Attempting to sell his new jobs bill earlier this month, which would include new taxes and fees focused on wealthier Americans, President Obama said:
All I’m saying is, if you’ve done well — I’ve done well —
then you should do a little something to give something back.
Elizabeth Warren, a former assistant to the President and now a candidate for the United States senate, was widely quoted recently expanding on the same theme:
You built a factory out there? Good for you. But I want to be clear: you moved your goods to market on the roads the rest of us paid for; you hired workers the rest of us paid to educate; you were safe in your factory because of police forces and fire forces that the rest of us paid for. You didn’t have to worry that marauding bands would come and seize everything at your factory, and hire someone to protect against this, because of the work the rest of us did.
Now look, you built a factory and it turned into something terrific, or a great idea? God bless. Keep a big hunk of it. But part of the underlying social contract is you take a hunk of that and pay forward for the next kid who comes along.
This line of thinking portrays business owners as free riders who have ridden to success largely at the expense of the rest of the community. It suggests that investors in a successful business benefited from publicly-provided goods and services “that the rest of us paid for” and provided no compensating benefits to the community in return.
This representation is wrong on both counts. First, business activity is taxed all the way along the line. Imagine if the factory that Warren was describing were located in Manukau. The owner would have paid business, personal income tax, indirect taxes, ACC levies, and local authority rates. It would also pay the pre-tax wages of employees, thereby enabling governments to collect taxes on employment incomes. The taxes the government collects from investors in the business and the incomes drawn by its owners and employees will have continually contributed to the provision of all the goods and services mentioned by Warren.
Second, Warren’s statement ignores the contribution a successful business has already made to the wider community through the benefits it has conferred on its customers.
Economists commonly represent the benefit a business activity confers on the community as the sum of the surpluses accruing to consumers and producers. The consumer surplus is the difference between the benefit conferred and the price paid; the producer surplus is the difference between the price received and the cost of supply.
These surpluses are illustrated by the chart from Wikipedia below:
As competing businesses find ways of lowering the cost of supply, the supply curve in the diagram will move down, leading to a lower equilibrium price and an ever larger consumer surplus. Competition is a major mechanism for transferring the benefits
from productivity improvements from producers to consumers (and workers).
It follows that successful businesses “give back” to society every day by creating the very goods and services that allow people to be more productive, stay healthy or simply enjoy life, and commonly selling them for less than customers would be willing to pay. While successful entrepreneurs often become rich, the amount they earn in their lifetime is likely to be only a fraction of the wealth their businesses generate for society at large (further reading on this point can be found in William Baumol’s book The Free-Market Innovation, Machine: analyzing the growth miracle of capitalism).
Notice also that the producer surplus will accrue to investors, which frequently include small investors and pension funds as well as the wealthy individuals that are the target of Warren’s statement.
I covered this issue in more detail some time ago in a speech on business as a vocation.
Warren’s arguments also assume that the best way to give back to society is by paying more tax or donating to charity (though it’s clear she strongly favours the former over the latter). I’ve said before (for instance, here) that Bill Gates has contributed much more to the world through the creation of Microsoft’s software than he can possibly hope to achieve through his philanthropy. Andy Kessler makes the same point when writing about Wilson Greatbatch, the inventor of the pacemaker, who passed away last week:
History has proven that the road to increased standards of living and wealth was built on productivity—doing more with less. It was the Industrial Revolution that got us out of the growing fields and into factories, which allowed us to pay for roads and teachers and civil servants. And now the move out of factories into air-conditioned offices is creating anxiety. It shouldn’t. Labor replacement is productivity. James Spangler’s vacuum cleaner. The Walker brothers’ dishwasher. Clarence Birdseye’s flash freezing. DuPont’s Kevlar. And John Simpson’s guidewire catheter for angioplasty and heart stents — the list goes on. Each invention generated wealth because it improved our lives, not because someone “gave back”.
Aside from outsized government-assisted profits (think US telecom, asbestos removal and Derek Jeter), it is the delivery of these productive goods and services that increases our wealth. The inventors get wealthy but society gets wealthier. No forced giveback needed.
As we approach this year’s general election, it’s worth understanding which parties
are focused on increasing our productivity and which believe we need to “give back” more of our wealth. The former will help us move forward. The latter will result in the opposite.