Perhaps the most common misunderstanding of the case for cutting taxes is that the benefits of tax cuts are reaped overwhelmingly by those individuals whose taxes are cut. Because a disproportionately large share of tax revenues are paid by high-income individuals, and because businesses pay more taxes when they are thriving than when they are struggling, it seems to follow that when government cuts taxes, it bestows favors on the rich and successful at the expense of the general public.
Progressives and other opponents of tax cuts also believe that whatever benefits reduced rates of taxation might have for the economy as a whole come mainly from the greater spending that tax cuts encourage the rich and successful to do. Some of this spending, it is believed, might “trickle down” to ordinary workers and families, but these gains to the masses are (the progressive tale concludes) tiny in comparison both to the huge gains of the rich and to the damage inflicted on the public treasury.
But this progressive take on the economic case for cutting rates of taxation is completely mistaken. The economic case for cutting taxes is not that the economy will be ‘stimulated’ by increased spending done by high-income workers and shareholders who, as a result of the tax cuts, have higher disposable incomes. Instead, the economic case for cutting taxes is that productive activity (not least, investment) is discouraged by taxation and, thus, encouraged when tax rates are reduced.
Government gets most of its revenues from taxing productive activities. As proponents of taxes on carbon emissions and proponents of protective tariffs on imports correctly recognize, when you tax an activity, less of that activity occurs. Income taxation reduces the amount of productive labor performed in the market. Corporate taxation reduces corporations’ efforts to increase their efficiencies and innovativeness. Capital-gains taxation reduces productive investment and risk-taking. And so it truly follows that reducing these taxes increases the amount of productive activity that occurs in the market.
Cardiovascular surgeon Jones who, when income taxes are cut, performs three more surgeries annually, of course benefits. But the greater, economically significant benefits are reaped by people who enjoy the resulting increase in healthcare. Shareholders of Acme, Inc. of course gain, when corporate taxes are cut and the business successfully reduces its operating costs by two percent. But the greater, economically significant gains are reaped by Acme’s customers, who pay lower prices, and by Acme’s workers, whose wages rise because these workers are made more productive. Among the consumers who benefit from Acme’s improved operating efficiency are also the customers of Acme’s competitors who, to successfully compete with Acme, must lower their prices or improve their product qualities.
Investor Smith who, because rates of capital gains tax are cut, is incented to invest a million dollars in entrepreneur Williams’ idea for building a better mousetrap, is of course rewarded if Williams’s new firm proves profitable. But the greater, economically significant rewards are reaped by entrepreneur Williams and, even more so, by Williams’s employees and (sorry mice!) by buyers of mousetraps.
These realities are often hidden from the general public, not only by simple ignorance of economics, but also by poor language.
A chief culprit here is a commonly used descriptor of the free market: “private-enterprise system.” The free market is private only in the sense that decisions of what and how to produce are made by individuals spending their own resources rather than by government officials spending other people’s resources. But in a free market any entrepreneur or investor who produces and invests only to directly satisfy his or her own private desires – any entrepreneur or investor who disregards the desires of the public – will not long survive as an entrepreneur or investor.
Lady Gaga earns millions of dollars annually not because performing gratifies her directly, but, rather, because her performances please millions of people (nearly all of whom are strangers to her) so much that each of her fans willingly pays her to perform. Jeff Bezos is a multibillionaire today not because he finds great personal satisfaction in doing online retailing, but, rather, because his online retailing skills and efforts satisfy the desires of hundreds of millions of us in the general public. Warren Buffett’s net worth exceeds $100 billion today not because he has a personal, noneconomic attachment to the companies in which Berkshire Hathaway invests, but rather because he is unusually skilled at directing resources to companies that are themselves skilled at producing goods and services that are eagerly purchased by countless members of the general public.
In the market, economically profitable (and, hence, taxable) activities are overwhelmingly those that successfully improve the welfare of the general public.
Ironically, the only truly private enterprises are those that exist and survive because of special privileges granted to them by government. The cane-sugar farmer in south Louisiana or Florida acquires his hefty income not by satisfying the general public, but instead because we in the general American public are obstructed by our own government from buying imported sugar. The U.S. government harms the public in order to bestow unearned riches on American sugar farmers. Only through such interventions as protective tariffs, subsidies, and occupational licensing restrictions are owners of firms able to satisfy their own private desires without having to satisfy the desires of the general public. Only through such interventions are the ‘profits’ and incomes of protected producers extracted from the general public rather than being the rewards for contributing to the general public.
Ordinary men, women, and children will prosper only if, and only to the extent that, truly productive activities are not unduly discouraged by taxes and other government interventions. Income, corporation, and capital-gains taxes are taxes on the general welfare. Also harmful to the public welfare are protective tariffs and similar restrictions on how people may peacefully spend their own money.
This article, Taxes, Special Privileges, and “Private Enterprise”, was originally published by the American Institute for Economic Research and appears here with permission. Please support their efforts.