The Genius of Capitalism and the Tax Cut Debate
Capitalism is based on the theory that given adequate financial incentives to produce, human ingenuity is capable of coming up with almost everything. You can see a good example of the truth of this, I think, in America’s long-standing debate over whether or not reducing taxes on rich people is a good idea. Rich people, by definition, have a lot of money. Consequently there’s an enormous quantity of direct and indirect demand for policy ideas that serve their interests and flatter their prejudices. And much as theory would predict, recent years have seen an enormous blossoming of arguments about why rich people should pay less in taxes.
There’s a certain beginner’s level of this. Here, when progressive tax policy has been in place during a period of growth, and that growth has led to a budget surplus, you argue not that it’s smart to balance the budget over the course of the business cycle, but rather that the surplus reflects the government “overcharging” in taxes that should be returned to those who pay the most taxes; which is to say to those who have the most money; which is to say to the rich. That’s a 1999 argument. Then if the economy falls into recession wiping out the surpluses, you argue that a tax cut for the rich is needed as economic stimulus. That’s a 2001 argument. And if the economy is growing during a period of conservative tax policy, you argue that the low taxes produced the growth so need to be kept in place forever. That’s a 2005 argument. And then if the economy falls into recession again, you argue that additional permanent tax cuts for the wealthy are the only solution.
Ta-da! That’s a little business cycle mojo.
But true artists can come up with more innovative arguments. On Friday, for example, I heard someone say that the reason it’s important to cut taxes on rich people is that economic growth comes from people starting new businesses and most new businesses are financed by borrowing money from family—a rich uncle, for example. Therefore, the richer our rich uncles get, the better off the rest of us will be. After all, we can hit them up for loans!
29 Responses to “The Genius of Capitalism and the Tax Cut Debate”
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March 2nd, 2009 at 8:54 am
An excellent choice to use Scrooge McDuck, the rich uncle who would never divest as much as a nickel to a relative. A man who worships money. A modern investment banker or hedge fund operator.
March 2nd, 2009 at 9:01 am
Very true, Matt.
Recall, however, that what you characterize as a 1999 argument was actually used in 2001, pretty much right up to the time that the tax cut passed congress. Very shortly thereafter new economic projections called into doubt the magnitude of supposed overcollection, and the switch to what you characterize as a 2001 argument took place seamlessly in a short period of time.
March 2nd, 2009 at 9:01 am
An important insight! When conservatives talk of the redistributive, egalitarian virtues of the market, they are thinking of a rich uncle loaning money to his nephew.
March 2nd, 2009 at 9:14 am
The investment theory of stimulus is just wrong in so many ways.
1. It’s rooted in the long-discredited Say’s Law: that demand is driven by supply. Produce more, and people will buy more. Huh?
2. It assumes that investment is what’s preventing businesses from expanding. Ask any businessperson today: are you just waiting for someone to lend you money so you can hire more people and build production capacity? If they did so, would you? Get real.
A company called Grant Thornton runs an annual survey of privately held businesses worldwide, asking them among other things what constrains their growth.
In 2007, only 9% of privately-held U.S. businesses cited a “shortage of long-term finance” as a constraint on expansion.
These privately-held businesses are exactly the hotbeds of innovation and entrepreneurship that supply-siders love to crow about. (I know about these, I’ve been an equity partner and/or principal in four privately-held startups, all started on a shoestring, and all of which eventually sold, for a total of tens of millions of dollars.)
The problem for these companies is not on the supply side. (Except supply of labor: 34% cited shortage of skilled workers as a constraint. Think: education.) It’s on the demand side.
March 2nd, 2009 at 9:19 am
A few Democrats should be arguing for raising taxes on the very wealthy back to 70 percent or so – what they were before the early 1960s. And then let President Obama push the compromise position of raising taxes just a bit.
March 2nd, 2009 at 9:23 am
The progressive business cycles is no less asinine:
1) In a boom period argue for more entitlements because the rich can afford to share
2) In a depression argue for more entitlements because it’s stimulus dammit!
It is one thing to call fiscal conservatives unprincipled scum who are driven more by ideology than logic but to call them this when you do exactly the same thing?
