Eat the rich, or incentivise the rich to do the right thing?

Much of the debate on ending Ireland’s fiscal crisis has centred on the combination of tax rises and spending cuts required. The left have been particularly vociferous in calling for an increased tax burden on the rich, while at the same time wondering “where’s my stimulus package?”. Many years ago, TJ Rodgers, a tech entrepreneur and investor, put forward strong arguments for allowing the wealth creators to create wealth, rather than governments. Keynes argues that severe downturns create irrational pessimism dampening the animal spirits of entrepreneurs and investors. While Keynes suggested that the government should take their (wealth creators) place when they can’t continue to invest, getting out of this mess in the best possible shape may be more likely if the government helped raise their spirits instead.
The goal of redistributive policies – or tax rises and stimulus plans in today’s enivornment, is to take some of the wealth that the rich have accumulated (or earned) and redistribute it to the less well off in society. A government stimulus package would be used to generate state industries that would channel the redistribution by hiring workers, creating much needed jobs. This all sounds pretty good, as far as it goes, many super-rich have more than enough to live on and unemployment is high. Providing the stimulus plan is spent on investments that will yield a real return to the state the tax payer will come out a winner. The question remains – good as this option sounds, is it the best option?

Who are the best wealth creators?

Does the state & her politician’s and bureaucrats have all the answers? Are our civil servants the best investors of capital in the state? If so, then we should all gladly hand over any extra capital we have to the state, so that as a group we can all reap the collective reward in higher living standards.
Or is it possible, that the best investors of capital are distributed throughout the population, with no special increased density within the state sector? If so, how could we test this thesis and identify the best investors of capital? It is reasonable to assume that the best investors of capital would have proportionally more capital at their disposal, having had successful investments in the past. In other words the people capable of getting the best return from investment capital will be disproportionately present in the wealthiest cohorts of society.

Should all wealth be treated equally

All wealth is not equal, those rich who have inherited their wealth have displayed no great skill at gaining a positive return from capital. The same could be said of employees who simply refused to spend and merely saved and accumulated capital from their income. Others may have generated wealth from overseas investments and while this is positive, generating extra wealth that is controlled from within the state, it’s not quite as valuable as profitable investments within the state.

My point is this, sorting out Ireland’s problems is not as simple as increasing the tax burden on the rich and then assuming that the state will most efficiently and successfully reinvest the extra capital gained to the benefit of all. (Should the state feel so inclined and the government has shown no inclination thus far). Instead, we’d be better off instigating “use it or lose it” tax and tax relief schemes. Ireland suffers a severe budget deficit (thanks to both structural factors – e.g. reliance on transactional taxes and benchmarking, and cyclical factors – increased welfare payments and the like), as a result taxes probably do have to rise and spending should be cut. We should be very careful about how taxes are raised, and about what shelters are left in place. Individuals in an economy respond to incentives. Throughout the bubble the government incentivised property investment and development. Unfortunately, all to predictably, these incentives were successful in their own aims – to devastating effect today. It’s time for the government to incentivise sensible investments in sustainable businesses that will benefit the national economy. Raise taxes for sure, but only for those who won’t or can’t put their wealth to good use.

Encouraging genuine wealth creation

The ICTU were wrong to oppose the BES expansion. The BES is an example of the type of scheme we need now – to encourage productive investment with some of that €300 bn we have sitting unproductively on deposit, without necessarily resorting to statism. We do need to close the budget deficit as government borrowing is going balloon when we bail out the banks. I’m not convinceed we can borrow without limit either. While Japan’s debt to GDP ratio is close to 200%, unlike Zimbabwe, Japan has huge foreign currency reserves. If we need to raise taxes, surely the best policy is to ensure that there are clauses which allow those who know how to generate wealth, to use their own wealth to good purpose. In the common good it’s surely time to use it, or lose it?

——

I found the excellent TJ Rodgers article via Paul Graham’s latest essay – Graham is a tech entrepreneur and investor responsible for funding dozens of startups creating hundreds of jobs and in generating millions in new wealth for the US economy. TJ Rodgers on wealth creation, and investments – why the free market bests government subsidy and intervention. I thought the passage below enlightening –


So please allow me to reintroduce myself: I am an excess of the 1980s. Based on my ownership stake in Cypress, I am one of the people who, in the President’s words, “profited most from the uneven prosperity of the last decade.” I became a paper millionaire in the 1980s–eight times over, in fact.

