Friederich Hayek on the Economy

John ArmstrongEconomy/Economics

One of the more formidable voices in economics was that of the late Friederich A. Hayek (1899-1992). In his classic, The Constitution of Liberty (1960), he argued that progressive taxation does not accomplish what most people believe. Taxing the wealthy at higher rates, in order to provide for larger government spending for the poor, does not obtain the desired goal according to Hayek. Hayek said: “Not only is the revenue derived from the high rates on large incomes, particularly in the highest brackets, so small compared with the total revenue as to make hardly any difference to the burden borne by the rest; but for a long time . . . it was not the poorest who benefited from it but entirely the better-off working class and the lower strata of the middle class who provided the largest number of voters.”

Hayek believed, as do most fiscal conservatives, that in principle the progressive tax is a political issue more than a tax issue. In theory it sounds like it is fair for the wealthiest few to help the rest of us but sharing their income in certain managed ways but in practice this is simply not what actually happens. This argument seems counter-intuitive until you actually examine both revenues and the history of what the progressive income tax has done to our nation’s ability to generate larger sums of revenue through higher rates of taxation.

The largest number of Americans seem to believe that raising taxes on the rich is good for all the rest of us but remember that the definition of “rich” gets changed as things move along thus before long the tax rates filter down to most middle class people too, in various ways that are not all rooted in taxes. The real loser could be the small business owner who is the backbone of any economic recovery. I do not debate the question of “stimulating” the economy by creating bank liquidity but I do believe a wholesale government spending spree will not have an overall positive impact on our economy. Why? There is no real proof for this conclusion.

One of the greatest downsides to this approach is the way it kills the incentive of the very wealthy to create new jobs, to spend large sums of money on new capital ventures and thus to raise the boats of all of us in the process. The myth that often supports this theory is the one which sees the whole economy as a finite pie. There is only so much pie and we must more evenly share the burdens and the benefits of that pie. But what if we can make a larger pie? The truth is that we can and we have and this is part of the greatness of America.

The solution, it seems to me, is not to reduce the pie but rather to better regulate corrupt practices of some and enlarge the pie at the same time. Hayek also believed, and I think demonstrated, that progressive taxation tended to push the worst people to the top and not the best people. Maybe we had better rethink the class warfare danger that promotes so much through more taxation before we remake society along class lines.