Debt and our Children

One regular topic these days in our political discourse is the lament that we are leaving a great burden of debt to our children, and this, of course, is truly lamentable and should not be done.  Currently and most recently this concern has been expressed most passionately by the Republican party and its supporters due to the perceived rise in national public debt under Democrats.  This complaint, coming from Republicans, is absurd for a number of reasons that have been discussed elsewhere, but there is another reason that I haven’t seen why the complaint is indefensible coming from Republicans.  Indefensible because their policies are vastly worse for our children in regard to the debt under which they are being placed.

Consider first how we used money and what its function is in the economy.  The basic, fundamental act in an economy is that one person does something useful for another, the second person does something useful in return.  While doing something nice, or helpful for someone else is certainly a virtue, no one does, nor really can, work extensively to provide for another person in return for nothing.  We people, to survive, need to trade.   With simple barter, in prehistoric times, this is simple.  Fred gives Barney a newly made spear, Barney gives Fred some of the meat from his hunt.  This can work because it involves only two people.  As societies become more prosperous and people become more specialized in the useful work they do, the trades need to involve more and more people so that simple barter becomes impracticable.  Money is the elegant solution to this problem.  So today instead of you providing some service that is of value to your employer and she provides some goods or services to you, your employer provides you with money that you can then use to complete the trades you need with other people.  The money serves as an indicator of the useful labor you’ve done so that you can now trade it for someone else’s useful labor and the basic exchange, useful labor for useful labor, is retained.

But now consider the Republican policies of low taxes on the extremely wealthy, especially those who rely heavily on government services to earn their income.  So, for example, Bill Gates (replace with Steven Jobs if you are a Mac user) did a great deal of useful (at least work that a lot of people found useful.  This is the last nod I’m giving to Mac/PC debate) work in the 80s and 90s creating an operating system for computers.  In return for this service he earned a great deal of money and is therefore able to command a great deal of other people’s labor, good and services in return for the great value he added via Microsoft.  All is well and good so far.  However, no matter how it pains Republicans to hear this, he did not do it on his own with no assistance from government.  He needed the government to guarantee his intellectual property rights, he needed government to provide a special legal status with regard to liability to raise the capital he needed, in short he needed a great deal of assistance from government. 

This in turn is fine, but then it is also fine to have government capture a portion of the revenue it helped to create and spend it in a manner to the benefit of the general populace.  If instead we follow the low tax policies of the Republican party we are insuring that Bill Gates (and others in the same situation) will then be able to leave behind vast fortunes to their children, fortunes comprised largely of value produced by the government.  This in turn means that these children and their children in turn will be able to benefit from the useful labor of the descendants of the less fortunate without doing anything of value for them in return. 

Let me reiterate that last paragraph.  It is true that during the 80s and 90s Bill Gates became wealthy by providing a useful product to many people.  In return for the value he provided then much of the goods and services produced by the nation were provided to him, making his life very comfortable and secure.  Due to Republican tax policies his children will continue to enjoy the results of your children’s labor without themselves needing to do anything in return.  The only value we can expect to get from the Gates family was added in the 80s and 90s and yet for generations to come we, and our descendants, will need to provide for them getting nothing in return.  This is truly leaving our children indebted for the future. 

Now if it were the case that the people such as Bill Gates earned their fortunes entirely on their own, then perhaps there would be nothing to do about it.  But as I point out above that is not the case.  Rather they depend heavily upon Government support therefore the Government should be charging them money for the service.  That would be the most important step to riding our children of future debt.

Parable of the Travelling Merchant

This tale is set in colonial America.  A small isolated village is a reasonable place, the price of a days labor is $1, a nice simple figure and the range of things done in the economy is small and straightforward.

 

The Merchant Thomas Smith is travelling, as is his wont, from town to town and village to village in Colonial America, hauling his cart laden with wares that he has purchased at previous stops and hopes to sell at future stops.  On this day he is off on a road he hasn’t travelled before and comes upon the very poor, unfortunate town of Arkham.  As Thomas entered the town he could see that although the town was well situated near water and other necessary resources, the state of the buildings and the roads and the people indicated a quite depressed condition for their economy.  Little was in repair and less was being done by anyone.  It seemed to be a poor choice for the destination of a merchant hoping to increase his prosperity, but Thomas was always a hopeful sort and decided he would first see if he could learn more about the town and its history.

