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Real Capitalism Versus Rich Dude Capitalism – Part 2

In Part 2 lets compare the effects of marginal tax rates between real capitalism and Rich Dude Capitalism.

If you listen to the advocates of tax reduction for the Rich Dude Economy they will argue that tax rates should be reduced, with the rationale that it will give the rich more money to hire people and therefore expand the economy.  Lets test the theory.

Assume that an entrepreneur has a goal of $1 million dollars of income, net of taxes. Let’s compare the results of two marginal tax rates on the entrepreneur, and importantly the impact on the society in which the individual lives. Let’s compare a 35% marginal tax rate versus a 90% marginal tax rate. These reflect the current marginal tax rate and the highest marginal tax rate historically, which occurred primarily during the Eisenhower administration in the early 1950s.

  • At a 35% marginal tax rate, the entrepreneur will have to generate $1,538,461.54 of new taxable income in order to reach the goal of $1 million of income net of taxes.
  • On the other hand, the entrepreneur at the 90% marginal tax rate would have to generate $10 million worth of new taxable income to reach the goal.

Though the entrepreneur would undoubtedly rather face the prospect of having to do 15% as much work to reach the goal, it would be much better for the society as a whole if over $10 million in growth were infused into the economy.  This growth would employ more people, and feed the economy in many ways.  Critics may say that the entrepreneur would simply refuse to work if  the tax rate were that high, but there is no historical support for that supposition.  In fact, business has been very robust during very high periods of taxation.  While the point is not to advocate a 90% tax rate, it is very clear economically that higher taxes create economic expansion.

We often ask ourselves why the Tea Party voters seem to be voting against their best interests. Somehow they have aligned their perceived self-interest with that of the entrepreneurs, rather than themselves as consumers and voters. They have confused “free markets” with freedom. Free markets mean freedom of entry into the market by competitors when there are high rates of return in that market relative to other options. It does not mean you’re free to do what you want to make a lot of money. In fact, much to everyone’s surprise, competition is designed to limit freedom of action to just that which serves the public interest of producing the most at the least cost.

It’s quite clear that the effect on jobs, investment, total output, and production of goods and services is larger by a factor of 6.67 times in the case of the higher marginal tax rate. Those who believe that lowering tax rates is better for the economy have been duped. They are confused that what seems good for the individual can be extrapolated to be good for society.

Comparing the Outcomes
Lets compare the difference between Rich Dude and real capitalism.  In Rich Dude capitalism the Rich Dude is viewed as the determining factor in economic success.  The theory is they should be incentivized to invest more, with the risk being that they will instead just consume the windfall.  That’s free market economics to Republicans and the Tea Party. Instead of competition we have coddling and hopeful handwringing.

In the case of real capitalism the logic would lead to an increased tax rate which would put competitive pressure on the entrepreneur, because if they don’t generate the added income and output to get or keep the million dollars then a new market entrant(s) will take that market share or figure out a way to generate the new business.

What kind of capitalism do you have at this time in America? Republicans and the Tea Party believe that they have convinced the American public that Rich Dude capitalism is the way it should and does work. The Democrats that make their weak “fair share” arguments and “ability to pay” arguments are not very convincing because they don’t really address the fundamental behavioral issue, which is that the endpoint of the economic process is producing the most goods and services at the least cost. Therefore when you raise the taxes on the Rich Dude you force them to work harder (produce more goods and services) than they were producing at a lower tax rate or face increased competition from those who also want to replace the lost net income before the taxes were raised. That would be using competition to improve society’s economic fortunes.

The Republican and Tea Party agenda, largely representing the business sector and thus entrepreneurs faced with this question of what they would do at different tax rates, prefer to listen to the selfish interests and not society’s interests. The Democratic Party uses a very subjective equity argument to counter this right-wing agenda rather than the more clear-cut argument about incentives based on responses to different tax rates. The two outcomes differ substantially as you can see from the impact of the different rates on output and employment.

Those who favor lower tax rates argue simultaneously that these job creating entrepreneurs are the most dedicated workers in our society and everybody else is either lazy or dependent on them for their jobs. Yet in the same breath they say that if you raise the marginal tax rate to 90% these champions of capitalism and the American way will just quit working or leave their beloved country to find tax havens elsewhere. This is bizarre when you consider that they oppose giving money for doing nothing to those who are impoverished because it’s a disincentive to work. It is important to note that welfare bums and entrepreneurial bums react exactly the same way when given money for doing nothing.

