Why Taxing Wealth is a bad idea?

by Alex Merced

In his¬†new book, “Capital in the 21st Century“, Piketty advocates for a global tax on wealth as a way to curb growing income inequality. Of course, as a libertarian you can probably guess I think this is a bad idea but for good reason. I have discussed income inequality in previous articles I’ve written, and disagree with Piketty that the correlation between the return on capital and income inequality means the capital growth is cause of the inequality (thus taxing it the cure). Instead, I believe my other article on how monetary policy and inflation increase income inequality not only explains the correlation (inflation increases returns to capital and decreases return on wages) but also just makes more sense in explaining the trends discussed by Piketty.

Although in this article I’m less concerned with what is the true cause and cure for income inequality, but with how bad a solution a global tax on wealth would be. Taxing wealth would not only have the effect of reducing and confiscating wealth which of course is abhorrent from a libertarian perspective, but it will also make capital gravitate to more risky investments than they otherwise would, destabilizing the capital structure of the economy.

So why would higher taxes mean riskier investments?

From an investors point of view, you are generally not just looking for a high % return but generally a return after you adjust for inflation and taxes. The higher the taxes and the higher the rate of inflation the higher return needed to survive both.

For example:

Let’s say you have a 10% (which is pretty good) with a tax rate of 35% and inflation rate of 3%

After taxes you will have a 7.5% return (10 – 35%)

Adjust that for 3% inflation (7.5 – 3)

your at a 4.5% return (and this ignores state and other taxes, also ignoring any issues in measuring inflation)

The point being is that as the hazards of inflation and taxes build up, one must seek more return and the name of the game is “more risk, more reward” meaning that higher returns will be found in increasingly risky investments.

Why do riskier investments return more?

Imagine a world where investments of all levels of risk gave you a 10% return, which one would you choose to put your money in?

If you answered the safest, that would be quite rational and would be what many others would do as well. The result is, that everyone wanting the safest investment will bid up the price which in turn reduces the return on investment (your giving up more for the same thing) and the return will continue to go down until the return goes so low it’s not worth it to investors to bid it any higher.

These investors would then do the same with the next safest investment, etc. By the time you start getting to the riskier investments there will be less potential buyers so they won’t be bid as high, and when you get the riskiest of investments they may be bid down (because maybe 10% return is not worth the risk) so a lower price would give you a higher return (giving up less for the same thing).

Bottom line, investments are generally priced heavily based on risk and reward. So more taxes and inflation will just lead to an increased demand for risk, which at some point will create a scenario that bad investments may outweigh good investments and growth turn into a slump.

The Mechanics of the Minimum Wage [Video]

by Alex Merced

Often times when you try to create protections or regulations of the market, the result is to create an undue burden on those least able to bear them. The result is those at the very bottom can seem stuck there, and those who are somewhat to very well off find themselves relieved of a lot of competition, allowing them to take a bigger participation in the ever changing economic pie. The minimum wage is one of the policies that have these results. Although due to the amount of labor that may already be working at bottom of the income ladder can be limited, the result of this policy for good or worse can be hard to truly measured or seen. Yet, understanding the impacts of market intervention on economic disparities and in turn economic tolerance needs to be more part of the economic discussion.

Income Equality and Income Mobility – The New Frontier for Libertarians

by Alex Merced

Often times we hear conservative pundits, and the occasional libertarian one, respond to social and economic critiques concerning income equality with a dismissive tone. They will say it doesn’t matter as long as there is mobility or “equality of opportunity.” However, recent studies make it clear that there is a ¬†correlation between economic equality and mobility. So how do you make an argument for the free market in light of this data? Some, such as libertarian philosopher/economist Roderick Long, have already begun attempting to have a deeper libertarian discussion about equality, and at least about what kind of equality libertarians should be concerned with. Libertarians don’t need to shy away from discussing economic equality because there is a compelling case to be made that economic equality has plenty to do with a free, or at least a freer, market.

Before arguing the case one must discuss the causal direction in this relationship between equality and mobility (assuming there is one). Does more equality lead to more mobility? Or does more mobility lead to more equality? The answer to this question should lead to very distinct policy views. Progressives, through their policies of redistribution to create equality, argue that equality will create mobility. I would contend that this is putting the cart before the horse. Increasing mobility would lead to more equality. Thus, policies of redistribution are not needed if mobility can be repaired.

In economics there is a theoretical condition of “Perfect Competition.” This is a situation where so many firms compete over the potential earnings in a particular sector that those firms inadvertently evenly distribute those earnings. Labor markets are similar. Higher wages will attract more participants which, over time, will result in reducing the amount of earnings each individual makes because the total earnings is split among more workers. This result is another sort of equality. The implication is that if wages aren’t being distributed more evenly that must mean something is prohibiting or limiting the participation/competition in that market for wealth (profits from your enterprise, earnings from your investments, or wages from work).

