Politicians and pundits alike have offered economic arguments in favor of allowing the so-called "Bush tax cuts" to expire and of levying higher taxes upon the richest among us. Now economic arguments purport to demonstrate which decisions will maximize the welfare of economic agents, but they do not claim to show which decisions are moral. Economics can certainly supplement moral reasoning, but it cannot replace it. Jonathan Cohn of The New Republic modestly attempts to rectify the above situation by offering a moral argument in favor of, as he writes, "soaking the rich." Unfortunately for Mr. Cohn, it can hardly be said that he demonstrates the goodness or effectiveness of such a policy.
Cohn begins by recognizing the fact that, in response to conservative arguments in favor of extending the Bush tax cuts, "President Obama and his supporters" have argued that "[p]reserving tax cuts for the wealthy would drive up the deficit without substantially improving the economy," a claim to which Cohn agrees "wholeheartedly." Its true that extending the Bush tax cuts would expand the budget deficit given that the deficit is the difference between the amount of money the government spends and the amount of money it acquires through taxation, where the former exceeds that latter. However, Cohn fails to demonstrate why this result makes the extension of the cuts undesirable. The free market argument against deficits is, to be specific, an argument against any runaway spending that perpetuates deficits, not the mere deficit itself. Cohn does not undermine this argument by emphasizing the fact that an extension will broaden the deficit, since the extension in no way requires an increase in spending.
But Cohn naturally does not dwell on "budget arithmetic" and allegedly identifies two flaws in the claim, accepted by the "Republicans and many of their supporters," that "allowing tax rates on upper incomes to rise would punish the rich for their success, taking away money that the rich have earned." Cohn argues that such a proposition ignores the "power of luck," the fact that great wealth is a product of both a good work ethic and good fortune, whether such fortune comes in a material form as in "access to advanced technology and good schools" or other forms such as "good health or loving parents."
Cohn tries to insure himself against counter-arguments by admitting the importance of a good work ethic, but goes on to assert that he knows of hard working individuals who nevertheless dwell on a lower part of the "income ladder." He adds that "[b]etween 1980 and 2005, the richest 1 percent of Americans got more than four-fifths of the country's income gains. Does anybody seriously believe that the other 99 percent didn't deserve to take home a much larger share?"
Cohn's second objection is closely related and will thus be treated along with his first. He holds that "the conservative argument...fails to acknowledge the debt wealthy people owe to society." The self-made man, Cohn says, "is not exactly self-made," benefiting as he does from "the accomplishments of past generations," and from "the support of public institutions" and "services" that "foster innovation and lead to greater productivity."
To begin, Cohn overestimates the relevance of good fortune. Sure, the rich benefit tremendously from and depend upon the effort of others during the process of becoming rich, but Cohn tacitly assumes that the rich can become rich without compensating their benefactors. After all, Cohn argues in part that taxes should be raised upon the rich in order to indemnify those who have assisted the rich in becoming rich. This sort of asymmetrical wealth production does not exist in a market environment however.
In a market environment, where there exists a division of labour and where ownership of goods is exchanged voluntarily between economic agents, the potential rich (primarily capitalists and entrepreneurs) must produce goods for sale that others are both willing to buy and capable of buying, i.e., must satisfy customer demand, if they plan on becoming affluent. In a market society, people must engage in mutually beneficial commerce if they are to survive and, better yet, to thrive.
Entrepreneurs prosper when they satisfy customer demand and embark upon such an endeavour by acquiring factors of production (land, labour, capital goods) with financial capital (money for investment) and using such factors cooperatively to produce goods that other economic agents (either consumers or other producers) want. Lets assume that Lumber Inc., a lumber producer, must acquire 10 particular factors in order to yield lumber and other lumber goods. Before Lumber Inc. can begin production, it must approach each producer in the market that possesses the factors necessary for production and must give each producer money in exchange for ownership of their factors. The labourers must be paid wages for their labour, the heavy machinery producers must be compensated for relinquishing their heavy equipment, the land owners must be compensated for relinquishing the land upon which Lumber Inc. wishes to begin production, etc. So, if Lumber Inc. becomes fabulously rich after having procured and put its factors to use, it can thank the other factor-sellers (its benefactors) for assisting it, but its also true that they are reimbursed by Lumber Inc. for their assistance.
