Don’t Kill the Golden Goose

A central concept in Modern Macroeconomic theory is that capital stock will be accumulated through the process of saving for the future. A new country, starting with a low capital level, will accumulate capital for some number of years or decades until reaching an equilibrium level of capital stock.

Progressive taxes on capital income imply that the equilibrium capital stock level will fall. In fact, capital income taxes can be high enough such that capital accumulation is significantly diminished.

This capital stock level is a form of wealth. This is a useful kind of wealth, often it can be used to create more income or more wealth. In some cases it can be consumed. Think of an Ipad, a modern example of capital. An Ipad can be used for work or play, i.e. it can be used to create either income or wealth, or it can be used for leisure, i.e., consumption. Macroeconomic wealth is like a savings account, if it is too small then prospects in an uncertain world are not as good. It can be too large too, but this is a rare problem in nations these days.

It is not automatic that countries accumulate capital. Many countries, there are numerous examples from all over the world, have not done this or cannot do it despite generous natural resource endowments. This is the topic of research in Development Economics and in Economic Growth theory. We believe that institutions are important to the accumulation of capital, especially the rule of law, with an open and fair legal system and contract enforcement. But there appears to be more to it, hence there is ongoing research.

Given that capital and wealth accumulation are not foregone conclusions for many countries, and given that the United States has been a highly impressive capital accumulation machine, I dub the United States economy the Golden Goose. Obviously, I am using the United States as an example, because there have been other economies that have been capital accumulators. The original Golden Goose idea was for something truly rare. However, I stick to calling the United States the Golden Goose, since there are a lot of important factors that must be in place to enable capital accumulation, and there are a depressingly large number of countries that have not found a growth combination.

A second central Macro-theoretical concept is that a larger government has implications. A larger government means greater taxes. Government debt is not a long term option, because at some point, that debt must be paid by taxes. However, this is frequently a generation against generation issue, as current public debt is usually not paid through current taxation, but rather, by future taxation.

There are two new ideas that have gathered some momentum in United States politics recently. One is that the size of the government should be larger, and the second is that taxation should be more progressive.

There are a couple of ways that taxation can be made more progressive. The plainest way is to raise the top marginal income tax rate on a type of income. However, taxes can be shifted from labor income taxes to capital income taxes. This makes taxation more progressive because capital income tends to accrue to wealthier households. This second way of making taxation more progressive has recently gained political momentum.

While taxation cannot be perfectly flat, the important point from theory and experience is that taxes can be too progressive.

I would like policy makers to understand the macroeconomic impacts of implementing these new ideas in the United States. A larger government would imply greater levels of future taxation. Greater levels of future taxation, combined with a more progressive tax system, would imply a noticeably lower level of equilibrium capital in the United States. In other words, it is possible to kill the Golden Goose.

Capital and wealth accumulation should be understood by those in favor of government as essential, something to foster. Why? Private economic activity is needed to support any benevolent government, regardless of size. It provides the funds the government needs to operate.

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