American Corporations are not Loyal to the United States
The United States is a very strange country. It is apparently one of the few countries (or perhaps the only country) in the world where people defends an economic system on the basis that it is the “national way of life”. If you don’t defend laizze-faire capitalism, then you are not a patriot. Usually, countries try to adopt the most efficient economic systems and adapt according to their reality of their internal and external markets. Not the United States! This even reaches the level of being detrimental to Americans in general. Individualism is one of those national myths which many Americans try to stick with, and one basis to reject taxes: “It is my money! … Mine! Mine! Mine!” Yet, this clearly goes against the direct benefit of the people who subscribe this statement.
In June, Stutsman County residents rejected a measure that would have generated more money for roads by increasing property and sales taxes.
“I’d rather my kids drive on a gravel road than stick them with a big tax bill,” said Bob Baumann, as he sipped a bottle of Coors Light at the Sportsman’s Bar Café and Gas in Spiritwood (Etter, 2010).
On the other hand, the American right-wing has an irrational love for Adam Smith’s “invisible hand of the market”, a fetish which, as we have seen in our previous post, would make Smith pale. There is an unfounded belief that markets always lead to a better society as a whole, a bold belief which Adam Smith, as a good ethicist, never held in his lifetime.
Yet, as many of the patriotic Americans show a commitment to the laizze-faire capitalism, American corporations never ever show their loyalty to the United States, especially its people. Unnoticed by the news (especially corporate news in general) is the fact that corporations consistently betray the United States. For instance, during World War II, American companies invested heavely in Nazi Germany and Fascist Italy when these regimes were in power. One prominent business man is Prescott Bush, the grandfather of George W. Bush, had very profitable deals with Hitler at the time. Corporations like Coca-Cola, IBM, among others did so too. The situation is no different today. BP has made deals with Iran’s government (here is the TIME report). General Electric, Halliburton, Conoco-Phillips may have operations in Syria, Iran, and Lybia (see the 60 Minutes report here). In 2010, about 300 American corporations were approved by the U.S. government to make business deals with Iran (see New York Times report here).
While this is happening, many American corporations keep closing doors in the mainland to move overseas. Many people in the conservative spectrum of U.S. politics rightfully denounce these moves as being detrimental to the American people. Yet, they consistently keep electing the sort of government which is willing to grant all sorts of freedoms to the same U.S. corporations which keep trading with the enemy and are willing to go overseas leaving Americans out of work.
Capitalism may have the uncompromisiing loyalty of the American people, but capitalism has no such uncompromising loyalty to Americans in any way. Why is this the case? As Napoleon Bonaparte once said in 1815:
When a government is dependent upon bankers for money, they and not the leaders of the government control the situation, since the hand that gives is above the hand that takes… Money has no motherland; financiers are without patriotism and without decency; their sole object is gain.
At the end of the day, corporations in general are about the bottom line, how much money can they deliver to their shareholders at the end of any given quarter …. that’s it. Their loyalty is to the shareholders, not the American people. Many on the right accuse Chomsky on being unpatriotic when he says that privatization does not mean that you give a public institution to some nice person, but means to give a public institution to an entity totally unaccountable to the people. Since he is an anarchist, such accusations hardly keep him awake at nights. Yes, usually private institutions can do things efficiently, but, people always miss the point about what is this efficiency about: corporations are efficient in order to create wealth for its shareholders, they are not efficient to create wealth for the people. I have to keep reminding people that corporations are legally bound to place their shareholders interests above everything else, even the public good. Unrestricted corporate activity will do no good to the American people.
So, if this is the case, then why the heck should Americans be uncompromisingly loyal to American corporations? If they lay off people, as we have said in our previous post, it is because of a shrinking market, or an enhanced technology, or the bottom line. If they move overseas, it only means one thing, they would profit more overseas than in the mainland. If they trade with the enemy, it is because they find such opportunities profitable. It is all about money … not about you!
Tax Exemption in Puerto Rico, our Experience
As a Puerto Rican, I have studied the economic experience of Puerto Rico under U.S.’s rule, especially after World War II. After the war, our governor Rexford Guy Tugwell (one of President Roosevelt’s great advisors) engaged in a program whose sponsor was Teodoro Moscoso, a businessman who looked for a way to use Puerto Rico’s position as territory in relation to the Internal Revenue Code in order to attract U.S. capital. The basic mechanism to carry out this ambitious program to industrialize Puerto Rico was using tax exemptions. Any U.S. subsidiary or corporation established in Puerto Rico would enjoy tax exempt profits under Section 931 of the U.S. Internal Revenue Code. This was the beginning of a radical move of the government to stir the Puerto Rican economy away from agriculture and more to an industrial and urban way of life. This kept progressing during successive administrations until 1976, when additional incentives were created, such as tax exemption on repatriation of profits to the U.S. mainland. This was Section 936 of the Internal Revenue Code.
