Do Low Tax Rates Really Encourage Investment?

Now that Republicans have taken control of both houses of Congress there is once again talk of boosting the economy by cutting taxes.

It made me realize that in the 20 years or so I have been reading the Economist I have regularly seen the assertion that low taxes encourage investment, sometimes by the Economist quoting Republicans, sometimes by the Economist theorizing or editorializing.  But I have never seen any data to support the assertion.

Looking back over the last 40 years I have a harder and harder time accepting that assertion as true, and am certain it is not true for all situations.

Recent economic history has made it pretty clear that the theories of human motivation that the science of economics has been rooted in is to reality what a stick figure drawn by a 5 year old is to the reality of human anatomy.  This assertion that low taxes encourage investment is beginning to look to me like economic theory based on this stick figure understanding of human motivation.  It assumes every person is motivated by money above all, and that nobody ever feels like they have enough money to focus on other things.

This assumption doesn't square with my life experience or research findings I have seen.  

A research study from a couple years ago found that for most people about $70,000 a year is enough, beyond that figure money doesn't  motivate them.  I'm sure there are people who want far more, but I can't imagine that there is anyone that doesn't have a point where they feel their needs and wants are met, at least in what money can buy. So for most humans who reach the point where they have enough, if they continue working it is not for the money.

So what is it?  I think there are lots of potential explanations.

I came out of law school just about the time Ronald Reagan took office.  Within a couple years he started the rash of tax cuts that have characterized the last 40 years of government policy.  When I first started practicing law lawyers expected to make good money, but it was only part of the reward.  As they built up their practice they hired staff so they could work reasonable hours and have a life as their practice expanded.

I left the practice of law nearly thirty years ago, but am in touch enough to know the practice has changed dramatically.  It is all about money.  To compete big law firms require their lawyers work incredibly long hours.  The have downsized the amount of support staff enormously.  In the law business it is pretty clear to me the primary result of tax cuts has been longer hours for those driven to succeed, layoffs of the staff that used to lighten their load, and more money in the pockets of the most driven individuals.

For the lawyers in big firms I don't think it is all about the money.  It is about prestige, accomplishment measured against your peers.  To the extent it is about the money its not fundamentally about what they want to buy, it is that how much money you have is the marker of how successful you are.  

Back in the early 1950's, partly to pay off the debt of WW II, Congress created really high tax rates for people that made a lot of money.  If you were hauling in vastly more than most other people each year the dollars at the top end your pile of money were taxed at 70, 80 or even 90% of what you took in.

The logical response of the very wealthy at that time was to limit the amount of money they took in personally, so they focused on building empires.  They hired lots of people, started new companies.  Instead of paying high taxes to Uncle Sam they plowed money into building for the future.  The following couple decades are now viewed by economists as the golden years.  Low unemployment, high wages, a health economy.

Contrast that with the last couple decades of boom and bust and asset inflation.  Big companies are currently rolling in money but they are generally not hiring or starting new businesses, they are kicking out the money in enormous salaries for the top executives, or using stock buy-backs to pump up their stock price, making both the top management and shareholders wealthier.  Low taxes on individuals make this an economically rational choice.

Individual wealthy people also generally aren't starting new businesses and hiring people.  They are trading in stock, real estate, art, classic cars - building their personal wealth and in the process inflating asset prices.  The assets aren't improved, no value is added.  The price just keeps going up because the people with lots of money are swapping them back and forth, both as an easy, low maintenance way to store your money, and as a way to  evidence their high status in society.  But it is not generating productive economic activity.  

It seems to me our tax cutting policies of the last 40 years have stood motivation on its head.  The 1954 Tax Code, with its high marginal rates discouraged what I would describe as frivolous earning and spending to encourage people to invest in real productive activity.  The 1954 tax code also had a provision called income averaging, so the people who were just making lots of money for the first time could average their income over the last five years for tax purposes.  This provided a ladder for people to get up to that position of comfort before the really high tax levels kicked in.   Income averaging disappeared with the Reagan tax cuts in the mid-1980's.

I think if we really want to rebuild an economy that works for everyone we need to start looking at high personal tax rates that kick in at some point on the income scale to make overbuilding your short term personal fortune less attractive than building long term investments.

The Problem Isn't God

For decades the Middle East has been full of dedicated warriors of God convinced God wants them to fight non-believers.   That mind-set has now developed to what is perhaps its logical conclusion.  ISIS, the self proclaimed Caliphate of the Levant, essentially kills or enslaves anyone who disagrees with them.

In India millions have been killed since the country achieved Independence as different religious sects wrap themselves in their religious beliefs and attack others with different beliefs.

In the US, for last couple decades politics has been dominated by people who believed God wanted them to punish homosexuals, even though their religion reveres the ultimate man of tolerance and peace.

