Wealth, Innovation and "Job Creation"
Jim:.
First, if it’s very uncertain how tax policy is going to affect innovation, why does that imply that taxes on the wealthy should be low? One assumption would be that innovators are very sensitive to the taxes imposed on them, and that if they are taxed too much they will just stop working (and live off their already-accumulated wealth, I suppose). But the opposite assumption – that, to the extent that people are motivated to work for monetary reasons, it’s generally to achieve a certain level of consumption – seems at least as plausible. And it implies that higher taxes would make those motivated to innovate by the promise of financial reward more likely to work harder – because they’d have to work harder to reach that level of consumption. (And those who are motivated just by the desire to innovate, and those who are motivated just by the desire to see their bank balance go up, would be unaffected by their tax rates – innovating is still the only way to innovate, and earning money is still the only way to make the bank balance go up.)
If we knew that, at any given level of taxation, higher taxes would depress innovative activity, I could see how skepticism about our ability to predict how far it would be depressed would militate in favor of low taxes. But if we are uncertain about the sign of the effect at a given level of taxation, how do you conclude that low taxes are always preferable?
It seems to me that the consequences of high taxation that we really need to worry about are uneconomic efforts to recharacterize income as something non-taxable, and the risk of high-earning individuals changing jurisdictions to avoid tax (which is a particular concern for states with high income taxes neighboring states with low ones – Massachusetts versus New Hampshire, for example). But, again, it seems to me that simply declaring that you can’t possibly estimate these effects doesn’t get you anywhere.
Second, Adam Ozimek’s argument is, basically, that there are positive externalities to the efforts of very innovative people that cannot be captured by them because they aren’t part of their product. Thus: even if Steve Jobs captured exactly 100% of the value he added to Apple, he can’t have captured 100% of the value he added to Apple’s employees, whose human capital was upgraded by working at Apple, value they will be able to monetize when they go off to start their own firms. Nor can he have captured 100% of his contribution to the creation of the massive cluster of innovation that is Silicon Valley.
But I’m not clear why Ozimek thinks this should be the case. If we posit a truly efficient market, then Apple employees know that they are getting experience at Apple that they will not get elsewhere – and Apple will know they know this. And Apple will therefore offer lower salaries than other firms that do not provide such experiences. Doctors who want to work in Boston often get paid less than those who are willing to work in Fargo in part because Boston has better weather and sushi restaurants – but largely because Boston is a huge medical hub and Fargo isn’t. That is to say: getting a job in Boston will do more to upgrade your human capital than getting a job in Fargo will.
I’m not saying I believe everyone earns 100% of the value of their marginal product. I’m just saying that I don’t see why Ozimek is so confident that high earners are an exception, and earn less than they contribute, for the reason he gives. And given that it’s pretty easy to find real-world examples of high earners who make more than their marginal product because they have found ways to extract rents, it strikes me as a little peculiar to take this particular tack against Krugman’s argument.
Third, it seems to me that Krugman doesn’t address the real implicit reason why people refer to high-earners as job creators: to whit, because they are good at deploying capital.
It’s not true, after all, that if Steve Jobs, say, earned exactly 100% of his marginal product that therefore nobody else benefited from his innovations. That would be true if he took his earnings with him to Mars, and never recirculated them into the terrestrial economy. But people don’t generally take their accumulated wealth to Mars; they usually spend or invest it.
Assuming no effect whatsoever on incentives, taxing high earners transfers their earnings to other people – either to the government, which then makes the decisions about spending or investment, or to the citizenry at large if the money is simply redistributed. If you do the former, you’re substituting the government’s views on how optimally to spend or invest the money for those of the high-earning individual. If you do the latter, you’re substituting the citizenry’s.
Saying, “these people are job creators” is another way of saying, “I think these people will be good investors, will deploy their wealth in ways that will further increase the productivity of society.” It’s basically saying: these are the right people to bet on if you want to deploy capital optimally.
(I want to stress: I’m not making this case; I’m just stating what I think the case is. I’m not sure what a good empirical test would be of the proposition.)
I think the “textbook economics” answer to this would be: if these individuals are genuinely better at deploying capital, capital – whether they own it or not – will flow into their hands to be deployed. A rich entrepreneur doesn’t actually need his own wealth to start a new business – he’d be able to borrow any money that was taxed away and make the same investments he would otherwise. If the government taxes a bunch of money away from great investors, that doesn’t actually reduce the amount of capital they have to deploy – because the money will flow back to these investors and out of other investors’ hands, and it’s most marginal investors who will lose their access to capital, to be replaced, effectively, by the government.
This question, “who will be a better investor” is not so simple a question to answer. It matters greatly what you mean by “better” – better for whom, and over what time horizon, and under what circumstances. Which is why I keep coming back to the question of what our spending priorities – not just the government’s, but our whole society’s – ought to be. But at this point I think we’re out of the textbook.
