Debt & Taxes
2021-11-01 · Guest: Chris Edwards (Director of Tax Policy at Cato) · 52:32
Principles of tax policy and proposed wealth taxes
Bob Zadek and Chris Edwards discuss the fundamental principles of tax policy, the historical context of the 16th Amendment, and the potential economic consequences of proposed wealth and billionaire taxes. They explore how tax structures impact innovation, specifically through angel investment, and address the looming concerns regarding the national debt.
Topics: Tax Policy, 16th Amendment, Wealth Tax, Billionaire Tax, Capital Gains, Innovation, National Debt, Cato Institute
Speakers: Bob Zadek, Chris Edwards
Introduction to Fiscal Policy [00:00]
Bob Zadek: Good morning, everyone. Welcome to the Bob Zadek Show, the longest-running live libertarian talk radio show on all of radio. The show always of ideas, never once the show of attitude. Thank you so much for listening this Sunday morning.
My goodness, are we going to hear nothing other than billionaire tax, increasing the debt, raising corporate and individual income taxes, global minimum corporate tax? Is there nothing going on in the entire universe other than fiscal policies? One would think not if you had the bad judgment to listen to the daily news. I thought that since we are hearing so much about tax policy, spend policy, billionaire tax, increasing capital gains rates, changing the minimum tax, paying fair share and the like, it’s important that we understand a little bit about what’s really going on. What is the factual, the economic, the fiscal policy basis behind all of the hyperbole?
In short, as we observe, ultimately vote, as we observe and vote on issues this important to us, pocketbook issues, at very least we ought to understand what’s going on. To help us understand the issues, I’m delighted to welcome back to the show Chris Edwards. Chris is the Director of Tax Policy at Cato and editor of—and the topic says it all—downsizinggovernment.org, which is available through the auspices of Cato. Chris is a top expert on federal and state tax and budget issues, has spent his public and private life studying these issues. He really knows what’s going on. And Chris, at the risk of embarrassing you, whenever my wife and I get invitations to attend Cato events so we can learn what’s going on in the world and understand it better, if you were in our household, you would hear one or the other of us say to the other, “Oh great, Chris is speaking. We have to go.” So Chris, you are in my household the main event at most of these functions. So thank you very much for agreeing to share your wisdom this Sunday morning.
Chris Edwards: Well, thanks very much, Bob. And in all truth, the people who support and follow Cato are some of the smartest people around as well, and I learn a lot from people like you who support the Cato Institute. So we’re very appreciative.
Principles of Good Tax Policy [02:59]
Bob Zadek: Thank you so much. Now, Chris, this morning, let’s get into it. In the news, as I said in my intro, is major, major changes in both the policy surrounding how we tax income in this country, both how we tax it and the amount we take tax dollars from and who pays and who doesn’t pay. Also, the other half of the equation is, of course, what the government does with the money once they take it from us. Those are two very different topics. We’ll try to cover them separately so we can do a careful and as thorough as we can in an hour analysis.
So let’s start with the very broad topic of tax policy. Now, clearly, irrespective of how anybody feels about the appropriate size and scope of government, irrespective of that issue, even those of us who favor a limited government, we favor government. Government is essential to our well-being. Okay, so the government needs money. It doesn’t have any money. The only way it gets money is by taking it from its citizens and residents. So the government has to take money in order to carry on the functions that we all agree are necessary.
So now we have the government must take money. If you were to analyze tax policy, or putting it differently, you’re sitting around in government and saying, “Okay, we need money to function. Nobody disputes that. So we have to take money from other people.” Now, in your judgment, Chris, applying your worldview, your philosophical view, your economic view, if you were designing—if you had the government starts with no tax revenue and it needs tax revenue—what should the standards be? Forgetting about rates, forgetting about amount, what should the standards be in designing a tax policy? Putting the question a bit differently: what is good tax policy, good for the country—very broad, I know—what is tax policy that is good for the country as opposed to tax policy that is bad for the country? And of equal importance, how do you reach the conclusions you’re about to share with us?