The transparent injustice of people wrapping themselves in religious belief to judge and punish others causes some folks to reject the whole notion of God.  But the void left by the rejection of God is often replaced by other ideologies that, in the end become logic obsuring naked self interest.  ISIS is oddly reminiscent of the Kymer Rouge in Cambodia a couple decades ago, who slaughtered all those of who did not accept their rule in the name of communism, a doctrine that explicitly rejected God.

The problem isn't God, it is our hubris.  A basic truth is that we cannot know the exact nature of reality, we can only infer from what we can perceive about the world.  Even with Science we regularly see yesterdays truth superseded by a different and more nuanced reality.   But imprecision can spark indecision, so we follow leaders whose personalities reject imprecision by adopting a plan that creates rules for action.  God becomes the logic that fills the void to the personal advantage of the leader (and by association the like minded followers).  God becomes a tool for pushing those who are not us down for the benefit of us.

All the major religions have enjoyed periods of peace and tolerance.  But when times get tough our tendency to frame our view of God in a reflection of our own needs and desires produces persons impatient with inaction who rally others of like mind to political action, or violence.

Ironically, the most dedicated religious folk often reject the notion that Darwin described reality with his theory of evolution.  Then they adopt religious views that are in essence a reflection of Darwin's fundamental tenant, survival of the fittest.  Life is a battle and God is on our side, we are chosen to lord it over others.

If one believes the history of the evolution of human society reflects the influence of God it becomes obvious that whatever force it is that we call God favors, above all else, that we cherish and respect our differences, instead of using them as catalyst for battle.   Societies based in survival of the fittest among competing religious groups tend to foster turmoil and conflict, societies based in respect and cooperation tend to foster peace and prosperity.

Democracy is in one sense fundamentally consistent with the notion God favors respect and tolerance.   A functioning democracy requires a degree of respect and cooperation.  Like the proverbial canary in a coal mine, if democracy is wobbly, or cannot survive it is a reflection of the fact the society is still fragmented into groups in survival of the fittest mode.

Global Warming - Why We Won't Muster An Effective Response

One of the reasons I am operating from the assumption no significant response will happen to slow down global warming is because almost any response by individual countries will be ineffective if it isn't simultaneously adopted in every major industrial country in the world.  That won't happen due to the realities imposed by countries economically competing with one another.  An example is the proposed Carbon Tax intended to encourage a reduction in greenhouse gases.

Here's a hypothetical:

USA.Inc and China.Inc both manufacture widgets.  It costs both $1 to produce each widget.

The US imposes a carbon tax that adds $.05 per widget to USA.Inc's cost per widget.  The US also imposes a border tariff on incoming widgets of $.05 per widget, so USA.Inc and China.Inc, in theory, remain equally competitive within the US.

But USA.Inc is no longer competitive anywhere outside the US, because their fixed cost on every single widget they manufacture is now $1.05 and China.Inc's fixed cost per widget is $1.00.  So USA.Inc's market share outside the US will plummet, while their market share inside the US will remain static, so they will sell fewer widgets.  This undermines their economies of scale, over time driving their fixed costs per widget up even higher.  At the same time China.Inc's market share is rising, they may be experiencing greater economies of scale so their cost per widget may continue to come down over time.

USA.Inc won't just stand by and sink into bankruptcy.  Their only real solution will be to move their manufacturing facilities to another country so they don't have to pay the tax, and only pay the tariff on widgets sent to the US.

So the net effect of a unilateral carbon tax adoption by the US will be more US companies moving operations out of the country, fewer jobs in the US, and a slowed down economy, while boosting the economy of countries that are not addressing global warming.

If we adopt a carbon tax will other nations also adopt one out of the goodness of their heart or to avoid our tariff?  Short answer is No.  It is hard for me to imagine, for example, China's leadership, having suddenly been handed the gift of a huge industrial competitive advantage over wide swaths of US industry would upset that situation.  (Or our Congress doing anything if China suddenly made their industries less competitive).  They would take about it, and might eventually, dawdling around for 10 or 15 years to let their industries get thoroughly entrenched as market leaders, but by that time the damage to the US economy will be considerable, and probably very little will have been accomplished in reducing greenhouse gases.

So in essence to effectively address the problem we have to get much of the world to agree to the solution, simultaneously.   Will Russia, a oligarchy built on oil wealth, or any country whose political stability depends on selling petroleum to the rest of the world, jump on board?   Will teetering governments in developing countries who would have to tell their people they have to wait to achieved the access to stuff they see on electronic media be able to put the whole country on the path of delayed gratification?

I hope to be proved to be an excessively cynical old Grinch, but I put that hope in the same category as my hope to discover the fountain of eternal youth.