A couple days ago I emailed George Reisman, professor emeritus of economics at Pepperdine University, and brought to his attention a recent article by Henry Blodget at Business Insider. Refuting this article would bring him great intellectual pleasure, I said.

Reisman emailed a reply to Blodget, and has granted me permission to reproduce it here.  It follows.

Dear Mr. Blodget:

I’ve read your article “Finally, A Rich American Destroys The Fiction That Rich People Create The Jobs.”

In a capitalist economy, the wealth of the rich is in the form of capital, i.e., wealth employed in the production of goods and services for sale. This wealth is the foundation both of the supply of products that people buy and of the demand for the labor that people sell. The greater the wealth of the capitalists, the higher are real wages, both because of a more abundant supply of products produced and a greater demand for the labor of wage earners. Diverting funds used to purchase capital goods and pay wages into spending for consumers goods, which is the effect of virtually all taxation that falls on the rich, and also of government borrowing, reduces both the demand for and production of capital goods and the demand for labor. In other words, it serves to hold down production, keep up prices, and hold down wages.

Consumers are not responsible for the industrial development of any country. Consumers have myriad needs and desires, which go unmet except to the extent that businessmen and capitalists find ways of supplying them through the development of new and improved products and more efficient, lower-cost methods of production. When such improvements are introduced, consumers can be expected to buy them, frequently on a very large scale. The firms and industries producing the better and/or less expensive products then expand and again and again become major components of the economic system. This, however, does not represent an increase in the overall number of jobs. For example, while the development of electric light led to major increases in employment in producing light bulbs and electric lamps and wiring, it also led to the near total wiping out of the production of candles, lanterns, and gas light, with a corresponding loss of employment in those areas. Similarly, when the automobile replaced the horse and buggy, the vast number of jobs created in the automobile industry was accompanied by a massive loss of jobs on the part of buggy builders, blacksmiths, horse breeders, harness makers, and oat growers.

More consumer spending financed by inflation, i.e., the creation of new and additional money, has the potential for increasing employment in some circumstances, but only insofar as the sellers of the consumers’ goods that are faced with the additional spending save and invest their additional sales proceeds. If they too consumed, or if the government taxed away their additional sales proceeds, there would be no increase in the spending for labor or capital goods and no increase in employment. The ability of inflation to promote employment also depends on labor unions being weak or non-existent. To the extent that unions exist and are powerful, they will take advantage of the inflation to raise money wage rates even in the midst of mass unemployment, thereby nullifying the ability of more spending for labor to increase employment.

While on the subject of inflation, it should be realized that it is inflation, particularly in the form of credit expansion, that is responsible for the perceived increase in inequality of income. New and additional loanable funds, manufactured by the banking system, with the sanction and protection of the Central Bank (in the US., the Federal Reserve), enter the capital markets and proceed to raise the prices of stocks and real estate, thereby creating capital gains on a massive scale. New and additional money and spending also serve to increase nominal profits, inasmuch as they raise sales revenues immediately but increase income-statement costs only with a more or less considerable time lag. And if the process continues, increases in income-statement costs are accompanied by still further increases in sales revenues. For example, consider a very simple case. A businessman spends $100 on January 1^st to produce a product that he will sell on December 31^st for $110. This year, however, there is a 10 percent increase in the quantity of money and volume of spending, and so our businessman will be able to sell his product for $121 instead of $110. Profits now equal $21 instead of just $10; in terms of a percentage of sales revenues and costs they are approximately doubled, and are correspondingly increased relative to wages.

However, when the effects of taxation are taken into account, it turns out that these seemingly high profits are accompanied by a sharp decline in real profits. Assuming the same tax rate on  profits, say, 50 percent, the businessman who earned $10 without inflation had $5 left that he could either consume or add to his business, because $100 of sales proceeds were sufficient to replace the goods he sold. Now, however, with inflation, he has $10.50 of profit, almost all of which is required to replace the goods he sells, which goods now cost him $110 instead of only $100. This leaves him with only 50 cents that he can use to consume or add to his business.

Hopefully, the above makes it clear that in an environment of inflation, taxes on profits can virtually never be low. In the above example, the tax rate would need to be approximately halved just to remain the same, given the approximate inflationary doubling of the profit income subject to taxation. It’s also extremely difficult to understand how, even apart from inflation, anyone could believe that today’s tax rates are low by historical standards. For most of American history, i.e., 1776 to 1913 (with the exception of the Civil War), there was no income or inheritance tax, period. Indeed, prior to the Civil War, the only sources of federal revenue were tariffs and the proceeds of land sales. After the Civil War excise taxes on tobacco and alcohol were added. That was it, until 1913. And when the income tax was first introduced, the maximum rate was 6 percent. Thereafter, as nominal rates rose, so too did the number of exemptions and “loopholes.” “Loopholes” can easily have the effect of making extremely high nominal tax rates end up being radically lower in actual impact. For example, fewer countries have higher corporate tax rates than Sweden—52 percent the last time I checked. Yet Sweden also allows firms automatically to deduct up to 50 percent of their profits as tax-free reserve for future investment, which reduces the effective rate of corporate income tax in Sweden to 26 percent, which is considerably less than the current 35 percent rate in the US. Actual, effective tax rates on profits in the US are by no means low.

I will close now. If you have found any of my comments helpful in any way, and would like further elaboration on the nature of capitalism and economic freedom then I would like to recommend that you download (without charge) the pdf replica of my book Capitalism: A Treatise on Economics. The book is fully searchable and hyperlinked. It can be downloaded from my website simply by clicking on its title in the previous sentence.

Cordially,

George Reisman

George Reisman., Ph.D., is Pepperdine University Professor Emeritus of Economics, a Senior Fellow at the Goldwater Institute, and the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His website is www.capitalism.net and his blog is georgereismansblog.blogspot.com.