For many years, Puerto Rico was placed at the very top of the list of countries which attracted U.S. capital overseas. Yet, that is no longer the case. As I pointed out elsewhere, Section 936 was eliminated due to global concerns. The world changed. Why was the U.S. so rich during all of these years. Very simple! Although I know this subject is controversial, the New Deal, Roosevelt’s Keynesian approach to the U.S. economy, paid off. Also, the U.S. involvement with World War II paid off enormously, and government injected a great deal of capital to the economy, which made it recover. U.S. investments world-wide were mostly involved with extracting natural resources from other countries. Europe in general was destroyed during World War II, so was Japan and China. India was still poor mostly because of all the years under Brittish subordination. For all practical purposes, in the democratic-capitalist block, the United States was the sole player in the world with its own prosperity.
For that same reason, Puerto Rico also prospered, it experienced exponential economic growth, but not economic development (the reason for this last statement will be explained in detail in a future blog post). For all practical purposes, corporations had all the reason in the world to establish themselves there, not elsewhere. Puerto Rican labor force was (and still is) of the highest quality, and it was also cheap. The infrastructure was one of the best, because, during World War II, the local and the federal governments invested heavily on roads, electricity, water supply, among others. The local government also provided buildings to fascilitate production in Puerto Rico, as well as a national bank (Banco Gubernamental de Fomento) which invested heavily on attracting capital and providing financial support for these companies.
Yet, in the 1980s there was an air of change. Already the U.S. Congress was making statements about the fact that tax-exempt corporations working under Section 936 were not producing the amount of jobs projected by its partisans. Quite the opposite, the economy of Puerto Rico seemed to stall, while U.S. corporations evaded billions of dollars in taxes using U.S. territories. This is the decade when the term “corporate welfare” was widely used in Congress for years to come. Again, the failure to create jobs did not stop these corporations from investing in Puerto Rico. Up to 1993, Puerto Rico still was at the very top of the list of countries which attracted U.S. capital. This began to fail in 1995, when President Clinton approved the elimination of Section 936’s tax benefits.
Why was it eliminated? In part, it was because after the collapse of the communist block, corporations wanted to invest heavily world-wide without any sort of restriction, and countries involved in free trade agreements would resent Puerto Rico having all the advantage in a new globalized market. Europe was no longer in ruins, but became an economic power enough to rival the U.S. dollar. Japan was another economic superpower, whose Yen also rivaled the U.S. dollar. Free trade agreements were being signed all over the place, in Asia, and America. This would make many industrialized countries participate in free trade agreements in order to let corporations freely invest in new countries, sometimes with tax exempt status. More markets were created around the world than ever before, as countries started to compete with each other as tax havens for corporations to evade tax payments to their respective governments.
As a result, U.S. corporations started leaving Puerto Rico to establish themselves on countries like Ireland, which became an economic super-power in Europe, and Singapore which became another big economic powerhouse in Asia. Under the current circumstances, corporate tax subsidies don’t work anymore. Puerto Rico kept choosing the strategy of corporate tax subsidies, with no beneficial results in any way, and major political parties keep adopting these non-sensical policies despite repeated statements made by reputed and serious economists that this is the wrong path to take (see Collins, et al., 2006, which is a study made by economists from the Brookings Institution and the Center for the New Economy). Even the renowned independentista economist, Francisco Catalá Oliveras, has repeatedly recommended to tax those foreign corporations which are going to leave anyway. This is a no-brainer! If, no matter which program of tax subsidies you give them, these corporations will leave soon anyway, why the heck not tax them?! There is no loss in this specific scenario, and Puerto Ricans would have everything to gain. Needless to say, the Puerto Rican government did not revoke their tax subsidies and refuse to tax them.
Unfortunately, in the early nineties, the amount of capital proceeding from 936 corporations added up to $13 billion, in 2001, it was reduced to $1 billion. In the new neo-liberal fever, Puerto Rico also sold its public phone company, which used to produce lots of revenue for the government. It privatized its own health care system and implemented an HMO-like model, which greatly increased health care costs. It partially privatized the water company, driving its costs higher. It is no surprise that under the tax subsidies model, and the sour pill that our governor, Luis Fortuño made us take (i.e. following his Republican conviction that government was the problem and that about 20,000 employees should be fired), Puerto Rico’s debt increased to a new record high of $65 billion. It is trying to keep up the system unsustainably using non-recurring funds (mostly coming from loans) to finance recurring operations. The financial services which grade credit are primarily concerned about the value of government bonds in the long run, especially those regarding the University of Puerto Rico and pension funds. In November 2011, Wasmer, Shroeder & Company, strongly advised its investors to watch out for Puerto Rican bonds in a report whose title speaks a thousand words: “Puerto Rico: Greece of the West?” A lot of our loss of capital which Pueto Rico could tax without any sort of loss is diverted to the Cayman Islands … the joke is on us, Puerto Ricans!
