The subject of this, present article of mine is essentially limited to an analysis and critique of a major aspect of the views on taxation attributed to Obama. That aspect, in the words of The Times’ article is that “Obama’s agenda starts not with raising taxes to reduce the deficit, as Clinton’s ended up doing, but with changing the tax code so that families making more than $250,000 a year pay more taxes and nearly everyone else pays less. That would begin to address inequality.” He will “use the tax code to spread the bounty from the market-based American economy to a far wider group of families.”
Obama’s agenda, we are told in more detail, includes “a $500 cut in the payroll tax for most workers” and major middle- and lower-income tax credits, to the point of simply handing out government money to those for whom the tax credits more than eliminate the taxes they would otherwise have to pay. “These tax cuts,” Leonhardt writes, “are really the essence of his market-oriented redistributionist philosophy (though he made it clear that he doesn’t like the word `redistributionist’). They are an attempt to address the middle-class squeeze by giving people a chunk of money to spend as they see fit.” (Of course, no mention is made of depriving anyone who is to be compelled to pay for this largesse, of the ability to spend the money he has earned as he sees fit. Obama’s concept of “market-oriented” works out to be that money is taken from some people at the point of a gun and then spent according to the free choice of those who are given the loot.)
By the same token, they deprive business firms of the funds with which to buy capital goods. This, together with the greater spending for consumers' goods emanating from the government, as it spends the tax proceeds, causes the production of capital goods to drop relative to the production of consumers' goods. This implies a reduction in the degree of capital intensiveness in the economic system and thus its ability to implement technological advances. The individual and corporate income taxes, and the capital gains tax, of course, also powerfully reduce the incentive to introduce new products and improve methods of production. In all these ways, these taxes undermine capital accumulation and the rise in the productivity of labor and real wages, and thus the standard of living of everyone, not just of those on whom the taxes are levied.
Two major impediments make it difficult for people to recognize the fact that everyone would benefit from reductions, or, better still, the total abolition of all of these taxes on the so‑called rich—made possible, of course, by equivalent reductions in government spending. The first is simply massive ignorance of economics, especially of the general benefit from private ownership of the means of production. People have not grasped the profound insight of Mises that, in a market economy, in order benefit from privately owned means of production, one does not have to be an owner of the means of production. This is because one benefits from other people’s means of production—every time one buys the products of those means of production.
One benefits from other people’s means of production not only in one’s capacity as a buyer of products but also as a seller of labor. Other people’s means of production, other people’s capital, are the source both of the supply of the goods one buys and of the demand for the labor one sells. The greater is other people’s accumulation of capital, the more abundant and less expensive are the products available for one to buy in the market and the greater is the demand for the labor one sells in the market and thus the higher the wages at which one can sell it. Abundant and growing capital in the hands of one’s suppliers and potential employers is the foundation of low and falling prices and of high and rising wages.
In contrast, the view of redistributionists, such as Obama, founded in the most complete and utter ignorance, is that the only wealth from which an individual can benefit is his own. This is a view that was not unreasonable in the ages before the rise of capitalism and its market economy. Until then, the only people who could in fact benefit from a given piece of land or a given barn or plow, or whatever, was the family that owned them and used them to produce for its own consumption. This is the view that the redistributionists continue to hold, centuries after it has lost its applicability. They have not yet awakened to the modern world. And it is on this basis that they support the redistribution of wealth. The redistribution of wealth is allegedly necessary to enable an individual who does not own the wealth presently owned by others to benefit from that wealth. Only as and when their property passes to him can he benefit from it, the redistributors believe. This is the kind of “largesse” Obama intends to practice. It is taking funds from those most prodigious at accumulating capital, capital that would benefit all, and then giving the funds to others to consume. Meeting the needs of the poor with the consumption of capital is Obama’s formula for prosperity.
The second impediment that stands in the way of people recognizing that everyone benefits from tax cuts for the rich is something closely related to redistributionism. This is collectivistic habits of thought inspired by Marxism and its doctrine of class interest. What I mean by this is that when it comes to matters of economics, most people tend to think of themselves essentially as members of the class of wage earners rather than as separate individual wage earners, and to think of their interests as indistinguishable from the interests of other wage earners.
Thus, an individual wage or salary earner knows that he would certainly be better off if his own taxes were reduced by some given amount than if the taxes of a millionaire or some large corporation were reduced by that same amount. As far as it relates just to himself, that conviction is absolutely correct. I, for example, would be much better off if my taxes were reduced by, say, a thousand dollars a year than if the taxes of some contemporary John D. Rockefeller or the taxes of General Motors were reduced by a thousand dollars a year. Where most wage earners go wrong is in generalizing from what is true of a reduction in their own, individual taxes, in comparison with an equal reduction in the taxes of businessmen and capitalists—the “rich”—to conclusions about the effects on them of reducing the taxes of other wage earners, in comparison with the same amount of reduction in taxes on businessmen and capitalists.
