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A Financial System Which Rewards Failure and Punishes Success

December 7, 2023

The two most important lessons one can learn in economics are: “There’s no such thing as a free lunch” and “Incentives matter.”

In a world of scarcity, every choice we make has an opportunity cost. As rational beings, every one of us is trying to achieve the best outcomes under the current constraints.

Frederic Bastiat noted that where the law protects the natural rights of the individual to life, liberty, and property, man has to choose between two unpleasant conditions — a life of effort or a life of privation. With the spread of the global free enterprise system, billions of people made their personal cost-benefit analysis and chose work over poverty. Free markets removed the old social barriers and unleashed the energies of the masses to accumulate wealth through productive activities.

Old habits, however, die hard. Before the rise of capitalism, small elites created and maintained institutions that helped them to plunder the lower classes. Over the course of time, democracies replaced the ancient oligarchical regimes.

With public access to the government and the process of legislation, the people learned to vote for “free stuff” from the public coffers — education, healthcare, food, housing, etc. In this manner, we have learned a new way of enjoying the labor of others without guilt. Plunder of the many by the few was replaced by universal and reciprocal plunder. 

In the course of time, we fell under the impression that it was possible to use the state as a magic wand to enrich individuals at the expense of everyone else. That made organized plunder acceptable. To pacify our consciences, we have created “a legal system that authorizes it, and a moral code that glorifies it,” as stated by Bastiat.

What are the consequences of this process today? While entrepreneurship and innovation have removed many natural obstacles to achieving high living standards, we have shackled ourselves with a fiscal system that punishes success and rewards failure.

Of all fiscal penalties, the income tax is the worst idea because it discourages the productive efforts of the largest group of people. A tax is what a tax does. Higher tax rates mean higher penalties on the taxed activity. 

An income tax makes it more costly to work. Since people respond to incentives (costs and benefits), fewer people will find it in their best interest to be more productive. 

This leads to slower economic growth. The solution here is to abolish this tax or, if that is not politically feasible, to move to a flat income tax rate applied to all, with no exemptions or deductions.

Economists like Art Laffer argue that marginal tax rates have significant impacts on output. Reducing tax rates increases the incentive to earn more by producing more wealth — to work harder, to invest in research and development, to supply more resources, and use them more efficiently, growing the economy. 

High tax rates suppress these beneficial actions by discouraging foreign investment and by creating incentives for domestic businesses to channel their funds to activities that have tax-shelter benefits but are less profitable. This leads to the misallocation of resources away from their most productive uses. High marginal tax rates have an adverse effect on the rate of capital formation and the efficiency of its use.

Perverse incentives created on the spending side are less visible but more harmful.

There is another way that such fiscal policies make America less productive. The perverse incentives created on the spending side are less visible but more harmful. People hooked on welfare lose much of their incentives to look for a job.

For example, if the income of a low-income family rises above a certain level, they lose cash subsidies, state-provided employment, and training services. If the family does slightly better, they are denied subsidies for housing and utility costs. Beyond a certain point, they can no longer receive food stamps, and so on. They may be poor, but they are not stupid, and it is not rocket science to see the benefits of accepting less productive, low-paying jobs or just pretending to look for them to become eligible for handouts.

When President Lyndon B. Johnson’s administration started the “war on poverty” 51 years ago, the poverty rate stopped declining and stabilized at around 15%. Over the years, more than 120 anti-poverty programs have been established, 72 of which provide benefits directly to poor individuals. The cost of our federal welfare spending combined with local and state programs adds annually to a trillion-dollar penalty imposed on the most productive Americans in order to reward other Americans for being unproductive.

Like Reagan said, the best social program is a productive job. Empirical data proves him right. America’s Founders knew that if the government tries to do something for one citizen, it must rob another citizen – “and in the process gains control over both.” (TheJohnBirchSociety, 2012) 

If they were alive today, they would probably fight another revolution against the injustices perpetrated daily by their government, just as they fought against their government 250 years ago. The income taxes and the welfare state throw sand in the wheels of the free enterprise system. They diminish the incentives for both taxpayers and welfare recipients to be more productive. They erode our character and stand opposed to American values.

We must heed the words of Dr. Adrian Rogers, former president of the Southern Baptist Convention: “When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. As a wise man once said: You cannot multiply wealth by dividing it!

ABOUT THIS AUTHOR

Kristin Tokarev is a recent alumna of Northwood University who graduated with a BBA in Economics in 2021 and an MSBA in Business Analytics from our DeVos Graduate School of Management in 2023. Kristin was a prolific videographer throughout her time at Northwood and has been nationally recognized by Stossel in the Classroom’s Student Video Contest. Kristin has accepted an offer to work in New York City with Dr. John Stossel to promote the values of freedom and limited government as espoused by The Northwood Idea. 

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