Monday, October 12, 2015

Jumping the gun on "taxes and entrepreneurship"?

This Friday, October 16, is the date of the fifth (I think) Annual NYU-UCLA Tax Policy Symposium. It will be held at UCLA, and I will be flying out there late on Thursday night (after an afternoon class) in order to be the moderator for one of the panels.

This year's topic is Tax and Entrepreneurship, and the schedule is available here. The session I'll be moderating has the title "Can Entrepreneurship Justify the Capital Gains Preference?" It will feature papers by Victor Fleischer and William Gentry, and Ed Kleinbard will be our featured commentator (although I might possibly have a couple of much shorter things to say as well).

I will admit that I am somewhat of a skeptic about this topic on the merits, although it's timely and well-chosen in terms of contemporary debate. Consider the title of the day's first panel: "Goals and Design Principles - How Should We Use the Tax System to Encourage Entrepreneurship?"

While I haven't seen the papers for this panel, I think its title is jumping the gun a bit. Who's to say that we should be using the tax system to "encourage entrepreneurship"? I start out as very skeptical about this.

To think otherwise requires going outside standard economic models to posit a kind of market failure that has not, to my knowledge, been convincingly demonstrated. What makes this particularly ironic is the fact that proponents of "encouraging entrepreneurship" may often think they are being pro-market, and indeed in some cases this may rise to the level of ideology. But clear thinking reveals that, without a market failure claim, the case for particularly "encouraging entrepreneurship" collapses.

Let's start here by employing a conventional neoclassical model. People work and invest in order to reap economic rewards, and at the margin the market (and thus social) value of what they supply equals the cost to them of supplying it. We get the efficient outcome, but then, alas (from an efficiency standpoint), the tax system drives a wedge between supply and demand by taxing the value of economic production.

By imposing the tax, therefore, we are discouraging all productive activity, "entrepreneurship" included but without there being anything special about it.  So while reducing discouragement of all productive activity would be a good thing, from an efficiency standpoint, why exactly do we want to "encourage entrepreneurship"?  Unless there's more to the story, such an approach would inefficiently favor one branch of productive activity - which we haven't even, as yet, defined, or ascertained that we can identify in practice even if we know what we mean in theory - relative to other productive activity.

Is it being claimed that "entrepreneurial" activity is more tax-elastic than other modes, providing an efficiency reason for applying a lower rate?  No, that does not appear to be the primary claim, and if it were the rhetoric wouldn't specify positive "encouragement." If anything, successful "entrepreneurs" may often end up earning rents, which would imply lesser tax-elasticity and thus that perhaps we can tax them more highly than others without creating efficiency costs.

The claim is rather one about positive externalities. Supposedly, the successful entrepreneurs transform society, create economic progress, expand employment and others' wealth (not just theirs), create higher consumer surplus from the products they introduce, etcetera. Now again, this is an argument about market failure - not about freeing up markets. Only because (or rather if) these supposed magicians are creating benefits to others that they can't personally capture, and that markets don't enable them to extract, do we have any particular reason to "encourage" their activity relative to any other type of market activity.

Suppose we agree that intellectual innovators and pioneers help to transform society or expand the economy, making things better for everyone. Are these the same people as the "entrepreneurs" who would benefit from a lower capital gains rate in the scenario where they hit a home run? Are the supposed "entrepreneurs" in the data sets that studies use - e.g., self-employed businesses or whatever categories they employ - the same people as the ones who, in this story, are creating positive externalities?

Suppose we have a creative innovator, a unique individual who is poised to do great things that could have a general social payoff.  To what extent are the positive externalities that this individual is likely to generate correlated with the taxable income that he or she ends up earning? Is there a theory explaining why, the more this individual earns, the greater the external benefit to others?

If we are looking to intervene economically in the market, via the tax system, by tax-favoring some activities relative to others, how high on the list should these "entrepreneurs" be relative to all other individuals and activities that might yield positive externalities? What about nursery school teachers?  Artists? Scientists? What about - well, fill in the blank.

What about people who look a bit like entrepreneurs, so far as our identifying markers are concerned (e.g., being self-employed or getting long-term capital gains down the road), but who are imposing negative externalities, such as from rent-seeking? Are they relevant to the story as well? How much do we actually know about the balance between the negative externalities they create, and the positive externalities that "good" entrepreneurs create?

Okay, I realize that there is a burgeoning literature on "entrepreneurship." I'm loosely familiar with it, but certainly don't know it that well. Hopefully I will learn a bit more about it at the symposium. But based on what I know so far, I am skeptical about the extent to which this literature makes a convincing connection between (a) credibly demonstrated net positive externalities and (b) the "entrepreneurs," identified via imperfect markers, who ostensibly should be "encouraged."

I also am suspicious of the incoherent market triumphalism that celebrates "winners" without recognizing that the case for particularly encouraging them through the tax system rests on a claim of market failure, rather than on one about markets' virtues.

UPDATE: I am pleased to see that the papers at the NYU-UCLA symposium generally or mostly approach the topic without premature buy-in to the stance that I criticize above.

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