Since the Puerto Rican government granted corporate tax exemptions, government is still unable to address many of the problems it had effectively, especially roads, electricity, water supply. The average tax contribution of foreign companies to the Puerto Rican government is about 4%. In Ireland it is 12.5%, while in Singapore the average is about 10%. Even with its meltdown, Ireland is still in a much better economic shape than Puerto Rico at the present moment. There was a contraction of Singaporean economy by a 0.8% in 2008, but it recovered, showing a 14.5% growth of its GDP (2010), even when we are still not out of world-wide recession. Isn’t it interesting that most of the time, countries which have mixed economies and tax the rich usually have much better services, goods and jobs, than those which do not? Some of these successful countries are: Singapore itself, Finland, Denmark, New Zealand, Switzerland, the Netherlands, Canada, and Norway. These also happen to be among the least corrupt governments in the world, and many of them happen to be social-democratic governments.
I ask … what the heck is the basis to say that taxing corporations would drive down the economy?
Singapore’s Use of Tax Subsidies
The signficant difference between Singapore and Puerto Rico becomes apparent when you realize that the latter has relied its economy almost completely on tax exemptions without creating a single job in recent years, except part-time jobs with lower wages. Yet Puerto Rico has an extremely low labor force rate (which, in 2011 fell below 40%, one of the lowest in the world). Again, does tax exemption create jobs?
Singapore is another sort of country. Yes, it is ruled by an authoritarian government which tries to control its ethnic diversity and the economy. Yet, its authoritarianism is not the main explanation for why it has been so successful over the years. The vast majority of authoritarian governments around the world are doing worse off than Singapore. What is its secret?
Simply speaking, they do not rely exclusively on tax exemption to foreign corporations. Yes, they do use tax subsidies to attract foreign capital, but they don’t give those tax subsidies forever, and not to whoever appears at its doorsteps. Many countries in the world which compete as tax havens, usualy make the mistake of extending tax holidays for big foreign corporations, a strategy which usually does not lead to better improvement of their populations. The competition among countries make them give more tax benefits and provide other incentives in detriment of their own people. Yet Singapore is another story. If you own a company which wants to take advantage of Singapore’s tax subsidies program, your plan better lead to job creation and the general economy’s improvement. No program which benefits you as business man is unconditional in Singapore. Yes, tax subsidies are increasing in Singapore as it is lowering its tax rate on foreign corporations, yet this is also being planned as a bigger progressive tax policy, where rich people actually have to pay more.
Contrast the Republican (especially Tea Party) way of thinking with President Lee Kwan Yew. President Lee tells the story of when representatives of a German company were concerned that after several calculations, they would find more profitable to leave Singapore to another country, that they would love for Singapore to lower further its tax requirements and extend them. President Lee talked to his advisors on the matter, and in the next meeting, he looked at the documents with the proper research and said: “You are right. Singapore apparently is too expensive for you, and you would find it profitable to invest elsewhere. However, I will not lower taxes for your benefit. May I help you with your luggage?”
On the other hand, instead of relying on tax subsidies, what Singapore has done is to diversify every aspect of the economy. Even if it doesn’t have lots of natural resources, they have agriculture, producing good of all kinds, inviting young company matrices to be established in Singapore, it has an air line, a governmental universal health care system (one of the best in the world), high quality roads, electricity, and water utilities, it has not abolished assistance to the poor (even though poverty level in Singapore is significantly lower than other countries in Asia), with low unemployment rate (2.2%), low cost housing, and so on. It relies basically on exports, which is one of the highest in all of Asia. Needless to say that it is one of the most environmentally friendly countries in the world. They intensively train their labor force for new jobs available in the market place as the economy and world reality keep diversifying and changing. I may add that it has also a very aggressive savings program (sometimes to 40% of earnings), which continually nourishes the economy. This is the key to Singapore’s economic success …. not total reliability on tax subsidies which are, after all, only temporary and conditional.
We are in a Different World, Tax Exempt Status Should Not be the Norm
No longer is tax exemption one of the top criteria corporations use to establish themselves in any place in the world. Yes, it was a strong force for many years, but not not now. The opening of the global market has made multinational corporations to multitask production in key countries in the world, although this situation keeps changing over time. Tax subsidies are no longer the main path to attract corporations in the United States, except in some specific cases. Usually many of the companies asking to establish themselves anywhere in the U.S. are either companies providing goods and services which would provide them anyway without any tax-exempt status, or could be companies providing products to consume, which would also provide them anyway without tax-exempt status. WalMart has been one of those megastores which have lobbied extensively in state governments, and even municipal governments, for tax subsidies. Once a WalMart is established somewhere in a commercial strategic zone, it destroys the competition which is usually made up of tax-paying smaller or medium-sized stores. This inevitably leads to low wages, the prevalence of part-time jobs, no funds for fire departments, for police, for public education, and so on. In other words, those cities and states end up being worse than before. The same thing happens with other mega-stores which compete with others such as WalMart.