How did I profit? I started a company in Silicon Valley. I obtained stock in that company when it had one employee (me) and one used computer. I worked with that company for a decade–sixteen hours a day, six days a week–to help get it where it is today.

And where is it? Over its ten-year history, Cypress has generated over $1 billion in cumulative revenue, made over $160 billion in profits on which we paid $60 million in taxes, created 1,500 jobs which paid cumulative salaries of nearly $500 million, on which our employees paid further taxes of $150 million. We have shipped cumulative exports worth $300 million. We have generated a market value of $500 million for our shareholders and employees–all of whom own stock in the company.

If that is an “excess of the 1980s,” let’s have more! As an entrepreneur, I should not have to apologize for my success and that of my company. I am offended by the administration’s divisive rhetoric. As we debate the virtues of raising taxes on individuals and corporations, let’s not debate abstractions. Let’s debate the realities of who pays taxes and the impact of raising taxes on those people and companies.

I don’t want sympathy. But I do want to expose the shaky foundations of the logic behind the administration’s program. I am a person of simple tastes; therefore, I still have most of the wealth associated with my Cypress shares. What have I done with that wealth? I invested it. In fact, I invested it in precisely the kinds of companies on which the administration wants to shower taxpayer subsidies–the world’s most advanced competitors in fields such as semiconductors, biotechnology, software, networking, environmental sciences, and health care.

Attached to my testimony is a list of 99 companies in which I hold investments through my participation in three venture-capital funds. Nineteen of those companies are innovators and leaders in high-speed data communications–real companies that are making real components of today’s existing data superhighway. Other companies are innovators in the field of high-performance computing–including MasPar.

Every incremental dollar that Washington takes from me comes directly out of my investments in these companies. I cannot sell my house or car or cut my food bills. But I am going to be forced to invest less. After all, the cash to pay my higher taxes has to come from somewhere. In essence, the administration is arguing that by taking my money in the form of higher taxes and “investing” it in subsidies, it can make better investments–more jobs and wealth–than the venture-capital firms with which I invest–firms that are the envy of Japan and Europe. That logic defies common sense. Does anyone believe that Washington invests more effectively in high technology than the free market?

  • Kensei

    Wow, so wrong.

    The goal of redistributive policies – or tax rises and stimulus plans in today’s enivornment, is to take some of the wealth that the rich have accumulated (or earned) and redistribute it to the less well off in society. A government stimulus package would be used to generate state industries that would channel the redistribution by hiring workers, creating much needed jobs. This all sounds pretty good, as far as it goes, many super-rich have more than enough to live on and unemployment is high. Providing the stimulus plan is spent on investments that will yield a real return to the state the tax payer will come out a winner. The question remains – good as this option sounds, is it the best option?

    Deadly confusion of two things. Redistributive polcies do push money downwards. This is not always done directly. Education and health costs money, quite a lot per person in fact, and the average person may extract far more from the system than they pay in this fashion. Does it make sense they should pay their own way? Money has to come from somewhere, and the marginal next dollar/pound/euro is much less important to a millionaire than soemone living on the poverty line. There is also the aspect of pushing demand downward, which remains to an extent a good idea. Some level of redistribution is universally accepted. Even those who favour flat taxpropose high personal ceilings tahtw oudl remove the poorest form tax. It is in modern terms unassailable a as concpet.

    The goal of a stimulus is not to redistribute wealth. It is to maintain demand during a downtown and prevent a vicious cycle form taking root; any redistributive qualities are purely incidental. The state is not hoping for a return. It hopes for a multiplier effect, sure, but at the end a stimulus is going to need debt.

    The rest is tedious lionise business types stuff that got us into this mess. They are not special people. Most fail. We should be encouraging more people to do it, because you do not need to be special to do so. Part of is turning moral hazard on its head — creating a system where taking risks make smore sense because the consequences are less severe, that might mean strengthening social safety nets. But that is a good idea for long term advancement and finding new avenues of growth once the worst of this crisis has abated, itwill not solve the immediate problem.

    That said there are limitations to the use of both, particularly redistribution which I hope to tackle in a later post at some point. But if there is a lesson from the latest crisis, it is that inequalities and imbalances matter.