Chris Edwards: Well, there are three basic principles the government ought to follow in tax policy. The first is they ought to extract the needed amount of taxes with the least damage to the economy. And unfortunately, the Democrats and Biden are going about it in the worst way today by raising the top rate, by raising taxes on corporate investment. Those things damage the economy probably the most out of any types of taxes. So the first thing we want to do is we want to have a flat, low-rate system with a neutral base to create the least economic damage. That’s the first thing.
The second thing is we want the simplest possible tax system. No special favors for individual industries, flat rate, as few deductions and credits as possible so it’s simple, so it’s easy for the IRS to raise the money, it doesn’t cause civil liberties damage by the IRS digging around in your affairs. If you had a simple tax, it makes the administration easy and paperwork costs—the vast paperwork costs that it takes people to comply with the IRS rules—is a waste for society. So we should simplify the code.
And the third principle of tax policy that is often forgotten is transparency. We live in a democracy. We need to know what the government is doing. The government tax system ought to be visible, as equal as possible, and transparent so we can see what the cost of government is. You go to the grocery store, you can see how much everything costs and you decide how much of it you want to buy. We need the same with our government. But the current federal tax code is not transparent. A good example is the three or four hundred billion a year raised by corporations. That burden, that corporate tax burden, is passed on to all of us as individuals, but it’s hidden from us as voters. So this is one reason why Biden and the Democrats want to hike corporate taxes by hundreds of billions of dollars, because it won’t be immediately visible to voters, and yet it does huge damage to the economy. So again, the three principles: as little economic damage as possible, as transparent as possible, and as simple as possible. That’s what we want out of the tax code.
The Economic Impact of Tax Rates [04:30]
Bob Zadek: Now, you explained the first sentence you offered in answer to my question was, “It should do as little damage to the economy as possible.” And you then observed that current tax policy, especially what Biden is proposing—Biden and others are proposing—does damage to the economy. Help us understand how some tax policy does less damage to the economy than others. Every tax policy takes wealth from what is called the private sector—that is, the private sector gets to decide how the money is spent and used—and gives it to the public sector, government, so it can decide how the money is spent and used. Whatever tax policy it is, wealth is transferred from the private sector to the public sector. So if we start with that premise common to all tax policy, how does some tax policy, specifically Biden’s, how does it damage the economy? And it’s really important for our listeners to understand that. Then they can follow along the debate on a much more informed basis. Help us understand that dynamic if you would.
Chris Edwards: Well, the first principle in tax policy that you learn as a tax economist is that the damage from taxes rises more than in proportion as the rate goes up. And in fact, as the tax rates go up, the damage rises as a multiple. So that means that a 40% tax rate is actually four times as damaging as a 20% tax rate. It’s not twice as damaging, it’s four times as damaging. And there’s basic sort of supply and demand reasons for that. But essentially, the higher the rate is, the more extreme the behavioral response to the tax rate. And large behavioral responses create this excessive damage. So as tax rates go up, investment drops, work effort drops, innovation drops, the number of new startups and new enterprises in the economy drops. So the first issue has regards tax rates. You want low, equal tax rates on everyone to minimize the damage.
And then the second major area of tax code efficiency is the tax base—what you tax. And for a long time, libertarian and conservative economists have argued that a tax base of consumption is much less damaging than the current tax base that heavily taxes income and capital. Why is that? Because in the long run, the way the economy grows is by business and individual saving, building new factories, buying new machines, saving money and building capital for the future. We want the sort of the tree of the economy to grow larger, and we don’t want to chop down the branches or the trunk of the tree. We want to harvest the apples and then tax the apples at their consumption. Liberals don’t agree with that. Liberals want to tax capital heavily. And the problem with that is it shrinks the overall size of the economy. The economy grows less because businesses have less money for investment, there’s less money flowing to new startup businesses. So that’s the second principle here: we want to tax consumption, which is essentially what people take out of the economy and consume, and we want to tax capital less so that the overall economy grows, which in the long run is better for all of us.
The 16th Amendment and the Definition of Income [06:31]
Bob Zadek: That’s a wonderful analogy. If you tax the tree, if you cut the branches off the tree, you end up with less apples. If you tax the apples, the tree continues to produce at least the same quantity of apples, usually more because the tree is itself growing. So the tree produces more and more apples each year. We still end up with apples being supplied to the economy, to stretch the metaphor, apples being supplied to the economy, but we don’t eliminate the source of future apples. That’s a wonderful analogy. I like that a lot.
