The market already rewards risk-taking—taxes don’t have to

For most of my working life I’ve been a tenured university professor, which means I can’t be fired except for cause. In theory, the powers-that-be could shut down my department or, for that matter, my university. But both events are unlikely. In any case, neither has happened during my four decades at my current job. In short, I have had very secure employment—which has completely suited my highly risk-averse personality.

Being a prof, most of my friends are profs. But over the years, especially the years spent sitting in freezing-cold arenas watching my two boys play organized hockey, I met and became friends with a number of small-business men and women. No, they weren’t all short (which is the image that always comes to my mind when I hear or read about small-business people, usually without the hyphen). Some were quite tall, in fact. But their businesses were small, in the sense of not being household names, except perhaps (some of them) locally, and not being on the FP500 or even 1000. Hearing their stories about what their businesses did and watching them work their cell phones even as their kids were wheeling round the ice, I came to admire their energy and drive.

I also noticed that many of them drove late-model BMWs and Mercedes rather than aging Hondas, as I did, and lived in bigger houses in better parts of town (though I have no complaints about my own living conditions) and often sent their kids to more expensive and probably better schools.

More power to them, was my conclusion. They have riskier jobs (if being an entrepreneur is actually a “job” rather than a vocation). If they don’t deliver, they and their families don’t eat. I would find it hard to live that way but most of them seemed quite happy with that deal and even appeared to enjoy the risks they were called on to take. I don’t begrudge them the extra money they make. They’ve made their choice and I’ve made mine.

But what I’ve just described is a market premium for risk. People who do riskier things make higher incomes, on average. Not all of them. Some risks don’t pan out and the people taking them suffer as a result. But to get people to take these risks, assuming most people prefer less risk to more, their incomes have to be higher on average. (If you’ve got a society of risk-lovers, by contrast, the premium might go the other way: You’d have to pay extra to get people to do risk-free jobs. No one would want to be a professor because it was so b-o-r-i-n-g. But most societies don’t seem to operate that way.)

The risk premium has to be there to get otherwise risk-averse people to take a gamble in activities that don’t offer a sure thing. But so long as labour markets are allowed to adjust, it will be. If there’s no premium, people will line up to become professors. As professorial wages get bid down as a result and the scarcity value of entrepreneurs rises, the premium will open up again and the flow will reverse. That’s all good.

I raise this all in the context of the federal government’s proposal to crack down on tax rules that allow small-business men and women to pay substantially lower taxes both on average and at the margin than apply to us wage-slaves (to use the technical Marxian term). I’m fine with a market income premium for entrepreneurs. But the market produces such a premium already. It exists. There are ample market rewards for entrepreneurship (apart from it possibly being its own reward). Do we really have to add tax advantages on top of that? My entrepreneur friends not only make more money than I do to compensate them for their risk-taking but then they pay less tax than I do, too?

That hardly seems fair.

Nor is it self-evidently mandated by economic efficiency. Tax us both the same—tax us fairly, that is, on the principle that “a buck is a buck is a buck”—and their incomes (after-tax now) will still be greater than mine. True, the tax will create disincentives. But it does that for all of us. And there are very few taxes, if any at all, that don’t involve disincentives, that is, that don’t discourage some activity or other.

Because of the disincentive effects of high taxation and also because lots of public spending is of doubtful benefit, we should certainly have lower taxes all round. But we shouldn’t have lower taxes for some people’s income just because of how they’ve earned it. “Broaden the base, lower the rates,” that’s the tax economist’s mantra, now and forever.