  • Kensei

    I should also add my utter distatse for the ancedotal evidence at the end of this. It misses the point on a few levels

    1. Plenty of examples of excess that were less successful or produced through fraud: see Madoff

    2. This is not an on/off switch. If the overall rewards were 10% less than he received would he have failed to setup and run his business? That’s a stretch. 20″? And so on. There is clearly a sweet spot which is where we should eb aiming.

    3. It says nothing about whether the system acts as a barrier to entry once his busness is successful due to incentivising the rich.

  • Mack

    Kensei –

    Hold on a sec. I was (attempting) to discuss an form of stimulus for the Irish economy. The best and most effective way to create jobs and employment. Not suggesting individuals should have to pay for their own health or education costs (although there are strong arguments that those who could well afford it should).

    It’s a simple question really – as there is no real difference between a Euro invested by the state or by an individual. Do you believe that the state is always going to be better at getting a return? The evidence stacks up strongly against that argument (I must have missed the Soviet Google).

    It’s clear we need investment now, and there are many ways of going about gettin it. One, is for an over-borrowed government to borrow more and have beaurocrats create businesses. The other is have succesfull business leaders attempt to create new business.

    By the way – do you seriously believe the likes of Paul Graham and TJ Rodgers are responsible for this crisis? They didn’t perform financial tricks – they bult real businesses.

  • Mack

    Kensei – I wonder did you read what I wrote.

    Use it or lose it.

    You say


    “This is not an on/off switch. If the overall rewards were 10% less than he received would he have failed to setup and run his business? That’s a stretch. 20”? And so on. There is clearly a sweet spot which is where we should eb aiming.”

    If they don’t invest now – creating jobs now – the government should take their wealth off them now and do the work for them.

  • Mack

    By the way – I accept that stimulus plans are not neccesarily redistributive by themselves, as they involve state borrowing rather than tax rises (which Keynes would not recommend). The post was long enough without having to break every paragraph down pedantically. Tax rises and stimulus plans are the current solutions proffered by the ‘progressive’ left. I accept the need to create demand, but I’ve massive reservations about using the state to create new industries – politicians can always override the creative destruction of the market mechanism to the impoverishment of society as a whole.

  • Kensei

    Mack

    Hold on a sec. I was (attempting) to discuss an form of stimulus for the Irish economy. The best and most effective way to create jobs and employment. Not suggesting individuals should have to pay for their own health or education costs (although there are strong arguments that those who could well afford it should).

    It may not be what you intended, but it is what you said when started to go into a critique of redistribution. Anyway, economically there may be rational reasons for the well of to pay, but there are important societal and poltiical reasons they shouldn’t.

    It’s a simple question really – as there is no real difference between a Euro invested by the state or by an individual. Do you believe that the state is always going to be better at getting a return? The evidence stacks up strongly against that argument (I must have missed the Soviet Google).

    Perhaps you missed the Manhattan Project, or the amount of innovations to come out of NASA, or blue sky improvements universities backed by state money or inhdustries reliant on military spending. Perhaps you missed the importance of taxing leaded petrol higher so unleaded would become the norm, or the importance of building infrastructure to enable new businesses to be created. No motorways, no motels to serve them. I believe in a mixed economy that is strongly tipped towards the private sector, but a mixed economy all the same. A goverment cautious, but assuredly activist.

    In any case, the key thing about a Stimulus package is that it is short term. There is no “return” involved. It is madness to talk of it. It’s all cost. The governemnt may direct money towards getting certain political goals done. That is fair enough. better to stick money where you want as long as it supports the original goal.

    No one is agruing for state run industries (well, maybe SF….). It is a straw man argument.

    It’s clear we need investment now, and there are many ways of going about gettin it. One, is for an over-borrowed government to borrow more and have beaurocrats create businesses. The other is have succesfull business leaders attempt to create new business.

    You can’t create businesses if you can’t get credit. You can’t sell software to businesses that have no money to invest, you can’t sell mobile ring tones to people who can’t afford to pay their phone bill. Private investors are fleeing to safety. This is not a good environment for starting new businesses. That’s the whole point, usual rules are suspended. Governemnt is the spender of last resort. We need to stabilise, then we need to build.

