Accumulation of capital is the essential portion of a capitalist system. As societies become more advanced, the machinery and supplies needed to keep it running become more expensive, and soon exceed the average day-to-day cash flow of an individual. Few of us can afford to buy the buildings and machinery for, say, an auto assembly plant. So somehow there has to be a mechanism for accumulating enough surplus capital to invest in such expensive infrastructure.
To start or expand a small business an entrepreneur may be able to assemble the required capital from his or her own savings, and perhaps borrow some from a local bank. But for larger business ventures, an entrepreneur needs to find other sources of capital, and the usual way to do this is to find investors who have extra capital available and are willing to put it into the new business venture in hopes of earning an attractive return.
So for a capitalist free market system like ours (almost) is, the availability of surplus capital, and of investors willing to risk their surplus capital on promising business ventures, is essential. One wants government policies that encourage people to accumulate capital, and to invest that accumulated capital in new business ventures.
The problem is that as soon as politicians see a pile of accumulated capital, whether in an individual’s bank account or in a corporation’s bank account, there is an irresistible urge to try to tax part of it away on the grounds that “the rich” ought to pay more. If governments really were able to confiscate all the accumulated capital of “rich” individuals and corporations, the immediate result would be a crisis in business, which could no longer find investment capital to keep operating and expanding.
Similarly, one takes the risk of investing one’s surplus capital in companies hoping for a good rate of return. If government sharply reduces that rate of return by heavily taxing dividends, it becomes much less attractive to take the risk of investing.
Now it is true that we have grown up a whole class of short-term investors who are in essence just gambling – traders who really have no real interest in investing, but who just gamble on day-to-day fluctuations in stock prices. So there is some logic to taxing more heavily positions that are held only for a short time – that is in essence simply a gambling tax.
But one wants to be careful about taxing too heavily either the accumulation of surplus capital or the returns from investments, popular though such taxes are with populist politicians and the general public. The accumulation and (long-term) investment of surplus capital is what makes our system work as well as it does.
Of course, there is an argument for having government take all the accumulated capital and itself deciding whom to fund. (It is never stated this bluntly, but that is in essence what happens when government taxes heavily and then subsidizes businesses or industries with the taxed money. It is also what happens in Communist “central planning” economies). So why would this not be as good, or even better?
The reason is twofold. (1) When an investor invests (and risks) his or her own money, they have the maximum incentive to be careful, to do due diligence, and to watch the investment carefully. When a government bureaucrat does it, it isn’t his or her money, it’s just “play money” and isn’t watched nearly as carefully (if at all). (2) Investors care about the business succeeding. Governments usually care about other things, like advancing ideological causes or favoring powerful supporters. So in general, having the government make investment decisions has never been anywhere near as effective or as efficient as allowing individual investors to make investment decisions, as anyone can see who reads recent economic history.
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