In considering, for example, whether the taxes of businessmen and capitalists as a class should be reduced by some large sum, such as $100 billion, or whether the taxes of wage earners as a class should be reduced by that sum, almost everyone mistakenly assumes that the interest of the individual wage earner lies with the tax reduction going to the wage earners, as though all wage earners shared a common class interest against all capitalists. This, however, is a fallacy, which becomes apparent as soon as one objectively analyses the situation from the perspective of the individual wage earner. Then it becomes clear that much more is involved than the matter of a reduction in the taxes of the rich or an equal reduction in the individual wage earner's own taxes. For example, while it is certainly true that I gain more from my own taxes being cut by $1,000 rather than the taxes of a Henry Ford or a Bill Gates, it is absolutely false to believe that I gain more from the taxes of my random fellow wage earners—call them Henry Smiths and Bill Joneses—being cut by $1,000 each rather than the taxes of Ford and Gates being cut by $1,000 each.
What is actually involved in the question of a reduction in taxes on businessmen and capitalists as a class in the amount of $100 billion, versus an equal reduction in the taxes of wage earners as a class, is two separate, further questions, that represent distinct elements of this question. There is first the question of the benefit to an individual wage earner of his own taxes being cut by $1,000, versus the taxes of any businessman or capitalist being cut by $1,000. We know the answer to this question: it is more to the individual wage earner's interest that his own taxes be cut. But then there is a second question. Namely, which is more to an individual wage earner's self‑interest: a reduction in the taxes of businessmen and capitalists in the remaining amount of $99,999,999,000, or a reduction in the taxes of wage earners other than himself in the same remaining amount, that is, of 99,999,999 other individuals very much like himself perhaps, but not himself, each getting a reduction of $1,000?
In other words, put aside the question of a cut in the individual wage earner's own taxes of $1,000 versus a $1,000 cut in the taxes of businessmen or capitalists. Consider only the effect on his self‑interest of a cut in the taxes of all other wage earners besides himself—all of the Henry Smiths and Bill Jonses of the country—in the combined amount of $99,999,999,000, versus an equivalent cut in the taxes of businessmen and capitalists—all of the Henry Fords and Bill Gateses of the country. A $99‑billion‑plus cut in the taxes of all those other wage earners will make each of them better off, but what will it do for him, for the particular, individual wage earner we are focusing on? To what extent will his fellow wage earners save and invest their tax cut and so raise the demand for his labor? To what extent will his fellow wage earners increase the demand for capital goods and the rate of business innovation and thus bring about improvements in the quantity and quality of the products he buys and thereby increase the buying power of the wages he earns?
It is obvious that the individual wage earner benefits far more from tax reductions on businessmen and capitalists, the so‑called rich, than from equivalent tax reductions on his fellow wage earners, and that this is true of each and every individual wage earner, for any wage earner could take the place of the particular individual we have focused on. A tax reduction on businessmen and capitalists will promote capital accumulation, far, far more than a tax reduction on the mass of the individual wage earner's fellow wage earners. The average businessman and capitalist will save and invest the taxes he no longer has to pay, in far greater proportion than would the average wage earner. He will be induced to introduce more improvements in products and methods of production, which are also a major cause of capital accumulation, and is a process in which wage earners qua wage earners play little or no role. (This is not to say that wage earners are never responsible for innovations. They often are. But as soon as they are, they typically become businessmen. Fundamentally, it is always the prospect of higher profits that stimulates innovations, not the earning of higher wages. It is the prospect of higher profits that leads employers to offer incentives to wage earners to make innovations.) And the greater saving of the businessmen and capitalists will promote innovation by virtue of making the economic system more capital intensive. Thus the individual wage earner has far more to gain from the taxes of businessmen and capitalists being reduced than from the taxes of his fellow wage earners being reduced.
The gains from this aspect of the matter are so substantial that they almost certainly outweigh the fact that having them precludes the ability to have the benefit of one's own taxes being reduced by a sum such as a thousand dollars a year. This is merely to say that the gains to an individual wage earner of his own taxes being cut by a sum such as $1,000 a year are far less than the gains to him of the taxes of businessmen and capitalists being cut by an immensely larger sum such as a $100 billion a year—that is, by an amount that equals the potential $1,000 tax cuts of all the millions of other wage earners in the economic system, which, in the hands of those fellow wage earners, would have been of little or no value to him.
