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Friday, December 21, 2012

The concept of incentives is one the right needs to hammer home over and over. Here’s Cliff Asness in the Wall Street Journal a couple days ago, pushing back against Warren Buffet’s theory that, essentially, tax rates don’t factor into investment decisions:

Mr. Buffett is undoubtedly right that rich people will continue to invest some amount in something regardless of the tax rate (except for a 100% rate!). He’s also undoubtedly right that an investment that easily clears all hurdles will likely still be attractive after a small tax increase. But life, and the investment decision, occurs at the margin. Fewer and smaller investments will be made if the after-tax prospects are worse. It’s just math and logic, unassailable and commonly accepted regardless of one’s political persuasion.

Some recent commentators have actually tried to prove the illogic that Mr. Buffett merely asserts. They argue that if an investment was profitable at a 15% tax rate, it will still be profitable at, say, a 35% tax rate?just less so. Therefore investors will still go ahead with it. But here, as in so many things, the government doesn’t play fair. It taxes gains, but losses are deductible only under certain conditions and circumstances. In finance-speak, the government grants itself a call option on your profits. This fact alone will make investments that were profitable at one tax rate decidedly not so at a higher one.

It’s easy for Buffet to point to a great investment and argue it would still be worth doing under higher tax rates. It’s much more difficult to demonstrate the marginal effects, which, across the entire economy, contribute to stagnation.

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