Now, the founders abhorred, they were fearful of an income tax. So much so that in the Constitution given to us by the founders, an income tax was per se unconstitutional. It took one of the two worst amendments, in my opinion, to the Constitution—and they are side by side, the 16th and the 17th Amendment—it took the 16th Amendment in 1913, a constitutional amendment to permit the country to have an income tax. What was there, if you know, Chris, what was there about the income tax that so concerned the founders that they made the concept itself unconstitutional?
Chris Edwards: Well, it wasn’t just the income tax. If you go back to the beginning, in the 1790s, there’s a huge battle between Hamilton and the big government sort of faction and Jefferson and Madison and the smaller government faction. Hamilton favored so-called internal taxes. He wanted to tax Americans directly, whereas the Jeffersonians basically wanted to rely on import duties to fund the federal government. And the election of 1800 was largely fought over, was substantially fought over that issue. Jefferson won the White House and repealed all internal taxes, including the taxes on whiskey that had caused a huge rebellion in Western Pennsylvania. Anyway, that was where we started, that the Jeffersonians didn’t like the idea of IRS-type agents swarming around the country hitting people with taxation. Import taxes to them seemed more transparent and easy to collect.
Fast forward a century, yeah, we got the 16th Amendment, we got an income tax. One of the problems with the income tax is that the constitutional amendment did not define what income was. The amendment says “income from whatever source derived.” And there’s been a battle since the beginning over the last century over what that means. Liberals, people on the left, have a very expansive idea of what income is, and they tend to favor double taxing income. Conservatives and libertarians have a more limited understanding of what income is, and they don’t think it includes this double taxation of savings that happens under the income tax.
Bob Zadek: Now, many students of the Constitution identify themselves as originalists. That is, you interpret the Constitution based upon the generally understood meaning of the terms at the time the Constitution was ratified. That’s a very simplistic but I think accurate summary of originalism. So let’s apply that to the 16th Amendment, which just unhelpfully says “income from whatever source derived.” Is there any indication what the ratifiers of that amendment meant at the time it was enacted when they discussed income? Or is there just no guidance whatever, so the court, ultimately the court is on its own, which means government is on its own to define income any way it wishes?
Chris Edwards: Well, here’s the thing. Before the 16th Amendment was ratified, the federal government could tax income, but it had to be—the burden had to be apportioned sort on a per capita basis between the states. And the purpose of the amendment was so the government could just impose an income tax kind of any way it wanted. But even before, I mean, even before the 16th Amendment, in I think it was 1909, the federal government imposed a corporate income tax. And they got around the prohibition on apportionment by saying the corporate income tax is an excise tax. So they didn’t even call it an income tax, you see. And in my view, the corporate income tax is the worst type of income tax we have, and the government didn’t need the 16th Amendment to impose it.
So the 16th Amendment isn’t kind of everything. It only—the government was able to kind of get around the prohibition on this really bad type of taxation before that. But anyway, ever since the federal income tax was imposed, the economists and members of Congress on the left have had this expansive idea of income, which economists call Haig-Simons income, which essentially includes the overall value of all your wealth appreciation during the year. So if your house rises in value ten or twenty thousand dollars in a year, this expansive left-wing view of income suggests that you ought to be nailed by the IRS on taxes on that appreciation this year and every year. If Jeff Bezos’ Amazon wealth rises by ten billion this year, he ought to be banged right away with taxes on that. So that’s the left-wing expansive view of income taxation. Conservatives and libertarians have long thought that no, income should be more narrowly defined to basically just be consumption. What is it essentially that you’re taking out of the economy? If Jeff Bezos owns Amazon and let’s say he’s a frugal fellow that lives frugally and he leaves his wealth invested in Amazon, that shouldn’t be currently taxed because his wealth is generating GDP for the overall economy. It’s only when people take out their money out of investment and they consume, that’s when income ought to be taxed. And the current federal income tax is sort of a compromise. So we tax capital gains on realization, when Bezos sells some shares of Amazon, he realizes the gain, it’s taxed then. But the Democrats you see are pushing to expand that. They want to tax capital gain appreciation when it happens and not waiting till the realization event. So there’s been this constant struggle, you see, over what the meaning of income is.
