Keynes's Law That Marginal Propensity to Save Increases with Income Is False, Thus Invalidating the Justification for Highly Progressive Income Taxes

Friedman wasn't the only one who cast doubts on Keynes's theories. He verified Simon Kuznets's studies at NBER denying Keynes's "psychological law" that the "marginal propensity to save" increases with income, at least on a countrywide level. Kuznets, who later won a Nobel Prize, showed that since 1899 the percentage of income saved has remained steady despite a substantial rise in real income. This discovery was all the more important because the Keynesians used the idea of an increasing propensity to save by the wealthy to justify highly progressive income and estate taxes as a way to encourage a high-consumption society and avoid stagnation. According to the Keynesians, consumption was the key stimulant to short-term economic performance and progressive taxation would raise a country's propensity to consume. Now, under the weight of historical evidence, the Keynesian prescription appeared impotent.

--Mark Skousen, Vienna and Chicago: Friends or Foes? A Tale of Two Schools of Free-Market Economics (Washington, DC: Regnery Publishing, 2016), Kobo e-book.

The Keynesian Consumption Function Is Fundamentally Flawed and the Expenditure Multiplier Is Closer to 1 Than the Textbook Version of 4 or 5

Friedman demonstrated that the Keynesian consumption function did not fit the historical evidence. Crucial to the Keynesian case for increased government spending to bring about full employment is the consumption function--the notion that there is a stable short-term relationship between household consumption spending and household current income. According to the Keynesian model, government spending would increase household incomes through a leveraged multiplier effect. However, using a massive study of consumption data in the United States, Friedman showed that households adjust their expenditures only according to long-term or permanent income changes, and pay little attention to transitory patterns. Therefore, the Keynesian consumption function was fundamentally flawed and any leveraging of government expenditures through the multiplier would be much smaller than expected. Friedman's diligent and comprehensive work set a new high standard of empirical scholarship, and later research by Franco Modigliani, James Tobin, and other Keynesians confirmed this "life-cycle" or "permanent income" hypothesis of consumption. Further studies over the years validated Friedman's conclusion that the expenditure multiplier is closer to 1 than the textbook version of 4 or 5.

--Mark Skousen, Vienna and Chicago: Friends or Foes? A Tale of Two Schools of Free-Market Economics (Washington, DC: Regnery Publishing, 2016), Kobo e-book.

According to Menger, Income Is Not Distributed; It Is Produced

The Marginalist Revolution solved another quagmire in economic theory: Menger taught a new generation of economists that production and distribution could once again be linked together. The demand of consumers ultimately determines the final prices of consumer goods, which in turn sets the direction for productive activity. Final demand establishes the prices of the cooperative factors of production--wages, rents, and profits--according to the value they add to the production process. In short, income is not distributed, it is produced, according to the value added by each participant. Under this new brand of microeconomics, profits and use are directly connected through their marginal utility. Prices reflect the consumer's most highly valued (marginal) utility, and profit-driven production seeks to meet those needs.

--Mark Skousen, Vienna and Chicago: Friends or Foes? A Tale of Two Schools of Free-Market Economics (Washington, DC: Regnery Publishing, 2016), Kobo e-book.