At the time of the writing of this article, there are several major protests being held in cities throughout the world under the “Occupy Wall Street” banner. In the midst of one of the greatest economic downturns in the past hundred years, citizens are taking to the streets to protest the gross disparity in wealth between the wealthiest Americans and the large majority who are struggling to get by. This movement has brought the issue of economic disparity to the forefront of the mainstream media. As the Obama administration proposes a special tax on annual income over a million dollars, it is pertinent to discuss what money really is, how it is accumulated, and the effects of taxation on individuals, corporations, and the economy as a whole.
I remember first gaining an understanding of the existence of money as a child while shopping at a toy store. Learning that I could not have a toy that I wanted because it was too expensive was a harsh reality to take in. This was clearly a problem. There are all these amazing toys out there, but for some reason I can only have the cheap ones? Something was clearly wrong.
I thought that I had solved the problem of money not too long after my discovery of its existence. “Why doesn’t the country just give everyone a million dollars so that we can all be rich and have all the toys we want?” It seemed like a great idea.
Of course, we all know why this doesn’t work. If the country gives me a million dollars, then it must give the guy who works at the store a million dollars and the guy who makes the toy a million dollars. The worker will quit his job, and the toy maker will stop making toys. The price of the toy will have to go way up to make it worth it for the toymaker to produce the toy and the worker will demand more money to sell the toy. All of the sudden I’m paying 100,000 dollars for the toy that once cost 100 dollars, and before you know it, my million will be gone.
The principle that I learned is that the value of money is only related to the fact that there is a disparity in how it is distributed. The fact that only a select few have a lot of money gives money its value. This principle goes back to the first monetary economies.
Before money, economies were based on a system of barter. The hunter would give meat to the berry gatherer, who would provide the hunter with berries in return. Once additional products were demanded, the barter system broke down. If the hunter needs shoes, the clothier needs meat and the shoemaker needs clothes, the hunter will have to trade his meat for clothes from the clothier, then trade the clothes to the shoemaker for shoes. Every individual would have to carry a variety of goods to trade, depending on what was to be demanded by a trading partner. With the introduction of money, the hunter can sell his meat for money, and then purchase what he wants with that money.
The money that the hunter receives in exchange for his meat is the value of the hunter’s contribution to the economy. If one chicken’s worth of meat is worth one pair of shoes, then both will be worth the same amount of money. When the hunter makes a purchase with money, it is as if he is using a chicken, or a pair of shoes to make the purchase.
Even in a modern economy, this truth still holds. The value of all money is still based on the product of the individual producer at the bottom of the chain. The worker in a factory in China, the farmer on a mega farm in Nebraska, and the homebuilder in Orange County create the wealth that gets distributed up the economic chain. When I make a purchase at 7/11, it is as if I am exchanging the work that produced that money for what I am purchasing.
With modern technology, of course, it takes fewer and fewer workers to produce base goods. The worker at the bottom of the chain actually contributes a huge amount of wealth to the economy. In America, only 2% of individuals work on farms, but those individuals provide enough food for more than the entire population of the country. Fortunately, a new level of the economy arises once our basic needs are accounted for; the service economy. New products and services are demanded which go beyond the basic needs of the individual. Attorneys are required to settle disputes, doctors fix the sick and graphic designers create images. This new level of service providers takes the wealth that has been created at the bottom and redistributes it again at the next level of the economy. Individuals in the service economy only have this luxury, however, because of the money creators at the bottom of the chain.
Going back to our primitive economy, another phenomenon exists which affects the distribution of money. With the introduction of money, the rise of a middle man will likely occur. The shopkeeper collects goods from those who produce them, and provides the producers with money that they can then exchange for other goods. The shopkeeper will sell goods for more money than he pays for them, thus making a profit. Once the shopkeeper has paid for all of his needs, he will likely still have money, which leads to savings, and the accumulation of wealth.
