Known Unknowns

The should economy


Welcome to Known Unknowns, a newsletter that believes growth is endogenous and stochastic.

Where should growth come from?

We are at a pivotal moment in our history. I’ve said it before, and it appears to be true: Big shocks are always followed by a shake-up of the welfare state and who bears risk – and what we are seeing is a big shift, not only in new entitlements and the government becoming the dominant investor in the economy but also in where we want growth to come from.

I hear the capital gains tax proposal, which taxes capital at an extremely high rate, even higher than income for high earners, probably won’t pass. Even if it does, people who make more than $1 million will find ways to lower their tax liability. But it is still important and interesting. Biden has said many times he thinks it is outrageous people pay a higher tax on income from labor compared with income from capital.

In fact, there are several economic reasons capital is taxed at a lower rate than labor. To name a few: Capital income has already been taxed, it is riskier (and therefore worth less), capital investment has positive externalities for growth, and capital income taxes create scope for more distortions (for example, timing when you sell shares) and is easier to avoid, which creates all kinds of trouble and messes with prices in capital markets.

So, in light of these efficiency issues, I think Biden’s framing of capital taxes versus labor taxes is bizarre because it seems to presume there is something wrong with earning money from investments. What makes one more honorable than another? I honestly don’t know. I guess it is a question of values, and I don’t think there’s any shame in earning money in markets – more people than ever are investors and take risk to do so. Is that money somehow tainted because I did not earn it sitting on my sofa writing economics commentary?

That is why, whether or not this plan passes Congress, it is important. It reveals a big shift in thinking about where growth and prosperity should come from. The word should is critical here. As an economist, I’ve always been more interested in where grow can come from. Because growth is something we want that benefits everyone, even if some benefit more than others. I’ll take it where I can get it, so long as it is ethical and sustainable.

But now it seems like we don’t want growth, unless it comes from certain places, i.e., the government or industries we like (that do nice things like make electric cars). One of Biden’s economic advisors wrote a book a few years ago that argued growth comes from consumption. She said the more we can consume as a society the more we grow, so we must take money from investors and give it to consumers. This struck me as not entirely correct if our objective is long-term sustainable prosperity – or it works in the short run; over the long run, however, growth comes from the supply side or innovation, which the private sector is better at.

But this consumption-as-a-means-to-growth ideology appears to be driving policy. We are taxing private sector profits, and the returns on risky investment to the private sector (double taxation – but that’s for a different day). Both of which make risky investment and innovation less attractive. We then take that money and give it to other people who will consume more.

I don’t doubt the private sector will find a way around this. The tax code is arcane enough; we’re destroying efficiency more than creating revenue here. But I think the shift ideals of how we will grow in the future are important. It is less about growing the pie and more about making sure worthy people and industries get a bigger share of that pie. As a neo-classically trained economist, it worries me (a lot), though I am also curious how long this experiment will last and what we’ll learn from it (you never know).

Shareholder primacy

I have a long essay in the spring issue of City Journal on shareholder primacy. I wrote it a few months ago, but it turned out to be quite timely. I agree that, when public companies put shareholder value first, sometimes society doesn’t benefit. Firms don’t always account for externalities on the environment; sometimes they have lots of market power, etc. But just like democracy, shareholder primacy is terrible and yet still better than all the alternatives.

Once you have multiple stakeholders, a firm’s objectives become muddied and often a question of values. Should workers in Alabama have more of a voice than workers in Michigan? Should a surf wear company sell a life-saving piece of equipment that may encourage inexperienced surfers to take more risk? Should MLB boycott Georgia?

These are all value judgments, and we are nation of people who hold different (and reasonable) values – and lately values have become politicized. The good thing about focusing on profits is they are objective and not subject to political capture.

And that is better for society and firm profitability. We don’t need more division, and corporations should feel free to hire people with different political leanings. Work is one of the few places where we encounter people with different viewpoints lately. If every company takes moral stands, our workplaces and their customer bases become more politically homogeneous. And that’s bad for society and profits.

Milton Friedman’s argument still stands. In fact, it is more relevant than ever.

In other news

Young people around the world are anxious

Until next time, Pension Geeks!