    Where is this magic money coming from if not the government, Mack?

    By the way – do you seriously believe the likes of Paul Graham and TJ Rodgers are responsible for this crisis? They didn’t perform financial tricks – they bult real businesses.

    No, but the attitudes that lionise busines leaders, that made sensible discussion about tax impossible, that blindly assumed that privisation of any form was inherently superior to public ownership, that took accout only of talent based and not bargaining based arguments of resource allocation, that focused its fire in stripping all regulatory protections excetera most certainly was. And, given the piece above they most certainly were involved in that.

  • Dave

    I don’t understand why folks cling to a religious belief in governmental infallibility despite a mountain of incontrovertible evidence that governmental incompetence is the appropriate belief. It is almost like folks believe that gombeens from Offaly, Kildare, or such desolate ilk are anointed with wisdom by the simple expedient of the voters putting an X beside on said gombeen’s name on a ballot paper, or, if not by that expedient, by the seal of office or the wealth of civil service data that goes in one ear and out the other, unhindered by any matter in between. And if they can’t grasp the data, then folks believe that civil servants can, and so said gombeen can be safely relied upon to put its own X on an option that was selected by said civil servants, thereby requiring no more brain power than was used to put an X on a ballot paper.

    So, democracy is debased to stupid people making stupid decisions to elect other stupid people to make stupid decisions. And that’s why the element of religious faith plays a key part: they need to believe that stupid people will make clever decisions, and that they will benefit from their own stupid decision to elect a gombeen (typically a school teacher on a career break or a solicitor with a grubby office above a hairdresser’s shop). They won’t, of course, but that’s faith for ya. These are the clowns who promoted macroeconomic policies that promoted borrowing, leading the economy deeper and deeper into debt, and telling the people that this expansionist policy would generate the wealth required to repay the debt that sustain the growth. They failed abysmally. Now they say that the way to solve the problem that they created by promoting borrowing and spending is to borrow and spend more.

    If you want to rely on the genius of government, then you had better start with a system that ensures that an ample supply of geniuses is elected. You need people who have proven their exceptional abilities in their respective fields: highly successful entrepreneurs, top executives, brilliant academics, etc. Under the present party political system, you get mediocre muppets who are chosen by their ability to make the leader look good by simply looking more pitiful than the leader. The system is designed by muppets to further the interests of muppets.

    If making generating wealth was easy, we’d all be millionaires and nobody would fail in business. It isn’t easy: it requires a particular type of skill set to succeed, and it requires an eye for an opportunity that a committee of left-wing muppets sitting around a table will never possess. These muppets should not be allowed to squander taxpayers on money in an area that they are wholly in ignorance of. As most businesses will either fail or have modest success, the taxpayer should never be exposed to the level of risk involved in creating wealth. This should always be left to those who have the skills and who have the courage to assume the risk.

    In regard to Keynesian muppetry, most money that will be spent by the state will squandered as degraded investment. This directly displaces quality investment since it takes the wealth from those who had the skill to generate it in the first place and makes the reinvestment, not by those skilled parties, but by government muppets who never had the skill to generate it, but merely tax it. So, public sector spending takes good money from the economy and turns it into bad money. For every billion squandered by public sector muppets, you will get considerably less return on investment than you would get from the private sector from whom the government took the money.

    When you do this with a trillion, you degrade it considerably, leaving the economy in a far worse condition than it would have been in if that trillion was left in the hands of the productive private sector (who generated it in the first place) rather than taxed and squandered by the state.

  • Kensei

    Dave

    I don’t understand why folks cling to a religious belief in governmental infallibility despite a mountain of incontrovertible evidence that governmental incompetence is the appropriate belief.

    Straw man from the get go. Try again.

  • Frustrated Democrat

    The problem with governments is they don’t treat money as though it was their own, they spend it travelling first class and building massive edifices, luxury offices and glossy brochures for every occasion.

    In private industry when it is personal money we tend to do with more modest expenditure because we are spending our own money. We invest it wisely because we know how hard it is to make. We can’t tell our customers that they just have pay more with no discussion negotations or competition.

    Who would you prefer to look after your money? It doesn’t really matter since you have no choice.