Usually, the norm is that if a corporation plans to move to another state or overseas, will do so regarless of whether it is given tax-exempt status or not. Usually tax subsidies are the result of lobbying by corporations, which basically means that a legalized bribery is in order to support or oppose certain government policies. Lawrence Lessig, in a very thorough and well-researched book about problem of corporate lobbying and how it is destroying democracy, makes the point very clear that the reason why many decent politicians are so easily corrupted within the system, it is because the system itself is corrupt. The book is called Republic, Lost, and I highly recommend its reading.
For all practical purposes, governors and Congressmembers are dedicating themselves almost fully to raising funds, much of which come from people associated with the corporate sector. Even when a candidate may know for sure that tax exemptions will not create jobs, he or she will favor it to pay back a corporate favor (often without being conscious of doing so).
The evidence has shown consistently that tax reduction as general policy leads to a worse state of affairs. There is no evidence at all that a general policy of lower taxes make states or the U.S. as a whole any better. As one of the millions of examples I can show in this blog, I want to use the one manifest evidence about how lowering taxes lowered quality of life, while many corporations and rich people were made richer. In 1978 a referendum was carried out, the people of the State of California approved Proposition 13, which basically limits taxes on “real property”, which led to lower tax rates for California. What was the inevitable outcome? The effects of Proposition 13 is described extensively in Peter Schrag’s Paradise Lost: California’s Experience, America’s Future.
This is a non-partisan thorough analysis on the degrading economy of California ever since Proposition 13 was passed. Shrag sums up his conclusions:
Californiaś schools, which, thirty years ago, has been among the most generously funded in the nation, are now in the bottom quarter among the states in virtually every major indicator–in their physical condition, in public funding, in test scores–closer in most of them to Mississipi than to New York or Connecticut or New Jersey. . . . Its once celebrated freeway system is now rated as among the most dilapidated road networks in the country. Many of its public libraries operate on reduced hours, and some have closed altogether. The state’s social beneefits, once among the nation’s most generous, have been cut, and cut again, and then cut again. And what had once been a tuition-free college and university system, while still among the world’s great public educational institutions, struggles for funds and charges as much as every other state university system, and in some cases more (Shrag, 1999, p. 8).
The right-wing is obsessed against taxes, because it leads to government waste. The lesson of the famous “Bridge to Nowhere” is an iconic and symbolic illustration that this indeed occurs. And much of the right-wing in 1978 advocated for Proposition 13 on the same basis. The lesson to be learned here, though, is that when you cut taxes to eliminate government waste, you also cut taxes which eliminate valuable government programs, especially those which help to create more jobs and better address the needs of the population. Yes, many people abuse government programs, but as the economist Robert H. Frank points out, the problem is not whether these programs are abused by the people or the government (sometimes they are), the real issue is that eliminating these programs would create far more costly problems for government in the long run. The starve-states-to-pay-debts policy is bad for this specific reason.
More evidence that cutting tax on corporations does not necessarily lead to more jobs is the evidence gathered by the non-profit organization GoodJobsFirst.org, which tracks the effect of government subsidies for U.S. corps (download the PDF version here). I also highly recommend Greg LeRoy’s The Great American JobsScam, an excellent book on how corporations in general manipulate the public into thinking that lowering taxes will create jobs, and shows ample evidence that they do not.
Why should anyone feel any patriotic duty to a system which, set completely free, is actively working against the American people? Why should market fundamentalism equate the “American way of life”?
If you didn’t understand anything I have argued here, I leave you again with Bill Maher to explain it to you in a way you will understand:
Some Thoughts on Ireland
We all know that during most of its history in the twentieth century, Ireland had a systemic economic problem. Yet, after a consensus made by the private sector, the public sector, and workers, everyone sacrificed a bit of their own interests to make Ireland work. The result was a booming economy. It even became a country with higher GDP per capita than the UK.
Yet, it made one crucial mistake, mostly due to the side effects of uncared boom economy: it deregulated the banking system, and assumed the neoliberal position that losses in the market should be adopted by the government, which non-surprisingly led to its current collapse in the market. Privatize profits, socialize losses.
This is an important observation to make, since the rise of Ireland’s economy is the product of intensive cooperation between different sectors of society. As Charles Darwin discovered in his life time, and as scientists who favor the idea of group selection point out, cooperative societies will usually survive better than non-cooperating societies. Unfortunately the formulae being applied to Ireland in this recent Irish economic recession has nothing to do with cooperation. Basically because of the right-wing leadership in the European Union, Ireland is now required to adopt neoliberal measures, including tax subsidies and government cut on social programs in order for it to pay its debt. The fact that Ireland is tied to the ever declining Euro makes matters worse.