March 2nd, 2009 at 9:41 am
@ Gordon Gecko
I haven’t heard anynone talk about increasing entitlements as part of the stimulus discussion. Are SS or Medicare or VA benefits being expanded? I think you meant to say that government spending will be increased to provide a stimulus to the economy. Now, stimulus spending, by definition, should be short term. Unfortunately, some of the spending in the stimulus bill is not really short term and should never have been included in this bill. However, they are not increases in entitlements.
March 2nd, 2009 at 9:42 am
There can be no doubt that a huge portion of the investments made by those who got tax breaks under Bush were bad investments. Just as you can lead a horse to water but can’t make him drink you can give someone a tax cut but you can’t make them invest it wisely. The investments that those tax cuts went to were entirely in financial assets that of course inflated. Since there was so much money looking for a place to go Wall Street couldn’t create enough collateralized debt obligations and credit default swaps to meet the demand. No matter the that the mortgages underlying the MBS’s were crap the money poured into buying them, thus encouraging the hunt for every more home buyers to fill the demand for paper.
Need I point out that a home has zero productive value. It produces no cash flow. Nobody cared about that however because of course home prices were going to continue to inflate forever and give capital gains. Which is all a vision of capitalism and markets which is totally divorced from Adam Smith or really any traditional concept of what investment is.
All the tax cut engendered investment gains have been wiped out and now the markets are taking out the principal. And that’s just looking at it from the tax cut beneficiaries. From the Treasuries point of view it has already payed out in the bailouts at least three hundred percent over the amount it didn’t collect. The Bush tax cuts today have probably now porduced a negative return in the macro sense of at least 400%. A 400% disinvestment. I am pretty sure it will reach at least 1000%.
March 2nd, 2009 at 10:01 am
The first thing I thought of when reading this post was a Central European saying. When a child keeps demanding something rather expensive, a parent will often say, “Who’s going to pay for it? Your rich uncle in America?”
Sounds like someone at your conference heard that as a child and took it as a serious policy proposal.
March 2nd, 2009 at 10:04 am
This reasoning is common on the right. I’ve heard them say we should give drug firms monopoly profits on the premise that they will use the proceeds to fund R&D.
As any economist will tell you, excess profits don’t prompt generosity. People invest in the enterprises that promise the best returns. If your small business promises a high return, Rich Uncle Skeleton will send his money in your direction.
March 2nd, 2009 at 10:19 am
We should heavily tax the incomes of the rich for the same reason we heavily tax their estates: to prevent the generational accumulation of staggering wealth that leads to a politically powerful overclass (aristocracy).
And it recycles that money directly back into the economy. Unlike the rich, the government doesn’t hoard, it spends.
March 2nd, 2009 at 10:22 am
Colonel Danite,
87 billion of the stimulus funds are allocated for medicaid alone. If this was not an increase, entitlements wouldn’t be growing faster than inflation or disproportionate to GDP.
But it goes beyond entitlements. Welfare expansion, increased unemployment insurance, and generous housing provisions are all examples of progressive interests advocated during recessions and expansions (for entirely different reasons). Why is this so wrong when people on the right do exactly the same thing (albeit over taxes instead)? If either side can make a strong argument who cares how disingenuous they are?
March 2nd, 2009 at 10:32 am
All this rich uncle talk reminds me of the poor uncle with the gambling problem that can take your money at will. O yea, that’s the government.
March 2nd, 2009 at 10:39 am
I have to admit, I almost fell out of my chair when I heard the rich uncle argument, and I hardly hold the same economic views you do.
March 2nd, 2009 at 10:46 am
There are many who argue that capitalism is a rather recent phenomenon, distinct from the existence of incentives to innovate or the ability to sell and trade.
March 2nd, 2009 at 11:25 am
The money unleashed by the Bush tax cuts to invest was faced with a problem. The world was awash in stuff to sell. TV’s and cars and computers and on and on and so there were no particularly good places to invest in as far a traditional investment in plant and equipment to provide a positive cash flow and so grow the company and pay dividends. So the money went to more speculative areas which counted upon simple inflation of asset prices. Huge amounts of that were made in debt which had low yields but that was made up for with leverage. The trillions flowing into hedge funds were often leveraged 20X’s or more. Let’s make no mistake this was pure speculation.
