2007-12-11

Taxing investment to spend it on consumption

Tim Bray recently wrote this in passing:
[L]ike most Canadians, I have long loathed Mr. Black for his lecturing tone, towering arrogance, and unbearably-pompous writing style. I’ve also loathed his wife Barbara Amiel for over twenty years, since she was an newspaper writer in Toronto, reciting the dogma: we should slash social benefits and labour laws to motivate the poor to work harder, and simultaneously slash taxes and otherwise send money to the rich to motivate them to work harder.
This was essentially about Conrad Black's prison sentence, about which I also commented on Tim's blog. But here is my response to the economic and moral assertions that Tim makes:

[...]

As for the lower-taxes-for-the-rich and less-benefits-for-the-poor jibe: this is obviously unpopular, but it has a point. Motivation requires both a carrot attracting to desired behavior, and a stick warning to stay away from undesired behavior. Aside from Paris Hilton, most rich do not get rich by sitting idly on their asses. Work and sacrifice is required to get there, and the sacrifice typically involves producing economic benefits for everyone else that exceed whatever the rewards are. The "progressive" tax policies remove the "carrot" which stimulates people to strive for achievement, by reducing the rewards. Meanwhile, the social benefits for people who are "down on their luck" remove incentives to stay away from economically unproductive behavior.

It gets worse. The rich do not stay rich by spending all their money on consumption. The majority of a rich person's income must be reinvested, or else they will not remain rich. Investment is what drives productivity growth, and productivity growth is what makes it possible for everyone, including the poor, to live in relative luxury today compared to what there was 200 years ago. Most poor households today have air conditioning. Everyone has cell phones, and obesity is a problem that affects poor people. This was not the case 200 years ago, and it was not because the food back then was more healthy!

Now, what income taxes do is, they take away much of the money that would be spent by the rich on investment, and it also takes some of the money they would have spent on their own personal consumption, too. Now this money is given to people and projects where it is spent on immediate consumption. The consequence is less investment in the economy overall, and the consequence of that is less productivity growth. As a result, instead of the real wages of the median worker growing like this:

Year 1: 1.04
Year 2: 1.08
Year 5: 1.22
Year 10: 1.48
Year 15: 1.80
Year 20: 2.19

they grow like this:

Year 1: 1.02
Year 2: 1.04
Year 5: 1.10
Year 10: 1.22
Year 15: 1.35
Year 20: 1.49

While the median worker may benefit to some extent from redistribution of income in the short run, in the long run, the exponential effects of reduced economic growth make things worse not just for the rich, but for everyone.

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