The Wealth Tax and the Billionaire Tax [08:43]
Bob Zadek: Now, what’s—you have written recently, taking what we have discussed so far and applying it to current events, you have—we have on the table, perhaps off the table, but it’s not—it’s maybe out of sight but not out of mind, at least not Elizabeth Warren’s mind and others on the progressive left, the issue of what has been called sometimes the billionaire’s tax, the wealth tax. And a wealth tax, in many people’s minds who are fortunate enough not to think about tax policy 24 hours a day the way you and I do—they live far more rational lives—but when they live their rational life, they often do not focus on the great difference between wealth and income. And the tax on wealth, the proposed tax on wealth, which it looks like it’s off the table, tell us what was proposed, why you have identified it as I think the worst tax idea ever—maybe even more extreme than that—and help us understand why a tax on wealth got your dander up and why it is so different than a tax on income.
Chris Edwards: Well, you can look on the Cato website to see my study from a little while back called “Taxing Wealth and Capital Income.” Basically, more than a dozen European countries used to have these things called wealth taxes, which were annual taxes on the overall gross amount of the wealth of wealthy individuals. So a wealthy individual in France or Sweden, they would every year add up the overall value of what they own, not only their housing but all their business assets, and the government would bang it with a tax.
There’s so many problems with this. The first problem is that the government’s always carved out exemptions. And so if you think about if the federal government tried to impose a wealth tax in this country, a large part of the wealth in this country is farmland. And the farmers are such a powerful lobby, there’s no way in hell that the federal government if it imposed a wealth tax would be able to impose it on farmland. Can you imagine the government hitting wheat farmers and corn farmers every year on the gross value of their farmland? There’s no way it would happen. So the government would end up having this narrower wealth base and there’d be lots of assets like farmland that were exempt. And so then rich people would move all their assets, they would start buying up the tax-exempt assets like farmland. And so you get this really distortionary situation.
So those sorts of distortions are one of the things that ultimately killed the European wealth taxes. Just about every country in Europe has repealed these wealth taxes because they were shot full of loopholes, they hit wealthy people unfairly in these unequal ways, and they damaged investment. Here’s the basic math is this: if you put, you know, people like Elizabeth Warren say, “Well, my wealth tax would only be 2% a year.” But supposing you had an asset that returned 6% a year in annual return. If you put a 2% wealth tax on that, it’s like a third of the overall return. So it essentially is like a 33% income tax banged on top of all the income taxes already on the return from the assets. So these wealth taxes would be hugely damaging. Just about every country in Europe has repealed them. And I don’t—Elizabeth Warren and Bernie Sanders keep talking about it in this country, realistically it’s not going to happen, and they sort of use it though as a bludgeon to batter wealth in this country.
But here’s something that I’m surely you know, Bob, that wealth is beneficial. The economy wouldn’t grow without wealth. Bezos and Elon Musk both have wealth over a hundred billion dollars, but that wealth is almost totally business assets. It’s not personal consumption assets. There’s a statistic actually that the very wealthiest people in the economy, only 2% of their assets are personal consumption assets like their homes, for example. 98% is their ownership of business assets. Those business assets produce millions and millions of jobs and GDP for the economy. So wealth is good. Wealth is business ownership. And business capital or business ownership is the creation of jobs. Amazon employs over a million people, and they’re able to do that because the wealth, the capital in the business. So wealth is a good thing, not a bad thing.
Bob Zadek: What strikes me as strange, kind of irrational in the whole discussion of the billionaire’s tax, it’s not as if government believes that ownership of marketable securities, of stock in Amazon, investing in Amazon, it’s not as if government considers that to be somehow bad for society and let’s punish it. It’s the concentration of wealth. If Bezos’ wealth was scattered among a hundred thousand people, nobody would care. So for some reason, we have decided—and it’s wholly irrational—that it’s the concentration of the wealth in one person that somehow makes it a target for taxation.
