Tax Cuts and the Problem of Economic Growth

Caleb Smith
U.S. News /05 Jan 2018

Tax Cuts and the Problem of Economic Growth

It has finally happened. After a prolonged period of political bickering Congress finally adopted the new tax bill. The triumphant Republicans are proclaiming the beginning of a new era and the humbled Democrats are rallying what is left of their loyal following to challenge the Republicans in 2018 and later.

There is no need to go into the details of the new bill since there has been little else that politicians, pundits, and media people have been doing over the past several weeks than to talk in minutest details about the promised benefits, hidden flaws, and outright injuries that the new bill will bring to the American people. Predictably, opinions fall strictly along party lines, and there is plenty of criticism. There are several main lines of criticism. Some argue that the bill benefits the rich and robs the middle class and the poor people of America. Others focus on the fact that the Republican majority has adopted the bill without reaching out to the Democratic minority that threatens a payback when the pendulum swings the other way and the Democrats eventually become the majority. There is no doubt in the minds on the left that this comeback will finally happen but there is no proof nor credible argument to support this claim.

However, in the heat of the debates few, if any, address the main issue in connection with this bill in a rational and analytical manner: Will it work? When asked about their rationale for proposing and adopting this bill, the Republicans make a forceful argument that over the last decade, if not longer, American economy has been very sluggish. At no point it has shown growth rates that would exceed 3%, which, in their view, is unacceptable, especially since many of them, including President Trump, have a strong belief that American might and power, indeed its security, rest on economic growth. They expect the tax cuts to stimulate the economy and make America, in Trump’s catchy sloganeering phrase, “great again.” There have been some isolated voices, mostly among the media people, that have asked the Republican leaders if they are sure that this is what is going to happen. The Republican response has been in the best traditions of American pragmatism: “We cannot know if we do not try.” And that’s where this line of questioning usually ends. Few, if any, venture into the uncharted waters of the future effects of this bill.

One can understand such timidity: there are few hard data and arguments that one can use to make reliable predictions for the future, especially the distant future. However, this fact does not mean that there is no credible basis for making educated predictions about future trends. Many simply do not have such basis for their judgments or do not know how to use it.

The proponents of tax cuts tend to look at the bottom line; and this bottom line is often pragmatic and short-term. Will more money in the economy increase economic activity? It certainly will. Will an increase in economic activity bring more revenues to the government? It probably will. Will this growth lead to more jobs and higher incomes? Perhaps it will. The common thinking behind tax cuts often is that these short-term results are good enough for now and we do not have to worry about what comes next because there is only so far into the future we can see. Yet, the point is that we need a long-term solution to the problem of growth. Each consecutive economic cycle produces more uncertainty and more instability. President Trump has not promised to stimulate the economy for the next couple of years. The tone and passion of his statements intimated that he had in mind a more permanent solution.

So what is the basis to make an informed prediction as to the permanent solution. First of all, there is the past experience. The passing of the new bill is not the first time that our government has enacted major tax cuts. There was a significant tax reduction that went into effect nearly thirty years ago and the long-term effects have been, to put it mildly, unimpressive. A number of economic disasters followed those cuts, including the financial crisis of 2008-2009. But even more importantly, those cuts did not generate economic dynamism. In fact, decades of sluggish economy have followed their adoption and that is what has led to the current bill.

Few have provided an objective and dispassionate analysis of the reasons why the past tax cuts have had these effects. For the most part, proffered analyses have had distinct signs of partisanship. Those who have attempted to provide an objective assessment point to a multiplicity of factors that are just too many to give a definitive solution. But there have been no reflections that have addressed a possibility that there might be something wrong with our economic thinking and the way we run our economy based on this thinking.

The proponents of the tax cuts tend to look away from the experience of the last few decades. This tendency is not a result of ignorance or ideological blinders; rather it is due to the fact that they see no alternatives to the two principal strategies that we have practiced in the post-WWII years: it’s either some kind of a new New Deal or the neoliberal perspective that originated during the presidency of Ronald Reagan that both the Republicans and the Democrats largely followed since the 1980s. Ironically, Democratic critics of tax cuts also do not see any new alternatives. They accept the notion that the time of rapid and dramatic economic expansions has passed and slow incremental growth is all we can expect from our developed economy, provided we distribute the wealth differently from what the Republicans advocate.