On his own, the hunter is limited in the amount of wealth that he can accumulate. He is limited by the amount of food that he can produce in a given day minus his expenses for himself and his family. The hunter can only increase his wealth by becoming a middleman. He can train several other hunters to hunt, then collect their spoils, give them money, and sell their meat to the shopkeeper at a profit. The hunter now has a hunting business, and is essentially operating like the shopkeeper.
The shopkeeper’s accumulation of wealth is only limited by the number of customers purchasing goods and suppliers providing him with goods. In the modern economy, the shopkeeper’s limitation has grown to an enormous extent. The shopkeeper can sell goods to billions of customers. Bill Gates became the richest man in the world by selling billions of copies of Windows at $100 a copy. Gates produced a product that was useful. Individuals purchasing a computer with Windows purchase that product with money that they have earned. The money they have earned has a value based on the initial creation of wealth by the producers in the economy. Bill Gates was able to accumulate his billions in profits because the producers at the base of the economy pushed their wealth up the chain, with billions eventually landing in his pocket.
Wealth is created based on a pyramid. The producers at the bottom of the pyramid push wealth up the chain, and the business owners at the top are the eventual benefactors. In essence, the rich can only become rich because of the contributions of the poor. In an economy with 10 individuals, the wealthiest individual can only accumulate a fraction of the money that can be produced by the other nine individuals. In an economy of 7 billion individuals, the wealthiest individual can accumulate a fraction of the wealth that can be produced by the other 6,999,999,999 individuals. The wealthiest 1% in America could only become wealthy because of the other 99%. Anyone who is wealthy got that way because other individuals gave them money in some way shape or form.
Many wealthy individuals would say that they became wealthy because of their own hard work, ingenuity, and perseverance. This is true, and the wealthy need to be commended for what they have done. Becoming wealthy is not easy, especially in a world with so many people who want to be wealthy, and so few who actually are. Even those who have inherited their wealth only did so because someone in their family line figured out how to accumulate wealth so that his or her heirs would not have to worry about doing so. This point, however, does not detract from the fact that the wealth was created because of the contributions of the poor and middle class, and this principle must be remembered when determining how wealth should be redistributed.
Going back to our primitive economy, there is another factor which arises that affects how money is distributed. The early shopkeeper accumulates his wealth, and stores it in his home. The jealous hunter breaks into the shopkeeper’s home, kills the shopkeeper and takes his wealth. The hard work of the shopkeeper has now been destroyed by one criminal act. Enter the King.
The King, or the Government in modern times, organizes society so as to allow individuals to keep their wealth. For the early shopkeeper, it is worth it to dedicate a portion of his wealth to the king, who will maintain order. If the hunter kills the shopkeeper, the king will punish the hunter with death. The hunter is thus detracted from committing a crime. If a neighboring village invades, the king assembles an army to fight them off. The king is the absolute protector, and is in charge of the general welfare of all in the kingdom.
Of course, the king is also responsible for wealth redistribution. If the shopkeeper loses his wealth, the king will provide him with food, so that he has the opportunity to rebuild his shop, and accumulate wealth once again. By providing for the poor, the king redistributes wealth from those who have accumulated it back to those who produced it, or will produce it in the future.
The issue then arises over how much in taxation can be appropriated by the king. If the king takes too much, the shopkeeper will lose his incentive to maintain the shop. If he can no longer accumulate wealth, then there is no purpose in continuing the process of shop keeping. He will simply resort to working. However, if the king takes too little, the shopkeeper won’t receive adequate protection, and the society will fall apart.
In modern society, the role of the government has expanded greatly. With more and more money being created by producers, citizens come to expect that more and more money will be spent by their governments on maintaining a good society. Economic downturns lead to situations in which society demands high sums from its government to maintain a decent existence. Government expenditures are needed to put money into the pockets of the producers, who will make purchases that allow the shopkeepers to accumulate more wealth. All of the workers who produced the wealth when times were good now require that the wealth be redistributed to them when times are bad.
There is no ideal rate of taxation. The rate should be high enough for the state to acquire the revenues required to provide the services that its citizens demand. Of course, there is also no ideal level of services that the state must offer to its citizens. The role of the government is to find this equilibrium. The state must redistribute money from those who have accumulated it to those who produced it in order to create more spending and producing. The government should not be afraid to raise taxes to meet the tax revenue equilibrium.
