Wealth Creation Jude Wanniski December 20, 1996

Supply-side Economics Lesson No. 4

Memo To: Brian Carlson
From: Jude Wanniski
Re: Wealth Creation

We have a new student in the class, Brian Carlson, who joins Kevin Isbister, our first student. Brian poses a most interesting question this week: “Is gambling a ‘zero-sum’ activity? Seems to me that though a few politically connected riverboat owners are getting rich at the expense of people who can ill afford to throw their money away (I mean, have you ever been in one of those things?), nothing is actually being created... no wealth, that is. In addition, the money and time spent are diverted from other areas of the economy where wealth can be created.”

My response: Is wealth created when you go to a barber and have your hair cut? Of course it is. You pay the barber out of your after-tax income, which is your wealth, and he adds it to his after-tax income, which is his wealth. $10 has changed hands, and nothing seems to have been created in dollar terms, yet your hair is cut. That is the gain to society. If society is run so poorly that you cannot afford to have your hair cut, there is no work for the barber and his wealth is diminished. What does he do with the $10. He now has the wherewithal, the wealth if you will, to come to you and ask you to cut his grass this weekend. At the end of the weekend, the $10 has made a round-trip, no wealth seems to have been created in the sense you meant it, yet your hair is cut and his grass is cut. When the government is able to keep track of such transactions, it will demand some of the $10 you pay the barber and will then demand some of the $10 the barber pays you. Up to a point, it’s worth it in a complex society to give the government its due, because it has provided the “money” instead of you having to barter a haircut for a grasscut. In a complex society, you really don’t have time to walk around the community with a sign saying “Will cut grass for haircut.” Now, you can increase your wealth if you can learn to cut grass better or faster, which means you can either charge more than $10 or can get $10 for a half-hour of work instead of an hour. If you can rent a power mower instead of a manual mower, you are essentially investing after-tax income on the chance that it will increase your earning power. If you dream up a better way of building a power mower, and can get it patented, you can sell it or lease it to thousands or millions of grass cutters, and you will become enormously wealthy, with more money than you can possibly spend on haircuts or anything else in your lifetime.

But what about gambling? Gambling resorts provide services that are the equivalent of hair cuts. You take $100 to a casino and over an evening’s time at the slot machines, you leave it there. The casino has the $100, and you have the equivalent of a hair cut -- except in this case you have acquired an evening’s worth of entertainment as well as the opportunity to increase your wealth in the process, if you are lucky. The people who own the casinos are nothing more than bankers, financial intermediaries is the usual expression, who arrange a place where the fellow who cuts hair and the fellow who cuts grass bring their day’s wages, say $100, for fun and possible profit. The amount the casino owner takes from each transaction is quite precise, although occasionally someone will figure out how to beat the odds -- say by counting cards at blackjack. If you shoot craps, over the course of an evening, the casino takes about 1.5% from each transaction, whether you are betting with the house or against the house. This 1.5% is the equivalent of a fee you are prepared to pay a bank to put you together with people who have more money than they need to spend, and wish to have it put to use -- say in the construction of a home -- which you will pay back over time, with interest. Part of the interest goes to the bank, part to the bank depositor.

If you are looking for an argument against gambling in the economic realm, you are more likely to find it in the tax codes. All growth is the result of risk taking. If you invest your after-tax income as a barber in a bigger shop, hiring more barbers, you need to feel the effort will produce greater wealth for you -- more after-tax income that is available to be spent on goods and services. If the after-tax return on a bigger shop is small or negative, you may decide to hell with it, and go to Vegas to attempt quickly to increase your wealth by a streak of good luck. In this model, you can see that lowering the tax rates on investments in barber shops, as well as lower tax rates on people who need haircuts, will cause the gambling that people do at casinos to drop off and the gambling they do on the productive efforts of each other to increase.

In this sense, you can do battle against Sodom and Gomorrah by cutting tax rates where they most discourage people from investing in each other. This is why supply-side leaders, like Jack Kemp, urge elimination of the capital-gains tax. There is nothing that would do more to reduce gambling as a prosperous industry than a cut or elimination of the capital gains tax. The prospect that President Clinton and the GOP Congress will do this next year is already having a dampening effect on stocks traded on Wall Street that are related to casino gambling. Earlier this year, I wrote a client letter, “Wynning and Trumping in Sodom and Gomorrah,” which is available on this website. Thank you, Brian, for your most interesting question. If you wish to read more in detail about gambling economics, from one of the best economists in the world, I suggest you look into the works of Reuven Brenner of McGill University in Montreal. Reuven, a good friend, has written: History -- the Human Gamble (1983); Betting on Ideas (1985); Rivalry (1987); Gambling and Speculation (with Gabrielle Brenner, 1990); Educating Economists (with David Colander, 1992); and Labyrinths of Prosperity (1994).

Website fans who are auditing these courses are invited to submit questions. When one is selected, you become a full-fledged student. We now have two, Kevin and Brian. At some point, I believe we will close the class to matriculation.