An Evil Tax? Jude Wanniski January 14, 1997

Memo To: Andrew Feltus
From: Jude Wanniski
Re: Evil taxation, etc.

Here is the question you e-mailed me on Friday:

Andrew Feltus: A friend and I were discussing the supply-side lesson of the day, and he asked me which tax was the most evil. I responded that I thought taxes that taxed income again were the most evil or the second kind of tax you talked about (inheritance, gift, dividends), but I thought you would say capital gains taxes were the worst. My question is why should you tax human capital at a different rate than real or financial capital. After all, I spent more money on my education than I did on any other investment I have made (am not homeowner). This I think has raised my current level of income, but I am still taxed on that marginal increase at a higher level than I am on my capital gains (including social security and state taxes). I understand the destructive effects of taxes, particularly on risk taking, but I think it is hard to differentiate between the risk taking of investing in the stock market and risk taking from the opportunity cost an entrepreneur takes to create a business. Thus, it is more of a political issue to cut capital gains taxes rather than all marginal taxes. Am I am getting this right?

Jude: I don't know if I would call one tax or another an "evil" tax. There are plenty of miserable countries that have no capital gains tax, but insanely high taxes on ordinary, personal income. Mexico has no capgains tax on any stock traded on the stock exchange. Ordinary workers pay income tax of 34% on all taxable income above $4000 or so. I'd say that was unconscionable, and in fact have been saying that for a long time, but nobody listens.

Your question about human and financial capital is an interesting one. You cannot buy an education without after-tax income and you cannot get a capital gain without after-tax income. In other words, when you get your paycheck, tax has been deducted. You then pay all your bills. What you have left over is disposable, after-tax income. You can choose to buy a college degree in business and finance, or you can choose to buy an interest in a potential income-earning asset with your disposable, after-tax income. If you buy the education and are successful in getting an intellectual capital gain, you can get a better job, which means you will have a higher income and pay higher taxes. Buying education is the least risky form of investment, the one that cannot be confiscated by the government. It is thus the most secure. The government gives you that loophole.

If you choose to remain relatively uneducated, but in possession of a potential income-earning asset, you had best have chosen wisely, or you will have no education and no asset. There is really not much difference in using your after-tax income to buy a share on the NYSE or starting your own company. The biggest difference is when you start your own company, you accumulate "sweat equity," which increases the value of your property in a way that does not require you to share your success with anyone, either bondholders or shareholders. Of course, after you sweat as much as your body and mind allow, you will have to go to creditors or investors to finance additional help.

There really is no such thing as capital which isn't human. I observe this silly discussion about why we should invest some Social Security money in the stock market, instead of the current "pay-as-you-go Ponzi scheme." The truth is, all investments are "pay-as-you-go." You eat the loaf of bread baked today. You can't invest in a loaf baked today that you hope to eat in 20 years. The world economy is a giant mechanism for enabling net producers to feed net consumers on a day-to-day basis. If the Trust Fund holds bonds or stocks, both will have to ask the people who are producing goods in the year 2112 to exchange them for debt or equity to feed and clothe the retirees at that date. The idea that stocks have a higher rate of return than bonds is a stupid reason for having the Trust Fund invest in more stocks and fewer bonds. It would automatically ensure that in the future, returns on bonds would be higher than returns on stocks. The Soviet experiment in communism was nothing less than a "pay-as-you-go" scheme in which the government owned all the shares of all the enterprise.