In my own opinion, if you want to encourage innovation, I wouldn’t focus on keeping taxes low; I’d focus on keeping them simple, because complexity rewards large firms with the wherewithal to do the financial engineering necessary to optimize their tax position, which in turn gives them an unearned competitive edge. And more generally, I’d focus on what other barriers incumbents have erected to prevent disruptive innovation and to extract rents. The existing patent system, which imposes a huge burden on small, young firms, is one good example of where to look. Most broadly, we should be trying to reduce the friction associated with innovation, rather than focusing on the monetary returns to innovation.
As Paul Graham points out (http://paulgraham.com/inequality.html), overly progressive taxation penalizes risk taking. Do you take the 10% chance of making a million or the 90% chance of making 100K? If the former gets clobbered by progressive taxation, take the latter. Smart people become corporate drones and government bureaucrats instead of entrepreneurs.
Our current efforts to reward these risk takers, however, also benefit trustafarians. Once solution would be to raise the capital gains rate up to the ordinary income rate while lowering the corporate income rate down to something like 20%. This leaves the tax rate the same for tomorrow’s startup entrepreneur while making rich passive investors pay more taxes than Grandma with her nest egg.
— Carl · Nov 28, 06:45 AM · #
If we knew that, at any given level of taxation, higher taxes would depress innovative activity…
Keep in mind that innovative activity and taxable innovative activity are two different things.
— The Reticulator · Nov 28, 02:31 PM · #
My own comments to Jim’s post pretty much mirror Noah’s; I would just add that the conviction that innovators can and should capture the entire value of their contributions leads directly to the kind of obstructive rent-seeking Noah speaks of in his last paragraph.
— John Spragge · Nov 28, 04:14 PM · #
“obstructive rent-seeking”
I’d just like to point out that while rent-seeking is a real thing, sometimes what theorists call rent-seeking could be more accurately described as “normal people trying to grab some security and stability in a sea of creative destruction”.
Mike
— MBunge · Nov 28, 04:34 PM · #
The problem with innovation in the US has nothing to do with patents or taxes or regulatory reform. The problem is that the amount of capital available for private equity financing has plunged 80% over the last few years. There simply is no money available to fund the great new ideas that we see. Until you address that problem, there will be no innovative companies arising out of Silicon Valley or elsewhere.
No one understands this issue and worse, no one even CARES to understand the issue. Rather, they would prefer to use this crisis to merely beat their own drums regarding whatever issue they like.
“A rich entrepreneur doesn’t actually need his own wealth to start a new business – he’d be able to borrow any money that was taxed away and make the same investments he would otherwise. “ This sentence shows how much you don’t know about this world. Entrepreneurs do NOT borrow money! From whom would they borrow? Banks? Wall Street? Those guys only lend money on collateral, and a startup has no collateral. Worse, even if you could borrow money you must immediately start to pay back the loan at the time when you have little or no revenue and you need to build your company. ONly a fool would borrow money for startup even if he could.
No — the entrpreneur doesn’t borrow. Instead, he gives away equity positions in his company to angel investors and venture capitalists. I notice that in this entire article, not a single mention was made about them, and yet their participation in the innovation process is crucial. And since half of all VCs are now out of business, you can see why we are in a crisis.
But go ahead — talk about patents and taxes. It won’t do anything except excite the Grover Norquists of the world. But it won’t do a damn thing to promote innovation.
— Randy · Nov 29, 10:07 PM · #
Carl, you make a reasonable argument, but my own experience as an entrepreneur suggests to me that tax policy will do little to encourage the creation of sound businesses. A business must have good technical, organizational, and marketing planning. The people undertaking the must have a strong basis to believe they can succeed and a personal conviction they will. Corporate and government structures offer huge advantages for the implementation of creative ideas: security, readily available capital and other resources, and above all both initial and on-going peer review. The idea that corporations and governments employ only drones and bureaucrats completely misstates the role of both governments and corporations, to say nothing of educational and research institutions, in the innovation process.
Mike, can you give me an example of activities termed “rent seeking” that in reality only involve individuals seeking security? I don’t necessarily disagree with you, but I would like to know exactly what you mean.
Randy, without disagreeing that a decline in venture capital has created serious problems, I would point out that the rent-seeking Noah speaks of tends to consume venture capital funding. In the absence of venture capital, persons interested in innovating can still do so through crowd sourcing and free software. Rent seekers tend to block these channels.
— John Spragge · Nov 30, 05:28 AM · #
“Mike, can you give me an example of activities termed “rent seeking” that in reality only involve individuals seeking security? I don’t necessarily disagree with you, but I would like to know exactly what you mean.”
