To the pillory for success

• This column was first published in Maverick, 22 March 2007. Click here to subscribe to it in its full print glory.

Politicians – like the village magistrates of old – enjoy punishing prosperity. Using laws and taxes, they set out on populist crusades to discourage the very success they promise the people.

“One of the sad signs of our times is that we have demonized those who produce, subsidized those who refuse to produce, and canonized those who complain,” wrote Thomas Sowell, a senior fellow at Stanford University’s Hoover Institution in the USA.

Several recent local incidents form a pattern, which neatly illustrates this point. Let’s consider three instructive examples: Fidentia, windfall taxes, and the taxes on capital gains and dividends.

The first case is a little like Enron. Whether or not the pretentiously-named J Arthur W Brown [the chief executive of financial services firm Fidentia] is guilty of the charges for which he has been arrested, the likely response from politicians will be that “we must do something”.

That’s true, of course. That’s why we have laws against fraud and theft. We must simply enforce them.

That’s also why custodians of funds have a duty of trust to manage those funds according to the risk profile of their owners. I’d suspect that widows and orphans, for example, have a very low tolerance for risk, and would accept low growth in return for a secure future. When a union pension fund abuses this trust and gambles money away on dodgy high-risk investments – for whatever nefarious purpose – they should be held to account. Similarly, when taxpayer’s money is handed to a sectoral training and education agency, taxpayers probably expect that the money will be used for, uh, training and education in the relevant sector. Not for educating civil servants at the investor school of hard knocks.

All these responses are catered for in existing law, however. The Scorpions (not the scorpions) have arrested J Arthur W and company. The Financial Services Board, funded by Business Against Crime, is pursuing a private prosecution of the fraudsters at Alexander Forbes. Cases such as Leisurenet, MasterBond and Tigon make headlines because they’re exceptional and people go to jail, not because they’re the norm.

Yet they fuel a great distrust of those who succeed in business. The result is over-reaction, as US lawmakers did in the wake of Enron, WorldCom and other boomtime frauds. Like ours, those perpetrators too were caught and convicted under existing laws. But that’s not good enough for vote-hungry politicians.

The innocent majority got saddled with a massive new burden of laws and procedures, whose only real purpose is to try to eliminate risk from the system. Problem is, that not only raises the cost of doing business for the honest majority and puts a damper on economic growth, but it also eliminates the potential rewards of taking informed risks. It punishes success. It hurts productive companies that operate within the bounds of the law.

Let’s stop using oppressive but populist laws to discourage what we’d like to see more of. And while we’re at it, let’s stop using tax for this purpose too.

When someone invests in a company, or buys an asset as an investment, they take a calculated gamble on the future profitability of the company or future value of the asset. If the government proceeds to tax this potential future profit, there is less incentive to invest. As financiers say, the “hurdle rate” – the expected growth forecast that marks the stop-go decision for a potential investor – is raised.

Since capital growth is what creates new jobs and new wealth, what on earth makes governments think it’s a good idea to tax it? You tax cigarettes not only because smokers are a soft target, but because you want to discourage smoking as a matter of public policy. You tax clothes from China not because it’s a good source of revenue, but because you’re trying (however misguidedly) to discourage people from buying them.

Tax is a policy instrument, just as much as it is a revenue generator. I don’t like this notion either, and would prefer revenue to be generated simply and efficiently by a single consumption tax (like VAT), a flat income tax rate, or if you feel some redistribution is politically necessary, a negative income tax.

The latter, which had the support of the legendary and sadly late free-market economist Milton Friedman, involves a cash-back income subsidy below a certain wage minimum, and a flat tax rate above a moderate income level for high-income earners. The tax on the rich raises revenue, some of which funds the income subsidy for the poor. Even better, the poor get to choose for themselves how best to use that money, instead of being forced into inefficient government service delivery programmes, which usually fail to deliver services anyway.

(Instead, we get a discredited social security idea that even rich countries with far fewer poor people can’t afford, from the same government that punishes the means by which such a system might be funded.)

Still, tax as policy instrument is what we’re stuck with. But why then punish what you want to encourage, namely capital gains? Why punish the successful investor, the engine of the economy, by confiscating dividends earned? Why reward the inefficient manager for not running a lean operation and returning excess capital to investors who can put it to more productive use?

Nevermind that the really rich will find ways around these taxes, and the lower and middle classes – owners of pension funds, unit trusts and insurance policies – will bear the brunt. The incentive is contrary to our explicit goal: economic growth, job creation and poverty alleviation.

And when a few companies end up making money even in the face of all this opposition, what do they get? A windfall tax! “Why was you driving so fast, sonny?”

No matter that sonny invested and worked hard during the bad times, and is earning the just rewards of this risk and perseverance when things turned around. No matter that sonny didn’t get squat from government when the oil price was at $10, or the gold price at $250. Now that his bet on the future needs of the market – which is all investment really is – is proving to be right, he gets punished for it. That’ll teach sonny to invest in capacity. That’ll teach him to keep people employed and keep spending on R&D even when he’s making losses.

(Granted, companies such as Telkom and Sasol, with their regulated prices, their histories as state-owned enterprises, and their conversion into protected private monopolies, are exceptional cases. Windfall taxes and other expropriation measures are still a bad idea, because by confiscating what investors thought they had bought on good faith you discourage future investment. However, the issues relating so such state-spawn are different and beyond the limited space I have here.)

Economic freedom – the ability to pursue an occupation and own the fruit of your own labour – is an essential component of political freedom, as Milton Friedman so clearly argued.

When politicians impose laws and taxes that restrict this freedom by punishing economic success, it doesn’t matter what good causes they invoke, or how much they pillory the productive for “not caring”. The fact is that the very people the government claims to care about are hurt by such intervention. They’re a disincentive for investment, for honest business, for taking risks, for being productive, and thus they restrict the very economic growth, job creation and poverty alleviation that politicians claim to champion.

Good intentions have never fed anyone. Besides, who’s ever met a politician that doesn’t revel in the power to tax and legislate for transparently populist causes?