Chris Edwards: But let me pop in there, Bob. See, this is the thing. Amazon’s Bezos’ wealth is not concentrated. It’s actually distributed across the entire economy. Amazon owns warehouses and distribution facilities, vast fleets of trucks and planes and the whole bit, distributed across our entire economy, which is hugely beneficial for everyone, for people and workers and consumers in every state of the nation. So I would argue that Bezos and Amazon wealth is not concentrated, it’s actually very much distributed across the whole economy.
Bob Zadek: But the focus is on the fact that Bezos is a billionaire only because ultimately at the very tippy top of the pyramid, it’s on his balance sheet rather than a hundred thousand people’s collective balance sheet. For somehow that gets people all tied up in knots, and I don’t understand why. I could understand if behavior, if having economic power, that power is then misused in ways that are illegal or they violate public norms, bribery and the like. It’s the behavior, it’s how you use the wealth that is either bad or good, but not the ownership itself. That’s neutral in terms of its effect on the government, and there’s no reason to focus—
Chris Edwards: So here’s the way I think people are worried that individuals have substantial amount of, I guess you could call it power from their large ownership of large businesses. But the best way to control that power that people like the owners of Facebook and Amazon and other big companies have is intense competition. So we need to open barriers in every industry for intense competition. The thing about wealthy people like whether it’s Zuckerberg or Bezos or Elon Musk and others, ultimately consumers decide how much money flows to their businesses. But they’re each trying—they’re competing with each other, they’re each trying to undercut each other’s businesses. So the best check on billionaires is other billionaires able to aggressively compete against them. And as I’ve written in my Cato studies, one of the problems with the economy is that the government itself puts barriers on competition that we ought to get rid of. Get rid of the barriers to competition, allow the billionaires to vigorously, dog-eat-dog go after the wealth of each other. That’s the way to check their power and wealth.
Bob Zadek: Of course, you’re needless to say you’re 100% right. And it’s—if you use your wealth to help buy those barriers, to manipulate government, cronyism as we call it, different conversation entirely. You’re of course exactly right. And we are watching at least at the space exploration exploitation level, we are watching Bezos and Branson and others competing to control the universe, kind of an interesting battle, and privatize space travel. So that’s the very competition you mention. Ten years ago, it was inconceivable that there would be private businesses making money off the universe.
Chris Edwards: That’s right. And actually, if you look at that industry, it used to be a government monopoly, NASA. It was a monopoly. And economists don’t like monopolies because they become very inefficient and bloated and wasteful. That exactly was what NASA was. If you look at the massive cost overruns on the International Space Station and stuff like that, NASA was this hugely inefficient thing. And Musk, actually Musk is I believe his companies now is the major launch provider for NASA, which is contracted out. He’s slashed the cost of NASA launches, so that benefits all of us. Richard Branson, one of the other entrepreneurs in space, is one of the most remarkable entrepreneurs of recent decades. If you look at what he’s done, he’s gone into the passenger rail industry in Britain, he’s gone into the airline industry, into the music industry. Every time he’s gone into these industries with the purpose of undercutting the existing businesses and providing higher quality at lower prices. So that’s what we want entrepreneurs to do. And I don’t begrudge people like Branson at all for the large wealth they’ve created because they’ve created it by providing better services at lower cost for consumers.
Innovation and Angel Investment [12:50]
Bob Zadek: Now, in the beginning of the show, I had asked you to observe and establish your standards for what would be good or beneficial tax policy, given that we have to have taxes to begin with. And you explained your standards to us. In applying those standards, in your opinion—and you and I both know about all of the insidious weaknesses and flaws in a VAT tax, but a VAT tax is a consumption tax, and we can explain VAT very briefly to our audience in a moment, Chris—but in general, is an income tax per se the wrong way to raise revenue as compared with excise or VAT taxes?