The same applies to capitalists who prosper when the entrepreneurs they previously equip with financial capital successfully satisfy customer demand. If the venture capitalist firm VentCap Inc. purchases debt or equity instruments from Lumber Inc. and Lumber Inc. earns a windfall, then VentCap Inc. will earn a return. Again, Lumber Inc. is partially responsible for VentCap Inc.'s success, but VentCap Inc. recompenses Lumber Inc. by previously giving it financial capital. These exchanges between entrepreneurs, capitalists, and other factor-sellers are positive-sum exchanges. VentCap inc. and Lumber Inc. benefit mutually from their commerce.
Furthermore, the size of an entrepreneur's or capitalist's wealth is determined by his/her's ability to produce, i.e., his/her productivity. If an entrepreneur or capitalist earns billions in profits in a genuine market economy, then such an entrepreneur or capitalist must have satisfied customer demand on a sizeable level; if an entrepreneur or capitalist hasn't satisfied customer demand on a grand scale, then its certainly not the case that either would earn billions. So there's nothing morally wrong with the fact that "[b]etween 1980 and 2005, the richest 1 percent of Americans got more than four-fifths of the country's income gains," if in fact the richest 1 percent produced four-fifths of the country's income gains."
As far as compensating government services is concerned, the wealthy pay dearly in this country. Economist Alex Tabarrok wrote in December of 2007 that "[d]espite all the deductions, loopholes and clever accountants the federal income tax is strongly progressive. Moreover the federal tax system remains progressive even if you include the payroll tax, corporate taxes and excise taxes." In his post he cites a CBO study that discovered that, in 2005, the richest 1% of Americans paid 27.6% of all federal taxes, followed by 43.8% for the richest 5% and 54.7% for the richest 10%.
Moreover, Cohn takes the productivity of the rich for granted. If taxes increase, then the incentive to produce decreases and if the incentive to produce decreases, the productive yield of labour decreases and the appeal of leisure rises. An increase in taxation is a sufficient cause of a decline in production. In addition to this, if production falls, then the quantity of goods offered at various prices falls and prices for these goods will rise. This helps to explain why GDP per capita among European nations has lagged behind GDP per capita in the U.S. for decades.
To boot, if taxes rise on profits, the ability of entrepreneurs and capitalists to satisfy consumer demand will fall. Profits, as stated earlier, are the result of the successful satisfaction of customer demand and the size of a firm's profit margin correlates directly with its past performance in satisfying demand. Unlike what many assume, firms reinvest the bulk of their profits towards the enhancement of their productive capacities. As economist Ludwig von Mises states,
"the average man [does not] comprehend that profits are indispensable in order to direct the activities of business into those channels in which they serve him best. He looks upon profits as if their only function were to enable the recipients to consume more than he himself does. He fails to realize that their main function is to convey control of the factors of production into the hands of those who best utilize them for his own purposes."
If the most efficient satisfaction of demand is our goal, then the best firms - those that satisfy demand most thoroughly - should be equipped with the most capital with which to acquire factors in an attempt to satisfy further demand. A free market fulfills this end by allocating money away from firms that fail to satisfy demand (in the form of losses) and towards firms that successfully satisfy demand (in the form of profits), all in accordance with previous performance. The profits that demand-satisfying firms earn enable them to acquire further productive factors with which to satisfy some other yet-to-be satisfied demand. Taxes on profits reduce the financial capital of productive firms and hence reduce their ability to acquire further factors and ultimately to satisfy the demands of their customers. Such taxation is a wasteful undertaking: it removes scarce resources from the productive private sector where the probability that they will be used efficiently is highest.
So, while its true that the rich must acknowledge their dependence upon society, its equally true that society must acknowledge its dependence upon the rich. The rich in a true market economy are rich only because they cater, in some way, to the desires of others.
Surely the economic problems caused by taxing the rich should inform a moral argument against it. After all, the wants of consumers and the integrity of the economy are both at stake.
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