How to make the economy go zoooom in the night.
Part 2 of 2
TAXES, REGULATION & ECONOMIC GROWTH
Former Federal Reserve Chairman Alan Greenspan regularly spoke of the need to unleash 'animal spirits' to attain and sustain robust economic growth. Greenspan identifies the uncommon motivation impelling certain entrepreneurs to spend 100 or more hours per week for years building their own new business as 'animal spirits'. That type of entrepreneur is convinced the world needs the products and services to be produced by their new company, which production requires new jobs.
Most of us are not much like Bill Gates or Steve Jobs or Jeff Bezos (or Henry Ford a century ago) and the first difference most of us might notice is the inhuman hours these entrepreneurs put in for many years, until their company (Microsoft, Apple, Amazon and Ford, respectively) succeeds.
Today, each of these firms employ tens of thousands of highly-paid employees. Nearly all the many millions of people employed in the private sector, fill jobs created in the first instance by successful entrepreneurs. If we truly seek long-term economic growth, (assuming the education issues are properly addressed) perhaps the right question to ask is which tax and regulatory environment cause 'animal spirits' to flourish, allowing Herculean efforts (100-hour work weeks for years) to be rewarded appropriately?
We are seeking to understand the underpinnings of economic prosperity in a capitalistic society. We know that when the overall capital stock (not 'capital' as a factor of production) is growing, then so too is the macro-economy. Therefore, we need to explore how we make the capital stock grow.
Capital Stock Growth
Perhaps a closer look at Apple's products will prove instructive. Mainly Apple sells a mix of notebook computers, smart phones, desktop computers, computer tablets, digital music players and access to digitized tunes. In the fiscal year 2011, Apple reported revenues of $108 billion.
The total cost to make or provide access to these products in 2011 was approximately $74 billion, leaving $34 billion before-tax profit, or $26 billion, after taxes, to add onto and grow the capital stock.
In other words, we consumers, in a mostly free global marketplace, willingly traded $108 billion of our own money for Apple items we valued at $108 billion - but that only cost Apple $74 billion to produce! Subtracting the $8 billion of taxes paid to government entities, the remaining $26 billion can be added to the capital stock.
Each time that profitable transactions like these take place in the global marketplace, the capital stock can grow. If a significant majority of the private companies around the world experience similar profitable bounty, even if not to the same degree as happened at Apple, then the total world capital stock can grow, which is desirable.
Especially when this capital stock growth happens at a fast pace, like it did for most of the 17 years from 1983 to 2000, in America.
Uncertainty Due to Tax Rates
What has changed to cause the business activity among many global players and wannabe entrepreneurs to be subdued? What exactly unleashes 'animal spirits' over the long-term that allows for economic prosperity?
If we look at the financial statements of American financial institutions and large American public companies in 2012, we discover over $3 trillion of unused capital sitting on their balance sheets. Why? What might cause entrepreneurs to step forward and take calculated risks, using that $3 trillion to build the capital stock and create new jobs?
Here is one answer.
First of all, entrepreneurs like to make and to keep money. But making money is not really their primary goal, because after earning $10 million, or $100 million or perhaps their first billion dollars, these entrepreneurs do not stop, and additional money earned just becomes a way to keep score. Often entrepreneurs, rather than slow down, instead accelerate their immense efforts to make larger sums of their own money.
However, if government entities seem to be demanding an ever-growing percentage of the value these entrepreneurs are creating, then a significant portion of the satisfaction quotient (Maslow's hierarchy of needs term is 'self-actualization') is removed from the business environment and such achievement becomes much less interesting. If entrepreneurs feel unable to predict what the top marginal tax rate will be that affects them, then the consequence is restraint to those invaluable 'animal spirits'.
Specifically, if the effective tax rate to be paid by the entrepreneur is perceived by the entrepreneur to be relatively unpredictable during the five-year or ten-year or longer planning horizon, then entrepreneurs wonder why they ought to make Herculean efforts today. Why not just wait until the planning-horizon tax-rate facing the entrepreneur is more settled?
