the Tax Foundation, the average state’s income tax rate for the middle-class taxpayer is 4.82 percent, which brings the total to 43.12 percent in federal and state taxes. And it’s going higher, thanks to the nearly $500 billion in tax increases for 2013 that some have called Taxmageddon. In January of next year, the federal income tax rate for middle-class taxpayers is scheduled to rise from 25 percent to 28 percent, and the payroll tax is scheduled to rise from 13.3 percent to 15.3 percent. This drives the marginal tax rate based on the aforementioned three taxes to 48.12 percent. Add in state and local property, corporate, excise, and other state and local taxes, and the percentage of each additional dollar that is taxed hovers around 50 percent.
If you want spending to “prime the pump,” maybe stop taking 50% of people’s stuff. Don’t you think people would spend more if they had more of their money to spend, whether it be on goods and services or on expanding businesses or investments?
Another concern is deleveraging. But here again, the prescription is the same. If people can keep more of the money, they won’t go into hock as easily, and so there’s less need for deleveraging. Beyond that, let’s say that we’re already in a situation where deleveraging is necessary and occurring in widespread fashion (which is exactly where we are now, by the way). Here again, letting people keep more of their money will allow them to delverage faster, which will end the pain faster.
No matter how you slice it, the answer is the same: lower taxes.