Well, one of the more obvious areas is professional or vocational licensing. Putting aside reasons of health, safety, competence and what have you, licensing regimes can and almost certainly are used to control the supply of service-providers in order to benefit those currently licensed.
Now, taken to extremes, the negative economic effects of such behavior is undeniable. At far less extreme levels, however, I see such licensing regimes as similar to unionization. Where unions are the intermediary between employers and workers, licensing serves something of the same role between service-providers and customers.
Basically, I find that many supposed intellectuals who are largely insulated from the forces of creative destruction have a reflexive animosity toward the efforts of others to insulate themselves the same way. I don’t want economic vitality stifled, but I don’t believe human beings should be reduced to nothing but cogs to be worn down, used up and thrown away.
Mike
— MBunge · Nov 30, 05:11 PM · #
Mike, I sort of wonder about the moral calculus that says “sorry, Joe; you can’t be allowed to ply your trade. It’s much more important that Dr. Bob over there have a predictable revenue stream coming into next year, because how else is he supposed to know whether to put that pool in?”
Licensing should be for public safety and that’s it. It’s not a progressive agenda item to make sure that entrenched interests have stable business revenue.
— Chet · Nov 30, 05:55 PM · #
“It’s not a progressive agenda item to make sure that entrenched interests have stable business revenue.”
It shouldn’t be a progressive agenda item to reduce people to replaceable cogs in the economic machine. I also find it interesting that your example involves a high income field where licensing is literally a life-or-death issue. Would you be such a condescending dick when talking about a plumber or a welder?
I’m also not sure of the moral calculus that says “Those workers over there have the legal right to extort money from their employers at the threat of strike…but those workers over there can go fuck themselves.”
Mike
— MBunge · Nov 30, 07:14 PM · #
I don’t know what that means, frankly.
Uh, yeah, I would. Because it’s condescending and dickish to prevent some people from plying their trade just so some other people – who already have jobs! – don’t suffer the indignity of making a slightly lower wage.
Its bullshit. Being unemployed – being, in fact, muscled out of employment by a government-sponsored cartel – is much, much worse than taking a pay cut because somebody who does what you do opened a shop down the street. That’s why we only do it when there’s a compelling public interest in making sure people don’t ply that trade until they’ve met a certain standard level of training and competency. Lousiana’s florist cartel certainly doesn’t rise to that standard – but I bet it makes a shitton of money for florists.
Really? You’re puzzled? I’m pretty sure that moral calculus doesn’t add up. But we’re not talking about unionization; we’re talking about cartels. You’re in favor.
I’m not. And my position is the more liberal. Entrenched interests – at any income level – don’t have the right to muscle out newcomers. Breaking cartels like that is actually a progressive agenda item.
— Chet · Dec 1, 01:11 AM · #
“I don’t know what that means, frankly.”
That’s not surprising.
Try this. Why does the term “rent-seeking” not apply to a wide variety of union activity.
And by the way, your position is not liberal. It’s neoliberal. But I’m sure that’s another distinction that’s beyond your comprehension.
Mike
— MBunge · Dec 1, 04:31 PM · #
It probably does. What does that have to do with people being “cogs”?
Precisely wrong.
— Chet · Dec 1, 04:56 PM · #
“It probably does. What does that have to do with people being “cogs”?”
It has to do with the childishly cavalier way you talk about the livelihood of other people. Their hopes, their fears, their needs are just bullshit to you. They are nothing but cogs who exist only to serve their assigned role in your economic theories and they’re not allowed to be any more than that.
I do supposed you could call that attitude “progressive”…in the same sense that eugenics used to be a progressive preoccupation.
By the way, what do you do for a living?
Mike
— MBunge · Dec 1, 05:19 PM · #
That doesn’t actually answer the question. And I’m actually taking their livelihoods pretty seriously – I’m talking, of course, about the people who won’t get a livelihood thanks to the cartels you’d like to set up.
The people with the money and power to establish an anti-competitive government-granted regulatory monopoly? Don’t be a fucking idiot – their livelihoods aren’t at stake, only some fat paychecks. And it’s morally monstrous to put people out of work to put a few more zeros at the end.
No, they’re bullshit to you. You’re the one who wants to keep people from working so some fucking florists can charge $120 for a dozen roses.
What on Earth is wrong with you, Mike?
I’m a biochemist. The way you project, I assume you work at a movie theater?
— Chet · Dec 2, 02:37 AM · #
I am coming around to the idea that low taxes discourage risk taking. It is easier to hoard money and join the rentier class to maintain it, than put the effort into developing new business ideas or inventing. If you have less to lose, then you will be willing to take more risk. Anecdotal evidence of the last 40 years would suggest this is true. It certainly matches with my psychology.
— Mary · Dec 9, 10:29 PM · #