By John L. Chapman, Ph.D.                                                                                                                                                  Washington, D.C.

Elizabeth Warren, the Harvard Law School Professor who recently entered the Democratic Party primary race for the U.S. Senate seat in Massachusetts (currently held by Republican Scott Brown), made news in her announcement for the race by opining on tax policy.  Ms. Warren, who spent much of the last two years in Washington advising President Obama on the passage and implementation of the Dodd-Frank Financial Reform legislation, is a proponent of progressive taxation, and voiced her support in unusually blunt terms:

“I hear all this, you know, ‘Well, this is class warfare, this is whatever. NO! There is nobody in this country who got rich on his own — nobody.  You built a factory out there? Good for you.  But I want to be clear. You moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police-forces and fire-forces that the
rest of us paid for. You didn’t have to worry that marauding bands would come and seize everything at your factory — and hire someone to protect against this — because of the work the rest of us did.

“Now look, you built a factory and it turned into something terrific, or a great idea. God bless — keep a big hunk of it.  But part of the underlying social contract is, you take a hunk of that and pay forward for the next kid who comes along.”

It is at once a very clever and soothing-sounding argument, steeped in ostensible communal harmony and, as Mr. Obama is wont to say, a “We are all in this together” aura.  But cleverness is also the hallmark of spectacular demagogues, and that is exactly what Ms. Warren is, in framing the argument for progressive taxation as such.  It is important for all taxpayers and investors to see through her verbal stratagem and, pursuant to the defense of a free and prosperous society, apprehend its underlying venality.

Ms. Warren’s argument, on its surface, sounds innocent enough, even, one may say, “fair”.  A factory owner gets rich, but he did so utilizing taxpayer-funded public utilities and infrastructure, his employees were educated in taxpayer-funded schools, and he is protected by taxpayer-funded police and fire protection.  He is also protected, ultimately, from “marauding” bands by the national defense forces of our armed services.  Having benefited from all this publicly-funded largesse, this successful factory owner must now  remit a “hunk” of his wealth to the government for the benefit (which Ms. Warren does not specify) of future citizens.  Ms. Warren asserts that this is part of the “underlying social contract” in the United States, and therefore, she infers, her thesis is perfectly reasonable.

The art of demagoguery consists in arousing the emotions, passions, and prejudices of people via purposeful manipulation and propagation of falsehoods, in order to gain political power or influence.  And in this practiced art, we now learn that Elizabeth Warren is every bit as accomplished as Mr. Obama himself.  For there was nothing accurate in what she said, if one includes the purposeful omission of relevant facts that counter her argument; but she certainly was able to stoke the emotions of those who understand nothing concerning tax policy or the drivers of prosperity, yet are certain that ill-gotten gains accrue to the owners of capital in this country.

First of all, the tenor of her statement leads one to infer that the factory owners have not — again quoting President Obama — “paid their fair share” yet, and hence must be separated from a “hunk” of their wealth to “pay forward” their social contract’s obligation.  As George Mason’s Russ Roberts pointed out in the Wall Street Journal, this is absurd on multiple levels, and we offer our own thoughts here:

• Taxation in the U.S. is already deeply progressive.  In 2008, the latest year available, the top 1% of filers paid more than 38% of all federal income taxes, and the top 50% of U.S. taxpayers paid 97.5% of all income taxes.  In terms of total taxes, the top 1% paid more than $722 billion in 2007.  Demagogues never opine on the specifics of this issue, or on the fact that nearly half of all taxpayers in the U.S. pay no income tax.  What does Ms. Warren consider to be the right amount for the “hunk” of wealth to be “paid forward”?  Clearly, unless Ms. Warren’s factory owner has effectively bought off the federal government in the same manner as General Electric, he is already more than paying his “fair share” in taxes.    To infer that he has benefited disproportionately from resources that emanate from society’s public goods is purposeful and willful misleading of those lacking in clever guile.
• Indeed, this is important to reiterate: by definition, public goods such as roads or national defense are of course paid for via taxation, but are used and consumed by all, regardless of their private pursuits.  Ms. Warren tacitly concedes that her interest in confiscating a “hunk” of wealth from the rich factory owner bears no relation to his over-use of the roads that run to his factory, versus any other user of the road. No, he is to part with more of his wealth for the express purposes of redistribution — for purposes that Ms. Warren as a politician will now wield the power to decide.
• Ms. Warren infers that all of these public services are provided in an efficient and effective manner.  One word in the current political discourse, “Solyndra“, gives lie to that notion.  The federal government wastes hundreds of billions of dollars in taxpayer money every year, and in an example of gross corruption often, at taxpayer expense and in full public view, bestows favors on constituencies who will in turn gladly help to perpetuate its power (e.g., UAW workers employed by government-run auto companies).
• Related to this, it is laughable for Ms. Warren to mention the public education of the factory workforce, from which the factory owner has ostensibly benefited and for which he now must pay.  There are two things to say to this: first, again, this is double-counting.  The factory owner pays property taxes that already represent his ongoing contribution to the public school system.  To now be asked to pay again is a ruse; the purpose Ms. Warren has in mind is, again, a tax on wealth for redistributive purposes.  Secondly, in the real world that evidently eludes Ms. Warren, the public education system in this country is a disaster: it is far more likely that Ms. Warren’s mythical factory owner had to pay for continuing education and remedial training for his workforce, funds which can only come via reduced profits, because his workforce was ill-equipped to handle basic tasks as products of the public schools.  Shall the factory owner be asked to pay for the continuing gross incompetence and failure of the public education system and its Democrat constituent union-member teachers and administrators?

