Stimulating Job Creation

Observation: Current tax and monetary policies are subsidizing unproductive asset allocations and a flight to safety for private capital; thereby obstructing economic recovery.

Let that sink in. There will be no sustainable economic rebound until we recognize that our tax and monetary policies created structural misincentives and destabilized our economy. An economy over-weighted toward trading and speculation, where investors receive preferential tax treatment while actively seeking shelter from uncertainty and risk, will not generate robust job growth. If the productive deployment of capital is the key driver of economic growth and prosperity (the central tenet of capitalist theory) then “Our political and economic leadership need to examine and address the ways our tax and monetary policies subsidize unproductive private capital.” We offer preferential tax treatment to investment income with the stated objective of encouraging productive investment. But the structure of our policies is inadvertently subsidizing unproductive, illiquid, and speculative investments – and penalizing capital allocations most directly responsible for job growth.

How so? Let’s say I have $2 million of capital available to invest. If I invest it directly as equity in a productive enterprise, generating jobs and profits, I become subject to substantial equity risks as well as multiple layers of taxation; on profits, dividends and capital gains. Alternatively, I can minimize my tax obligations and in most cases my principal risk, by seeking a multitude of alternative asset allocations. I can park my money in cash or Treasury bonds. I can receive favorable tax treatment for debt instruments. I can speculate in gold, real estate, or other tangible assets. I can speculate in valuation fluctuations of publicly traded equities or complex structured securities and derivatives (which is distinct from investing in productive operations). In nearly all cases, the lower my risk, the lower my taxes. The only real exception to the low risk/low tax relationship is where I have actual losses; yet even there government steps in and subsidizes them with tax loss offsets, thus rewarding failure while taxing my successful competitor more heavily. If I don’t need income, I can minimize taxes by sheltering profits and deferring gains, often to near perpetuity. Our tax policies are skewed to favor and subsidize low-profit, unprofitable, and illiquid capital allocations.

If we desire to stimulate job growth, priority number one should be examining and correcting the structural flaws in our tax policies that inadvertently distort investment decisions. We have to stop trying to re-inflate the bubble and turn our attention to the underlying fundamental misincentives of tax policy. The FED may be able to boost asset values and stock market indexes temporarily, but doing so will not produce a broad, sustainable, productive economy.

Unfortunately, instead of addressing this fundamental challenge our current public tax debate is a battle of bad ideas. America is headed to the polls in November faced with a false choice. Doubling down on the failed strategy of tax cuts for the wealthy (the conservative choice) will accelerate wealth and income inequality, increase budget deficits, undermine social welfare programs, and eventually lead to social unrest. But unless we modify existing structural misincentives, higher tax rates (the liberal choice) will encourage more aggressive tax avoidance efforts and thereby exacerbate economic stagnation and instability.

Neither party is addressing the fundamental structural flaws and misincentives in our investment tax policies. By inadvertently favoring unproductive capital we have abandoned Adam Smith's Invisible Hand and are distorting investment incentives - to our great detriment.

We tend to think of economic stimulus as requiring governmental disbursements. I posit that if Governments would simply level the playing field and stop subsidizing unproductive capital with ill-conceived preferential tax and monetary policies the natural response would be an aggressive reallocation of private capital that would provide far greater economic stimulus than anything government can afford to offer directly. The key to job growth is comprehensive structural reform of investment tax policies aimed at restoring the principle of equal treatment which lies at the core of both democracy and capitalism.

I believe that by fundamentally rethinking the structure we use to tax capital and investments, and eliminating misplaced biases and subsidies, private capital will flow naturally toward more productive investments, stimulating job growth and sustainable economic expansion. As a secondary effect, it also provides the opportunity to reduce marginal tax rates on earned income and equalize tax rates between labor and capital; an opportunity which is both a) a desirable objective in and of itself, and b) a useful and compelling argument that could generate broad public support for reform. 

To learn more and engage in constructive discussion I invite you to read the short post Want Job Growth? – Reinvigorate Capitalism, a longer article published by Tax Notes Factual Distortions Derail Productive Debate on Tax Reform, and/or a brief summary proposal, Premise: A Citizen’s 2% Solution.  Reactions and rebuttals will be gratefully received, either here at No Labels or the comment forms related to the referenced links and public postings.