  • Reader

    Mack: The same could be said of employees who simply refused to spend and merely saved and accumulated capital from their income.
    I disagree. I am a worker who has saved. While my money has been waiting to help my growing children make their own start into the world, and to prepare for my own retirement, that money has been invested at low risk and a modest rate of return, so that it might be lent out to others willing to take a high risk for a high rate of return. Savings are the other side of the investment coin.
    And I would be mightily resentful of a government that taxed my meager interest extortionately, seized my capital, or demolished its value with inflation. If my money is to be pissed up the wall, I would at least like to have the pleasure of doing that myself.

  • Mack

    Reader, Kensei –

    The effective tax rate on savings interest in Ireland is 26% (DIRT tax), this compares with an effective tax rate on income of around 15% and an effective tax rate on inheritance of around 3% (figures from Michael Taft’s analysis here – http://notesonthefront.typepad.com/politicaleconomy/2009/04/april-2nd-afternoon-the-recession-diaries.html).

    You could argue that the tax rate on savings is high enough, likewise the profits on the Irish equivalent of mutual funds are taxed at 26% (and every 8 years are deemed to have ‘matured’ regardless of whether they are redeemed or not).

    Profits on capital gains are taxed at around 20%.

    The kind of thing I was thinking of was ->

    From income –

    There is currently no limit on the amount of before tax income company Directors in Ireland can pay into their pensions (whereas all other employees are capped at an age dependent amount). What you could insist is that any money invested over the standard employee threshold is invested into the expansion of an existing Irish-based business or a new local start up.

    From existing wealth –

    The effective tax rate on profits from funds invested in appropriately in local businesses could be substantially reduced – this would reduce the governments tax take from DIRT etc, but hopefully would also reduce the governments social welfare payments and increase income tax payments.

    Likewise capital gains tax on new appropriate investments could be substantially reduced.

    The existing BES scheme could be expanded.

    This should attract a lot of capital that could be invested locally to the benefit of the economy now – and in the future.

    Kensei – Google itself evolved from the commercialisation of university research. There’s no argument from me that government (and commercial spending on research is important), but I think suggesting we don’t need a return from the huge sums that may spent on stimulating the economy is madness.

  • Peter Fyfe

    Dave

    ‘democracy is debased to stupid people making stupid decisions to elect other stupid people to make stupid decisions.’

    Any alternatives or is it another pointless rant about something you don’t like?

    ‘You need people who have proven their exceptional abilities in their respective fields: highly successful entrepreneurs, top executives, brilliant academics’

    Are these types currently barred from politics or what?

    Mack

    So much of this goes down to that usual crap spouted in the US about Government wasting wealth creators money. Small portions of government spending is seen as conventional investment. Most of it comes down to investing in infrastructure, health education, military policing and other public services. Nothing mentioned there is invested in to make big money returns but a long term investment into the country as a whole. This makes the arguement about who is better at creating wealth redundant. You will struggle to find many that don’t beleive in a free market for most industries and services. People know private companies perform better and are better value for money for the consumer. Much of what the government provides must be provided to all regardless of there ability to pay and as such must be payed for by the taxpayer. Does TJ Rodgers believe he would have been that rich withpout any inout from the government. I am guessing he will have benefited from the education of his staff and the infrastructure all around him. These are just two of the things he relies on provided by the state. I wonder how succesful his business would have been without this support.

  • Kensei

    Mack

    Kensei – Google itself evolved from the commercialisation of university research. There’s no argument from me that government (and commercial spending on research is important), but I think suggesting we don’t need a return from the huge sums that may spent on stimulating the economy is madness.

    In which case the Atlas Shrugged rhetoric is unhelpful to your point.

    Of course we need to row back. I envisage that most Western economies will come out of this will a high debt-to-GDP ratio. From there, they’ll have to have growth in the economy outpace the growth in debt – probably run surpluses. The US did this very successfully after WW2. The budget did not balance each and every year, but by the mid 50’s it was well down. The US of that periodf had some advantages that made it easier but the principle remains: both Ireland and the UK have done it in the past. But that is not a question for now. It’s a question for when there is some light at the end of the tunnel.

    On the tax proposals, many are probably sensible and no doubt a there are others. But a hell of a lot of those are going to have to go to fill the giant budget hole. Ireland is basically forced into procylical policy with the financial situation. Some government funds for startups is probably a good idea (perhaps taking some equity so if any succeed, the state can cash in and get out) but in the short run it is not a good job creator. And we are highly concerned with the short run here. Money would be better spent maintaining needed investment in infrastructure and education and maintaining unemployment payments to stop a collapse in demand.

