Two Cheers for Wealth Creation
Do we want people to create wealth or not? Do we even understand how wealth is created?
March 19 2012 by ChiefExecutive.net
The Republicans seem to want to talk about taxes and opportunity. The Democrats are obsessed with income inequality and a notion they like to call “fairness.” The President hammered his doctrine of “fairness” relentlessly during his State of the Union speech. Even independents, when polled, seem to favor the “rich,” loosely defined, “paying their fair share.” However, here’s the central question no one seems to be asking. Do we want people to create wealth or not? Do we even understand how wealth is created? When most politicians talk about spreading the wealth around, as Obama did with Joe the Plumber during the 2008 campaign, their understanding of wealth creation is a bit like the medieval notion of phlogiston, a substance that miraculously comes into being during combustion. Politicians, naturally, feel called upon to ensure that it is distributed “fairly,” a euphemism for taking it by force through taxation and regulation from one group and giving it to another.
In the real world most of us inhabit, wealth is created when someone—an entrepreneur—takes risks and creates something people value. Profit, if it is realized at all, is nothing more than the surplus generated after the entrepreneur covers his costs and effort. Most entrepreneurs don’t even get to see much of that because failure rates in new business creation are steep. Many of our political leaders are oblivious of the risks involved and simply assume people will start businesses and create jobs regardless of the impediments put in their way by government. Steve Jobs did not create the iPod and iPhone for money alone, but he clearly expected to reap the financial rewards from his efforts. Could a similar venture get funded today? Could a 20-year-old college dropout, fresh from some ashram in India, attract funding for a capital-intensive venture based on the manufacture and sale of a $2,500 product for which the market is exactly zero? There is a reason why the tax rate on invested capital is lower than for the rate on income. Even Warren Buffett knows the difference despite his canard about paying at a lower rate than his secretary.
Barack Obama has made certain never to repeat the phrase “spreading the wealth around,” but he continues to bang on about “economic justice”—the immorality of income inequality. The notion did not begin with him. It’s been a central tenet of socialist thinking since Karl Marx. It’s the animating idea of an entire class of elites in academia, Hollywood, the media and the lumpen intelligentsia of Georgetown and the Upper West Side of Manhattan. They believe inequality does not result from inequalities of merit, ability or effort, but from discrimination, exploitation and systemic unfairness. A world defined by economic equality, the argument goes, will be a fairer and happier one. Bringing the top down, whatever its consequences is as good as bringing the bottom up.
This is how statists—those willing to place economic control and planning in a consolidated state government—understand the path to greater enlightenment and well being for the rest of us. It also explains why they are willing to sacrifice entrepreneurship for higher taxes, greater regulation and federally managed corporations like government motors. It is the equality of misery, which is all you get when you punish economic liberty. Punitive taxation dismantles the link between effort and reward. Everyone appreciates the need to pay for important services that only government can provide, but raising taxes for the sole purpose of income redistribution raises no one’s well-being because it raises virtually no revenues. In fact, revenues actually decline in the long run because of the negative incentives. As a result, there is less to redistribute.
A Small Business Administration study found that a reduction in the marginal rate of one percentage point increases the rate of startup formation by 1.5 percent and reduces the chance of startup failure by more than 8 percent. Furthermore, a 2008 World Bank study found that a 10 percent increase in the effective rate reduces the investment-to-GDP ratio by 2.2 percent and foreign direct investment by 2.3 percent. Tax rates don’t just influence how much investment, growth and job creation will take place in America. In a global economy, they will profoundly affect where a business will chose to invest or expand. Since 1986, all the OECD countries, except Japan, have lowered their statutory and marginal rates, while the U.S. has not. As a result, we cannot assume that the next Apple will emerge from the U.S. at all.
The irony is that President Obama is uniquely positioned to revive our economy through lowering the rates necessary to boost expansion and attract the nearly $2 trillion in potential investment sitting on the sidelines. Any Republican candidate advocating this will be demagogued by the left for being “unfair,” but it could be a Nixon-goes-to-China moment for the President—if only he would see the opportunity for himself—and for the rest of us.