After a brief time he learned that the cause of the impoverished state of the village.  By some strange chance the town was completely devoid of money.  No type of currency could be found, neither coin nor paper of any kind.  The exact cause of this strange state of affairs need not concern us now (this is after all a parable).  So in this town while all types of simple barter could be done, any more complex transaction was impracticable.  The blacksmith needed coal for his forge but the coaler did not need any tools, he needed his roof patched.  The main who could repair his roof, however, needed no coal, he needed land cleared, and so on.  So the village remained in very unkempt state with may of its houses in disrepair, fencing broken down, animals untended, land going to waste, roads in need of attention and generally in a very poor state.  Thus the town seemed a poor place for Thomas to spend his time.  Given the general poverty of the area, he could find no tradable goods to purchase, and of course given the absence of money, no one in the town could purchase his goods.

And yet, there was much opportunity for prosperity, and trade, in Arkham.  The townsfolk were capable of producing many things of value.  The land could be cleared and the animals could be tended.  Beyond that there was evidence that people could make many things of value for trade.  One woman of the town had, in the past, made beautiful ceramic ware (but her kiln was now cold and she had no clay), the blacksmith had skill and could make wonderful tools (but he was out of coal)yet another townsman did fine woodworking (but he had no wood and his tools needed attention from the blacksmith).  A long list of similar stories could be told of the townspeople of Arkham.

Given the possibility of prosperous trade from Arkham to the rest of the region, Thomas pondered what he could do.  He had his cart, laden with various goods for trade, goods which he had purchased for a total of $50, but which he could expect to sell for a total of $100.  In addition he had but $2 in cash on him, as at this stage in his travels he had most of his capital in his tradable goods.  Now, as stated, he could hardly benefit anyone with his tradable goods, but he thought he might do something useful with his cash.  There was nothing of value here for him to buy, but it occurred to him that another use might be made of his two dollars.

He took one of his dollars and gave it away to one of the villagers.  He purchased nothing, just gave it away.  The glad recipient of this bounty immediately set off with his new riches and paid the one dollar to the fellow most skilled at repairing roofs, to repair his leaking roof, the greatest hindrance to his prosperity.  The fellow who got the dollar to repair the roof set in to do the job, but first went to the blacksmith who he paid a dollar to fix his plow.  The blacksmith, before setting to work on the plow, first paid the collier for a dollars worth of coal and the collier went and paid another villager a dollar to fell trees and create some lumber.  Before the day was out that one dollar, given away, had done some six or seven dollars worth of work throughout the town.  Seeing the wonderful effect of this one dollars rapid pace through the town, Thomas sent his other dollar off on much the same trek.

After two or three days of this the town was already much improved.  Walls had been whitewashed, roofs had been repaired, land cleared, fences mended and host of other tasks had been completed.  The prosperity of the town was rising fast as the two dollars in currency were passed quickly from person to person compensating each person in turn for useful labor done.  Each person in turn could provide some valuable service to a fellow townsperson, knowing that he or she could expect to get someone else to do something useful in return. 

Before the week ended the basic needs of the town had been addressed and people began to produce goods above and beyond anyone’s immediate needs.  The one woman’s kiln was again being used to produce ceramic ware, the woodworker produced some of his fine utensils and the blacksmith was producing extra tools of fine quality. 

At first Thomas was just pleased to see the good being done by his two dollars, which was, after all, a small part of all his capital.  By means of this small donation he was able to do a great deal of good.  This alone pleased him much.  But as he saw the changes coming on about the town, especially the latest, the production of finished goods that could be traded, he soon realized that he could recover his two dollars, and not only that, he could join in on the rising prosperity his generosity had started.