The GOP is pinning their future on the tax bill.

There are several important lessons we can learn from our economic experience of the past few decades and we will be fully justified to apply them to the future. We can fully expect that, like the previous tax cuts, the new tax cuts will stimulate technological advances and these advances will undoubtedly bring many benefits. But they will also have a downside effect. Technological advances achieve efficiency and save labor. They tend to put pressure on employment and incomes, particularly in occupations and jobs displaced by these advances. If in the 1980s and 1990s, these technology innovations reduced the number of blue-collar workers in manufacturing, the new surge in technology will threaten even such occupations as lawyers and doctors.

The rapid advancement of technology and science, the wholesale introduction of increasingly sophisticated robots and computers, and now the information and communication revolution are changing our lives. They are displacing human labor from occupations that require performing routine physical and mental tasks. This trend will undoubtedly continue with the new tax cuts. The projected numbers even with the allowance for excess are very telling. According to these numbers, there will be 90% fewer lawyers needed in the not-so-distant future. Computers and new devices will be performing diagnostic tasks that today require medical expertise of highly skilled doctors. There will be self-driving cars delivering goods and passengers to their destinations, 3D printing on order, and much, much else that we cannot even imagine today. All in all, about 70-80% of jobs in existence today will disappear in the next 20 years. Granted these numbers are mere extrapolations that may or may not be precise but the story they tell is still impressive and disturbing. The writing is on the wall but we have to read and understand correctly what it says.

There is little doubt that the new tax bill will make more money available for investment; and investment means growth. The question, however, is: How much growth and for how long? Will this move resolve the problem of growth that has plagued our economy for several decades now or will it be a temporary stopgap before the economy slows down again?

The framers of the bill and everybody else understand very well that the profits from the projected growth will go primarily to investors who will reinvest them into the economy. The anticipated and largely short-term effect will be growth, reinvestment, and increased dynamism of the economy. There will undoubtedly be more computers, more robots, and more automatons. The economy will move more aggressively in the direction of high-tech innovations.

Technological advances are the kind of innovations that tend to save labor. They will increasingly replace human labor in performing routine and even no-so-routine (considering the progress in AI area) manual and mental tasks. As a result more people will be displaced from jobs that require performing such tasks and the displaced people will drift to the low end of the market. Such was the outcome of the previous tax cuts and we have no reason to expect anything different.

Why do they have to move into the low end of the market? We manage our economy largely on the basis of hierarchical interactions. The dominant method of management in our economy has been and remains largely command-control. Command-control operations are fairly simple; they do not require much creativity and can be relatively easily simulated by machines. For this reason, high-tech developments will be well suited for applying machine operations in hierarchical structures, particularly at their lower levels where most currently existent occupations belong to the category of middle-class occupations. The displaced individuals—those who thrived under conditions of command-control management and routine operations—will be ill suited for creative occupations and self-generating types of employment that are in demand today. They will have to accept jobs with lower status and pay or leave the job market altogether. Thus the number of people in the lower end of the market will start once again growing and the number of those at the middle and high end of the market will decline.

This development will have a profound effect on our production. The primary beneficiaries of the projected new growth will be those at the high end of the market. The demand for creative labor will grow and individuals capable of performing such labor will be naturally in short supply and, hence, command high incomes. They will be the primary consumers in this emerging economy and the production will have to cater primarily to their tastes and whims since that is where most of the money is going to be.

Since consumption will concentrate at the high-end of the market, production will also gravitate toward the high end. As production will pursue high-end customers, it will most likely focus on products that should meet the demanding and sophisticated tastes and whims of high paying customers. There will be more exclusive real estate, more extravagant yachts, more private planes, and other luxurious items chasing the increasingly smaller number of customers. Consequently, while the value of produced goods may remain high, the volume of production may very well be declining.