In more extreme cases, those who support tax reduction blindly seem to relish the Ayn Randian concept of a capitalist strike against society in a tax rebellion, if tax rates on the rich are raised. The oversimplified and tired arguments of Ayn Rand were her response to Soviet totalitarianism inappropriately transplanted into a relatively competitive market economy she did not understand. Her grand schemes were never so detailed as to deal with variations in marginal tax rates and their effect on entrepreneurs. Interestingly the argument is very Marxian by the right-wing with the capitalist class rising in rebellion instead of the proletariat. Nonsense! Ayn Rand would find herself perplexed by the outcome. Her objectivist status and libertarian leanings all were designed to decentralize power where in fact her followers knowingly or unknowingly have used her logic to concentrate power in the hands of the increasingly small number but increasingly Rich Dudes in the economic system.

If you actually believe in competitive capitalism you would reason that someone in society would simply take the place of the petulant entrepreneur and do the hard work of generating the $10 million worth of new taxable income in order to get the $1 million net of taxes. Are the entrepreneurs who will quit working because they have to do a lot of work uniquely gifted and can’t be replaced? Are we to give up $ 8 ½ million worth of potential output along with the accompanying jobs without any hope of someone else doing that work if the current entrepreneurs leave the country?

Other countries will soon learn that competitive tax reductions are ultimately disastrous for the winning country as many communities in the United States have discovered when they use tax breaks to entice fly-by-night companies to relocate. In the aggregate all the competing towns lose tax revenue and individually the tax burden is simply shifted within their communities. When the company leaves chasing better tax breaks communities suffer substantial dislocations.

I’m sure you remember from your history classes that during the period when we did have a 90% marginal tax rate the economy collapsed and we went into a huge depression over the period 1950 to 1965. This is when the federal marginal tax rate never fell below 91%. Excuse me, it’s very hard to remember that happening because it didn’t happen at all. In fact the GDP of the United States increased in that timeframe by 2.36 times and was the most dominant economy in the world. In the comparable 15 year time period from 1996 to 2011 when marginal tax rates began at 39% and has been 35% since 2003 our economy has grown by 1.85 times. Interesting?

Does this mean we should set the marginal federal tax rate at 90%? Maybe, maybe not, but certainly moving it from 35% to 38% is more likely to create incentives to work harder by those who are capable and committed to the idea of entrepreneurship than it is to discourage the fainthearted fake entrepreneurs looking for a larger handout and less work. They are welcome to quit using valuable resources because we have others eager to take their place. In addition, we can be rid of this fraudulent argument that letting entrepreneurs keep more money and do less work by lowering tax rates rather than raising tax rates to pay off the debt and stimulate the economy is simply wrongheaded. It is their way of taking advantage of the confusion (that they perpetuate) over what seems logical from an individual’s point of view versus what society’s best interests are.

Comparing the incentive effects of marginal tax rates linked directly to the question of jobs and economic growth provides a much more useful insight than the muddled discussion over equity and the petulance of our spoiled entrepreneur class that seems to dominate today.

It is important in any discussion of national policy to remember that you cannot reason from the individual level when the question is about how we interact with each other. Solutions to society’s problem of slow job and economic growth cannot be solved by taking the position that we each behave as if we were the only person in the world. Our behavior depends on the behavior of others and the existence of conditions in the world over which we have no control. We cannot give in to those who substitute their self-interest for the proper functioning of incentives in the marketplace. No one person is irreplaceable, competition will prove that no one class can hold the economy hostage. This is important for the right and the left to remember.

Marxian logic is dead. The logic of Ayn Rand has also suffered a mortal blow. Her John Galt has been converted to Che Guevara. Che of course is a gray-haired eminence in a limousine smiling comfortably that he has fooled all those that followed old dead white guys from Adam Smith to Marx and Lenin. Watching the limousine go by one would hope that the Democrats would focus their arguments on the importance of competition in well-regulated markets. One would also hope that the Tea Party advocates and the Republican Party might return to their old values of accountability and efficiency in the marketplace.
Only the consumers and voters ultimately can make these changes by quitting their worship of the successful and start to create a market for goods and a market for ideas where success serves them.

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2 Responses to Real Capitalism Versus Rich Dude Capitalism – Part 2

  1. Rather, he owes Uncle Sam $42,622, which is an effective tax rate of around 24 percent. This is because parts of his earnings are also taxed at rates lower than his top, marginal tax rate of 33 percent.

  2. DENNIS O'DONNELL says:

    Thanks for your interest. The calculation I made was just an increase in marginal net income subject to the marginal tax rate assuming the entrepeneur was already at the previous max rate.This would work if the change in rate occurred on the fiscal or annual filing period date to make it a straight forward calculation.

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