    On the longer term, there si a risk public money for investment could crowd out private money but I think there could be a role for it based on a pluralist approach.

  • Mack

    Peter – No-one is suggesting there is no role for the state. Those entreprenuers / serial investors quoted would be big on education. Rodgers was canvasing Congress at that time so they wouldn’t subsidise the tech industry (as a tech entreprenuer and investor) as he felt it would distort the market and would paradoxically ruin American ability to compete (by allowing them to get fat-in-the-face).

    Kensei – Point is that research alone is not enough. Successful commercialisation is key. If noone else will try then central planning is better than despotism, but we know that those skills are dispersed widely outside of government, so let’s get the money into the hands of the people capable of doing so.

    In terms of benefits and costs. There is €300bn on deposit in Ireland, we’re a rich country – that invests a fraction of what Israel does in Venture capital. In the short run getting start ups hiring (in our industry get all those contractors from the financial industry, now jobless of the dole and paying income tax) would help massively. What’s missing is the culture of investing in and taking those risks. We know that these kind of incentives work in Ireland – just look what happened when tax breaks were given for construction.

    I agree about a pluralist approach. Whatever works to get us out of this mess..

  • Mack

    Apoligies for grammar above. To clarify about ‘financial contractors’ I meant software contractors working in the financial industry. But there are many types of startups that could take a big injection of capital and use it to put the legions of unemployed to productive good use.

  • Kensei

    Mack

    Kensei – Point is that research alone is not enough.

    But it is a necessary condition. Which means that the anti-government rhetoric is unhelpful.

    Successful commercialisation is key. If noone else will try then central planning is better than despotism, but we know that those skills are dispersed widely outside of government, so let’s get the money into the hands of the people capable of doing so.

    University research is not by its nature central planned in any case and many Unis are good at spinning out businesses. But even if the government is targeting the creation of specific industries it does not need done through central planning. It can fund several different promising areas, or replace some commercial funding that would otherwise be available, while taking some equity in new businesses and pursue their goals through pluralist processes.

    In terms of benefits and costs. There is €300bn on deposit in Ireland, we’re a rich country – that invests a fraction of what Israel does in Venture capital. In the short run getting start ups hiring (in our industry get all those contractors from the financial industry, now jobless of the dole and paying income tax) would help massively. What’s missing is the culture of investing in and taking those risks. We know that these kind of incentives work in Ireland – just look what happened when tax breaks were given for construction.

    I’m sorry, but startups are not going to put on huge numbers of jobs in the short term. Most startups are small and bootstrap or they die quickly. Moreso if the environment is tough. In a long run an increase is positive and will lead to higher employment so it is a good thing. But it will not solve the immediate problem.

    I am not a fan of anything that looks like sticking a railroad through property rights and would probably not constitutional, which you seem to be suggesting. If you want more VC spending, some targetted incentives towards new business.

    But that on its own is not enough. You have to have potential new business to invest in. To get to that point, you need to invest in unis, diversify potential funding (perhaps the co-op movement could be useful for reaching parts hard to hit by others) and you have to lower the risks involved with quitting your job, putting up all your cash (and maybe that of friends and family too) and taking a punt on something that could fail horribly. That is a trickier problem, and may involve strengthening the social safety net. More statist ina sense.

  • Mack

    No anti-government rhetoric, I have a different view of government’s role. That doesn’t make me anti-government. I think starting and running businesses is best left to those who have shown talent in starting and running businesses (as selected by the objective market mechanism) and that politicians should not be involved unless absolutely necessary.

    A large number of small startups would get enough people of the dole to matter. If capital is available for each stage – seed / angel / venture – some existing startups may scale up very quickly indeed. And that would make a big difference.

  • Mack

    Also there is no railroad being driven through property rights here either. The taxes on wealth are in place already, and they will go up tomorrow (and other rises will be signaled for the near-future, e.g. property taxes).

    I was arguing for government stimulus either by borrowing / out of tax revenues (worst solution), or by encouraging the wealthy to invest via lower relative taxation / tax reliefs the wealth.