I think that Ireland should ignore the European Union’s request, and create a new national consensus to deal with the problem without cutting taxes, nor by eliminating social benefits. I agree with Paul Krugman that the measures taken by Iceland are the way to go (see also his article “The Path not Taken” and “Eating the Irish“.
Collado Schwarz, A. (2009). Soberanías exitosas: seis modelos para el desarrollo económico de Puerto Rico. PR: La Voz del Centro.
Collins, S. M., Bosworth, B. P., Soto-Class, M. A. (2006). The economy of Puerto Rico: restoring growth. Washington, D.C. & PR: The Center for the New Economy and Brookings Institution Press.
Dietz, J. L. (2007). Historia económica de Puerto Rico. PR: Ediciones Huracán. (There is an English version available: Economic history of Puerto Rico: institutional change and capitalist development. US: Princeton University Press.
Etter, L. (2010, July 17). Economic crisis forces local governments to let asphalt roads return to gravel. WSJ.com. Accessed in: http://online.wsj.com/article/SB10001424052748704913304575370950363737746.html.
Irizarry Mora, E. (2011). Economía de Puerto Rico. México: McGraw-Hill.
LeRoy, G. (2005). The great American jobsscam: corporate tax dodging and the myth of job creation. San Francisco, CA: Berrett-Koehler Publishers.
Shrag, P. (1999). Paradise lost: California’s experience, America’s future. CA: University of California Press.
Lessig, L. (2011). Republic, lost: how money corrupts Congress – and a plan to stop it. NY: Twelve.
It often surprises me to watch presidential candidates debate about how to deal with several problems occurring today in the United States. I am not an American, and I don’t vote for the U.S. presidency. However, through social networking in Facebook and Google+, and what I read in the news daily, it seems that Americans are looking for a good candidate for the presidency.
The right-wing is now divided between the more intelligent conservatives and the Tea Party. I agree with the economist Robert H. Frank when he said that if you use Venn diagrams you will be able to see that the set of issues the Tea Party is angry about and the set of issues the Tea Party is confused about intersect perfectly in one whole circle. When they describe Obama as being a socialist bordering on Nazism and Marxism, they are not really thinking. The fact that Nazi means national-socialism does not mean that the sort of socialism that socialists in general are asking for involve concentration camps. Tea Partiers forget how many Marxists and Communists were persecuted by the Nazi regime, and how Hitler expressed his hate for them in Mein Kampf. Needless to say that not all socialists are Marxists. There are anarcho-syndicalists or libertarian socialists, which involve socialism comprised of free federation of communities of workes without the existence of a state. There are also socialist-democrats (and I count myself as one of them) who essentially advocate for a mixed economy where the free market should have its own place, but regulated by the government, while the government would assume the responsibility of certain essential goods.
Yet, Obama is none of these things. Supposedly, he is a liberal (pro-capitalist, but centrist), although I agree with Bill Maher that he is not even liberal. This means that Tea Party and other people in the right have absolutely no idea what they are talking about. If Obama were a socialist a la Soviet Union, he would have socialized all banks and private enterprises at this stage of his command. He hasn’t. He has only carried out a bad Keynesian approach, which is different from a Marxist approach. Marx wanted to abolish capitalism. Keynes wanted the government to intervene to save capitalism. Much of what Obama has done has been to temporarily assume the shares of some companies and bail out others which are “too big to fail”. I don’t think that this was a good approach to companies responsible for the economic downfall, but ever since Bush, this has been the tendency of the federal government (and most industrialized governments thus far).
On the other hand, for many liberals and progressives, Obama’s term has been an abysmal failure. Progressives elected him because he did talk about change in Washington, D.C., no more business as usual. He wasted a lot of valuable time trying to be “conciliatory” to an anti-conciliatory right-wing, especially when Congress was dominated by the Democratic Party. Before the 2008 elections, I knew he would also be a failure in terms of human rights. Before he was elected president, he voted for FISA. He promised to end the Iraq war and he did, but after three wasted years spending money on it, increasing the national debt exponentially. He promised to close Guantanamo … that never happened. He promised that his administration would be crystal clear regarding Iraq and government affairs in general, yet, the year 2011 is an all-time record of secrecy and censorship regarding freedom of expression (see the statement made by the Electronic Frontier Foundation). To make matters worse, still in the midst of a recession (with a timid sort of recovery), as we speak the President is preparing U.S. forces in the Ormuz Straight in an apparent plan to attack Iran. Suppose the U.S. win, will it stay in the same way that the U.S. stayed in Iraq, draining the U.S. economy and needlessly increase its debt? Obama has also been the president who has most enforced anti-immigration laws (more than Bush or any other Republican administration ever has), especially Hispanic illegal immigrants. And last, but not least, he signed the damnable National Defense Authorization Act of 2012 recently (December 2011) which opens the door to violations of human rights against American citizens. In almost all accounts, from a progressive and even liberal standpoints, Obama’s administration has been significantly worse than Bush’s.