As I have shown, the individual wage earner gains from cutting the taxes of businessmen and capitalists in part because the effect of their sharply increased saving is significantly to raise the demand for labor and thus, quite possibly, significantly to raise his own wage income. (Even if the effect is not to raise wage rates, but, in raising the demand for labor, to reduce or eliminate unemployment, that too operates to increase the funds available to the average wage earner—by virtue of reducing what he must pay to support the unemployed.) But far more importantly, the effect of cutting the taxes of businessmen and capitalists rather than of wage earners will be a substantial rise in the demand for capital goods relative to the demand for consumers' goods and a substantial rise in the rate of innovation, including under the latter head the ability of upstart new firms to grow rapidly and thus to challenge old, established firms.
The effect of this combination is continuing capital accumulation and thus a continually rising productivity of labor. The effect of this, in turn, is a continually growing supply of consumers' goods relative to the supply of labor, and thus prices of consumers' goods that are progressively lower relative to the wages of labor, which means progressively rising real wage rates, so that in not too many years the average wage earner is far ahead of where he would have been on the strength of a cut in his own taxes.
Starting with tax cuts for the so‑called rich—based on equivalent reductions in government spending—is the only hope for the resumption of significant economic progress, indeed, for the avoidance of economic retrogression and growing impoverishment. Because of this, it is actually the quickest and surest road to any major reduction in the tax burden of the average wage earner. It holds out the prospect of the average wage earner being able to double his standard of living in a generation or less. The average standard of living would double in a single generation if economic progress at a rate of just 3 percent a year could be achieved. Such economic progress would also mean a halving of the average wage earner's tax burden in the same period of time—if government spending per capita in real terms were held fixed, for then he would have double the real income out of which to pay his present level of taxes. And then, of course, once all the taxes that most stood in the way of capital accumulation and economic progress were eliminated, further reductions in government spending and taxation could and should take place that would be of corresponding direct benefit to wage earners, that is, show up in the reduction of the taxes paid by them.
Ironically, an aspect of this approach exists in, of all places, Sweden! What has enabled Sweden to have one of the world's highest burdens of taxation and, at the same time, to remain a modern country, more or less advancing, is the fact that the tax burden in Sweden falls far more heavily on the average Swedish wage earner than it does on Swedish business, whose tax burden is actually less than that of business in many other Western countries. (For example, when allowance is made for the fact that Swedish companies can automatically deduct 50 percent of their profits as a tax‑free reserve for future investment, the effective corporate income tax rate in Sweden turns out to be below that in the United States: 26 percent versus 35 percent.) If Swedish business had had to bear the burden of taxation borne by Swedish wage earners, the Swedish economy would long since have been in ruins.
This is certainly not to argue for taxation of American workers at a level comparable to the taxation of Swedish workers, or for any increase in the taxes paid by American workers whatever. It is to argue for reductions in government spending sufficient both to eliminate the budget deficit and to make possible substantial tax cuts on businessmen and capitalists, the so‑called rich. It is to argue that as soon as the resulting economic progress begins to increase the real revenues of the government, further tax cuts of the same kind occur, in order further to accelerate economic progress. It is to argue for the achievement first of the total elimination of the inheritance tax, the capital gains tax, the corporate income tax, and the progressive portion of the personal income tax, all taken together, and then, once that has been achieved, for the continuing reduction in the remaining personal income tax, until the personal income tax is totally eliminated. The essential mechanism for achieving these results is a combination of economic progress and continuing reductions in government spending. This is how radically to reduce the taxes of everyone. It is the only way.
Tax cuts to promote saving and capital formation which are financed by deficit increases are thus simply contrary to purpose. The fact that they are contrary to purpose remains if, instead of being financed by borrowing, the resulting deficits are financed by the more rapid creation of money. In this case, all of the destructive effects inflation has on capital formation come into play.
By the same token, balancing the budget by means of raising taxes is destructive of saving and capital formation to the degree that the additional taxes fall on saving and the productive expenditure of business firms for labor and capital goods. Ironically, it is precisely taxes that fall heavily on saving and productive expenditure that today's advocates of balancing the budget through tax increases favor. This is because the taxes they wish to increase are precisely those which land on corporations and the so‑called rich.
The only way that these advocates of balanced budgets through tax increases could proceed consistently with the goal of capital formation would be by increasing the taxes of the very people they claim to be concerned about, namely, the poor and the mass of wage and salary earners, who save relatively little. Indeed, the only way that greater saving and capital formation is possible in the absence of decreases in government spending, is by means not only of increasing such taxes to the point of balancing the budget, but also increasing them still further, to compensate for decreases in the kind of taxes that land more heavily on saving and productive expenditure. In essence, if one advocates greater saving and capital formation and yet refuses to support reductions in government spending, one is logically obliged to advocate increasing the taxes of wage and salary earners and of the “poor” in order both to balance the budget and to compensate for reductions in taxes on profits and interest and on the “rich.”
