"You Didn't Build That"

Ronald Reagan's legacy-defining tax cuts passed through Congress in 1981 and 1986 with broad Democratic support. The Tax Cuts and Jobs Act of 2017 on the other hand, failed to garner a single Democratic vote before President Trump signed it into law. In the latter case, the lack of concomitant spending cuts might allow one to frame this opposition as an act of fiscal prudence on the part of the Democrats. But the counterfactual - that if the legislation had also included a scaling back of Medicare benefits and a partial Social Security privatization then the Democrats would have leaped on board - strains credulity.

More likely, Democratic opposition is motivated, at least in part, by an increasingly ideological commitment to a European style social welfare state. Many Western European governments collect 40% or more of their GDP in taxes, while the United States collects just over half of that figure. In urging us to emulate the European model, the progressive left wing of the Democratic party not only downplays the perverse economic effects of higher taxes, they have taken to morally justifying progressive taxation as the "fair share" owed to society by those who have been successful in the private sector, on account of the government-provided goods and services which undoubtedly necessary to that success.

In 2011, U.S. Senate candidate Elizabeth Warren, now among the front-runners for the 2020 Democratic presidential nomination, made this argument explicitly during a campaign event:

I hear all this, you know, 'Well, this is class warfare, this is whatever.' No. There is nobody in this country who got rich on his own — nobody. You built a factory out there? Good for you. But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police-forces and fire-forces that the rest of us paid for. You didn't have to worry that marauding bands would come and seize everything at your factory — and hire someone to protect against this — because of the work the rest of us did. Now look, you built a factory and it turned into something terrific, or a great idea. God bless — keep a big hunk of it. But part of the underlying social contract is, you take a hunk of that and pay forward for the next kid who comes along.

In a 2012 campaign speech, President Obama reinforced this sentiment:

If you were successful, somebody along the line gave you some help. There was a great teacher somewhere in your life. Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you've got a business – you didn't build that.

These remarks no doubt build upon a foundation of truth: that some basic degree of public goods provision might be necessary to generate the conditions within which the private sector can thrive. But beyond illuminating a very basic economics insight, this line of argumentation falls far short of its goal: to justify progressive taxation as a part of the "underlying social contract" whereby private actors reimburse the government for the goods and services which they utilized en route to their success.

A Tale of Two Commuters

Imagine two commuters living equidistant from a downtown city law firm. One is an attorney at the firm, the other is her secretary. Each drives to work, thereby obtaining some value from the use of public roads. Each, in turn, imposes a roughly equal amount of depreciation on those roads, the cost of which must be defrayed via taxes. But what about the value "built" by each of them once they reach their office?

The attorney will almost certainly command a far higher salary than will her secretary. Insofar as these salaries emerge from a competitive market for labor, they reflect, at least within an order of magnitude, the respective marginal products of these commuters' labor. But, crucially, the attorney's higher salary is not attributable to a greater consumption of public goods. She traversed the same roads on the way to work as did her secretary. The two of them rely on the same police and fire departments. They may have even attended the same local, public K-12 schools. The attorney's higher salary is instead attributable to her command over a set of skills and human capital which are more scarce - and more valuable - on the market than are secretarial skills. The salary differential, and the difference in productivity it reflects, cannot be explained by differential public goods consumption. In each case, some degree of public goods and services may be a necessary complement to these employees' labor, but they are not sufficient to explain their differential success in earning taxable income. In what way is society justified in expropriating a greater percentage of the attorney's income because her labor is more productive, and therefore commands a higher salary?

Imagine, next, two rival international shipping companies. They operate an identical tonnage of merchant ships. They make equal use of publicly subsidized port facilities. They make equal use of the protection of the U.S. Coast Guard, and each benefits equally from the placidity of international shipping lanes due to the presence of the U.S. Navy.

Company A has cultivated an efficient corporate culture: its CEO has designed an innovative process for acquiring talented managers, who in turn are capable of literally running a tight ship. Embezzlement and misfeasance are minimized. Company B, on the other hand, is dysfunctional at every level of analysis. The incompetence of its senior executives percolates into inept middle-management, who in turn fail to properly motivate their employees. For every ton of merchandise shipped, each relying to the same degree on the aforementioned public goods, Company B generates less taxable profit than Company A. But Company A's greater tax burden cannot be attributable to greater public goods consumption by Company A. It is instead attributable to smarter management, more innovative practices, and an overall more functional corporate culture. In what way do Company A's unique characteristics which make it competitive and profitable justify extracting from it a larger tax burden? These are not society's contributions, for which the government is entitled to collect additional reimbursement.