We might also profitably ask what tax rate is seen as too high by the entrepreneur? Though seldom by name, the Laffer Curve peak also enters the entrepreneur's calculation. On 4/24/2012, an article in the WSJ opined that 50% or even 70% marginal tax rates would not lower tax revenues!
Peter Diamond and Emanuel Saez argue that the investment environment in America is to the left of the peak of the Laffer Curve, therefore an increase in US tax rates from where they are today will not decrease tax revenues. But at the URL http://www.bobkrumm.com/blog/?p=2354 Bob Krumm demolishes their argument.
More to the point, what the economist Art Laffer alleges is that there is some marginal tax rate, (most likely between 28% [Reagan tax cuts] and 35% [Bush tax cuts]), that represents the real maximum marginal rate of tax revenues that government can hope to collect. This seemingly unknown, yet still reasonable top marginal tax rate likewise significantly affects entrepreneurial behavior.
Uncertainty Due to Regulation
Additionally, because entrepreneurs like Henry Ford, Jeff Bezos, Bill Gates and Steve Jobs are building global-size firms, the current and future regulatory environment also enters their decisions to go or not go with establishing and building new companies or pursuing new endeavors within established companies. This consideration makes sense because their new future entity will cross many political boundaries, bumping into all sorts of known and unknown government regulations.
It is not complying with the regulations, per se, that causes entrepreneurs hesitation, but the added costs to be borne because of these regulations and the follow-on lawsuits that potential "damage to the environment" manufacturing may generate. One way to check the accuracy of this assertion is to look around at the manufacturing landscape in America today.
When Henry Ford established his automobile-making firm in America in the early 1900s, his factories were desirable to have nearby as factory jobs paid better wages than farming jobs.
Today, Apple avoids NIMBY (Not In My Back Yard) by doing most of its "messy" manufacturing in Asia, not in America. Amazon does not really do manufacturing, nor does Microsoft. Likewise, the 'dirty' petroleum industry has seen no new oil refineries built in America for 33 years. The doubling of refined oil output occurring during this period has happened by building out the production facilities already in place and adding more production shifts, as the NIMBY sentiment and fear of potential lawsuits has prevented approval of new locations.
More Regulations Are Coming
In addition to these known concerns for manufacturing in America, the added burdens and potential increased costs of new regulations to come are magnifying the unknowns and adding greater uncertainty to the investment environment.
For example, consider the 2000-page Wall Street Reform and Consumer Protection Act (Dodd-Frank) which has not been fully fleshed out, or the 2500-page Patient Protection and Affordable Care Act (Obamacare) also not fleshed out, and together these two new laws put thousands of costly new rules all entrepreneurs must follow on the books in America.
Is it really any wonder that the uncertainty in the investment environment caused by future likely higher marginal tax rates and likely large new regulatory costs, makes the entrepreneurial 'animal spirits' noises heard today akin to a whimper instead of a healthy roar?
It is reasonable to conclude that shoring up the investment environment certainty regarding future marginal tax rates and solidifying regulatory rules IS akin to feeding red meat to the 'animal spirits' lurking inside wannabe entrepreneurs! In order to undertake the outsize risks which lead to outsize rewards, these risk-seekers still like the risks related to future taxes and regulations to be as small as possible.
In this analysis, we have primarily looked at successful entrepreneurs who end up building large companies. But the same logic herein applies to successful entrepreneurs who end up building small to medium-size companies.
In fact, successful entrepreneurs create many more small companies, than they do large companies, and it is not the few large companies, but the many smaller success stories that contribute the most to economic prosperity. Yet the desirability of reasonable certainty regarding tax and regulation issues in the investment environment faced by wannabe entrepreneurs is exactly the same.
To summarize, if we want long-term economic prosperity, then we must reduce the uncertainty surrounding the investment environment, after dealing well with the education issue explained in my 4/11/2012 newsletter: by 1) cementing for 10 years or more the marginal income tax rate at or below 35% and 2) solidifying the unknown regulatory environment faced by wannabe entrepreneurs.
To enjoy long-term economic prosperity, there is no other way!