Capital and Capitalists
Jude Wanniski
February 6-11, 2004


From:Jude Wanniski
To: James K. Galbraith <galbraith@* * * * *.edu>
Re: Capital and Capitalists
9:18 am 2/11/04

That what I hoped you would say, Jamie. You know my real aim is to find common ground with you on fiscal policy so you can help move the Democratic Party in a direction that will make its economic agenda more attractive to the national electorate.  I'm hoping you will question my framework further after you have pondered.  JW

At 12:52 AM 2/11/2004 -0600, you wrote:

Just got your response, will read and ponder..   J

At 1:56 pm 2/9/2004 -0600, you wrote:


I'm trying to understand your analytical framework from the sketch you present.... to see why it is we differ so much. My guess is that you look at the economy from the top down and I look at it from the bottom up. You are not one to "romanticize the hardworking CEO." But neither am I. These are kinds of arguments I had with Herb Stein, a conservative Keynesian, who argued against a lower capgains tax and  lower marginal income-tax rates for that matter, on the grounds that he didn't know any ceos who worked less because they had to pay a higher marginal tax rate. But that's never been a part of the supply-side model, at least not of mine.

I'm of the Frank Knight school, believing that all growth is the result of risk-taking. The more risk-taking by entrepreneurs, the more failure one has to expect. Most corporations or partnerships don't last very long. Polyconomics at 26 years is a rare bird. Most jobs are created by companies that are trying to succeed and don't realize that they will fail. Most people are working for companies that will either fail or be absorbed by other companies that did succeed. In one sense, I am all in favor of failure, because it tells me there is a dynamism in the economy that is encouraging risk-taking. My son Matthew is a script reader in Hollywood. He has judged several hundred movie scripts submitted by people who are taking wildcat shots at the brass ring. He tells me only one script he has reviewed and given good marks to has made it as far as being bought with the idea of getting it financed and made.

In the world of entrepreneurial capitalism that I think about, capital investment is not, as you say, "governed mainly by the expected rate of gross profits, which is largely a function of the role of demand." That may be how the top of the economy works, with ceos of mature companies and their management committees trying to guess aggregate demand in their industry in the coming investment cycle. Only then do they commit capital resources scraped together in one way or another. It occurred to me very early in this game that the Business Roundtable opposed the GOP proposed capgains tax cut back in 1978 because they believed they would get minimal benefit from it as they had already run the gauntlet. The lower rate would invite capital formation from the unutilized time, talent and energy of the people in the economy and it would go to start-up companies or fledgling companies looking to expand after making the first cut of survival. From 1978 on, I've never been one to romanticize the hardworking CEO, and more often look at them as political barriers to the kind of risk-taking that brings about rapid economic growth. Here I am more clearly aligned with President Bush than with Paul O'Neill, the Alcoa ceo whose perspective is top down, like yours. The Texas oilfields taught both Bushes something about risk-taking, failure and the taxation of capital.

You say you did not "despise" the "wealth bubble" created by the high market. And I grant you that I would never accuse you or your father of despising men of wealth, just "because." You're not a communist. But because you are not a supply-sider and Karl Marx was a supply-sider, I have a greater affinity for Marx's view of capital formation than you do. I'm more of a Marxist. It was Marx who understood how men of wealth were naturally inclined to protect that wealth by using their political influence to prevent competition from coming up at them from the masses. In my long paper on Marx that you can access at my home page, I note that both he and Von Mises pointed out that established wealth favors high taxation of those who are seeking to acquire wealth, and that the only way to confound them was active, universal suffrage, which would give the masses the votes to lower tax rates where they were barriers to capital.

My "supply model" goes beyond Bob Mundell's, as I said at the outset, because of the influence of the Frank Knight thesis about growth (which I learned about from Reuven Brenner of McGill). And my definition of capital may be unique, in that I argue it is the available surplus of time, energy and talent of people in the exchange economy. In a perfect system, all the available surplus would be utilized by the system. In the Keynesian world, or monetarist for that matter, the economy is limited by the labor force's muscle and sinew and willingness to work to achieve a target income. You write of capacity utilization in that framework.

In my macro model, the imperfect economic system is one that limits the market's willingness to draw from surplus capital in order to finance new risky ideas, whether they are start-up or flings being proposed by Fortune 500 companies. Here is where taxation becomes critical. In order to draw out more of that surplus, the system being managed by the government must either increase the rewards to successful risk-taking or reduce the barriers to risk-taking of any kind. The mechanism of the market works to prevent unutilized capital from being allocated to projects that do not "make the cut," in the sense that market participants believe there will be a negative return. The market works efficiently at this level, but it is also what gets the market "a bad name" from socialists and communists and demand-side economists.

If it is true, as I believe it is, that all growth is the result of risk-taking, then an economic system so burdened with policies that smother risk-taking must give way to another system or the population will perish. Communism becomes attractive when capitalism fails, and capitalism fails when capitalists use their political powers to prevent capitalism from bubbling up from the masses. Under communism, all the resources of the people are under the management and control of the leaders, who take the risks of capital allocation on behalf of the people. It turns out after experimentation for most of the 20th century that the market is better than an expert cadre of bureaucrats grinding out numbers in the Kremlin. Especially when the market gets help from Ronald Reagan and the supply-siders, whose ideas have been to increase the rewards to capital and labor (the suppliers of goods) with appropriate macro policies.

It does appear to me that what I am arguing here is outside your ken and may be forever, if you can't make an intellectual adjustment. But you will surely see that if the policies you espouse would be followed by the US government, they would in my framework cause a collapse of the economy by dramatically decreasing the rewards to successful risk-taking and increasing the barriers to risk-taking at any level. This is not to say that you are wrong and I am right, Jamie, only to say that I now hope you have a better appreciation of my model as I think I have a greater appreciation of yours. I'd hope that common ground could still be found.


At 06:22 PM 2/6/2004 -0600, you wrote:


Like you, I favor a high growth rate, a profits boom, and a high rate of capital investment.  I liked the boom of the 1990s and did not despise the wealth bubble created by the high market.  The problem was that it wasn't sustainable -- something I said at the time. 

Where we disagree is over the role of taxation "of capital" in this process.  My view is that capital investment is governed mainly by the expected rate of gross profits, which is largely a function of the role of demand.  Increasing the overall level of activity should mean higher gross profits, irrespective of higher rates of taxation on income from capital.  Likewise,  lower rates of tax will not generate higher rates of investment if they are accompanied by lower rates of activity. 

The problem with current policy is that the pressure on states and localities, the household debt level, the low rate of capacity utilization, all point to low rates of activity over the long term.  No low rate of capital taxation can offset this.

On the other hand,  I'm open to cutting the corporate profits tax in exchange for high rates of capital gains taxation -- the prescription of Bill Vickrey over the years.  That was too complicated for the review.

Supply-side effects? I've never been one to romanticize the hardworking CEO.   I think the employment-inducing effects of cutting the payroll tax would be real.  So I would play that game lower down the income scale, if at all.

We should probably stick to collaborating on war and exchange rates, I suspect the gulf on these issues is pretty wide.