The logic of "you didn't build that" leads unavoidably to the following conclusion: few forms of proportional taxation, and certainly no progressive marginal rates, can be justified on the basis of public goods consumption. Not only does this line of reasoning fail in principle, but it would be utterly compromised during the actual practice of determining fiscal policy. Even if a wise philosopher-king were able to determine the precise percentage of a wealthy individual or a successful firm's income which was attributable to their use of public goods, our Congress falls far short of that Platonic paragon. The statutory tax rates which emerge from the political process are a function of just that - politics. They reflect the relative balance of power at a moment in time between pro-tax and anti-tax constituencies, imperfectly filtered through their representatives and adulterated by a nauseating amount of interest-group influence. To expect them to reflect, instead, the amount of a person's wealth which society helped "build" is simply fantasy.

Opportunity Zones Enrich Lucky Landowners

Last year's Tax Cuts and Jobs Act created "Opportunity Zones," which are neighborhoods chosen by politicians to receive special tax breaks. The Wall Street Journal recently published on an op-ed and a news story on O-Zones. Here is my unpublished response:  

Steve Glickman provided lobbyist talking points in "Opportunity Is Coming to a City Near You" (Oct. 24), but the reality of the new "opportunity zones" was reported by Peter Grant the same day in "Tax-Break Zones Lure Buyers."

Grant's article indicates that the 8,700 tax-favored O-Zones were a get-rich-quick bonanza for current landowners as the tax breaks were rapidly capitalized in prices. Many thousands of landowners saw their property values jump by as much as 50 percent, but that means that many thousands of other landowners just outside the O-Zones got the shaft. Politicians have drawn lines down streets in cities across the nation bestowing wealth to people on one side and bypassing people on the other.

The whole exercise is unseemly and distortionary, and it has set in motion a lobbying frenzy for years to come as landowners near O-Zones will demand that the lines be redrawn. The get-rich bonanza for O-Zone lobbyists has just begun.

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Here are other commentaries on the new zones:

www.downsizinggovernment.org/opportunity-zones-fuel-corruption

www.downsizinggovernment.org/opportunity-zones-will-help-connected-developers-not-poor

www.downsizinggovernment.org/o-zones-fragment-america

www.cato.org/blog/opportunity-zones-whom

The Senselessness of World War I, from Beginning to End

One hundred years ago Sunday, at the eleventh hour of the eleventh day of the eleventh month of 1918, the bloodiest war in history ended. In the New Yorker, historian Adam Hochschild writes about the senseless beginning of the war in an "epic chain of blunders, accusations, and ultimatums" and about its senseless end: "In the five weeks since the Germans first requested peace negotiations, half a million casualties had been added to the war's toll…. Worse yet, British, French, and American commanders made certain that the bloodshed continued at full pitch for six hours after the Armistice had been signed [at 5 a.m., with the news immediately radioed and telephoned to commanders on both sides]."

Cato senior fellow and historian Jim Powell wrote about the blunders and consequences of World War I in his book Wilson's War: How Woodrow Wilson's Great Blunder Led to Hitler, Lenin, Stalin, and World War II. He summarized his argument in Cato Policy Report four years ago:

World War I was probably history's worst catastrophe, and U.S. President Woodrow Wilson was substantially responsible for unintended consequences of the war that played out in Germany and Russia, contributing to the rise of totalitarian regimes and another world war. 

Indeed World War I was a catastrophe, a foolish and unnecessary war, a war of European potentates that both England and the United States could have stayed out of but that became indeed a World War, the Great War. In our own country the war gave us economic planning, conscription, nationalization of the railroads, a sedition act, confiscatory income tax rates, and prohibition. Internationally World War I and its conclusion led directly to the Bolshevik revolution, the rise of National Socialism, World War II, and the Cold War. 

On this weekend as we celebrate the end of this tragedy we should mourn those who went to war, and we should resolve not to risk American lives in the future except when our vital national interests are at stake.

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