United States Taxation
A country that taxes 90% of the income of its wealthiest citizens would likely not experience a great increase in revenues by taxing 95%. At a certain point, incentives are lost, and the producers can no longer accumulate wealth because of the unnecessarily high tax burden. However, the tax burden in the United States is quite low for the extremely wealthy.
An individual earning over a million dollars a year should pay an additional tax on his or her income in order to pay for programs that will boost the economy and bring back jobs to the wealth producers. Of course no one wants to pay more taxes than they already do. The wealthiest currently pay 35% in Federal Government taxes on income above $357,701. On capital gains income, the wealthiest only pay 15%, no matter how much they make. Of course, there are also state taxes and payroll taxes that the wealthiest pay, but in the end those with high incomes take home a lot of what they make after taxes.
Total government revenues actually went up when the Bush administration lowered the tax rates that Americans pay. This phenomenon, however, coincided with a massive asset bubble in the real estate industry. Tax revenues increased because wealth was being created artificially. Rather than wealth being created based on production, it was being created based on an artificial increase in the value of real estate. Banks essentially used an increase in property values as an excuse to print money, which was then redistributed through the economy. As soon as the real estate bubble crashed, tax revenues began to fall again.
Increasing tax rates on the extremely wealthy would only lead to a decrease in tax revenues if it caused a significant slowdown in an economy. The argument goes that small business owners won’t make investments if their tax burden is too high, since they will have less disposable income to reinvest in their companies. I find this logic to be unsound.
Take an individual with a successful small business that gets $5 million in annual revenues. After expenses, the company makes a profit of $1 million. If the business owner takes out all $1 million as personal income, he or she will pay about $300,000 to the IRS and another $100,000 in state taxes. This individual now has $600,000 in disposable income. If the Federal tax rate was higher and the individual had to contribute another $50,000 to the IRS, he would now have $550,000 in disposable income.Will this 8% decrease in spending money really make any difference in whether the business owner decides to hire more workers for his company?
Now assume that the owner reinvests $500,000 in to the company to open another office and hire more workers. The owner now earns only $500,000 in pre-tax income. He takes home $300,000 at a lower tax rate or $275,000 at a higher tax rate. The 8% difference is not the factor that will guide the owner’s investment decision. Regardless of the tax rate, the investment decision is going to significantly lower his after tax income in the short run.
The owner is only going to make the investment decision if he thinks that it will lead to more revenues for his company in the future, which will give him more profits before taxes. If he anticipates $6 million in revenues in the following year due to his $500,000 investment, then he will make the investment. His after tax income will only affect the spending
decisions he makes with his personal money, not the spending decisions he makes for his company. If anything, a higher tax rate will encourage the owner to spend more on the company so that he makes more profits in future years and takes home more money after taxes.
The thing that is going to determine the business person’s investment is anticipated revenue. This revenue will be determined by the amount of customers that demand her product. The amount of customers who will demand her product will depend on the amount of people who have disposable income, and the amount of disposable income that they have. If the economy is bad and people do not have disposable income, then there will not be anyone to purchase the business owner’s products.
The government’s role in a recession is to create more purchasers of products so that businesses can expand. The government cannot create more purchasers without additional money to invest in creating those purchasers. The government cannot raise more money without taking more money in the form of taxes.
A minor increase on taxes for the wealthy should not be looked at as the government punishing the wealthy for accumulating wealth. Rather, it should be looked at as the government returning to the masses a small portion of the wealth that the wealthy have accumulated so that the wealthy can have more opportunities to sell their products and services to the masses and accumulate more wealth in the future. The wealthy can only become wealthy if the masses are producing money. The masses can only produce money if they have jobs and security. The masses can only have more jobs and security if the Government makes investments that give them more opportunities and gives businesses incentives to expand. The Government needs money to make these investments, and the wealthy have the money available. Increasing taxes is the right thing to do, and the government should not be afraid to do it.