Do the rich really take risks.

Great Debates
1

Here’s an argument for the Republicans’ utter refusal to consider even a minor tax hike for the rich:

(The fact that this argument happens to come from a site devoted to denying global warming is purely a coincidence, I assure you. I’m sure we’ve all seen versions of this argument from many places, and the point is not to bash this one particular guy.)

First we must define “risk”. I shall define it as “putting oneself into a situation where chance and unknown factors affect the outcome, with a possibility of suffering considerable losses.” By this definition, as I see it, the rich basically never take risks, while the poor take risks constantly and the middle class frequently.

Imagine Joe Schmoe has a net worth of ten thousand dollars. Thus he is poor. Now suppose he finds a new job, but he must spend four thousand dollars on a used car to get him to work each day. This is a high risk investment. The car may break down, the job may not work out, are in various other ways he may lose the money. If that happens, he’ll have lost much of his net worth and a great deal of purchasing power.

Now imagine that Jane Bane has a net worth of one hundred thousand dollars. She is middle class. She decides to spend forty thousand dollars going to college and earning a degree, which she hopes will let her get a better job. This is risky, since the job isn’t guaranteed. However, I would argued that it’s less risky than what Joe Schmoe did, because even if the college degree doesn’t pay off, Jane’s loss won’t cut into her ability to buy necessities as much as Joe’s would.

Now imagine that John Dewey has recently retired from his profitable career at the firm of Dewey, Cheatum, and Howe. He has a net worth of one hundred million dollars, which makes him rich. He invests forty million dollars in a start-up company. The worst that can happen is the company going belly-up and his investment disappearing. In that case, he’ll have a net worth of sixty million dollars. With that sixty million dollars, he can still buy anything that a reasonable person could want to buy and have plenty left over. Hence he’s not really taking any risks with that investment.

2

I agree.

3

I disagree.

-XT

4

Many people who are now rich took extremely large risks in order to get where they are. Many failed multiple times before succeeding. So, sure, people take huge risks in order to become rich. History is also full of once-rich people who still take huge risks, fail, and end their lives destitute. There is no doubt that entrepreneurial risk-taking is essential in a growing economy.

Whether marginally higher taxation would reduce the incentive to take these risks is another matter entirely, of course.

5

I think you’re confusing two meanings of the word “risk”. I don’t know if there are proper terms for them, but let’s call one “risk of destitution”, and the other “risk of enterprise”.

It’s true that the wealthy do not generally run a risk of destitution. No matter what they do (unless they are excessively foolish), they will not be living on the street.

But they can still take on more or less risk of enterprise with a given investment. Mr. Dewey, in your third example, could invest that money in T-bills, or he could pump it into speculative R&D. The two options obviously have very different sorts of and amounts of risk, and the fact that the worst case scenario doesn’t end up with Dewey in the poor house doesn’t mean that we can’t talk about the risks of different investments in a meaningful way.

And that’s exactly what the post you quoted does. It’s saying that if taxes are sufficiently high on high-risk high-reward investments, then we’ll stop getting those investments, because the downside (risk of enterprise) is not sufficiently compensated by the upside due to high taxation.

That’s obviously and trivially true for a progressive taxation system with a sufficiently high rate at the upper brackets, and it’s probably somewhat true at the margin for any progressive tax system, although which rates are “sufficiently” high and how much the effect is at the margin are in dispute.

6

As an aside to the topic, the quote in the OP also notes the common conservative claim that raising taxes won’t “work” because the rich don’t have enough money to fix the deficit. So these conservatives propose solving the national debt by cutting government spending instead.

The national debt is currently $14,578,000,000,000.

The wealthiest ten percent of America’s population has an annual gross income of $3,856,000,000,000. Now obviously you cannot get fourteen trillion dollars out of a total of three trillion dollars. Only an idiot would claim that.

Here’s another figure. The entire annual federal budget is $3,456,000,000,000. The conservatives claim that we can eliminate the national debt of fourteen trillion dollars from the three trillion dollar budget.

