Investment is key, and it's silly to argue that tax hikes wouldn't reduce it.
The U.S. is holding a debate critical to its future -- whether to tax, redistribute and consume income that would otherwise be invested.
Warren Buffett has weighed in, supporting higher taxes on wealthy taxpayers ("Tax the rich -- we can take it," Nov. 27). Unfortunately, the evidence he uses to make his case is superficial and flawed.
Buffett, chairman of Berkshire Hathaway Inc., is an iconic leader. The U.S. needs insightful analysis from him. But his claim that taxing upper-income taxpayers doesn't reduce investment runs counter to economic logic.
Federal Reserve surveys show the top 5 percent of households save and invest 40 percent of their income. Median- income households save very little. The Buffett household probably invests 99 percent of its income.
If we tax, redistribute and consume income that otherwise would have been invested, the investable pool of savings declines. With a smaller pool of capital, less-attractive investment opportunities remain unfunded.
Buffett tautologically claims investors will continue to invest in opportunities with expected returns above the cutoff point. Of course. Investment is lost at the margin.
Buffett points to the 1950s and '60s, when marginal tax rates were higher, and claims that because the economy grew faster then, it can grow faster today with higher marginal tax rates.
What he fails to mention is that in the 1950s the advent of interstate highways and television knitted together the U.S economy. Large capital-intensive companies such as General Motors and Procter & Gamble raced to exploit previously unrealized economies of scale. As a result, entrepreneurs and individual tax rates mattered much less to growth then than they do today. Growth accelerated independent of the tax rate.
What's more, the U.S. had sent its workforce to college long before the rest of the world. That also opened new investment opportunities. Two decades of under-investment in the private sector -- during the Great Depression and World War II -- added further potential to the rebound. The cost of food dropped from more than 20 percent of gross domestic product to less than 10 percent, freeing resources to fuel the manufacturing boom.
A much smaller portion of GDP was taxed back then. Federal, state and local government spending was 28 percent of GDP then vs. close to 40 percent today.
The 1950s and '60s don't provide evidence that increased government consumption -- and the taxes needed to fund it -- has no effect on growth. They show that investment matters.
Buffett also claims the commercialization of the Internet in the early 1990s created a huge tailwind that benefited the rich -- as if investors did little to earn this success. Similarly, proponents of higher taxes and spending often claim that faster growth in the 1990s demonstrated that higher taxes on investors don't hurt growth. But commercialization of the Web would have accelerated growth independent of the tax rate.
Comparing U.S. growth with Europe's since the early 1990s removes the Internet effect. Both economies had access to the same technology and similarly educated workforces to capitalize on the Web's opportunities. Since then, the U.S. economy has grown 63 percent (through the end of 2010); France and Germany together grew less than half as fast. U.S. productivity growth increased from 1.2 percent a year from 1972-1995 to 2 percent from 1995-2004. Meanwhile, France and Germany's declined to less than 1.5 percent a year.
Without U.S. innovation, Europe's growth would have been lower.
It is true that higher labor redeployment costs slowed Europe's transition away from manufacturing. Yet that doesn't explain why young, talented European workers clung to jobs in declining industries while their American counterparts eagerly walked away from promising careers to join risky startups.
In the United States, higher payouts drove increased risk-taking. The most promising U.S. students flocked to business schools and worked much longer hours than their underutilized counterparts in Europe, whose work effort declined. The success of these Americans created Google Inc., Facebook Inc. and countless other companies that gave the U.S. workforce more valuable on-the-job training. That training increased the chances for entrepreneurial success.
Entrepreneurial success put equity into the hands of investors willing to underwrite risks that produce innovation. No surprise, the U.S. has more equity per dollar of GDP than Europe and Japan, and more innovation.
Although commercializing the Internet may have created a tailwind, a lot of that tailwind was earned.
Federal spending was also much lower in the 1990s than it is today: 18 percent of GDP vs. 24 percent. State and local government spending was lower, too. As a result, President Bill Clinton's across-the-board tax increase paid down debt, which strengthened the U.S. economy. Today, higher taxes are needed to fund an increase in unproductive consumption, which slows growth.
Far from showing that tax rates and government spending have no effect of growth, the 1990s provide evidence that payoffs for risk-taking and the accumulation of equity matter.
The debate over whether to tax, redistribute and consume income that would otherwise be invested is critical to the future of America. The nation can't afford to base its decision on superficial arguments. The country deserves better from a leader such as Warren Buffett.
Edward Conard was a partner at Bain Capital LLC from 1993 to 2007. He is author of "Unintended Consequences: Why Everything You've Been Told About the Economy Is Wrong." The opinions expressed are his own.
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