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I have been catching up on the Daily Show over the last few days, and tonight I watched Stewart speak about the economy with renowned economist Joseph Sitglitz.  Stiglitz is a former Chief Economist of the World Bank and professor at Columbia University.  One piece of the discussion especially caught my attention:

If you look at those who have made the most important contributions in our society, the guys who did the basic ideas behind the computer…medicine…DNA…they didn’t do it for money.  And if you had taxed them at 80% they would have done what they did.  So, this notion that innovation depends on the tax rate I think is absurd. (Episode 17,129 – 9:45)

I agree completely.  This juxtaposes the earlier episode with Edward Conrad of Bain Capital who argued with Stewart over the importance of the marginal tax rate in driving innovation, progress, and the economy.  I think Stewart hit it perfectly when he questioned Conrad’s understanding of human behavior:

Do you think, after being in the financial industry for a long time, that it has in any way skewed what you imagine drives human beings?  Because what you’re saying… does not speak to creativity and innovation.  It speaks to cost benefit analysis.  Being in a business that is creatively driven but economically feasible and successful, I can tell you, without question, that is the wrong way to grow creative endeavors. (June 7th Exclusive, pt. 2 6:03

Looking at these I can see how Stiglitz and Conrad are both correct.  I don’t think Bill Gates put much thought into the tax rate when he created Microsoft.  Even if he did, I the story doesn’t fit.  From 1975-1980, when Microsoft was being formed, the highest marginal tax rate was 70%.  So no, I don’t believe tax rates are relevant to real innovation.

On the other hand, I the tax rate absolutely plays a role in our incentives.  Take for instance a simple example of a worker earning an hourly wage of $10 working 8 hours a day.  With no taxes, the  opportunity cost of not working one day, the income he forfeits by taking a day off, is $80.  Now introduce a 10% income tax.  Suddenly he only brings home $72 every day, reducing his opportunity cost of a vacation day by $8.  When we start considering large sums of money and higher tax rates you can see how we might expect to squelch some “innovation.”

The difference in position lies with how we define progress. Conrad is right when he says higher tax rates will hurt the risk & reward system that drives innovation, but the question is what kind of innovation will it stop?  Someone designing a little trinket or gizmo to make a quick buck might be deterred by a high tax rate, but the people who revolutionize our society aren’t going to be stopped by a little less profit.  And if you can’t buy into that simple argument, just look at the tons of freeware software available for computers, phones, and other devices.  Many developers don’t even utilize ads.  They simply pursue projects for their own passion and achievement.

As a final thought, consider Maslow’s hierarchy of needs.  If you’re not familiar, Maslow’s hierarchy is a physiological theory that states humans have a hierarchy of needs starting with the basic physiological needs at the bottom of the triangle.  Only when these are filled can we progress to the next level.  We can question if our motivations are always so linear, but can you really deny those needs in the higher tiers?  Because if you insist a high marginal tax rate will kill innovation you are blowing the top off the pyramid.

Maslow’s hierarchy of needs

Oh, and speaking of the marginal tax rate, check out this history of marginal tax rates in the United States.  It is important to heed the note at the bottom that this is a simplification.  But still, I think it is quite obvious that America’s tax system did not always favor the rich…

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