Okay. Obviously nobody is going to pay off the entire national debt in a single year. We’re going to have to work on it for several years. But keep in mind that the people who are telling you we can’t find the money in a 3,856 billion sum are also claiming that we can find it in a 3,456 billion dollar sum.

I say we should compromise. For every billion dollars that is cut from the federal budget for debt reduction, we should match it with an additional billion dollars from the top ten percent of incomes.

7

There was a recent GD thread about the nature and role of risk in the economy.

Risk doesn’t have to be serious risk–it’s just, basically, in this context, spending money that you only have a chance of making back with profit.

And risk in this sense is important for economic development.

But it seems to me that this should mean we ought to try to make sure, if possible, that everyone has the means to take this kind of risk. Poor folks need only risk a tiny bit in order to be risking their entire livelihood. So I’d imagine they are less likely to take this kind of risk, and when they do, it doesn’t accomplish much. Meanwhile rich folks can risk tons while never risking their own comfort.

If we could enable everyone to be able to take real risks without those risks involving serious financial danger to themselves, this would seem to be a good thing–it would increase both the number of people risking, and the amount that they are risking, both of which I gather are supposed to be good for economic development.

8

iamthewalrus has already tackled this but I’ll add on one thing. As I see it, there’s no “risk of destitution” today even for those rich people who put everything on the line. Consider Donald Trump. Sometime in the 80’s he was the richest man on the planet. Then due to bad choices and bad luck (but mostly bad choices) he managed to ruin himself. In fact, he managed to do it repeatedly. And yet he’s still rich! He’s so rich that he can toy around with a presidential campaign just to boost his own ego. He’s hardly the only one who managed to ruin a company and yet remain wealthy after doing so.

9

You can only reach that conclusion with a very specific definition of “considerable losses” - defining it to mean interfering with your quality of life. Not how most would interpret that term.

Yes for the very poor buying a bicycle is considerable risk to having money for food the next day. Investing in a speculative business is out of the question. On the other hand, I, not rich but well off enough that I feel I have college for the kids and my retirement on track, can afford to use some smaller portion of my resources to take multiple bigger gamble investments of a more speculative nature knowing that my quality of life, my standard of living, is never put at risk.

10

The ones that invested with Madoff surely did take risks.

11

Did you miss the part where he put 40,000,000 dollars at risk? The fact that he will still be able to maintain an excellent standard of living isn’t relevant.

12

Just for the record, while it may indeed be true that “the rich” are indeed the ones who fund many of the risky new ideas, many that fail and some that lead to advances, and it is true that these speculators need to see “at least some incentive” to benefit from taking those risks or else they will not take them, it is not true that such implies that returning to older marginal tax rates that were less low for the rich than they are now would eliminate, or even marginally reduce, such incentives.

You may want to review this old thread in which I had provided quite a few cites that showed that we would, with repeal of the Bush tax cuts, neither have high marginal tax rates compared to our own county’s historical norms (including during some high innovation times) nor compared to international standards. In short, we are a long way off from marginal tax rates so high as to disincentivize innovation and risk taking. (And risk taking here is meaningfully **iamthewalrus(:3= **'s “risk of enterprise”, not “risk of destitution”.)

13

The economy is a bit scary. The rich are sitting on 3.5 trillion dollars . They are not investing it no matter how much investment banks beg. I am sure you can find an occasional rich person who is willing to take a risk, but the fact is that great wealth is sitting idle. The rich as a whole, are not taking risks.

14

Yes. As the last few years have shown. Enormous ones. With other people’s money. And they are then bailed out with other people’s money, a large chunk of which they reward to themselves in bonuses for their failures.

15

How could the bankers who destroyed the world economy, think they deserved big salaries and bonuses after the banking fiasco? We should have broomed the top management across the board. They were failures on an enormous scale.

16

You’re cherry picking, here. Donald Trump clearly has tremendous talent in both real estate development and self-promotion. The fact that he managed to narrowly escape personal and professional bankruptcy by restructuring deals doesn’t mean that no rich person could possibly end up that way. There are in fact plenty of once-wealthy titans of industry who die broke.

Any famous person you pick is going to be a pretty bad case study, because even if they go broke, they still have notoriety, which can be worth quite a lot.