Chris Edwards: Yeah, that’s right. Especially the current income tax is a grossly inefficient and complex beast the way it’s been enacted in the United States. So if you look at what the Democrats and President Biden are proposing now, they go the wrong way in all three of my criteria for the tax code. One, simplification: they go in the wrong direction. I’m all in favor of eliminating loopholes, in other words, narrow tax breaks in the tax code for wealthy people and everyone else. But the Biden people go in the wrong direction. They’ve proposed dozens of new tax breaks and tax credits for electric vehicles and renewable energy. So they’re going to increase the frenzy of corporate lobbying around the tax code with what they’re proposing and make it more complicated. In transparency, they’re going the wrong direction too. They’re increasing taxes in extremely complicated ways on corporations. That’s going to damage our economy, it’s going to be bad for all of us as citizens, but it’s going to be this hidden burden from citizens and voters. So that’s bad. And finally, the Biden and the Democrats are raising taxes in the most inefficient way by raising rates on high earners and entrepreneurs and small businesses, by taxing corporate investment heavier, which is going to reduce corporate investment and therefore reduce job opportunities for all of us. So on simplification, transparency, and efficiency, Biden and the Democrats are going completely in the wrong direction.
Bob Zadek: You have written extensively on the subject of the obvious need for innovation, that is the secret sauce that drives our economy. And you have written about angel investors and the vital role they provide. They are risk-takers. And people have to be motivated to take a risk, or else there will never be innovation. Innovation is always a gamble. You do not know when you are innovating, you have no idea—you have an expectation, you hope you’re right, but you do not have the certainty of knowing whether the money you invest will be down the toilet with nothing to show for it or will be wildly profitable like Amazon and PayPal and the like. So obviously, the incubation period, the angel investors which you have written about quite a bit, Chris, the need for the 330,000 angel investors in this country who provide the petri dish for innovation. And you have also written, and please help our audience understand how the proposed tax policies of the Biden administration take that fertilizer for innovation, that petri dish, and destroy it both with its approach to capital gains treatment and in taxing high net worth individuals with the so-called billionaire’s tax. Because without innovation, we are toast.
Chris Edwards: That’s right, Bob. So one of my recent studies at Cato is I looked at what’s called angel investment. I was interested in what is it that wealthy people do with their money. And one very interesting thing that wealthy people do with their money, as you said, there’s about 330,000 wealthy people in the United States who take a share of their income and they invest in startup companies. So Elon Musk himself took some of his previous wealth, I think from PayPal, and about 15 years ago he invested in this startup called Tesla. No one knew that it would be successful. He was investing in a startup car company going against all the big three car companies and all the Japanese car companies. He and the others with Tesla had this crazy idea that they could build a car company and compete against the big boys, and he’s been very successful. If you go back in US history and you look at the great companies, whether it was Apple Computer in the 1970s founded by Jobs and Wozniak, or if you go back to Henry Ford’s Ford Motor in the first decade of the 20th century, we remember the great entrepreneurs. But if you look at those great entrepreneurs, you almost always find a wealthy person who was willing to take a big risk and invest in that startup company. So the company that became Ford Motor Company was actually Henry Ford’s third try at starting a car company. His two previous car companies had failed. So he found an investor that was willing to take a risk and put his money into Henry Ford and that third try was successful. Similarly, Jobs and Wozniak, where they were nobodies, they were just these young long-haired kids in Silicon Valley in the late 70s. They had this crazy idea that they could create this personal computer. Of course, back then IBM was the dominant company and who would have thought that these two young kids could start this whole new industry that became the personal computer industry. But they went out and they found this investor who was willing to put $100,000 into them. So throughout our history, wealthy people have been crucial to take these huge risks on these startup companies. If you look behind just about any of the current high-tech successful high-tech businesses, whether it is Amazon or Spotify or Airbnb or Uber, those—no one knew that those companies would succeed. They all entered very risky industries, but they were able to convince wealthy people to put money in initially. And what is the reward for those wealthy people to invest in startups? Ultimately, it is a capital gain. They hope that maybe one in five or one in ten of their investments will be successful. If it’s successful, they get a big capital gain years down the road when they sell their stock. And that’s why capital gains taxation is so important, because high capital gains taxes greatly reduce that incentive for wealthy investors, angel investors, to invest in startup companies.
