Do taxes actually encourage risk-taking?
There are a few other not-quite-right arguments in my view. For instance, on page 69 Bergin claims that: “For entrepreneurs or people investing in new enterprises, theoretical work stretching back to the 1940s holds that taxes actually encourage risk-taking, because, as losses can be set against a tax bill, risk is effectively being shared with the government. Lower tax rates, by contrast, place more of the downside on the entrepreneur or investor.” (Italics mine.) Hang on: I thought the premise of this book is that people aren’t simple rational economic optimizers, and cannot be boiled down into a theory, so what is Bergin doing referring to “theoretical work” at all? Isn't he making the same mistake, in the other direction, of a Laffer?
Consider this: why not take this argument further and impose even higher taxes on everyone so that this will encourage millions of people to quit regular jobs and become the next Elon Musk by using a business as a tax shelter? The problem with this argument, in my view, is that it ignores the importance of time. A would-be entrepreneur’s willingness to work for years, often at a loss that could be set off against a tax bill, is not infinite unless they are running that firm as a pure lifestyle choice rather than to grow it. A business founder will want to plow back profits into the business to grow - that's obviously harder to do if the state takes a big slice of those earnings. A growth-minded businesman or woman will not be much consoled by the state giving them a tax break during a bad year. In the early stages of a firm, it's particularly important that earnings can be reinvested, and quickly. High taxes curb that. That seems self-evident.
(As an aside, it is true that there are people who can be “lifestyle entrepreneurs” taking this course for the sheer fun of it, profits be damned. But it seems unlikely that high tax rates on profits would not make people think harder about bothering with the risks in the first place, not to mention putting in the endless hours of trying to build a firm, working over weekends, managing hassles of payroll, suppliers, bureaucrats, etc. (4))
In one chapter Bergin challenges whether tax cuts shift attitudes toward work and leisure. He is right that when people get better off, they don't necessarily work even harder - they want a higher quality of life, including more time for leisure. But if their incomes are taxed more heavily, then while they may still want a holiday, they will have less money to spend on those trips to the South of France or Disneyland.
Top-down or bottom-up best practice?
Bergin argues against the idea of thinking of regulation as purely a cost that should be cut. He notes, quite correctly, that humans impose costs on unwitting others (water and air pollution, risks to life from badly-made cars, etc) and that the benefits of avoiding these harms must be weighed. He also argues that regulation can spur innovation that wouldn’t otherwise have happened. The latter point may be true, although it is not conclusive. Much activity in wealth management is about using technology, for example, to remove the pain of compliance. How much of that activity could be spent on building wealth instead?
In wealth industry, regulations have mushroomed – the SEC Regulation Best Interest regime (US), Dodd-Frank (US), MiFID II (European Union), Retail Distribution Review (UK), Senior Managers’ Regime (UK), and others around the world. Part of the justification is that Joe Public is in an unequal contest for information as a consumer, so the State must level the field. It is unclear whether the internet and other technologies have changed the game one way or the other. Whether the end-investor and consumer of banking and asset management services ends up better off after all these rules, is debatable. (The compliance industry has certainly boomed, mind.) I am unaware of any sustained cost/benefit analyses to say all this action has been a net plus for where it counts. Your correspondent has heard wealth managers – particularly the largest ones – claim that regulation simply spreads “best practice” to everybody. But without a degree of easement for smaller firms, red tape inevitably weighs proportionately more on the little guy. In fact regulation creates what economists call barriers to entry and cuts competition. And competition is surely the best protection consumers have.
We should distinguish State from non-State regulation. A company or voluntary association will have its rules; violators can be expelled. If you join an entity, you sign up for its regulations. Also, a big driver of standards is insurance – and Bergin doesn’t really mention this point. An insurer might, for example, only cover risks where a person has taken certain steps (fitting locks, replacing worn tyres on a car, etc) and that can drive standards up. Beware the fine print! It may well be that State rules can codify what the market has already set as good conduct. But rules can also ossify, particularly if vested interests are pushing them. And for all that Bergin concedes that regulations can sometimes be a burden, he doesn’t really spell out how to set the upper limits. A good idea in my view is sunset clauses on State rules – particularly for those enacted decades ago for activities that are defunct. The “regulation is good” argument requires governments to have the wisdom to see all sides of a question and not to fall into the trap of “safety-first”. The current lockdowns suggest that governments aren’t immune to getting this badly wrong.
Comparisons are hard
As Bergin argues, one problem in measuring economic ideas and treating them as if they were scientific theories is that unlike, say, Newton's Law of Gravitation, economics is ultimately about human relationships, and these cannot be tested and retested in a controlled lab experiment. The nearest one can get is comparing similar countries/cultures undergoing very different policies, holding some factors constant, and then working out what worked better. That's very hard to do. Some writers have attempted to do this, such as Germany-based academic and real estate investor Dr Rainer Zitelmann (5). One can compare former East and West Germany, North and South Korea, Chile and Venezuela, Hong Kong and mainland China (prior to 1997), 1970s Britain against 1990s Britain, and so on. These comparisons need to be done carefully, with lots of health warnings, but it seems broadly clear that free, open economies typically work better than closed, centrally planned, heavily taxed ones. Beyond that, though, working out what works best is difficult.
Bergin concludes by wondering if the whole economics profession needs taking down several pegs. Let pragmatism be the watchword, laced with humility: "When economists are involved in policymaking, their most valuable contribution often comes when they leave economic theory at the door."
This is a fine book that challenges a number of assumptions, although I found myself disputing some of Bergin's own assertions. I think one lesson is that if one wants free markets, low taxes and so on, these are also ethical arguments, and not just ones that can be decided by plotting data on a chart. Take taxation: for me, the debate is ultimately about whether we live in a socity where the individual gets to control the bulk of what they have and wish to do, or whether the State does.
Bergin has fired a praiseworthy warning shot at those who put too much confidence in models. The quality of public policy should be all the better for it, and once this lockdown nightmare is over, I look forward to chatting to Tom about it over a beer or two.
3, The claim that Rockefeller and many other contemporaries were “robbers” at the expense of the public has been challenged. https://www.amazon.co.uk/Myth-Robber-Barons-Business-America-ebook/dp/B004X2IJ72
4, Bergin, as part of this argument, cites data in footnotes claiming that entrepreneurs haven’t referred to tax rates as affecting their decision to start a business in the first place, innovate, etc. That claim appears to be contradicted, for example, by economists Nir Jaimovich and Sergio Rebelo. https://www.journals.uchicago.edu/doi/pdfplus/10.1086/689607
See also here for an overview of tax rates and the impact on innovation: https://www.thecgo.org/wp-content/uploads/2020/04/rif-2019.006.pdf