Supply-Side Economics Lesson No. 8
Memo To: Polyconomics U.
From: Jude Wanniski
Re: More on Gambling/Risktaking
Student Kevin Isbister has been brooding on Lesson No. 4, in which we discussed casino gambling and how it becomes more attractive to the masses when there is less risk-taking available in the economy at large. Says he: [Your] reasoning implies that something that I don't believe is a reasonable assumption; that the people who most frequent gambling establishments have the means to invest. Casinos around the country aren't patronized en masse by rich Texas oilmen, who possess the financial means and likely the accompanying smarts to recognize a bad investment when they see them. The bulk of a casino's income is generated by lower-middle-class to outright poor people who are enticed by the chance, remote as it is, to pull themselves into a higher tax bracket by putting some quarters in a slot machine."
The assumption of mine which you infer is that I wish to have the very rich who are in the casinos bet instead on small business. I was trying to make the argument that casino gambling in some, but not all ways, is a symptom of the problems in the general political economy -- where it has become increasingly difficult for an ambitious poor man to lift himself up by hard work, risk-taking and enterprise. Perhaps it would help if I turned the problem around, and began with a perfectly functioning political economy, and you would see that casino gambling and state lotteries do lose much of their appeal when individuals can work hard and save a sufficient amount to either invest in others in order to climb into a higher economic class, or invest in themselves to that end.
First, we should make clear that most of the savings and investment in the United States is done by ordinary people in the lower- and middle-income classes. That's where most of the money is in a $6 trillion economy. We don't expect the 125 million people who are in the work force to "know a bad investment when they see one." That's why we have a market economy, in which tiny amounts of money are deposited in banks, S&Ls and credit unions or pension funds or mutual funds. People who are supposed to know good from bad investments work for these institutions. They gather the mites into bundles and package them for other people who show up in search of capital. The mechanics of the marketplace requires that the experts -- the broad class of financial intermediaries -- be able to assess the likelihood of the potential return on investment to these bundles of cash.
In a casino, except when big wins are involved, there is no tax collector involved in the proceedings. Almost everyone knows which casinos have better payoffs, "looser slots," and that returns on the table games are fixed by the laws of probability. When you increase your savings out of your after-tax earnings, the financial intermediary in assessing the risk of investment must take into account the tax take of the government on a successful investment. This becomes very complicated, especially when the inflation rate is figured into the equation.
Remember, on one side of the economy we have people who are able to save something out of their after-tax income and on the other side people who need immediate resources to accomplish what they wish to accomplish. The financial intermediary is between them, undertaking the job of matching the funds of one with the needs of the other. When the intermediary sees the after-tax returns decreasing because the government has raised tax rates on returns, or expected inflation will produce fictitious returns on capital that will be taxed as real returns on capital, the intermediary will reject the "bet," because the after-tax payoff is too uncertain or likely negative. When the enterprise is rejected because of that burden of taxation, the number of people who would have been employed in that enterprise remain unemployed or underemployed. A small part of the economy that would have been, is not. A risk that would have been taken at X payoff, is no longer willing to bet at X - T payoff.
As you add these experiences up week by week, month by month, year by year, your healthy, growing economy will go into reverse gear -- which is what the U.S. economy has been doing for the past 30 years. The measure of the economy's production has been showing an increase, but that is only because the decline in capital formation has been offset by the number of people working. That is, it takes more and more people working to produce the same amount of usable goods. The government also measures unusable goods as part of "economic growth," so we are stuck with having 615 out of every 100,000 citizens in jail -- the highest percentage of any nation on earth. The cost of tracking them down, bringing them to justice, and caring for them in a prison system, is all counted as Gross Domestic Product! We also have almost a million lawyers plus the several million who work for them and several million accountants who count as part of the GDP. All of this economic waste is the product of a tax system and a monetary inflation that has smothered capital formation. In this corrupting atmosphere, the potential return on the investment of a dollar in Las Vegas becomes competitive with the investment of a dollar in your future through the market economy.
I hope you can see that when you have a market mechanism trying to link up savings over here with the demand for saving over there, there can be no deal if there is no positive return in the calculation. This is why the breakdown of capitalism because of poor tax and monetary policies will almost always lead to a socialist government. Because a people have to save and invest for the future to survive -- and must take risks to that end -- if the market mechanism will not let them do it, the people will turn to government to do it for them. As inefficient as the government is next to a free market, at least it doesn't pay taxes, so it can take risks which have positive returns, up to a point.
These should be simple concepts for those of you who have not been educated in a demand-side world, but they are almost impossible to grasp for an academically trained Ph.D. economist. The economics profession today says our problem is that our people do not save enough. The problem is that the tax and monetary system erected on the advice of these Ph.D. economists prevents the people from coming together in the marketplace to share their surplus time, energy and talent with others who have great ideas on how to succeed in business, but are short of time, energy and talent. From a supply-side perspective, we have too much savings in our economy -- an enormous fraction of our population which should be producing usable goods and services is instead "saving" itself from productive efforts. Practically the entire prison population is there because the society made it unattractive for them to take the normal risks that would result in self-realization, forcing them underground, where you only pay a confiscatory "tax" when you are caught.
Your question was an excellent one. All growth is the result of risk-taking and the human impulse is to advance by taking risks that have commensurate rewards. If the "system" of government discourages risk-taking through normal means of work, saving and investment, people will take abnormal risks outside the system, through legal or illegal gambling and even crime.