Mainstream media, academics and left-wing politicians complain that after a half-century of unprecedented income and wealth redistribution policies, U.S. income distribution, exclusive of welfare benefits, becomes more unequal.
Coming on the heels of the most massive government redistributive effort in our history, this is disappointing news, even though we gained an impressive overall increase in average living standards.
In 1964 President Lyndon Johnson launched his War on Poverty. But our political process provides that to reach one person in need, we must include some not requiring aid. After devoting tens of trillions of dollars from the public trough in income-redistribution efforts, coupled with regulations to benefit the less fortunate, we are reluctant to admit the war’s dismal failure.
Not to be daunted, however, erstwhile Democratic presidential candidate Sen. Bernie Sanders once called for additional welfare expenditures of $18 trillion. Today, instead of aiming directly at poverty, former candidate Hillary Clinton targeted aid for the middle class.
We desire to reduce poverty and to maintain a free society. But we have a misunderstanding of how to harness the free forces required for reducing poverty. First, it is vital to understand how a dynamic, free-market capitalism works. Secondly, it is important to grasp the role of a strong, public educational process dedicated to children, rather than teachers and administrators.
To help assure that a vigorous capitalism pervades our culture, we must provide a social incentive-reward-structure for innovative, risk-taking entrepreneurs to sacrifice personal consumption and hence provide the capital for new ventures; the easiest way to increase rewards is to reduce taxes and government regulations.
Secondly, those students likely to be involved in the cycle of poverty must seek, and be provided with, a quality education essential to satisfying the demand for skilled workers these venturesome enterprises require. In other words, those who benefit from poverty-erasing efforts must have the skills and the training to offer employers who are hungry to hire such employees. This requires more charter schools and school-voucher programs.
Experience has shown trying to reduce the statistical measure known as income inequality is the wrong means for reducing poverty. Once we grasp how free-market capitalism actually works, a real war on poverty can be launched – one with a much greater chance at success without sacrificing personal freedom.
The central mistake made by missionaries of socialist-statist governments, which includes former President Obama and Pope Francis, is their stubborn belief that by modifying or tinkering with the basic structure of free-market capitalism, a never-never land of idyllic, social and economic relationships will prevail. This tinkering – through legislation; executive orders; and court and administrative decisions – has led to disappointing results. Instead of reducing inequality, on average the war has increased it.
While the war drags on, many legislative acts tear into our personal freedoms. Take the right to contract, for example. In oversimplified form, it’s the rule that you cannot be forced to work with someone you find you cannot work with. It once was a pillar of our common law, and according to one of our Founders, James Madison, incorporated by implication into the Constitution. It’s a right that has been so eviscerated by judicial decisions that we hang on, with unbounded gratefulness, to the few shreds that remain.
Beyond the institutions of private property, personal responsibility and freedom to contract, lay the most important yet most misunderstood core of dynamic capitalism: the incentive-reward relationship. Many forms of life, including humans, want to be compensated for their efforts. In a capitalistic society, people enter freely into negotiated contracts to perform services, where the compensation is inextricably bound with the service performed – i.e., output is linked directly to the reward. Similarly, a businessman expects revenues to exceed his costs, including taxes, for him to survive. Profits must be sufficient.
A businessman’s dream, say an attractive new investment, must not only promise a reasonable profit, but before the investment is undertaken the riskiness of its expected after-tax profit must clear a reasonableness hurdle. In short, its profit-risk combination must be acceptable. His skill at assessing profits, and especially their risks, is one of the keys to his success.
Taxes, particularly those on income, play a crucial role in the corporate decision to invest capital. Political threats to increase them reduce after-tax expected profits, and thus increase the risk of the investment. This can lead to outright rejection of the proposal, and hence to less employment and growth in the economy.
Such effects have played a devastating role in our sluggish recovery from the last recession – as predicted, business expenditures on new investments, including durable goods orders, have been miserable over the past six years.
Business opportunities are dreamed up, designed, developed, marketed and implemented. Often this takes a visionary – an innovator who can struggle in a garage or basement. Only a few can duplicate the feat of a Steve Jobs, but society needs the millions who try, which is why we require a powerful, productive incentive-reward relationship driving our society.
We must provide a tax and regulatory environment that encourages venturesome risk-taking. And if we do – which implies much less government meddling in private activities, and fewer monkey wrenches thrown into the machinery of free markets – private corporate investment, the high-powered dollars, will take off; demand for labor will surge, unemployment will decline; and growth in the free-market sector will bloom.
This, with a student-oriented, vastly improved public educational system, will bring high-income-generating labor skills that will put a big dent in the number of people in poverty and, through the burgeoning demand for labor, raise incomes overall, including the middle class, the current focus of the media and many politicians.
This is a war many can support.
(The writer is a professor emeritus of financial economics at the University of Georgia. He lives in Aiken, S.C.)