Dear Mr. Blodget:

I’ve read your article “Finally, A Rich American Destroys The Fiction That Rich People Create The Jobs.”

In a capitalist economy, the wealth of the rich is in the form of capital, i.e., wealth employed in the production of goods and services for sale. This wealth is the foundation both of the supply of products that people buy and of the demand for the labor that people sell. The greater the wealth of the capitalists, the higher are real wages, both because of a more abundant supply of products produced and a greater demand for the labor of wage earners. Diverting funds used to purchase capital goods and pay wages into spending for consumers goods, which is the effect of virtually all taxation that falls on the rich, and also of government borrowing, reduces both the demand for and production of capital goods and the demand for labor. In other words, it serves to hold down production, keep up prices, and hold down wages.

Consumers are not responsible for the industrial development of any country. Consumers have myriad needs and desires, which go unmet except to the extent that businessmen and capitalists find ways of supplying them through the development of new and improved products and more efficient, lower-cost methods of production. When such improvements are introduced, consumers can be expected to buy them, frequently on a very large scale. The firms and industries producing the better and/or less expensive products then expand and again and again become major components of the economic system. This, however, does not represent an increase in the overall number of jobs. For example, while the development of electric light led to major increases in employment in producing light bulbs and electric lamps and wiring, it also led to the near total wiping out of the production of candles, lanterns, and gas light, with a corresponding loss of employment in those areas. Similarly, when the automobile replaced the horse and buggy, the vast number of jobs created in the automobile industry was accompanied by a massive loss of jobs on the part of buggy builders, blacksmiths, horse breeders, harness makers, and oat growers.

More consumer spending financed by inflation, i.e., the creation of new and additional money, has the potential for increasing employment in some circumstances, but only insofar as the sellers of the consumers’ goods that are faced with the additional spending save and invest their additional sales proceeds. If they too consumed, or if the government taxed away their additional sales proceeds, there would be no increase in the spending for labor or capital goods and no increase in employment. The ability of inflation to promote employment also depends on labor unions being weak or non-existent. To the extent that unions exist and are powerful, they will take advantage of the inflation to raise money wage rates even in the midst of mass unemployment, thereby nullifying the ability of more spending for labor to increase employment.

While on the subject of inflation, it should be realized that it is inflation, particularly in the form of credit expansion, that is responsible for the perceived increase in inequality of income. New and additional loanable funds, manufactured by the banking system, with the sanction and protection of the Central Bank (in the US., the Federal Reserve), enter the capital markets and proceed to raise the prices of stocks and real estate, thereby creating capital gains on a massive scale. New and additional money and spending also serve to increase nominal profits, inasmuch as they raise sales revenues immediately but increase income-statement costs only with a more or less considerable time lag. And if the process continues, increases in income-statement costs are accompanied by still further increases in sales revenues. For example, consider a very simple case. A businessman spends $100 on January 1st to produce a product that he will sell on December 31st for $110. This year, however, there is a 10 percent increase in the quantity of money and volume of spending, and so our businessman will be able to sell his product for $121 instead of $110. Profits now equal $21 instead of just $10; in terms of a percentage of sales revenues and costs they are approximately doubled, and are correspondingly increased relative to wages.

However, when the effects of taxation are taken into account, it turns out that these seemingly high profits are accompanied by a sharp decline in real profits. Assuming the same tax rate on profits, say, 50 percent, the businessman who earned $10 without inflation had $5 left that he could either consume or add to his business, because $100 of sales proceeds were sufficient to replace the goods he sold. Now, however, with inflation, he has $10.50 of profit, almost all of which is required to replace the goods he sells, which goods now cost him $110 instead of only $100. This leaves him with only 50 cents that he can use to consume or add to his business.