To really see whether it’s possible to be wealthy and risk becoming destitute, you’lll have to look at people who are rich, but essentially have no valuable skills or connections. Lottery winners, for example. Don’t a whole lot of really big multi-million lottery winners end up bankrupt within a decade?

17

Why are you using gross income instead of net, after-tax income? Clearly you can’t raise taxes on money you’ve already taxed, and even rich people have legitimate deductions.

In addition, I hope you’re going to dynamically score your tax increases. Increasing taxes on the rich by 10% isn’t going to get you an additional 10% in revenue. Some of that will be lost through dead-weight losses, increased tax avoidance activity, lower productivity growth, etc.

So how much are you actually expecting to extract from these rich people? The most common answer I hear is that the left just wants to go back to ‘Clinton era tax rates’. So, what - raise the marginal rate by an additional 5%? Which might get you additional income of 3-4% in the long run? That gets you an annual increase in revenue on the order of 70-90 billion dollars, which is the range I see repeated in the media most often. It’s also about the range that the Obama administration was talking about when it proposed its tax increases.

70-90 billion dollars per year won’t even pay the interest on the debt. 700 to 900 billion over 10 years is only a third of what was already agreed to in the last budget deal, and that in turn is only a tiny fraction of the amount the debt is supposed to increase over the next ten years. The actual savings required to get to a balanced budget will need to be about twenty times that size.

So once again, how is taxing the rich supposed to help here, other than getting you 5% of the way to a solution?

Great. So you’re saying you want to cut 1 trillion over 10 years, increase taxes by a trillion over 10 years, and declare the problem solved? I guess we’ll see you in bankruptcy court.

I agree with the Democrats that the solution will require spending cuts and revenue increases, but the rich just don’t have the money you need. The only countries that have managed to raise their tax rates above 20% of GDP consistently have done it with broad-based taxes - high excise taxes, a VAT applied to the entire population, higher energy taxes, etc. If you’re not willing to go there, you’re not serious about using taxes to solve the problem. Period. You’re just another class warrior trying to stick the blame for society’s problems onto the rich.

18

The rich are willing to take risks. What they’re not willing to do is gamble. There’s a difference. Investors require risks to be quantified and priced - the reason the financial system nearly shut down in 2007 wasn’t because there was too much risk - it was because the risk couldn’t be priced, so no one knew the value of the monetary instruments moving through the economy.

If I give an investor a business plan with a 50% chance of failure, I might get funding for it - if the return on investment in the case of success is high enough to warrant taking that risk. But if I give an investor a business plan with an unknown amount of risk, he won’t touch it.

The problem investors are facing right now is that investment risk is hard to price. Some of that is the fault of government regulatory uncertainty and uncertainty about the actions of the fed. Some of it is uncertainty about the resolution of the various debt crises around the world. These are chaotic events impossible to predict, and therefore price. That’s what really chills investment.

Take the health care bill. According to the bill, employers with over 50 employees who do not provide health care for their employees will be subject to fines of $2,000 or $3,000 per employee. In addition, health insurers will be hit with new fees, and the mandatory insurance clause kicks in requiring everyone to have health insurance.

What is this going to do to the market in health care? How much will prices go up for companies already providing health care? No one knows. In addition, this is going to cause huge sectoral shifts as labor-intensive businesses are hit harder than businesses that use less labor. In addition, companies that have currently negotiated with employees to provide higher salaries in lieu of health care coverage are going to find themselves with the higher salaries AND health care costs, putting them at a disadvantage.

What makes the uncertainty even higher is the penalties for companies that already have health care plans, but whose employees choose to seek health care from the exchanges instead. As I understand it, if even one employee chooses to do so, the company is fined $3,000 for every employee it has. How do you quantify that risk? To make matters worse, no one even knows what the health exchange coverage is even going to look like at this point, so no one knows if their current insurance is adequate. And no one knows what will happen to the cost of health care coverage overall once 30 million more people start seeking coverage.

If you own a company that has 45 employees without health care coverage, would you hire another 10 knowing that as soon as you hire the sixth, you are now going to have to remit $3,000 per employee to the government? That sixth employee sure is expensive, eh?