One of the two dollars, on its latest circulation around the village came into the hands of one young wife who had no longer any purchases to make among the residents of Arkham.  This would be all well and good in ordinary circumstances, but here it cut in half the work being done about the town.  Seeing this Thomas went to see if this woman would be interested in any of the wares in his merchant’s cart.  As it happened she was.  Several items of use about the house were exactly the sort of thing she wished to have and so he was able to capture his dollar back by trading items he had purchased for fifty cents, but had fully expected to trade for a dollar.  This time, however, rather than give the dollar away, he went to the woman will the kiln and ceramic goods and purchased, with the dollar he had back, goods that he knew he could sell, in another town not two days travel to the west, for two dollars for sure.  As the woman with the ceramics had other tasks she needed about the town, the dollar was again on its travels, making possible an increase by several dollars in the prosperity of town each day. 

With this trade, Thomas saw that his cart now had goods which sold on his usual route would bring him $101, one dollar more than the cart was worth when he arrived.  He had reduced the value of the cart to get the dollar from the woman who wanted his goods, but had raised it by two with the purchase of the ceramic wares from the second woman.  Over the next few days he was able, on several occasions, to capture one or another of the dollars (or the same one each time, who could tell) by trading off his goods, and then increase the value of his cart by buying up the tradable goods the villagers were now able to produce.  

So although a scant two weeks had passed from the time Thomas arrived in Arkham it had been transformed by his donation of two dollars from poverty to prosperity, and his cart, which upon arrival had goods worth $100, now had a set of goods worth $110.  So, in spite of his having donated $2 to the town, he was $8 richer than when he arrived. 

Corporate Income Tax

On October 28 Kevin Drum put up a post up titled Kill the Corporate Income Tax which seemed to me to be quite wrong. His main point was that it would reduce the incidence of lobbying because most lobbying is directed at corporate tax issues. This makes no sense to me, it would rather simply push lobbying toward ending regulations an or other mechanisms by which the Federal Government can direct favorable treatment toward corporations.

Beyond that, it seems to me that the corporate income tax is an eminently sensible tax which should certainly be preserved. To bring the issue into clearer focus a commenter posted links to two articles describing why the corporate income tax should be abolished. One of these articles comes from Beardsley Ruml the Chairman of the Federal Reserve Bank of New York and was printed in 1946. The other comes from William Vickery in 1996, a list of 15 fallacies in economics.

So my task now is the supremely arrogant one of explaining why I think they are wrong.

Chairman Ruml lists three reasons why the corporate income tax is a bad idea, the first of which is

1. The money which is taken from the corporation in taxes must come in one of three ways. It must come from the people, in the higher prices they pay for the things they buy; from the corporation's own employees in wages that are lower than they otherwise would be; or from the corporation's stockholders, in lower rate of return on their investment. No matter from which sources it comes, or in what proportion, this tax is harmful to production, to purchasing power, and to investment.

He further explains the problem as follows

Let us examine these three bad effects of the tax on corporation profits more closely. The first effect we observed was that the corporation income tax results in either higher prices, lower wages, reduced return on investment, or all three in combination. When the corporation income tax was first imposed it may have been believed by some that an impersonal levy could be placed on the profits of a soulless corporation, a levy which would be neither a sales tax, a tax on wages, or a double tax on the stockholder. Obviously, this is impossible in any real sense. A corporation is nothing but a method of doing business which is embodied in words inscribed on a piece of paper. The tax must be paid by one or more of the people who are parties at interest in the business, either as customer, as employee, or as stockholder.

My problem starts with the sentence “A corporation is nothing but a method of doing business which is embodied in words inscribed on a piece of paper.” It is true that a business may be organized as a corporation or it can forgo incorporation and run as a private business. But the state ob being incorporated must either add value to the business or it will leave the value unchanged or decreased. If it is the latter than any corporate income tax can only cause business to do without incorporation. However, the assumption here is that this leaves the value of the business unchanged so this imposes no cost on anyone. if, on the other hand, the state of incorporation increases the value of the business that the tax may be paid out of that increase in the value of the business.

Let us assume, for example, that a given business is operating unincorporated and generates a profit of $1 million. It then incorporates adds value to the business raising its profit to $2 million per year. Assume also that it must pay the full 35% corporate income tax which reduces its incorporated profit to $1.3 million. This is still $300,000 more that it had prior to incorporation. This kind of tax “burden” most people would be willing to endure. As far as the Chairman's options as to who has to pay for this tax, the business described above could increase the amount of dividends paid to investors by $50,000, increase wages paid to employees by $50,000 and reduce prices paid by consumers by $50,000 and still be $150,000 richer. Now, of course, it is possible to claim that all the value added by the status of incorporation should be given to the business and the failure to give this value away is forcing one of the three to “pay” the tax. But this seems to be equivalent to claiming that any time the government could provide a subsidy to some business and does not, the government is forcing the business to “pay”. This is hardly consistent with standard economics, particularly as argued by conservatives.