Back to the initial point however. The US and the developed world didn’t need any more stuff. Before the auto sales collapse there was a 33% world overcapacity in auto production. The list goes on and on. Here is a dirty little secret. The world in 2000 didn’t need a lot of investment in the stuff to feed consumer culture.
China made stupendous investment in plant and equipment but often at the expense of the rest of the worlds. America probably had zero net investment in plant and equipment during the 2000’s. It disinvested in those things. It did invest in retail space and distribution to fill that space but that was a mugs game.
The basic argument about the need for investment is unassailable. The question is what sort of investment makes sense in either a micro or macro sense. Of course we are told any money spent by government for the commons is not investment at all. You can’t win arguments with those who believe that. A line has to be draws also between investment and speculation. The entire financial sphere was overwhelmingly devoted to speculation. We will now live with the results.
March 2nd, 2009 at 11:53 am
Remember when you are talking about the impact of personal tax cuts on nonresidential fixed investments where the investments come from.
About 82% of investment is done by corporations. Another 7% is done by non-profits leaving some 11% to stem from individuals, S-corps, partnerships, etc., that are subject to the individual tax code.
The claims about the impact of changes in personal tax rates are just plain massively inconsistent with the role of units subject to those taxes in capital spending.
March 2nd, 2009 at 1:15 pm
There are also very few gay people in proportion to the total population so we should ignore them as a constituency when it comes to gay marriage and sodomy laws.
March 2nd, 2009 at 2:36 pm
Gordon, #13: “87 billion of the stimulus funds are allocated for medicaid alone. If this was not an increase, entitlements wouldn’t be growing faster than inflation or disproportionate to GDP.”
This is to help fund the expanding number of people who now meet the unchanged income and asset requirements for this program. It is not that the eligibility for the program is expanding, more people are meeting the eligibility requirements and that requires more money.
March 2nd, 2009 at 3:05 pm
you argue not that it’s smart to balance the budget over the course of the business cycle, but rather that the surplus reflects the government “overcharging” in taxes that should be returned to those who pay the most taxes; which is to say to those who have the most money; which is to say to the rich. That’s a 1999 argument.
Interesting, considering what happened to tax rates after 2000.
March 2nd, 2009 at 5:30 pm
We should heavily tax the incomes of the rich for the same reason we heavily tax their estates: to prevent the generational accumulation of staggering wealth that leads to a politically powerful overclass (aristocracy).
Ah, indiscriminate hate of wealth. Considering that it is great, accumulated, concentrated wealth that gave us the grandest, most valuable cultural heritage in the last 500 years, you must be against the accomplishments of Western civilisation.
See, for example, the grand palaces of Versailles and chateux. Blenheim Palace, of the Churchills. Castle Howard, where Brideshead Revisited was set. In fact consider Evelyn Waugh, the greatest prose writer in the English language of the last century, whose entire repertoire was based on the fabulously wealthy. Or consider the greatest architectural achievements of the Gilded Age, like the Biltmore Estate (constructed with inherited wealth) or the Breakers in Newport, RI.
In short, everything that has been great about Western culture, all the height of cultural achievement, would not have been possible without great concentration, and inheritance of wealth. Unless you are against cultural elevation, you should not be against inherited wealth.
March 2nd, 2009 at 6:04 pm
In response to Myles:
It wouldn’t take much time to make a list pretty buildings erected by “the state.” And it wouldn’t take much time to list some important cultural achievements created by the poor.
If “cultural achievement” is the only justification for obscene inherited wealth, then give me The Simpsons.
March 3rd, 2009 at 12:24 am
…In which Myles sets out to chronicle all the great cultural achievements of Western culture and ends up with a short list of very large houses and the literary works of a well-to-do-but-middle-class satirist of aristocrats.
March 3rd, 2009 at 1:42 pm
March 3rd, 2009 at 9:16 pm
without inherited wealth you would not have had plantations without plantations you would not have had slaves
without slaves you do not have blues or ragtime
without blues and ragtime you do not get jazz
thus inherited wealth created jazz
March 8th, 2009 at 7:49 am
See, for example, the grand palaces of Versailles and chateux.
which were financed by taxing commoners…