Thursday, February 14, 2008

Toward the Democratization of Capital

Wealth can only be created by work or invention. It cannot be created by monetary expansion. In recent years there has been an increasing interest in expansion of the money supply in order to increase stock market and real estate prices. The reason for the Federal Reserve Bank's interest in easing is that there is political pressure from wealthy interest groups on the Fed. The result of the excessive easing has been that those who hold equities have become wealthier relative to those who do not. As well, property, commodity and other asset holders have benefitted.

There are two effects. One is increasing income inequality and the other is a reduction in innovation and hard work. There are persistent shortages of workers in certain fields such as auto technicians and construction crafts. At the same time, innovation has been limited to a few narrow fields where capitalists feel comfortable financing new technology, notably computer, biotech and telecommunications. Innovation in alternative fields has slowed.

Progressive-liberals have advocated taxing the rich to equalize incomes. There are several problems with this. First, taxation is subject to exceptions that result in continuation of the pre-existing biases. The current income tax system is proof enough that progressive taxation does not work, and those at the high end of the system are least likely to actually pay. I sometimes wonder where the progressive-liberals who advocate progressive income taxation and the inheritance tax have been for the past 80 years. Have the Rockefellers paid any inheritance tax?

Second, taxation may inadvertently deter innovation. It may be true that many billionaires have profited from Fed easing and it is likely that there has been a crowding out effect whereby those in the riskiest and most innovative businesses have been crowded out by financiers, large businesses and technology firms who have monopolized access to credit. Imposing taxes on the wealthiest Americans may redistribute income or wealth from those who have benefitted from federal policy but may also deter those who have to overcome the massive disincentives that federal policy places on risk taking. The result may be even less productive innovation in the economy.

Third, some, including myself, object to taxation on philosophical grounds. It is compulsory and therefore creates an atmosphere of distrust.

Rather than an income tax on the wealthy, why not provide a tax credit to people who invest in assets like stocks and real estate? The tax credit could involve a sliding scale that maxes out at the top 5 or 10 percent of the income distribution and is indexed for CPI increases. Anyone who invests in assets would do so on a dollar for dollar tax reduced basis. That way, the middle class could more easily participate in the inflationary boondoggle and there need not be any compulsion involved in doing so.

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