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How Can Tax and Spending Policy Together Enhance The Wealth Of The Nation?


Buried in today’s partisan squabbles over President Biden’s ambitious domestic agenda is a fundamental question:  How can government best increase the nation’s wealth?

Does it do so by taxing the wealthy and spending more on income supports for much of the public, as many Democrats want? Or by limiting taxes on capital income and counting on the wealthy to save even more to spur private investment, as many Republicans believe?

Or is it time to consider a third option that seeks to enhance the wealth and ownership of financial, real, and human capital of everyone? Government can, for instance, demand more from the wealthy but use those additional resources to support broad-based investments in and by people.

Let’s parse this issue a bit further.

Economists have long recognized the importance of investment. But the nature of that investment is changing.

A hallmark of the industrial age was the accumulation of large, concentrated, masses of physical capital, often associated with economies of scale in production. That, in turn, started a debate over how to deal with the capitalists who through skill or luck garnered a large share of the nation’s wealth.

Today’s post-industrial age differs in two respects. Wealth has become associated less in physical capital and ever more in human talent and capital, sometimes embodied further in the organizational skills of a company, its new software or invention, and marketing prowess.

Second, and somewhat related, economies of scale have become more extensive. Compare what it costs to manufacture another car versus “producing” additional access to the latest software, movie, or hottest new video game.

Now, consider the implications for growth. On the one side, we want more investment and saving; on the other, like Henry Ford, we still want many people to be able to consume the goods and services that can be produced. And for those goods or services that have large economies of scale in production, it often cost society little to add additional consumers. If most consumption would be by the rich, that would reduce growth. One billion dollars will only buy one hundred $10 million mansions for which there are limited economies of scale in production. But it might purchase ten million vaccines that only cost $100 each to produce but are worth infinitely more.

Many modern economies have found a type of middle ground for getting both higher saving and more widespread consumption by allowing billionaires and oligarchs to hold onto even higher levels of wealth, but then redistributing some income to enhance the ability of most citizens to consume new goods and services.

You may think this would produce greater inequality of wealth, and you would be right. But recognize that in some ways it’s an easy way for government to promote saving. Often earning higher rates of return than most of us, the wealthy can easily allow their wealth to compound over time. Few of the wealthy are interested in consuming down their wealth. Many are so wealthy they can’t. Think of Warren Buffet or Bill Gates, Jr.

At the same time, concentration of wealth raises efficiency and equity issues. For example, new enterprises and ideas are the main vehicle for growth, but once well-established, businesses often engage in efforts to restrict competition. Meanwhile, those with limited wealth have fewer opportunities to compete with their new ideas.

To complicate matters further, achieving broad-based consumption, inclusive of transfers to those with limited income, requires broad-based taxes. Every modern economy depends on social security, value-added and other sales taxes, property taxes, fees, and the income taxes largely paid by middle and upper-middle income people, not just those with the most wealth or highest incomes.

So, how do we square the circle, tax, and spend to enhance growth in this economy? The trick is to recognize that building wealth for everyone plays as important a role as adding to income supports. Just as a family in providing for its kids must distinguish between education versus food, government must distinguish between investment versus consumption. For example, simply financing more years of retirement for everyone by taxing the wealthy more would discourage work, and—through the combination of less saving by the wealthy and less work in general—reduce society’s growth rate and, over time, lower everyone’s income.

A growth-oriented government, therefore, would make substantial efforts to increase national wealth by improving education and training. It would provide much higher levels of employment support since much accumulation of knowledge or human capital takes place on the job. It would retool tax policy to encourage much broader ownership of financial and real capital—particularly, homes, retirement assets, and small businesses. And it would often make these efforts in lieu of enhanced income supports or more tax breaks for the wealthy.

 



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