Both the right and the left are looking for new options, and the U.S. is paying close attention to Republican presidential candidates, given that the Democrats are pretty much stuck with Obama. What completely amazes me among all the candidates is the apparent blindness regarding taxes. Even Rick Santorum, a candidate I certainly do not respect (politically at least), stated that for job creation, we need to reduce corporate manufacturing rates to zero percent, and I know of other Republican candidates who would perfectly agree with that plan.
This is insanity!
Since when tax-exemption in any industry has been key for job creation?
Let’s Read Adam Smith Again!
Republicans and conservatives in general are supposedly followers of Adam Smith. I’m a socialist, but I can really, really appreciate Smith’s invisible hand doctrine. There are some forms of selfishness which benefit the public by creating innovation at low cost. If selfish people enter in the business world, in an environment of competition, the market will make sure that the public will have the best quality product at the lowest market price possible. This is perhaps one of the greatest insights in the history of political economy. Yet Smith himself was a lot wiser than his supposed disciples. Not always would the market benefit the public. We should take into account these passages from The Wealth of Nations:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible, indeed, to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. (p. 111)
To widen the market, and to narrow the competitiion, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can only serve to enable dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, as absurd tax upon the rest of their fellow-citizens. The proposal of any new law or regulation of commerce which comes from this order, ough always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it (pp. 213-214).
Yet, for some reason many people on the right, especially those of the Tea Party, readily ignore Smith’s advice. Smith’s position is not that the government should not participate in the economy …. period. On the contrary, when things are unequal, and certain people “of the same trade” conspire and oppress the public, the role of government is precisely to set the laws and regulations in order to prevent that from happening. Smith’s advice that government should not intervene with the economy has more to do with the fact that many people of “the same trade” will seek to go to government so that a certain bill is passed, so that a new law will benefit corporations in detriment of the public. In such cases, government should just stay out of the way, not legislate such policies, and let the “invisible hand” of the market rule.
However, there are some other aspects about Adam Smith’s doctrine which are usually overlooked by many of his supposed fans when they propose tax exemptions as the way of creating jobs. In the third chapter of The Wealth of Nations, Smith talks extensively about division of labor. This chapter is very illuminating.
As we all know, Smith held that the wealth of nations is basically the product of three components:
- Rent of Land
Rent of the land involves the sort of payment for facilities that you need for production (although in The Wealth of Nations Smith uses the term “land” in a broad sense, Smith uses examples of agriculture to convey his point). Salary is the nominal labor price which you pay your workers, while the benefits involve the profit component. Note that Smith did not dismiss taxes. Smith recommended that taxes should be established on luxury, as well as on the rent of land, not over benefits. (See an excellent brief summary on his views on taxes here). Actually, he elaborated extensively (about one third of his work) on how governments should tax. Certainly he, an ethicist, would have never subscribed to the slogan that “all tax is theft”. Yet, I want to differ from Smith regardding the idea that profit should not be taxed, and suppose tax on benefits to use Smith’s own theory to get to the point I want to make.
Notice that, though taxes themselves can serve to regulate the economy (e.g. taxes on luxury), nowhere in Smith’s analysis taxes (or lack of them) play any role whatsoever in creating jobs. That is because in the third chapter of The Wealth of Nations, Smith reveals the most fundamental aspect of job creation …. the size of the market (pp. 10-11, 21-25). When I explain Adam Smith to my students, I always say: “I wish that there were massive sales of philosophy books all over the world, so that we see the fruits of such industry of thinking and rationality. Yet, since the market of the Twilight series is much greater (yuck!), I guarantee you that the number of workers producing Twilight products is greater than those producing philosophy books (grumpy face)”. Since the Twilight market is a lot greater than the Husserl market, then the number of employees needed for the Twilight market will be a lot greater than the Husserl market.
Of course, taxes should not be so high as to strangle an industry. Taxes which require a hundred percent of profits would make any industry fail miserably. Yet, with more moderate taxes, let’s suppose 15% or 30% or so, an industry might persist (depending on the circumstances). Yet, once a right tax rate has been required by the state and the federal government, then the question is whether reducing it will create jobs. The answer is no, for reasons given by Smith himself in that third chapter. I will use a more “down to earth” analogy.
