Capital at Risk, Labor at Risk Jude Wanniski July 9, 1997

Memo To: Website browsers, fans and clients
From: Jude Wanniski
Re: Risk-taking, by capital and labor

On Wednesday, July 2, I happened to be in Washington DC and was located by the C-SPAN people for the purpose of doing their early morning “Washington Journal.” In the course of the hour-long show, I talked about the necessity of cutting the capital gains tax in order to encourage risk-taking. A big, strong, fearless fellow named Bob Melton, from Oklahoma City, wrote me the following e-mail, with an addendum. My answer then follows :

Mr. Wanniski... I watched your discussion on C-SPAN this morning and listened as you told of the danger of putting one’s money at risk. As a man who spent most of his working years below ground digging for lead, zinc, molybdenum, and uranium, I understand risk. So I do feel sorry for those poor babies who are forced to put their money at risk to make a living, instead of putting their lives and limbs at risk. And then they have to pay taxes! Shame on the government for taxing them! Just yesterday I wrote something on this subject and sent it to a local newspaper. I feel you should read it also. So I enclose it for your perusal...

CAPITAL GAINS TAX: The Republicans and the Boll-weevils, including Mr. Bill, claim that the rich guys will not invest in business and create jobs if the capital gains taxes are not reduced, or even better eliminated entirely. RIGHT! Lemme get this straight, they refuse to invest because they must pay tax on the earnings, and they are going to bury their money in a coffee can in the back yard. RIGHT! Only an idiot would refuse to make money because of the taxes on the gain. If a laboring man would refuse to go to work because he has to pay taxes on his earnings, you would call him a worthless lazy bum and call for his head on a platter. And that big lie about a capital gains tax cut creating jobs? If I had purchased 10,000 shares of Widget for $25 per share, and the market spiked so I got to sell my Widget stock for $35 per share, I have made a capital gain of a tidy 100,000 bucks. Now, where is the job I created? I mean other than by brokers and the Wall Street crowd, there was not one single job created by my capital gain. So much for that nonsense. 

Mr. Melton: You are in a major confusion when you equate labor at risk and capital at risk. The same principles apply to each, but entirely different things are going on. When you put your life and limb at risk, you expect a wage commensurate with the risk. If there is a job at McDonald’s flipping burgers at the minimum wage and a job at the pithead, flipping rock to get at the lead and zinc, also at the minimum wage, you would not go for the pick and shovel. The most ambitious laborers always head for the mineshaft when the hourly wage is significantly higher than even that of a carpenter or plumber. When the price of zinc rises significantly and remains in high demand, the mineowner must raise wages in order to attract more labor willing to take the risks. My father and both grandfathers, by the way, were anthracite coalminers in Pennsylvania. I was born in Minersville, Pa.

The only way a worker can get a capital gain is by putting his after-tax labor income at risk. Such income constitutes wealth, and can be consumed, saved, or invested. When saved, it earns a fixed rate of income, which typically produces no capital gain. When invested, it is put at risk with no certainty of any return. If the economy needs more capital, it can get it by increasing the reward to savings, but fixed-income savings generally flow to enterprises that have collateral. These are almost always older enterprises that have accumulated assets and can borrow against them in order to expand. As I pointed out on the C-SPAN show, if an enterprise has few or no assets to collateralize, it can only attract the capital it needs for growth if people who have after-tax income are willing to accept a paper share of the enterprise, i.e., equity. This is why I said the people who benefit most from no tax on capital gain are those who have no capital -- young black males, young black females, Hispanics, etc.  It does the worker no good to ridicule the man with capital for insisting on a commensurate reward for his risk, as a poor baby. If he wishes the man to invest the capital in his equity, the reward must be there, just as it must be there for the man to go into the mineshaft when he puts his labor at risk. If you allow politicians like Richard Gephardt or David Bonior to play mind games with you, persuading you that a capital gains tax cut benefits the rich, then you will never understand why the poor will remain poor and get poorer under schemes that are “fair,” in the sense that they reward all risktaking equally. 

In your example of how the market economy works, you surely now recognize that you have also erred in confusing saving with investment, as the former involves debt and the latter, equity. A man with wealth need not “put it in a can.” He can buy a government bond that pays a secure rate of interest. The government bond will then finance welfare payments for workers who are unable to find jobs that can support their families, only because the rewards to risk-taking are so high. When you invest in 10,000 shares of Widget at $25, you are betting that Widget will go to $35, which it will only do if it is successful in selling more widgets in the market, which of course requires more labor, more jobs. Widget can more easily hire those workers because it does not have to pay interest on your shares. You have put your $250,000 entirely at risk to ease the way of Widget in the market. When Widget rises to $35, it does so because the market puts higher value on its ability to return an investment. It has become a less-risky investment. When you take out your $350,000, you must now pay a 28% capital gains tax on the $100,000 gain, or $28,000. Because the gain is not corrected for inflation, if your investment ripened over several years, it could be that your real gain is not $100,000, but only $30,000. After a $28,000 capital gains tax, you are left with a return of only $2,000. Had you invested your $250,000 in tax-free municipals instead of putting it at risk with private enterprise, where jobs are created, you would be much better off. You see that now, don’t you?

The reason why so few people see it is that those who wish to have capital flow to them, instead of the people at the bottom of the economy who have none at all, will naturally do everything they can to arrange tax and monetary policies so that happens. The blue chip companies that have heaps of collateral are far less interested in equity than in being able to borrow cheap against their assets. The government is also more interested in selling its bonds than in making it easy for people to instead buy shares in new enterprise. This is not said in a pejorative way. Institutions are always biased toward their own self interest. When it comes to capital, it is always a struggle for the poor to get close enough to the levers of power to tilt policy in their direction.  

I do thank you for your e-mail. The way it was phrased led me for the first time to think of risk labor the way we speak of risk capital. Please let me know if my explanation is satisfactory, or if not, why not.