Kenneth D. Gartrell

By: Kenneth D. Gartrell

Based on well-worn rhetoric of class warfare, Barack Obama proposes to soak the wealthy by tax-based income transfers to the middle class and poor. The approach panders to short-term interests and to a perceived limited economic sophistication of both the middle class and poor. Raising the capital gains taxes and the top income tax rates will not negatively impact the wealthy. It might provide some small net short-term benefit to those at the high end of the middle class income scale. It will, however, with certainty punish the poor when everything is accounted for and the unintended consequences of the proposals are considered.

A decision to increase taxes on the wealthy and then use the proceeds to reduce taxes on middle class and poor citizens constructively results in a tax on capital and a subsidy to labor. There is no mistaking the essence of these proposals as Obama has often appeared on television proclaiming unequivocally that, “it is time to stop rewarding capital in our society and start rewarding labor.” This is quintessentially a Marxist doctrine.

Superficially this seems like a good idea for both poor and middle class. There are two reasons such proposals exist. The first and obvious reason is a near-term political calculation that voters are instrumental and will vote for a candidate who promises them more cash sooner. The second and less obvious is a belief among the left-leaning intelligentsia that the ideology of Marxism is the correct way to organize society. Based on this policy proposal, the elite will interpret an electoral victory as a mandate to make decisions on questions of equity, value and capital allocations in place of free markets.

The gimmick of the “soak the wealthy” proposal is only slightly less transparent than McCain’s idea of a gas tax holiday. The problem, however, for the “soak the wealthy” proposal is that its negative effects are longer-term and potentially more damaging to the overall economy. In addition to the direct economic consequences, acceptance of the proposal will legitimize a furtherance of Marxism and central planning in our system.

Class warfare coupled with skepticism of capital markets are classical elements of the 150-year-old Marxist ideology. There is nothing new or inventive about the idea. The historical and empirical evidence is that the underlying theory of Marxism is both wrong and counterproductive. The labor theory of value, the cornerstone of Marxism, is a disproven idea. It is based on the belief that the value of labor is static and intrinsic. In other words, so long as there is labor at a given intrinsic value (it is assumed, but never proven, that the providers of labor best know and understand the value of labor) it can, should and will be used to determine the value of goods and services. In such an ideal world no value or purpose is ascribed to capital.

The Political Battleground

If asked, a middle class or poor citizen might vote for a “soak the wealthy” proposal provided there are no other consequences. But, what would happen if they were honestly asked to vote themselves a 5% tax reduction, conditional on a 20% increase in the probability they will lose their job opportunities or lose their raises next year?

Raising taxes as proposed by Barack Obama reduces incentives for the wealthy to put capital at risk. Wealthy investors are more sensitive to small relative reductions in income per unit of risk than the poor or the middle class. The resulting negative effects on employment and income growth will have a small net positive impact on the middle class. Lost income and employment will create a large net negative benefit in lower income brackets.

The Wealthy Walk

Did you ever wonder why the wealthy do not buy lottery tickets, but the poor do? Economists explain it as a matter of the Utility of Wealth. This was an essential finding of economic research during the 1970s for which Tversky and Kahneman later won the Nobel Prize in Economics. The everyday intuition is readily understandable. Those having wealth are not inclined to lose it and those having less or no wealth are inclined to take greater risk to achieve it. As a practical matter, this means that in order for the wealthy to take risks, the relative payoff for the risk needs to be higher than for those who have less wealth.

Raising taxes as proposed takes away the incentive for the wealthy to put capital at risk. They are far more sensitive to small reductions in income per unit of risk than the poor or the middle class. A tax is a cost that the wealthy can defer and otherwise avoid by taking less risk in their investments.

The wealthy are inherently risk averse due to their high utility of wealth. Confronted with higher taxes the wealthy avoid higher risk/return investments. They shift their portfolios to less risky investments and tax exempt investments in order to off-set, avoid or otherwise defer higher taxes. The net consequence is that there is little to no effect on either their lifestyle or wealth. But, the unintended consequence of tax increases on the wealthy is a reduced incentive to work and/or the related propensity to put capital at risk. This plants the seeds of the ultimate harm to the poor and lower income middle class.

The Middle Class Talks

The middle class will be affected differently and not as favorably as might be imagined. On the one hand, the middle class do pay taxes and as such a reduction in taxes will marginally raise their incomes. But, on the other hand, the middle class also invests and earns the bulk of their income from employment. Increased taxes on capital will generally reduce the value of the middle class investment portfolios, 401ks and retirement plans. A likely marginal withdrawal of wealthy investors from the stock markets will reduce the returns to the stocks held by middle class investors. In addition to the loss of investment growth, the middle class will also suffer reduced employment opportunity and likely downward pressures on salaries and wages.

The degree of the economic offsets on the middle class is a matter of individual circumstances and related tax exemptions. Nevertheless, the essential point is clear. The middle class has as much, if not more, to lose than the wealthy from an assault on capital. What is gained in temporary tax reductions might easily be wiped out by offsetting wealth effects of a more permanent nature. On the whole, and at a rate that increases as income declines, middle class voters suffer under the proposals. Lower income members of the middle class pay less in tax and hence enjoy a smaller tax benefit. Likewise they also face more relative exposure to lost job opportunity and downward pressure on wages.

And the Poor Get Beaten Down

The poor are the ultimate losers in an assault on capital. The poor pay no taxes and as such receive no direct benefit from a tax cut. While they have no investments to suffer from a decline in capital appreciation, they will inexorably suffer a decline in job opportunity and wages. The relative impact would be large and as a result the poor would be the ones who end up paying the most for another unwarranted social experiment and the grab for power by the socialist intelligentsia. For a small net benefit to garner the votes of upper middle class voters, the socialists appear perfectly ready to once again throw the poor off and under the bus.

The outcome of the election is uncertain and it is an open question as to just how gullible the poor and middle class voters are. While capitalism was the victor over Marxism in the 20th Century the struggle rages on. It may be that today’s American Marxists are not devoted to the writings of Marx, Lenin and Mao the same way they were in the 1960s. It hardly matters, however, as any philosophy which is based on the same ideas as Marxism is Marxism by any other name. The coming election will show the extent that Marxism will continue to be an important part of the dialectic that Marx Identified as the inexorable force of history.