Let’s say that I want to create a business selling toasters in Puerto Rico. I do a market analysis and I find that in order to satisfy the effective demand (the number of people who want my products and can pay for them), I will need to hire 500 workers. I hire these workers, and the production process and sales lead to a net profit of $1,000,000.00 this year (without taxes). Suppose that I need to pay 15% taxes on profit. Then that means, that at the end of the day I will end up with $850,000.00.
Now, what would happen if the government, for whatever reason, wants to lower taxes to provide economic incentives (supposing that my market size remains the same)? Does it create more jobs? Not really. If my market research still shows that all I need is 500 workers, then hiring more workers than that will not give me an economic advantage over my rivals. As Adam Smith pointed out, the quality of production depends greatly on the ratio between those workers who are actually producing and those who are not (p. 8). If I hire more workers than I actually need, then that would be a disadvantage in the market.
On the other hand, it is perfectly conceivable that I could use that money to increase my workers’ salary. Yet, that would not be creating jobs, would it? All I am doing is keeping the same number of employees, but I would be paying them more. On the other hand, due to the competition in the market, if my rivals are not increasing their worker’s salaries, then that would mean that increasing my workers’ salaries would be another disadvantage in the marketplace.
So, what did the tax reduction accomplish? Making me richer … and that’s it. Let’s say that politicians wanted to reduce the tax rate from 15% to 5%, then I would end up with $950,000.00 profit. In other words, I would end up with $100,000.00 more without creating a single more job in the process!
Conclusion for Part 1
What we have seen here is just the beginning of how the right-wing (especially the radicals of the Tea Party) completely misunderstand basic economic concepts and how the economy works. Lower tax rates on corporations, taken on principle and completely decontextualizing the proposal, can be an incentive for industry but in detriment of the public. There is simply no way that a general policy of tax exemption will create jobs, simply because taxes (or lack of them) have no relationship at all with job creation. This is because job creation is directly related to market size (supply & effective demand), not to tax rates.
In other words, the key to creating more jobs is to create a market, and, as John Maynard Keynes pointed out, only government has the means, the motive, and the power to create those markets, and turn things around …. even if that means more government spending and debt! The problem with the federal government today is that it has made little effort in creating these markets through the component of effective demand, spent too much money bailing out corporations which are “too big to fail”, and spent trillions of dollars in a war everyone knew would not be won in the end. I’m sad to say that both Bush and Obama have contributed to this crisis.
This is not all I have to say about the subject, it is only the beginning. I want to talk in later posts about the role of tax exemption in the globalized world, and in the U.S. For now, I leave you with some final thoughts by Bill Maher.
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations. US: The Pennsylvania State University. (It can be downloaded here for free in its entirety in PDF Format).
In my dreams would I have imagined that I would read a book like this, especially during my research regarding applications of Darwinism to social. I know that in some tangential way, Darwin’s theory of evolution was related to the way we create economic systems. Darwinian natural selection has to do with the competition among individuals and groups for scarce resources. Humanity’s economic systems have to do with the distribution of scarce wealth. Also, we have to look at the fact that we inherit much of our behaviors from our ancestral animal behaviors regarding scarce resources. Yet, economic systems are conventional and, in a way, unrelated to nature.
Yet, there is a challenge being made by Robert H. Frank in his new book, The Darwin Economy: Liberty, Competition, and the Common Good. He predicts something rather odd: in a hundred years from now, if you ask professional economists who do they consider the father of their own discipline, instead of Adam Smith, most of them would say “Charles Darwin”.
Yeah, Charles Darwin!
Before you place Frank in a psychiatric facility (at least in your imagination), he invites us to take a look at the way Darwin describes natural selection processes. He reminds us of Darwin’s initial development of multilevel group selection, and how individual interests relate to group interests. For example, how did the gazelle accomplish its current average speed? Classic Darwinian natural selection would tell us that it is the result of species warfare. Nature selects gazelles who have the ability to escape predators using fast speed. In this case, through reproduction, the fastest gazelles pass on genes that will benefit the group. In this case, individual interests and group interests agree completely, since the group on average is better able to escape predators.
The same happens at the economic level. Adam Smith’s “invisible hand” of the market works perfectly in this case, because the competition among individuals or among companies benefit both individuals and groups.
Yet, there are other scenarios. The cover of Frank’s book tells us all about it. Consider the bull elk. They have antlers which function as weapons in order to compete with other males for female. The winner, gets to pass on genes. So, from the point of view of the interest of the individual bull elk, the bigger the antlers, the better! This leads to the prevalence of larger and larger antlers. Yet, the process cannot continue ad infinitum. Having very big antlers is a disadvantage from a group standpoint: large antlers increase the risk of getting stuck among tree branches in densely wooded areas, hence the risk of being eaten by wolves. If those genes are passed along, they would compromise the group. In this case, individual and group interests diverge.