Hopefully, the above makes it clear that in an environment of inflation, taxes on profits can virtually never be low. In the above example, the tax rate would need to be approximately halved just to remain the same, given the approximate inflationary doubling of the profit income subject to taxation. It’s also extremely difficult to understand how, even apart from inflation, anyone could believe that today’s tax rates are low by historical standards. For most of American history, i.e., 1776 to 1913 (with the exception of the Civil War), there was no income or inheritance tax, period. Indeed, prior to the Civil War, the only sources of federal revenue were tariffs and the proceeds of land sales. After the Civil War excise taxes on tobacco and alcohol were added. That was it, until 1913. And when the income tax was first introduced, the maximum rate was 6 percent. Thereafter, as nominal rates rose, so too did the number of exemptions and “loopholes.” “Loopholes” can easily have the effect of making extremely high nominal tax rates end up being radically lower in actual impact. For example, fewer countries have higher corporate tax rates than Sweden—52 percent the last time I checked. Yet Sweden also allows firms automatically to deduct up to 50 percent of their profits as tax-free reserve for future investment, which reduces the effective rate of corporate income tax in Sweden to 26 percent, which is considerably less than the current 35 percent rate in the US. Actual, effective tax rates on profits in the US are by no means low.

I will close now. If you have found any of my comments helpful in any way, and would like further elaboration on the nature of capitalism and economic freedom then I would like to recommend that you download (without charge) the pdf replica of my book Capitalism: A Treatise on Economics. The book is fully searchable and hyperlinked. It can be downloaded from my website simply by clicking on its title in the previous sentence.

Cordially,

George Reisman

George Reisman., Ph.D., is Pepperdine University Professor Emeritus of Economics, a Senior Fellow at the Goldwater Institute, and the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His website is www.capitalism.net and his blog is georgereismansblog.blogspot.com.

Little did I know that attempting to hire the employees needed, which I had thought to be the easiest part, would turn out to be a nightmare if not impossible.

…Before 2009 if our company advertised for an open position, on average we would get 20 to 30 applications, interview six to eight of the applicants, and hire one or two, based on the quality and potential of the candidates. This process has been deteriorating dramatically since 2009 and now at the end of 2011 it has completely hit bottom. Of all the applications that we have received this year, when asked why they were seeking a job with us, one out of three answered: my unemployment is running out and I have to go back to work.

Earlier this year after I hired two new full-time employees, went through our company’s orientation process, fitted them with our work clothing and booked them to start within a week, they both quit. One called ahead of the start date to apologize but wanted to inform us he would not be coming in because the government had just extended unemployment benefits again. The second one just did not show on his first day and when I called him he said he couldn’t come in now because unemployment had been extended and he was making almost as much as we were planning to start him out with.

…Our government is considering extending unemployment benefits again soon. The final absurdity might be that extending unemployment is the only thing that both the Democratic and Republican majorities both agree on.

In a state with the nation’s highest jobless rate, landscaping companies are finding some job applicants are rejecting work offers so they can continue collecting unemployment benefits. It is unclear whether this trend is affecting other seasonal industries. But the fact that some seasonal landscaping workers choose to stay home and collect a check from the state, rather than work outside for a full week and spend money for gas, taxes and other expenses, raises questions about whether extended unemployment benefits give the jobless an incentive to avoid work.

…Chris Pompeo, vice president of operations for Landscape America in Warren, said he has had about a dozen offers declined. One applicant, who had eight weeks to go until his state unemployment benefits ran out, asked for a deferred start date.

…Some job applicants are asking to be paid in cash so they can collect unemployment illegally, said Gayle Younglove, vice president at Outdoor Experts Inc. in Romulus. “Unfortunately, we feel the economy is promoting more and more people and companies to play the system and get paid or collect cash money so they don’t have to pay taxes,” Younglove said.

…A full-time landscaping employee would make $225 more a week working than from an unemployment check of $255. But after federal and state taxes are deducted, a full-time landscaper would earn $350 a week, or $95 more than a jobless check.

…The federal jobless benefits extension “is the most generous safety net we’ve ever offered nationally,” said David Littmann, senior economist of the Mackinac Center for Public Policy, a free-market-oriented research group in Midland. The extra protection reduces the incentive to find work, he said. It’s impossible to know exactly how many workers are illegally declining employment, but 15 percent of Michigan’s economy is underground, where people trade services, barter or exchange cash without reporting it to the government, Littmann said. One former landscaper, who has been on unemployment for a year, said he will search for work when the benefits expire, but he estimates he earns about $50 to $60 less a week than he would if he were working. “It’s crazy,” he said. “They keep doing all of these extensions.”

Our government is considering extending unemployment benefits again soon. The final absurdity might be that extending unemployment is the only thing that both the Democratic and Republican majorities both agree on.