But there is absolutely no reason to advocate such a downright fascistic policy. (As I’ve shown, just such a policy has been pursued in Sweden, the model country of today's “liberals.”) Instead of sacrificing anyone to anyone, the simple, obvious solution is sharply to reduce the sacrificing that is already going on—namely, sharply to reduce and ultimately altogether eliminate pressure‑group plundering and the government spending that finances it at the sacrifice of everyone. (The ultimate, truly progressive long-range goal would be the elimination of virtually all government spending other than for defense against common criminals and foreign, aggressor governments. The first is the police function of state and local governments; the second is the national defense function of the Federal government.)
This analysis makes clear that an essential flaw of so‑called supply‑side economics—the policy both of the Reagan administration and of the present Bush administration—was the failure to face up to the need to reduce government spending. While the policy of reducing taxes by both administrations was perfectly correct, most of the potential benefit of the tax cuts was lost through the corresponding enlargement of federal budget deficits. Regrettably, both administrations and their supporters lacked the courage required to abolish government spending programs to make those tax cuts possible without deficits.
Their failure to have done so explains why the great mass of the American people have not benefitted from the tax cuts as they should have. The explanation is that, absent equivalent reductions in government spending, the tax cuts did not translate into increases in capital formation, but the opposite. Instead of there being more demand by business for labor and capital goods there was less; instead of more rapid economic progress and rising real wages, there has been economic stagnation or outright decline, along with stagnant or falling real wages.
Ever-growing government intervention, especially in the form of environmental legislation, has also worked against capital accumulation by requiring the use of more and more capital to achieve the same results, such as requiring gas stations, dry-cleaning establishments, and numerous other types of businesses to engage in costly capital investment for the sake of protecting the environment rather than for the production of goods and services.
In addition, capital accumulation has been enormously undermined by the Federal Reserve System’s policies of credit expansion and inflation, extending back to its inception. In the last decade, these policies were responsible first for the stock-market bubble and then for the housing bubble. In both cases, vast sums of capital were wasted through malinvestment and eaten away though overconsumption based on delusions of prosperity. Thus, for example, in the housing bubble, not only were the housing-construction and building supply industries greatly overexpanded and an enormous number of homes built that should not have been built, but millions of homeowners were led to greatly increase their consumption on the strength of no foundation other than the rise in house prices induced by inflation and credit expansion. Earlier in the decade, the same kind of overconsumption took place on the foundation of inflated stock prices and similar malinvestment took place in other industries, such as telecommunications.
Finally, it must be mentioned that the Fed’s inflation and credit expansion have also been responsible for a vast, artificial increase in economic inequality since the mid 1990s, just as they were during the 1920s. This economic inequality was built not on inequality of economic contribution, as is normally the case, but merely on new and additional money. This new and additional money created by the Fed and its client banking system, poured into the stock market and then the housing market. In the process, it created vast paper capital gains in terms of stock and housing prices—the same paper gains that brought about overconsumption. In the case of the stock market, the paper gains went overwhelmingly to the wealthy; they had the largest investments in stock and were more likely to be in a position know how to take advantage of the rising market. At the same time, the artificially low interest rates caused by the infusions of new and additional money encouraged an artificial lengthening of what “Austrian” economists call the structure of production. Such artificial lengthenings create a corresponding artificial increase in the magnitude of profits in the economic system.
This last point can be understood by recognizing that when taken in the aggregate, the funds business firms expend in paying wages and in buying capital goods (e.g., materials, components, supplies, advertising, lighting and heating, as well as machinery and plant) generate or, indeed, directly constitute the great bulk of business sales revenues in the economic system. In every year, the expenditure for capital goods constitutes equivalent sales revenues to the sellers of capital goods. In every year, the payment of wages enables wage earners to expend an approximately equivalent amount in buying consumers’ goods from business. Thus the total of business firms’ productive expenditures in any given year directly or indirectly show up as business sales revenues in the economic system, for all practical purposes within the same year. (The extent to which the wage earners of any given year might wish to defer the expenditure of some the wages paid to them in December into January, say, is counterbalanced by the same kind of choices made the year before.)
Now sooner or later, those same productive expenditures that underlie most of the sales revenues of business also show up as costs of production of business needing to be deducted from sales revenues in the computation of profits.