Bob Zadek: And you described when you said angel investors, people who take equity startup risks, you said one in five or one in ten will succeed. It’s much closer to one in ten, of course, than one in five. So obviously, an angel investor, those who invest in startups, make a calculation that if nine fail and if one succeeds by enough, then that will compensate for the nine failures. Thus it makes sense because ultimately your decision to be an angel investor will be rewarded. But if you tax the heck out of the benefit, that means that now the angel investor cannot just succeed in one out of ten to get the same return, it’s now got to succeed in one out of six, which means it can take less risk, which means riskier ventures don’t get any money and we stifle innovation. So it’s really that simple.
Chris Edwards: That’s right. And investors always have alternatives. If we make investing in startups too burdensome from a tax perspective, investors are going to invest in safe, put their money into government securities, maybe into tax-free muni bonds, maybe into dividend-paying safe corporations. So that’s not good for the economy. If we bias everyone toward just investing in safe assets, we’re not going to get the innovation in the economy we need. And everyone wants America to be at the leading edge of all of today’s innovation industries, whether it’s biotech or software or whatever. To get that investment in those leading-edge innovative industries, we need to have a low capital gains tax, we need to encourage investors to invest in those risky industries.
The National Debt and the Tipping Point [15:53]
Bob Zadek: And especially since the use of the money, taking the increased tax dollars, the spending part of our discussion, and if that is simply used to transfer wealth through entitlement programs, the money you transfer into entitlement programs does not produce collective wealth in the economy. It encourages a bit of consumption, perhaps—in fact, I’ll say no doubt—but the benefit to the economy of increased family consumption is quite modest, indeed negligible, compared to the benefits to the economy from innovation. So we simply are—it’s a misuse for government to transfer wealth from the productive segment of the economy, which benefits everybody, to entitlement programs, which only benefit the recipient with not much spillover effect. It’s just not good for the country. It may be good for the ballot box, a buying votes kind of transaction. It may be good for the ballot box, it may be good for the politicians who vote for it, but it’s bad for all of us. And one would like to think our government makes decisions that are good for the country at large, not for individual voting blocks.
Now, Chris, there’s been a discussion—and we don’t have a lot of time for this, but I want to get the benefit of so much of what you know about the subject of—and I know it’s an hour program itself, Chris—wealth inequality. Does our system, our country, is it guilty of exacerbating income and wealth—two different subjects—income and wealth inequality? Is it a leveler making people more equal, or is it a contributing factor to the cancer of wealth and income inequality?
Chris Edwards: Well, if you look across countries in the world, some countries have more measured wealth inequality than others. And truthfully, the data we have on wealth is not very good. The government, of course, collects income data on Americans through your annual tax return, but the government has no real solid data on wealth. The thing with wealth is this: either it can be gained in an inappropriate and inefficient and unproductive way, as we were touching on earlier, through subsidies and cronyism and that sort of stuff. And if you look at some of the countries around the world with the highest levels of inequality, wealth inequality, like Russia, a lot of that inequality is driven by cronyism, and we all agree that’s a bad thing. You get cronyism when you have a big government and when politicians have their octopus tentacles in every part of the economy. So in a market economy, wealth gets created and accumulates through entrepreneurs creating things that consumers want to consume. And America is still mainly a market economy. We’ve got way too much cronyism. But if you look on the list of Forbes puts out a list of the 400 wealthiest Americans every year, the great majority of people on that list are people who are entrepreneurs who have created these great companies that benefit all of us. And as I said, we want all those folks to compete against each other, and vigorous competition is a great thing. But I don’t begrudge those wealthy people at all if they’ve generated the wealth through making consumers happy through creating better products. So you have to really look behind at where wealth came from. Cronyism is bad, market-generated wealth is good and it benefits all of us.