Efficiency is the most fundamental imperative of the marketplace, which means that everything that is produced must be consumed. Given this imperative, we can safely predict that the production in the economy revitalized by tax cuts will tend to gravitate toward the high-end of the market. As a result, the rich will get richer and the poor will get poorer both in relative and absolute terms. Also, since many displaced jobs will be in areas we associate with middle-class occupations, we are likely to see the continued erosion of the middle class. The most immediate effect of this trend will be a greater polarization of our society and social anomie.

However, as bad as this polarization may be, it will not be the only and even the worst effect of the new growth. The gravitation toward the high-end of the market will create a constant negative pressure on the rates of economic growth. Several conspiring factors will be significant in this respect. For one thing, due to the gravitation toward the high end of the market, a significant and constantly growing segment of the population at the low end will play an increasingly limited role in consumption and this factor will significantly constrain the future economic growth. The fundamental problem—the problem of long-term growth—that the current tax cuts purport to solve will remain unresolved and our economy will continue to pursue a perilous course.

Does this problem have a solution? Is it possible for humanity to break out of the current vicious circle and achieve a constant, stable, sustained, or even exponentially increasing economic progress?

Production and consumption are the two most important categories in our economy and economic thinking. They constrain each other and this mutual constraint acts as a limitation on the rate of our economic growth. The typical effect of the expansion of production is the increase in supply. Supply growth results in declining prices. The decline in prices signals that the market is saturated and production must slow down. When production slows down, supply diminishes and prices begin to grow, which triggers a new expansion of production. When production expands, our wealth grows and economy appreciates. Consumption generally depreciates products and thus our wealth declines and our economy depreciates. Thus, production and consumption constrain each other and this constraint limits the rate of our economic growth.

In order to solve this problem and achieve constant growth, we need to constantly rejuvenate our economy, we need to ensure a sustained supply of new products to the market and, moreover, we need to make sure that these products are needed. The main economic problem we face today is precisely in bringing novelties to the marketplace. Many business people, economists, pundits and politicians have stressed that we will have to innovate our way out of the current economic predicament. Therefore, creativity and creation are the key to solving the problem of growth.

However, creativity, or what we call entrepreneurship when we talk about economy, is not a science. We cannot use it in any predictable way. It is a very uncertain and contingent factor that is fraught with many unknowns and surprises. Therefore, the problem of economic growth is reformulated into the problem of how to make innovation constant, predictable, and steady, rather than sporadic and contingent. In other words, how can we control our creativity?

As has already been pointed out, consumption acts as a constraint on production. Production appreciates and consumption depreciates. The tendency of consumption to depreciate our economy is the reason for the existence of limits to rates of economic growth. As one can see, production and consumption are two most essential economic functions. They are mutually dependent, complementary and cannot exist without each other. The problem for achieving constant and sustained growth is that their vectors point in different directions: one toward appreciation and the other toward depreciation. However, do they have to be opposed to each other?

There are two kinds of consumption that we know. One kind of consumption is consumption of final products. Indeed, this kind of consumption always depreciates products. You drive your new car out of the parking lot and it immediately loses value. But this form of consumption is not the only one we know. There is also a form of consumption that appreciates products, for example, consumption of raw materials or semi-finished products. Another interesting case of consumption that appreciates is the consumption of technological devices and machines. Indeed, physical use of such devices and machines depreciates them. However, they also represent certain technological knowledge. Knowledge consumption involves our mind. Mental consumption inevitably involves mediation and, therefore, construction that takes place in our mind. In other words, in order to consume something our mind has to create forms of mediation that allow us to consume this something, or, in other words, we have to produce it in our mind. Our sense organs transmit to our brain electrical signals that the brain interprets. We produce reality and production necessarily involves appreciation. Thus mental consumption involves necessarily the creation of new knowledge and hence appreciation.

The above argument bears one important conclusion that consumption does not necessarily involve depreciation. Consumption can also, like production, be associated with appreciation, particularly consumption that involves mental activity that is associated with production of knowledge, or creation.