By the way, the historical creator of private sector jobs is small business, and all those small businesses out there just under 50 employees are probably sitting on their hands right now, waiting to see how this shakes out.

Now assume I come to you with a business plan for a restaurant. What’s my cost structure? Normally, the staff will be close to minimum wage, with their wages supplemented by tips. Most people in those kinds of businesses do not have employer-provided health care coverage. So should I assume that in 2014 I’m suddenly going to be paying $3,000 per year more for each employee? That’s a whopping increase in my labor costs of almost 20%. How will that allow me to compete against the large fast-food chains or other established restaurants?

This is just the effect from one aspect of one bill. Then there’s the 2,000 page financial reform bill, the manufacturing bill that changes the way inventory depreciation can be calculated, new EPA regulations, the threat of new taxes or an economic downturn because of high deficits, yada yada. Much of this is unquantifiable risk. How do you make investment decisions in that atmosphere? How do you know how much return you need on your capital to make the investment a better deal than just putting the money in a T-Bill or a Municipal Bond?

Speaking of employment costs… The new minimum wage went into effect in 2009, right in the middle of the recession. It raised the rate from $5.85 to $7.25. How much effect do you think that might have on employment when productivity is down? Now add in $3,000 in fines per employee from the health care bill, and compare:

Cost of a minimum wage employee in 2008: $12,168
Cost of a minimum wage employee in 2014: $18,080

How many industries in an economic downturn can afford a 50% increase in labor costs? Might that not explain why the unemployment rate among young people, who typically fill the low paying jobs, might be so high?

19

You made the very common mistake of assuming that John Dewey has all $100million in cash sitting in his bank account.

Net worth is a combination of your assets including cash, stock, houses, cars, etc. John could easily have $60million tied up as a 51% ownership in a larger company. Losing the $40million he had available to invest might cause him to have to sell some of that stock, which would cause him to lose control of the company and could eventually ruin him.

The point here is that you are trying to compare a rich person and a poor person then make value judgements based on what YOU think they could lose, and what YOU think would impact their lives. But you have no idea what losing $4000 would mean to the poor guy, or what losing $40million would mean to the rich guy, you just assume. There is a good chance the poor guy has no idea what $10,000 in assets even means, and won’t notice when it’s gone. He may not even be aware of the fact that he’s taking a risk. And it’s entirely possible that a person with $100million in assets feels every penny they lose.

My personal opinion on the issue: “taxing the rich” may cause reduced investments, but not specifically because of the direct financial implications such as “omg I’ll only stand to make $98million instead of $99million.”

“taxing the rich” has come to represent a lazy fiscal policy without real thought or consideration for what the hell is going on. And before someone goes off on another of their rants, gutting government expenditures (or a no tax increase policy) is just as stupid. But this thread is about “taxing the rich” and so the causal effect is that “the rich” perceive poor financial management, which will ultimately lead to an environment they don’t want to risk capital in.

To put it in terms of the poor guy: let’s say he’s weighing his options, but the government is in a heated debate about environmental policies, where one is proposing putting in strict emission standards on old cars. If the poor guy can only afford an old car, there is a risk the new policies will devalue his vehicle. He wants to buy a new car, something that would help the economy and his financial situation, but the government gridlock and jingoistic politics causes him to be fearful of buying a car.

When taking a financial risk, there are unknowns that can be weighted and accounted for. The car breaking down is a big problem. But it’s part of his investment decision, he could spend a bit more and get a more reliable vehicle, he could buy an after market warranty, etc. But there is nothing he can do if the risk is caused the governmental issues, and those issues might cause him to not invest.

20

Who exactly gave you the power to determine what is or isn’t relevant? Risk, as we’ve defined it, is not a dollar number, but rather a state of mind. It is the perception that one’s actions may lead to meaningful losses for oneself. Joe Schmoe’s four thousand dollar investment can do so, while John Dewey’s forty million dollar investment cannot. Dewey’s forty million simply means a lot less to him. The law of diminishing returns could make this argument formal, but the idea is common sense.