importance of investment is understood by all economists.
Without it, long-run improvements in economic welfare are
impossible. We want investment to occur whenever it is
likely to improve our lives. Unfortunately, very few of the
tax policy proposals touted in Congress as "investment-friendly" are
likely to do anything at all to increase desirable
investment in the United States’ economy.
To understand the flaws in these proposals we first need to
understand the difference between financial investments and
real economic investments.
investments---the kind that actually end up improving the
economic welfare of a population---involve purchases of capital
goods or other economic resources that are used to either produce
more capital goods or more final goods that consumers find
desirable. In other words, they either increase output or
expand the supply-side's productive capacity. This happens
whenever firms purchase machinery/equipment to improve productive
efficiency or when they spend money on the construction of new
stores or factories or on the salaries of new employees.
However, not all firm expenditures are
economic investments, e.g., money
firms on advertising that either (a) misleads consumers or (b) does nothing to help them
with their purchasing decisions.
Financial investments---are purchases or commitments of money
that provide the "investor" with an income stream. Saving
money is a financial investment because it provides interest
income; purchases of assets can be financial investments if they
eventually provide a capital gain.
Economic investments made by firms
are usually also financial investments because they generate
income that exceeds their cost.
The economic investments made by
governments that improve infrastructure or human capital are not
financial investments because they do not provide the government
with an income stream.
Some financial investments are also economic investments, but many of them
are not. The purchase of a piece of land, for example, is a
financial investment if it appreciates in value over time, but it is
not an economic investment if it just sits there, undeveloped.
Purchases of stocks in secondary markets (e.g., NYSE, NASDAQ) are
clearly financial investments if the stocks appreciate in value, but
they are not economic investments because they involve
nothing more than exchanges of titles of ownership of already
existing assets. They do not typically put any money into the
hands of firm managers that could be used for economic investments.
That normally happens only when stocks are first sold to
underwriters, prior to an initial public offering.
Supply-Side theorists have taken advantage of the impreciseness of
the word investment to craft tax policy proposals that
sound as though they are beneficial to the economy, but actually
are not. The famous Capital Gains Tax Cut, for example, is
frequently promoted as an incentive that would stimulate
“investment.” Unfortunately, the only “investment” that such a
tax cut is likely to stimulate is increased financial
investment in stocks and other real assets. One financial
investor hands money over to another financial investor for a piece
of paper. Very little if any of the money involved in these
transactions ends up being spent on capital goods that would
increase output or the productive capacity of the economy.
do firms need special incentives to motivate them to invest
in new capital goods? The answer is never. In
modern market economies, competition provides firm managers
with the most powerful motivation
to continually invest that they
will ever need:
They ultimately face both the
fear of bankruptcy and the fear of lost opportunity.
competition lowers its costs by investing in new equipment, or
improves the appeal of its products by incorporating new
innovations, then you’d better do the same or you will soon find
yourself driven out of business. With only a few exceptions,
additional government-provided financial incentives are nothing more
than an unnecessary waste of tax dollars.
Entrepreneurs do not need special additional
incentives provided by the government to encourage them to
assume the risks of creating a new business. True risk takers
believe that their ideas will succeed in the market and have so much
of their identities invested in them, they really don’t care if they
receive any return at all on their invested time and money,
sometimes for several years, as long as they have hope of eventual
success. The problem for them is not that they lack motivation; it's
that they can't
find someone who is willing to provide them with a loan that banks,
venture capitalists, and angel investors find too risky.
In confronting this situation, Congress has a couple of options.
It can choose
nothing and simply allow the marketplace to reward
firms-that-make-wise-investments with the market share of
other option would be for lawmakers to help entrepreneurs [and
established 'too-risky' firms] to obtain the funding they need in
the hope that they might then be competitive with better
rational way to do this would be to
marginal firms with
targeted investment tax credits or perhaps with guarantees on
These kinds of initiatives would put the money directly into
the hands of those who will be investing the money. Compare
this to the insane idea of giving tremendous amounts of extra
disposable dollars to wealthy savers in the hope that their extra
savings might somehow make their way into the hands of true economic
investors when private banks have already rejected their
borrowing plans as too risky. Very little, if any, of
those billions of dollars would actually end up helping needy
entrepreneurs and firm managers.