Economics can be made very complicated, but there are some fundamentally basic principles that dominate how an economy functions. We are currently in a relatively simple economic circumstance that requires a recession, which is why we are in one. Here is the reality: incomes for the very rich are soaring, incomes for the vast majority are stagnant. The stock market is struggling and nearly stagnant for a decade. Interest rates are near zero and actually negative in real terms. High unemployment, poor sales, and almost no investment. These all fit together in a simple process of understanding how an economy functions. The economy has too much savings and not enough spending and the reasons are rather easy to understand.
An economy functions through the flow of monetary income. When income is earned the recipients first pay taxes, then decide between spending and savings. After-tax income is either spent or saved, and an influential factor in partitioning income between spending and saving is the interest rate offered on saving by banks. Higher interest rates result in greater savings and less spending; lower interest rates result in greater spending and less saving.
What we are seeing now defies that: interest rates are near zero with very low spending. There is a simple explanation for this. In the current circumstance it is readily obvious that there is an excess of savings and a lack of spending that has trapped the economy in a lull. And the equally obvious source of this imbalance is that income recipients are over-saving and under-spending.
The reason for an excess of savings over spending is that excessive income is directed toward higher income recipients. It is a natural empirical fact that low-income people spend nearly all of their income and save very little, while high-income people save nearly all of their income and spend very little. Even though the ostentatious spending of the very rich may be appalling, they still spend only a small proportion of their vast income. Thus when the wealthy within an economy gain an excess share of the income, it will naturally lead to a recession because of insufficient spending and excess saving.
There is only one way out of this trap: income has to be diverted from the wealthy and directed towards the working masses who will then spend this income to regenerate the economy. There is no alternative, as long as income primarily goes to those who save it, there will be insufficient spending to sustain the economy.
Thus as part of its structural role in balancing the economy, the government can increase income taxes on the wealthy and divert it to spending on infrastructure. This tends to reestablish the healthy balance of the economy: interest rates rise and income recipients increase in number and spending. Income tax increases on the wealthy serve a two-fold benefit on the economy. First, the direct taxation and spending itself reduces savings and increases spending, but second, the wealthy become far more productive in their use of their income in order to offset the taxes. Given a choice between declaring a dividend that is taxable, they invest in their business to avoid that taxation. This investment in their businesses results almost directly in greater spending as employees are hired and assets are purchased.
The reality is that neither the wealthy nor the great mass of people make progress when the economy is trapped in this lull. The infrastructure crumbles and the productivity of the economy begins to fall. Meanwhile, the wealthy have no incentive to put their income to productive use, they just save it. When taxes increase on the wealthy, one response of the wealthy is to make more productive use of their income. When the economy begins to pick up, the wealthy gain by their ownership of stocks and assets.
Every economy has to balance spending and saving, there is no choice. In fact, one can easily predict that lacking sufficient income taxes on the wealthy, the economy will drift into a trap where excessive saving results in insufficient spending to power the economy. This is why the tax cuts of the 1920s inevitably ended up collapsing the economy into the Great Depression. It is also why most non-democratic countries consist of wealthy dictators and impoverished populations.
On the other hand excessive taxation on the wealthy typically has few ill effects because as spending increases the need for business investment results in the wealthy employing increasing numbers of assets that increase their wealth without producing income: they own investments instead of income. This is why the high taxes of the 1930s brought the country out of the depression: taxes reached 90 percent at high income levels. In fact, the boom at the beginning of the "roaring" 1920s was partly because the income tax applied only to the very wealthy and thus productive assets were put to use by the wealthy.
Where high taxation does have ill effects is when it results in excessive spending and insufficient saving. This can sometimes occur in a booming economy: there is insufficient savings to provide sufficient loans to business and high interest rates stifle new investment. Government spending is often a problem in such a boom by using resources needed by the private economy. The solution to this problem, in a booming economy with high interest rates, is to reduce government spending and cut income taxes on the wealthy so that their after-tax income goes to increasing savings that furthers the growth of the private economy.
Thus there is a simple general rule for keeping a vibrant economy: when the economy stagnates and interest rates fall, it means too much savings and not enough spending that requires an income tax increase on the wealthy; but when the economy booms but interest rates rise to exorbitant levels, there is insufficient savings and an income tax cut on the wealthy is needed.
Fortunately: when the economy is booming there is less need for government services and spending, so income taxes and government services can afford to be cut; but when the economy is struggling the government needs to increase spending to provide stability and needed services while the economy recovers and an income tax increase is needed to accomplish this.
The private sector benefits in both circumstances: the reason the stock market is struggling over the past decade is that this marvelous economic engine has insufficient spending to sustain it. A large income tax increase on the wealthy with an increase in spending on infrastructure will radically increase the ability of the private sector to conduct business and the stock market will rise with the economic resurgence. Eventually as the economy reaches a vibrant booming level, it will be necessary to lower income taxes on the wealthy to keep the boom growing.
Eventually a large income tax increase on the wealthy will happen, it just depends on how much suffering will occur before the public demands it. I remember an economic professor who said that people will always act rationally, but only after they have exhausted every other alternative. A large income tax increase on the wealthy is recognized by some of the wealthy as the only thing that will get the economy booming again. When that happens, the stock market will rise, jobs will be created, and the American dream will continue.