America prospers when risk is richly rewarded

Warren Buffett caused quite a stir last week. In a New York Times commentary, he told Washington to stop "coddling" the superrich. He said that last year he paid only 17.4 percent on his taxable income, while employees in his office paid from 33 percent to 41 percent.

Buffett is a spectacular judge of value in the market, but his suggestion that the tax system is no longer progressive is a head-scratcher. His impressions clash with numbers published by the Congressional Budget Office (as Michigan economics Prof. Mark Perry noted on his Carpe Diem blog).

Last year, the CBO looked at federal tax rates for 2007. It found that average rates -- for all federal taxes, including Social Security -- ranged from 4 percent for the lowest income group to 25.1 percent for the highest. Our tax system is solidly progressive.

Where Buffett was most off-base was his assertion that tax rates have little influence on decisions to undertake risk -- the impulse on which almost all economic growth depends.

"I have worked with investors for 60 years," Buffett wrote, "and I have yet to see anyone -- not even when capital gains rates were 39.9 percent in 1976-77 -- shy away from a sensible investment because of the tax rate on the potential gain."

The slippery word here is "sensible." Buffett tries to ignore the reality that a person's definition of "sensible" is liable to change if Uncle Sam reaches for more of the potential payoff.

Buffett is a Democrat, and Democrats often strain to believe that taxes don't change behavior.

People react to expected changes in their costs, even if the change is incremental. Is Buffett actually suggesting that if the current capital gains rate is more than doubled, the effect on the economy would be nil?

Class envy always rises when the economy lags. In a similar period in the early 1990s, Democrats badgered the first President Bush to abandon his "read my lips" pledge and accept a tax increase. He did so, and one result was the infamous luxury tax.

In those days, the villains du jour were yacht owners. So Congress laid new taxes on yachts, as well as airplanes and other luxury items, all in the name of "fairness."

One unexpected outcome was layoffs among middle-class workers in the boat-building industry. This was trickle-down economics, as practiced by Democrats. Instead of creating jobs, it wipes them out.

Many economists argue as if the only thing that matters for a buoyant economy is rising demand from the great mass of consumers. Nothing can happen until demand increases, we're told. Well, demand is crucial. But to look only at one side of the ledger is distorting.

What is the demand for an iPad in 1985? Zero: The product didn't exist. Demand cannot exist until the supply is brought to market, which is why the incentives to undertake risk are so important.

Yet we have a president who believes that those with the guts to risk scarce capital and bring new supply to market should get whacked if they're too successful, or if they earn income they don't "need," as he put it. President Obama thinks it's better to "share the wealth."

This puts the emphasis in the wrong place. The main goal should be to create more wealth. We're better off if entrepreneurial risk is richly rewarded.

Every private-sector job depended at one time or another on someone willing to take a risk and bring out a new product or service. Our economy cannot reach its potential if entrepreneurial "animal spirits" are treated in the tax code the same as collecting a paycheck.

Buffett is right in a general sense that our tax code is broken. More people in both parties understand it's time to do something about it.

This notion keeps coming back -- lower the rate and broaden the base and encourage more growth. Everyone understands the logic and the need. Everyone, apparently, except the man in the White House.

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