The same thing happens with the economy. Too much competition among individuals or corporations can lead to the sort of negative externality which can be a real problem, even a threat, to the group. In this case, when too much competition happens, and the interests of the individuals and groups diverge, Smith’s “invisible hand” breaks down.
Frank even adds another imaginary, amusing, but interesting statement. If bull elk were to be asked in a referendum whether to reduce their antlers by half, they would overwhelmingly favor it! Of course, such experiment cannot be carried out with actual bull elk, but we can do so with humans. We don’t have antlers, of course, but we are often found in competition, sometimes too much competition. Frank gives the example of an actual experiment being carried out with hockey players. Thomas Schelling, an economist, has pointed out the fact that when hockey players are individually given the choice of using their helmets or not, they usually tend not to wear helmets, yet, when they are asked to vote to implement a rule for the group to wear them or not, they invariably vote in favor of wearing helmets. Why is that? If you make individuals choose whether or not to wear helmets, they will choose not to, because not wearing a helmet increases a player’s advantage. Maybe he can see or hear better than players who are wearing helmets. As a result, those players who use to wear helmets will now choose not to, to gain that advantage. At the end of the day, no one will wear helmets, and everyone would end up having equal advantage. The downside of not wearing helmets, though, is that everyone is at risk of serious head injury. Everyone is worse off. This is similar to the bull elk having horns too big, there is excessive competition. So, when hockey players are asked whether to implement a rule requiring everyone to wear helmets, they will vote in its favor. A simple nod or loose agreement among players is not enough, they need a collective mandate.
The same thing happens to states. During the Cold War there was a huge amount of waste due to the arms race. In this sense, the U.S. and the Soviet Union were incredibly wasteful. In order to control that, they couldn’t control that race just with winks among their representatives and diplomats, but rather by signing treaties to slow the pace of competition or to disarm very harmful weapons. The treaty would include checking on each other’s facilities in order to be certain that this would be carried out. That’s how they could use enough money for education, health care, utilities, and so on, without spending it most or all on the arms race.
Frank argues persuasively that, contrary to what many progressives think, many of the ills of the economy are not produced by the prevalence of monopolies and oligopolies, but rather by too much competition. Libertarians are usually right when they say that government is wasteful. Yet, excessive competition can be incredibly wasteful too, in ways that are many times more harmful than government. Just one example (of the many offered in the book) when rich people celebrate parties for children’s birthdays. Here another element creeps in the competition process, the degree in which people spend on those kinds of parties is not based on absolute position, but on relative position. As a result, if you are a millionaire who celebrates their fifteen years-old birthday with a $5 million party, perhaps your neighbor will want to do it better and spend $6.5 million party for his fifteen-years old. This process will go on indefinitely leading to big waste of money. This is not a hypothetical situation, this really happens! At the end of the day, the children will be just as special, nobody is happier no matter how much money has been spent, so the money is … wasted … literally!
In these cases, Frank does not suggest that we forbid $5 million parties, but rather establish a steep progressive consumption tax that will persuade rich people not to spend too much. The state or federal income obtained through this consumption tax will serve for roads, bridges, security, firefighting, police, and so on. This will benefit both the rich and the poor. Frank argues that if you are a smart rich man, you would love to live in a place with those sorts of rules and laws.
Of course, libertarians and people of the Tea Party will say that all tax is theft, that we should diminish the government. Interesting thought, but, as Frank points out, we need to tax something. If we don’t tax, there can’t be a state, if there is no state then another country will invade … and you’ll end up paying taxes to that country.
Frank shows that in many cases, taxes are a unintrusive way to stir corporations and businesses away from the sort of harmful behavior which arises due to too much competition. The problem that we have now is that we are usually taxing the wrong thing: the payroll tax or the savings tax. Yet, we don’t tax harmful behavior enough. We usually penalize them, but don’t tax them.
The author of The Darwin Economy uses this Darwinian framework to evaluate the economy. Unlike bull elks or gazelles, who can’t communicate and cannot act in ways which are against their nature, we can make better choices. Darwin helps us evaluate these competitive dynamics that occur even in the economy, lets us evaluate the problem, while simultaneously helping economists point out possible ways of solving these problems. Within this framework, Adam Smith’s “invisible hand” insight is just a special case of a broader and more general understanding of competition. There are criticisms to both progressives and libertarians alike.
He applies this reasoning to lots of cases: such as pollution control, employees competition for better salary and safety, housing, alcohol, among many other aspects o the economy. It is also an invitation to many in the right wing to really think about how taxes can be beneficial for society as a whole when done the right way. Tax should not be a forbidden subject, especially in the United States. Let’s scap taxes to all useful activities, and tax to discourage activities, especially those which can cause harm to others: noise, carbon dioxide, road congestion, etc. Have a progressive consumption tax, not an income tax.
This is a fascinating book and I highy recommend it. For me, it has been very illuminating.
Video – Part I
Video – Part II