Should Private Wealth Fund Public Debt?

It is widely reported that 1% of the population owns as much as the poorest 50%.
However, when there are suggestions to increase the taxes of the very wealthy individuals and their corporations, the usual answer is that this will result in lost jobs since there will be no incentive for them to continue investing.

This sounds a reasonable argument at face value. But is it really the case? Or is it a tagline that interest groups are using?

Businesses invest because they expect that the rate of the return of their capital will be higher than the interest rate they will have to pay for the money they borrowed.

Also, although capital investments in the past implied significant creation of new jobs, the situation lately has changed. Investments are primarily technological and fewer people are needed. So, this argument becomes less and less strong.

While I was reading a book called`The Capital` by Thomas Piketty (the chapter ‘Metamorphoses of Capital’ to be specific), I finally understood why governments support private wealth.

(BTW, this is an excellent book and features in the library of anybody who wants to be somebody. If you read it though while you work full time, it will take you between 6 months to 6 years to finish it.).

Most of us are accustomed to the fact that the taxes we pay fund the public services we get (e.g. schools, roads, etc). So, it is natural that if we want more services, we need to pay more taxes (on profits for corporations and income for individuals) for the Government to be able to afford providing them.

The other funding option the Government has is to borrow money instead of increasing taxes.

Gross Domestic Product (GDP) is a key performance indicator for a country. The higher the GDP, the better the creditworthiness of a country. In other words, the country can borrow money at a lower interest rate (and pay for the services that needs to provide).

GDP is the sum of net public wealth and net private wealth. So, if the private businesses of a country are doing well, the GDP will be higher and as a result the better the creditworthiness of the country. Hence, they will be able to borrow at lower rates and fund the services.

This is the economic side. There is also a political one.

Governments need to win elections. So, they will choose the policies that will get them elected.

Increasing taxes is unpopular. Poor people don’t want to pay taxes. Rich people don’t want to pay taxes either. Hence, many Western governments prefer to borrow money instead of increasing taxes.

Until recently, it was a relatively good solution given the low interest rates. As a result, jobs have been created. Even if a few people have disproportionally benefited, the overall impact was positive.

During the last few years, the environment has significantly changed. The companies that fare better are the ones in the technology sector which don’t require many employees. For example, let’s compare Facebook and Pfizer. The market cap for Facebook Inc is around $760bn and employs 52,500 whereas, Pfizer’s market cap – a pharmaceutical company – is $200bn and it has 88,300 employees.

(By the way, Amazon’s market cap is $1.6 trillion and it has 840,400 employees – this is a significant bigger number than Facebook because Amazon needs many to work at their warehouses. Note though that most of these jobs are part-time and earn minimum wage.).

So, although governments benefit by having a strong private sector (which improves the GDP and as a result the interest rates at which a country borrows), it is also realistic to assume that from now on the growth will mainly come from technological advancements and only a small number of additional (and highly skilled) individuals will be needed. Hence, we need to prepare for this new norm and adjust our tax systems accordingly.

On reflection, it seems that the question of this post needs to be changed. It is not an either/or answer but at what degree the private wealth will fund public debt.

Why you need to care: We are at a turning point. The foundations of the social order of the past are changing. Tech companies in particular will create significant value but will employ only a small number of employees. Hence, although the governments benefit by having a strong private sector, they also need to consider the wider impact to the many. Our tax systems need to be adjusted for the new realities.

I started the b4iapply blog because I passionately believe in empowering people to make informed decisions about their career, their finances and other societal topics that affect all of us directly or indirectly. I only share my views and I aim to be balanced, constructive and solution-oriented.

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