Bob Zadek: You know, you made a point that I make quite often on the show. It’s not—it’s like when I ask somebody’s opinion. The opinion itself as a standalone one-sentence explanation is kind of uninteresting. But the reason how you got to that opinion, what your thought process was, I can roll up my sleeves, we can have a conversation for a weekend about how you got there. And you’ve just made the exact same point with respect to wealth. Wealth per se is just a calculation. It’s irrelevant to society so long as you obtained the wealth through socially acceptable, beneficial means, through competition, through providing consumers with what they want at a price they’re willing to pay for it. That means you have succeeded in making a lot of people’s life better and you are simply rewarded for benefiting so many people. So it’s never the wealth per se, it’s how you got it. If you got it through rent-seeking through the government—
Chris Edwards: To add something there on there. So when wealth comes from innovation, that benefits all of us. And to go back to what you’re talking about earlier about how the Democrats just kind of seem to want to confiscate money and use it for government purposes, I honestly believe it is—I am baffled by where people like Bernie Sanders think that innovation comes from. It is not from the government. If you look at all the great innovations in the American economy like over the last century or so, they almost all come from startup companies like Apple Computer that had these really bold ideas, individual people had these really bold ideas, they went out and they found some private funding for it and they really ran with it. The breakthrough vaccines from Moderna of Massachusetts and this other company BioNTech of Germany, those were privately funded innovations. Those companies didn’t depend on government subsidies. Those are privately funded innovations that have benefited all of us. So the fact that Moderna of Massachusetts now is making a lot of profits on its vaccine, well that’s great. It’s going to turn around and invest those profits into new innovations and development. So innovation and wealth go hand in hand and it’s something that the private sector can do and has always done and the government cannot do.
Bob Zadek: The last topic we’re going to have time for—we only have a minute or two for a subject that should be again a semester—is that of course we haven’t spent much time—that’s for another show, Chris—on the 28, 29 trillion dollars of debt and growing. There have been through my entire life, every time we hit a new level of debt in this country, debt as a relation to GDP, there have been predictions that we’re at the tipping point. And yet even when the tipping point was way below what it is now, we didn’t tip. How will one know when we really have hit the tipping point in debt, or are we just about there? We have about a minute, Chris.
Chris Edwards: Well, all debt is a cost pushed forward to the future. All that 28 trillion dollars of borrowings, ultimately we’re going to have to pay the interest and principal back on that, so it’s going to reduce the standard of living in the future. Every dollar of it reduces our standard of living and our children in the future. That’s one issue. The second issue is what you’re touching on is will it create a crisis and when will it create a crisis? We don’t know exactly. We do know that when countries get above around 90% of GDP in debt, it really starts reducing economic growth. And Greece when they went into their big crisis a decade or so ago, they were at about the same level of debt that we are here in the United States now. So those are two different questions. All debt, all government debt is going to reduce our standard of living in the future. But a second question is, is it going to precipitate a giant financial crisis? I think it is, but no one knows when that’s going to happen.
Bob Zadek: No one knows when that’s going to happen. I will just mention just a minor comment that it may be, we don’t really know, misleading to compare Greece debt with US debt. Greece was not the reserve currency, United States is. The dynamics in the world are different between people stop buying US debt versus stop buying Greek debt. So it’s really an unknown. We don’t know yet. We’ll know only when it happens, but it’s a little hard to know in advance.
Chris Edwards: Right, but think about it, Bob. Yes, we’re a different sort of a country than Greece. But because the United States is about a fifth of the entire world economy, it would be much more disastrous if the United States ran into a giant financial crisis for the overall global economy. I mean, Greece created a lot of ripple effects around Europe, but imagine if the United States got into such a crisis. It would be a global, terrible global crisis. So in my view, it’s even worse that a big country like the United States is in debt than a small country like Greece.
Bob Zadek: Chris, how can our friends follow your work at Cato?
Chris Edwards: You can just Google Chris Edwards and I also run Cato’s website downsizinggovernment.org. If you want to know what the solution to all this is, it ultimately is cutting government spending programs and that’s what the downsizinggovernment.org website is all about.
Bob Zadek: This is Bob Zadek. I’ve been spending an hour with Chris Edwards, who is the Director of Tax Policy over at Cato. We’re talking about debt and taxes, not particularly happy subjects, but it’s been an enjoyable hour, Chris. Thank you so much. If you’ve enjoyed the show, please let us know at my podcast bobzadek.com and give us any suggestions and comments and rate us if you feel like doing so. Thank you so much for your time this Sunday. Thanks again to Chris. Hope to see you soon again in person, Chris, and have a nice weekend.