Capitalists Can Bug Me – I Admit It!

As a committed child of the working classes, or more accurately a grandchild, nothing is more designed to get my back up than a conversation with an equally committed capitalist.

Now, having traveled through ‘B’ school and the banking industry for many years I have nothing against capitalism: I believe it to be the best system of wealth generation there is.

But.

It also needs to be kept in check. Unbridled capitalism produces enormous social cleavages and inequities that, as Karl Marx identified, sow the seeds of its own destruction. Marx was a brilliant economist, no history of economics can be written without acknowledging his contribution. It’s his politics that stunk up the joint. He made the terrible mistake of not recognizing that a strong democracy can rein in the capitalists such that the benefits of wealth creation still exist, but its excesses are properly mitigated. He thought we could only eliminate those excesses via the introduction of what history has shown to be a hopelessly idealistic ‘socialist’ system.

I digress.

The confrontation I had was a much smaller scale. The conversation was with a private equity fund partner. The conversation revolved around his complaint that Obama plans to raise capital gains tax up to the levels of ordinary income tax – something I applaud.

His argument was that capital gains should be privileged in the tax code with a lower tax rate because of all the wonderful side benefits of equity investment. To whit: the wealth creation I have mentioned above. To my ears this is tantamount to a claim that the profits of capital are more valuable than the profits of labor. And that I find reprehensible, because it enshrines, permanently, the advantages of wealth.

His argument conflates two separate themes.

First is the simple theme of the search for profit – aka ‘greed’. There’s nothing wrong with this I as I have stated. The pursuit of personal wealth is our most effective inducement for innovation and consequently well being. But I think that this theme is sufficient to justify the actions of a capitalist. It needs no support.

Instead my capitalist friend justified his dislike of higher capital gains tax on the second theme: that capitalists, by being willing to take risks and support new ventures, create jobs and other ancillary goodies for society. They therefore deserve a break from the burden of taxes as an incentive to continue to invest. After all, this argument goes, without capitalists taking risks we would all still be in the Dark Ages.

I find this curious.

Here we have a true capitalist resorting to his worthy social impact as a defense of his lower tax bracket. So capitalists are really misunderstood, and potentially overtaxed, socialists? I think not.

This is the argument perennially wheeled out by right wingers to combat a tax hike: a rise in taxes is a disincentive and therefore diminishes the wealth generated in the future. We are hearing this a lot lately as the Obama budget gets debated in Congress.

There are a number of problems with it:

The data doesn’t support the case. Were incentives, growth and lower taxes tied together we should be able to see the relationship in the record. Periods of higher taxes should presage periods of slower growth and vice versa. So how do we explain the surge in growth after the Clinton or Reagan tax hikes? And how do we explain the unprecedented growth of the 1950’s and 60’s when tax rates were generally much higher than they are now? Conversely, why didn’t the Bush tax cuts of 2001 and 2003 set off a mammoth boom in growth instead of the anemic sputter that ended in 2007? I am sorry but I just don’t see the cause and effect that the tax cutters and my capitalist friend are so dogmatically sure exists.

More to the point: why should returns to capital be privileged at all? Isn’t there an element of fairness that needs to be accommodated here? The tax code allows investors to write off losses from risky investments that went wrong. But in an efficient market surely the returns to capital take into account the fact that some investments will inevitably be bad. So investors are already being compensated for their risks. Why should we double the compensation by allowing write-offs of losses. And then to compound matters, why should we then tax the resulting gains-net-of-losses at a lower rate than any other form of income? For this I must also apologize: I just don’t see why returns to capital have to be taxed at a different rate than the returns to anything else. I smell too much of a bias against regular folks in that one!

Lastly I fail to see the efficacy of the final argument put forward by my capitalist friend. That, well, if you tax him at the same rates you and I are taxed, then he’ll just take his money and go home. He just won’t invest, and then won’t we all be sorry when those jobs he would created don’t materialize. Ummm. I think he forgot the profit motive that he himself is so reliant upon. A higher tax rate will not stop all investment. Investors will still be faced with a decision regarding what to do with their excess funds. The notion that higher tax rates will prevent all forms of investment is absurd. It implies that all investors would be content with a zero rate of return on their funds. Somehow that doesn’t square with the image projected by my friend.

It was the great insight of Adam Smith to identify that the greed of individuals, all resolutely pursuing self-interest, can produce an outcome beneficial to all. Social well-being from personal greed is the magic that Smith attributed to the ‘invisible hand’ of the marketplace. The development of economic theory is largely the story of eliciting the processes and forces that contribute to this ‘magic’. But Smith was an ethicist, not an economist, so his concern was not just with markets but with the consequences of them. In particular he enjoined us not to trust those in commerce because they would inevitably try to conspire against the rest of us: after all they are self-interested.

Commercially driven people, entrepreneurs, and investors simply don’t leave money idle. They make it work. No matter what the tax rate is.

So don’t go giving me any of this ‘capitalists-need-a-break’ stuff. And the old ‘Obama-will-ruin-private-enterprise’ refrain won’t do either.

Greed will drive the search for profit under any circumstance. And if Smith is right, as I believe he is, we will all benefit anyway. There’s too many ‘selfs’ in a self-serving and self-righteous’ argument. Let’s raise that capital gains tax, we need the money. And lets’ applaud the risk takers too. Just let’s not get confused over their motivation: they want to make a buck not create jobs. That’s a consequence of private equity investment, not its goal.

As I said: some of these arguments can make my blood boil.