The second book of Smith’s Wealth of Nations opens some interesting ideas about capital, banks and wealth creation. Political debates over taxation focus on the necessity of income inequality to create capital markets where the formation of new enterprises becomes efficient. Economics places a significant value on efficiencies. Markets are prized not because they permit economic freedom but their capacity to naturally lead to efficient outcomes. Inefficiencies exist within market economies. But the economist notes they are not sustainable long-term. Eventually efficient enterprises squeeze them out of the market.

Efficiency is the watchword for the twenty-first century. New levels of success are possible through numbers and statistics. Sports have been transformed through analytics. Baseball players are no longer evaluated based on personal judgement. Their value is established through statistical forecasts and projections. The Golden State Warriors transformed the game of basketball through their dominance of the three-point shot. It is easy to isolate sports as a male dominated source of entertainment. Yet it opens a door for a new acceptance for statistics to enter our life. Wearables count steps, active minutes, calories burned and heart rate. The world has been broken down into numbers and a quest for greater efficiency in every aspect of human behavior.

Anyone who has read Smith’s digression on the value of silver realizes he was not averse to data. He incorporates statistical information into his work. But he was not a trained economist nor was he a statistician. Wealth of Nations is the work of a philosopher. He worked out the ideas behind modern economics primarily through thought experiments. Economics and politics both suffer from the challenge to balance historical data and information with our own imagination of what remains possible. Data is all historical. This makes it difficult to project paradigm shifts. The supporting data may not exist until it happens.

Smith draws a unique insight on credit and debt in the fourth chapter of the second book. He notes how the debtor is rarely a spendthrift. On the contrary, the debtor’s parsimony is a precondition for the creditor to loan large sums of money. The creditor invests in enterprises where there is a strong likelihood for success. This tendency drove down interest rates in Smith’s time. Investors accept a lower rate of return when they believe there is a low risk of default.

This insight has dramatic implications for the notion of wealth inequality. Credit becomes a means to build national wealth. It transfers unproductive capital to those who can transform it into an enterprise to create wealth like a business. Today’s capital markets are even more complex. They include large venture capital firms, angel investors and initial public offerings. Tax cuts for the wealthy are intended to juice these capital markets because this is where the creation of large corporations becomes possible.

But this theory depends on the existence of new ideas and opportunities for investment. It does not conceive of a world of diminishing returns. But this may be the reality of wide income disparity. The centralization of capital necessitates a demand for debt. The United States may have reached this point in our economic history. The centralization of capital faces diminishing returns in national investment. Instead, capital has led to burdens of consumer and public debt.

The Laffer curve explained how there was a point where increased taxation brought about diminished tax revenues. This is not a myth. History is littered with examples where tax receipts increased after tax burdens were reduced. Of course, this has a lot to do with tax avoidance. Yet it makes intuitive sense that a tax rate of 100% would squeeze out the private economy. But the natural rate is unknown. Moreover, it is unclear how it changes over the course of history.

Perhaps the accumulation of debt is an indicator of tax potential. The mortgage crisis may simply represent taxes that were too low. Higher taxes may have forced investors to make efficient investments. And that may become the challenge for conservatives in this new generation of efficiency. Do lower taxes produce market efficiencies or do they face diminishing returns?

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