In reality, there can be many societal, geographical, and cultural reasons why certain wealth markets may not be as competitive as we’d like, but some of the strongest barriers come in the form of interventions in the market. Reducing the ability for people to participate reduces an individual of a lower economic condition’s ability to have upward mobility and also reduces an individual of a higher economic condition’s downward mobility. Upward and downward mobility are equally important (you have to be able to lose from bad choices and gain from good ones or the market mechanism loses much of its effect). Let’s take a look at different wealth markets and discuss some of the conditions reducing competition in them.

Wealth Market # 1 – Entrepreneurship

Entrepreneurship is one way people can elevate their economic status. Anything that increases the costs of entrepreneurship in time and money will have a disproportionate effect on small entrepreneurs (as they are less likely to have the time and money to pay these costs). Some of the biggest costs in running a business are the legal and accounting costs. An ever growing complex legal and tax system only make these costs greater regardless of the absolute size of the tax bill or legal fine (because of the amount of billable hours paid to accountants/lawyers to guide through the complexity).

These costs may make some businesses less profitable or slow down their growth, but, most disturbingly, they discourage potential entrepreneurs from throwing their hat in the ring to begin with. The answer is a simple one that people across the board can get behind, simplification. While I’m all for lowering taxes which would make the costs of entrepreneurship lower, simplifying the tax and legal codes so that people can effectively participate without huge legal/accounting overhead would encourage more entrepreneurship. It would also free up the firms resources to be used for things such as improving the product, decreasing prices, or even higher wages for those involved in production of the good or service. Keep it simple stupid.

Wealth Market #2 – Capital Investment

Another way of developing wealth is to take wealth you have from your small business or job and invest it into capital either in equity (owning property or stocks) or via debt (lending money or buying bonds). Buying equity/ownership in companies early in their life cycle is often where some of the largest growth in wealth occurs, and it would be people of a lower economic status who can benefit most from that dynamic (of course more risk, more reward). In an effort to reduce the risks to the common man, laws like Sarbanes Oxley in 2002 were passed to make publicly traded companies more transparent. While access to information to people who are investing their capital can lead to better investment decisions, the costs of preparing this information fell on the company (which is fine, but many of standards can arguably so stringent that the costs increase may be less than reasonable). Essentially, Sarbanes Oxley brought at least an appearance of transparency of public markets in exchange for higher accounting and auditing costs, higher legal costs, and higher cost for executive pay for public companies (more liability is placed on executives so it is sensible that they’d ask to be compensated for the risk).

With these higher costs most new businesses decide to raise money in private markets first (where only wealthy “accredited” investors can participate). As a result, companies that issue IPOs (initial public offerings) are often more mature compared the plethora of IPOs we saw in the 90’s. (While some companies fell prey to the bubble, many people were able to grow their wealth more efficiently since they were able to invest in companies earlier in their life cycle.) The problem is, if companies are not available to the public for investment until later in their life cycle, most of the growth in wealth is made exclusively for the already wealthy while the public is left with the scraps of growth. (Less risk, Less Reward).

To the credit of lawmakers, this has not been ignored and the JOBS act was primarily passed to deal with much of this issue, but layering a complex law over another may result in just increasing legal costs which offsets any savings from simplified accounting costs.

Wealth Market #3 – Skilled Labor

The reality of markets is that the demand for labor is constantly changing, not only the quantity but also the skills and knowledge demanded (Cobblers are of course are still in huge demand still, right?). This can cause what’s often known as structural unemployment (unemployment due to skills of the labor force not matching the skills demanded by firms looking for labor). The people in the most dire circumstances, as previously mentioned, have the least money and time to acquire new skills to enter a changing labor market, so of course increasing costs of attaining skills will disproportionately punish those less able to pay those costs and reward those who can (often people who are “better off”). Here a few of the ways these costs increase:

– Compulsory licensing requirements will often result in months of studying full time to pass exams just to be allowed to work in a particular field (The Institute of Justice has done a lot of work on Compulsory Licensing). While making sure people are qualified to do particular jobs is a good thing, most, if not all, licensing requirements are less about competence and more about making workers aware of the ever expanding regulations of their new field of work (essentially the result of complex laws).

– The cost of higher education is primarily the result of the diversion of credit into the education market. Making it easy to borrow money for education has reduced the incentive for education institutions to rethink the way they price their product (why do you pay the same tuition for all degrees despite the huge variation of potential income they provide?) and for students to think about how they finance their education (there probably is a kickstarter like site for tuition now, but one probably would have existed sooner). Aside from distorting the whole pricing mechanism for education, this diversion of credit also means less credit for other types of investment. This may affect the quantity of work for those graduates with huge debts.The cost is currently so high people don’t get do overs. If education pricing was more sane people could afford to go back if their first program didn’t necessarily offer them the income they expected or hoped for.


The ability for people to be upwardly mobile depends on their ability to participate in wealth markets, and the ability for the wealthy incumbent class to be downwardly mobile depends on the ability for others to compete with them in wealth markets. If wealth markets are more difficult to enter, then those at the bottom fall further behind and those at the top get further ahead. This creates the inequality we see today. So essentially, a more free market, when properly understood, can offer a clear path to a more equal or more “fair” distribution of wealth without the use of intervention and intrusions of government.