A key question is when do they show up as such costs of production? The same dollar amount of productive expenditure is capable of showing up as an equivalent amount of cost to be deducted from sales revenues within days or weeks or only over a period of months or years. For example, $1 million expended by grocery stores in buying produce at wholesale will show up as $1 million of such cost within days. However, $1 million expended in the construction of a new building with a depreciable life of forty years will show up as a cost of production to be deducted from sales revenues only after the building is fully completed, and then at the rate of just $25,000 per year, as per its forty-year depreciable life. Before $1 million of expenditure for the construction of such buildings could result in $1 million of depreciation cost being incurred each year, the process would have to be repeated for forty years, by which time forty such buildings would be in existence, each being depreciated at $25,000 per year.
The implication of this discussion is that shifts in the pattern of productive expenditure with respect to the time when the expenditures will show up as costs ready to be deducted from sales revenues, are capable of having a profound effect on business profits for a more or less considerable period of time. This is because while the sales revenues that result in any given year from any given amount of productive expenditure in the economic system remain the same, the costs to be deducted from those sales revenues that correspond to that given amount of productive expenditure are capable in varying degrees of being deferred to future years. Thus, for example, shifting $1 million of productive expenditure from the purchase of groceries at wholesale to the construction of a new building implies a reduction in the costs deducted from sales revenues in the economic system in the amount of $1 million in the current year. (The reduction is a full $1 million, because while the building is under construction it does not yet give rise even to the $25,000 per year depreciation cost that it will occasion when completed and brought on stream.) Thus, to the extent that the structure of production is lengthened and more and greater deferrals of cost accordingly take place in the face of sales revenues of any given amount, profits in the economic system are correspondingly increased. These are the profits of the boom period.
The Federal Reserve’s easy money, low-interest rate policy both puts new and additional money into the market that raises productive expenditures and sales revenues and simultaneously encourages the shifting of productive expenditures to points more remote from the time when they will show up as costs of production. Productive expenditures aimed at results further in the future are an inevitable accompaniment of lower interest rates. In this way, the policy of credit expansion brings about a systematic deferral of business costs in the face of any given volume of business sales revenues and a corresponding enlargement of business profits for which there is no sound underlying economic basis and which would not exist in the absence of credit expansion.
Thus, to the extent that it is not the result economic ignorance and/or sheer malicious envy, the left’s resentment of economic inequality turns out to be a resentment that logically should be directed against its own beloved policy of credit expansion.
Its response to the growing destruction it causes as it proceeds along in its mental fog is to call again and again for “change.” It brings about one change after another, each time for the worse. It can neither tolerate the conditions its policies create nor find the courage to admit how profoundly wrong it has been in urging its policies, which might then permit its members to begin to learn the economics and political philosophy they need to know to urge rational policies. Instead, it is so fundamentally and profoundly wrong that it goes on upholding its ignorance as truth even in the face of the worldwide collapse of what for generations its members had expected to become a utopia, namely, socialism.
Instead of taking the failure of socialism as evidence of its own ignorance, it chooses to take it as a failure of human reason. And in consequence it has now turned on reason, science, and technology. Perhaps in implicit recognition of its own capacity for destruction and carnage, it has turned from a movement that only a few decades ago eagerly looked forward to the results of paralyzing the actions of individuals by means of “social engineering” to now seeking to paralyze the actions of individuals by means of more and more prohibiting engineering of any kind. What the left should want to stop are its own actions. Because they are truly dangerous, and on some level it knows this.
Of course, in a further display of their ignorance and blindness, members of the left will undoubtedly characterize the line of argument I’ve presented in this article as the “trickle‑down theory.” There is nothing trickle‑down about it. There is only the fact that capital accumulation and economic progress depend on saving and innovation and that these in turn depend on the freedom to make high profits and accumulate great wealth. The only alternative to improvement for all, through economic progress, achieved in this way, is the futile attempt of some men to gain at the expense of others by means of looting and plundering. This, the loot‑and‑plunder theory, is the alternative advocated by the redistributionist critics of the misnamed trickle‑down theory. The loot‑and‑plunder theory is the theory of Obama, of the Democratic Party, and of much of the Republican Party. It is time to supplant it with the sound economic theory developed by generations of intellectual giants ranging from Smith and Ricardo to Böhm-Bawerk and Mises.
Copyright © 2008, by George Reisman. George Reisman, Ph.D. is the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996) and is Pepperdine University Professor Emeritus of Economics. His web site is http://www.capitalism.net/ and his blog is www.georgereisman.com/blog/. A pdf replica of his complete book can be downloaded to the reader’s hard drive simply by clicking on the book’s title Capitalism: A Treatise on Economics and then saving the file when it appears on the screen.