Consider too that the value added by incorporation does not come for free. For a number of businesses there exist some low probability events that would be extremely costly, perhaps ruinous, for investors under ordinary liability laws. Consider something like a chemical plant which could catch fire and destroy most of a town. If the owners of such a business are fully liable. then the cost of the damage done could certainly be greater than the total assets of the owners, in which case such an accident would ruin them. Under those conditions getting people to invest in such a business is very difficult and the amount of capital that can be raised to run it is limited. And where the capital invested is limited the returns on that investment are limited. Incorporation was invented to produce a state of limited liability to protect the investors against such a disaster. It functions essentially as an insurance polity against investment loss. The amount that an individual invests then is the deductable, all other costs in the event of disaster are paid for by someone else. Incorporation does not, however, eliminate the risk. The possibility of disaster remains, it just is not the investors who will pay (at least they will pay no more than the amount they invested, even if the damage done exceeds that amount to any extent whatsoever.) So if the investors are not taking the risk who does? That would be, in the example I cited, the people living near the plant whose property may be destroyed by such an accident.

If this seems abstract, consider the concrete case of an offshore oil exploration platform in the Gulf Cost. Since being incorporated the value of British Petroleum has been vastly enhanced by the fact that its investors are protected against investment loss in the event of a catastrophic accident. Being incorporated the business is able to raise far more capital than it otherwise would be able to do, and with that additional capital it can earn far more revenue. But that enhancement of the value of BP did not come from nowhere. It was made possible because the residents living around the Gulf Cost have been taking on some of the risk related to the oil exploration and extraction which is the source of BP’s revenue. Indeed, not only have they taken on some of the risk, they have recently had to pay a price in lost business, lost property, adverse health effects and the like due to the spill that took place earlier this year. In order for businesses to gain the revenue they do as a result of incorporation then other people, most of whom are not owners of the business, are taking on some of the risk, risk that involves very real costs to these people. If some of the revenue gained through this process is spent on things of value to those people on whom this risk is thrust, that is in no way a burden on the business gaining the benefit.

In short the nature of the corporate income tax is a matter of simple trade. People take on risk to enhance the revenue of a business which pays them some (but by no means all) of the additional revenue and both parties are better off. It is the opponents of the tax who are advocating a policy at odds with trade. They are calling for the government to spread risk from a business to people in the larger community solely to benefit the business and the modern conservative form of this policy is to adamantly opposed to those who take the risk gaining any benefit thereby. The transfer of the risk should be a one way street from the general population to the privileged owner of the business.

Now it is true, as argued by Ruml and Vickery, that with the corporate income tax in place the incorporated business will be able to either pay higher wages to its workers, charge lower prices or pay a higher return to investors (or some combination of the three) when compared to what that business would do in the absence of the tax. What is ignored in their argument is that it is equally true that if the tax is collected and the money spent on education, transportation, health care and the like, the sorts of things upon which the people who absorb the risks discussed above would have the have the money spent, will also result in higher wages spent paid to employees involved in these activities, higher returns paid to investors and an increase the value of the labor and capital employed by people touched by the improvements to education, transportation and the like. I am not aware of any good reason to think that the largest gains in wages, investment or prices would occur if we provide this service of sharing risk and give it away for free, nor do either of these men offer any such reason.

To summarize, the corporate income tax, in my view, is a simple matter of commerce between a general population and the practitioners of certain businesses. It is a service the population provides through the government which increases the revenue earned by the business. In return, and in complete adherence to the basic principals of market economics, the business pays the government for the service and the government spends the money on things which are needed to continue providing the service and on things which are of value to the owners of the business, which in the case of a government are the citizens of that government. This sort of trade is perfectly good and indeed is the basis of a country’s prosperity. Providing such services, or any services, for free, however, is potentially ruinous.