There is however a more fundamental error in Ms. Warren’s argument, and its jurisprudential roots are cause for concern about a U.S. Senate candidate who, in running for high national office, must swear an oath to defend the U.S. Constitution.  But here, she reverts to arguing in defense of an “underlying social contract”, rather than the U.S. Constitution (while teaching at Harvard Law School!).  Doing so is representative, once again, of a clever artifice: the “social contract” is purposefully undefined, and again, as Leftists are always wont to do, it is laden with emotion.  In fact, there is no social contract, underlying or otherwise.   There is only the U.S. Constitution.  And one must thank the Framers for this, for their intent, as outlined in James Madison’s Federalist Papers #10 and #51, was to check governmental power — and specifically, government usurpations — via a federal system, competing levels of government, and three separate branches.  Madison made no secret of the fact that the Constitution was designed above all else to protect property rights from an encroaching and arbitrary government.  And Madison would be appalled at a U.S. Senate candidate and Harvard Law professor who resorts to the ultimate in arbitrariness — an “underlying social contract” — to forcibly extract a “hunk” of a person’s wealth for uses the government sees fit to pursue.

Madison further outlined his thinking in an editorial essay in the National Gazette in March of 1792, on the meaning and importance of property, and it is worth quoting at length:

[Property] in its particular application means “that dominion which one man claims and exercises over the external things of the world, in exclusion of every other individual.”

In its larger and juster meaning, it embraces every thing to which a man may attach a value and have a right; and which leaves to every one else the like advantage.  In the former sense, a man’s land, or merchandise, or money is called his property.  In the latter sense, a man has a property in his opinions and the free communication of them.

In a word, as a man is said to have a right to his property, he may be equally said to have a property in his rights.

Government is instituted to protect property of every sort; as well that which lies in the various rights of individuals, as that which the term particularly expresses. …… That is not a just government, nor is property secure under it, where the property which a man has in his personal safety and personal liberty, is violated by arbitrary seizures of one class of citizens for the service of the rest. A magistrate issuing his warrants to a press gang, would be in his proper functions in Turkey or Indostan, under appellations proverbial of the most compleat despotism……. A just security to property is not afforded by that government, under which unequal taxes oppress one species of property and reward another species: where arbitrary taxes invade the domestic sanctuaries of the rich, and excessive taxes grind the faces of the poor; …….. If the United States mean to obtain or deserve the full praise due to wise  and just governments, they will equally respect the rights of property, and the property in rights: they will rival the government that most sacredly guards the former; and by repelling its example in violating the latter, will make themselves a pattern to that and all other governments.

While not flowery prose, particularly, the essay above is profound in its meaning and import.  Other than the Federalist essays by Madison on this topic, there is no finer writing in defense of property, after John Locke, than this.  What Madison says is unequivocal, and was at the time world-shattering in its unheard-of uniqueness:  Government is instituted to protect property of every sort.  In other words, the primal role of the federal government was, and is, to protect private property.

We go through the foregoing because core to the debate about taxation in this country today is incidence.  Who shall bear the tax, and how much shall it be, are central to every question about tax policy.  The political class has long been mistaken that economic agents do not respond dynamically to changes in tax policy, and that upper income levels and businesses have “deep pockets” that can be plundered at will.  Ms. Warren no doubt believes this, and believes that she can tax the factory owner with impunity.  The current disaster in Greece is but the latest example of the folly of this thinking: Greece has a progressive tax structure with marginal rates ranging from 18% to 45%, and the country has suffered from catastrophic capital flight in recent years.  An easy way to understand Greece is to apprehend that the country has been ruled by a gaggle of Elizabeth Warrens for decades.  As Reverend Wright famously said, chickens do, alas, come home to roost: can anyone recall the last consumer product invented in Greece? The last technical innovation?  The names of world-class venture capitalists or industrial captains?  Of course not, and the reason why is simple: too many decades of progressive taxation have led to a relative decapitalization of the Greek economy, and ultimately riots in the streets and social breakdown.  Such unrest is not imminent in the United States, but anyone who thinks the same cannot happen here is mistaken. And in the meanwhile, to a lesser extent, the same phenomenon of capital flight and decumulation has been happening in the U.S. as well.

Lastly, there is a moral dimension to progressive taxation, beyond the empirical fact that it breeds economic inefficiency and sub-par growth.  Worth repeating, Madison so eloquently said:

That is not a just government, nor is property secure under it, where the property which a man has in his personal safety and personal liberty, is violated by arbitrary seizures of one class of citizens for the service of the rest.

……. A just security to property is not afforded by that government, under which unequal taxes oppress one species of property and reward another species: where arbitrary taxes invade the domestic sanctuaries of the rich, and excessive taxes grind the faces of the poor;

Madison would have reminded Ms. Warren that the essence of constitutional government is equal treatment of all citizens before the law, as evinced in the fact that no citizen cedes to the government any power which the citizen does not already possess.  In this sense, the government is the agent of the citizen, not its master.  So Madison would have found no right in the Constitution to either treat different citizens differently in terms of taxation, nor the right to tax one citizen, the factory owner, with the express intent of bestowing those funds – that is to say, property — on, say, Solyndra, or ACORN.

As is always true, whatever is morally venal in political economy is also destructive of progress and prosperity.  Perhaps that is a topic that ought to be addressed in a Constitutional Law class at Harvard Law School.  Meanwhile, one sure way to incite a rally in U.S. equities tomorrow, and help recapitalize the U.S. economy more broadly, is to end progressive taxation by dramatically lowering (and flattening) marginal tax rates of all kinds.

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@alhambrapartners.com. 

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