We live in the era of knowledge society when knowledge is the main means of production and the principal product. The share of knowledge production by comparison with the production of consumer goods is constantly growing and already begins to outstrip the latter. Since consumption of knowledge, just like its production, is associated with appreciation, the transition to knowledge society suggests that in the modern economy both consumption and production will lead to appreciation and increase in wealth. They do not stand opposed to each other and their balance does not slow down the economy but is the source of its appreciation and constant growth. Balance in this case means that when production grows, so does consumption and both contribute to appreciation of the economy and economic growth. The constraint on the rates of growth disappears and the pace of economic growth can accelerate. The combined effect of growth that comes from production and consumption is double from what it is in our current economy. In other words, economic growth becomes exponential and limitless: as production increases, so does consumption, and more consumption leads to greater appreciation and greater wealth.

This infinite and exponential economic growth is not only possible, but is, in fact, essential. Without such growth our civilization simply cannot exist. Our civilization is essentially a dissipative system that constantly generates entropy. As soon as this system ceases to create new levels and forms of organization, it begins to deplete available resources. The only way it can sustain itself indefinitely is by constantly redefining itself in ways that allow us to capture new flows of energy and resources; and where there are new flows of energy and resources, work can be performed. It is our destiny to play this catch-up game, and the only way we can play it indefinitely is by constantly creating new levels and forms of organization of reality so as to maintain the overall entropy level at zero. There is no way for our civilization to go back to less powerful levels of organization of social production, as advocated by the adepts of de-growth, or even to maintain the same level of production organization (steady-state economy). Limits to growth or de-growth are not ultimately realistic possibilities. Our civilization can only move forward. If we decide to terminate the progress of our civilization, we will embark on the path that leads only to its eventual disintegration and disappearance—an option that even supporters of limits to growth or de-growth do not want to entertain.

Creation, true creation, generates new and more powerful levels of organization. When we create new and more powerful levels of organization of reality consumption and production are not opposed to and do not constrain each other. On the contrary, they complement and enhance each other. Therefore, if we make the process of creation central to our economic production, we will solve the problem of growth. How can we make the process of creation central to our economic production?

Horizontal (non-hierarchical) interactions are the source of creation. In the course of such interactions equal agents combine their differences and create new levels of organization. Combinations of differences expand the range of possibilities to which all and every agent involved in these interactions has access and, therefore, they represent a more powerful level of organization than that possessed by each individual or the sum total of possibilities that they possess as a group.

The emergence of new and more powerful levels of organization creates hierarchies that conserve and optimize what non-hierarchical interactions have created. Without hierarchical interactions, new and more powerful levels created by non-hierarchical interactions cannot be preserved. Thus both types of interactions—hierarchical and non-hierarchical—play an essential role in the process of creation.

Because the two types of interactions play an equally important role in the process of creation, they should be in balance. The process of creation vitally depends on this balance. The domination of one or the other type of interactions disrupts the process of creation and hinders its operation, if not indeed makes it impossible. If non-hierarchical interactions are dominant, the new and more powerful levels of organization they create cannot be conserved or optimized. The domination of hierarchical interactions makes the emergence of new and more powerful levels of organization difficult, if not indeed impossible.

At the present time hierarchies are the dominant force in our civilization and hierarchical interactions prevail in our social practice. This domination hinders our capacity to create and, as a result, acts of creation are sporadic and unsystematic; we cannot be certain if we will create innovations that will help us resolve problems that emerge in our civilization, including our economic problems, like, for example, the problem of growth. This is not to say that creative acts do not occur in our civilization. They most certainly do. But they do not occur because our social practice fosters them; rather they occur despite this practice.

In order to sustain the process of creation, make it systematic and predictable so that we could rely on it, we have to change our social practice in the way that would balance hierarchical and non-hierarchical interactions. Some practitioners and theoreticians in the field of management and organization are beginning to realize the necessity of such change, but we need to start a more systematic exploration of this important subject and engage in bolder experiments that would aim at advancing us toward this goal.

The current tax cuts will make more money available for investment and that will certainly result in some growth. However, as the preceding discussion suggests, by themselves tax cuts will not resolve the problem of growth. Indeed, they will most likely result in a short period of expansion of production, but more likely than not, this expansion will be followed by a new cycle of contraction that can be longer and more devastating than even the current one. The tax cuts adopted by Congress and new investments must necessarily involve fundamental changes in the way we run our economy and, in a broader sense, they should involve changes in our social and managerial practices.

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