Stephen Schwarzman — CEO of Blackstone, the fabled private equity firm — lives well. He made the news in 2007 when he staged a $3 million 60th birthday party for himself and several hundred of his closest friends at the Armory on Park Avenue. According to Gawker’s coverage of the event, “Rod Stewart was paid $1 million to perform for the assembled guests; Patti LaBelle sang ‘Happy Birthday.’ And the room was designed to replicate Schwarzman’s $40 million co-op at 740 Park Avenue.”
But Schwarzman believes the government is taking far too much of “his” money. He, like many other superrich people, hates paying taxes.
James Surowiecki, an economics writer for the New Yorker, offered these thoughts on Schwarzman:
He recently grumbled that the U.S. middle class has taken to “blaming wealthy people” for its problems. Previously, he has said that it might be good to raise income taxes on the poor so they had “skin in the game,” and that proposals to repeal the carried-interest tax loophole—€”from which he personally benefits—were akin to the German invasion of Poland.
Surowiecki went on to note that other wealthy executives have been voicing similar complaints. Venture capitalist Tom Perkins and Home Depot co-founder Kenneth Langone, for example, each likened populist criticism of the wealthy to the Nazis’ attacks on the Jews.
Why do so many wealthy drivers continue to favor lower taxes, even knowing that means further degradation of the nation’s infrastructure?
Hatred of taxes by the wealthy has had real consequences. Due in part to lobbying efforts on the part of high earners, for example, top marginal tax rates around the world have gone down dramatically since the 1970s. Rich people paying lower taxes means there’s less money for public investment in infrastructure and education. And less public investment is bad for everyone, including rich people.
In my just-published book about luck and success, I describe a simple theory in which tax resistance by the wealthy is rooted in two garden-variety cognitive errors. One implication of this theory is that it would be a surprisingly simple task to persuade the wealthy to view taxes differently.
Why do rich people hate taxes?
Tax revenue is what we use to pay for public goods and services. Everyone agrees, for example, that cars would be of little use without roads and that roads would be of little use without cars. What’s harder is to identify the best mix of the two categories. It’s fairly easy, however, to see that the current mix in the United States is far from optimal, at least from the perspective of wealthy drivers.
Consider this thought experiment: Which experience would a wealthy car enthusiast prefer — driving a Porsche 911 Turbo (purchase price $150,000) on smooth, well-maintained highways or driving a Ferrari F12 Berlinetta (purchase price $333,000) on roads riddled with foot-deep potholes?
It’s an easy question. Although some car buffs might quibble, I’ll assume for the sake of argument that the Ferrari would be judged the better car if both could be driven on good roads. But it wouldn’t be much better, since the $150,000 Porsche already has most of the design features that affect performance significantly.
The economist’s law of diminishing returns operates here with a vengeance. Beyond a certain point, it reminds us, the cost of achieving additional quality improvements rises very steeply. So if the Ferrari enjoys an edge, it’s at most a tiny one. How, then, could anyone argue with a straight face that it would be more pleasing to drive the Ferrari on pothole-ridden roads than to drive the Porsche on well-maintained ones?
Yet among the super wealthy, the actual quality mix of cars and highways in the United States more closely resembles Ferraris on potholes than Porsches on smooth asphalt. That’s puzzling, since the latter combination could be achieved at much lower total expense.
If most wealthy drivers would prefer driving a $150,000 Porsche 911 Turbo on well-maintained highways to driving a $333,000 Ferrari Berlinetta on pothole-ridden ones, why do so many wealthy drivers continue to favor lower taxes, even knowing that means further degradation of the nation’s infrastructure?
This strange position stems from a combination of two cognitive errors. One is the seemingly plausible, but essentially false, belief that higher taxes would make it significantly harder for wealthy people to buy what they want. The other is the tendency for them to underestimate the importance of luck in their own lives. Both errors make it more difficult to perceive and appreciate the possible attractions of high-quality public services financed by higher taxes.
Cognitive error 1: Rich people think higher taxes make it harder to buy desirable things
The first error was on vivid display during a lunchtime conversation several years ago with one of my colleagues. When he asked whether I’d heard about all the new taxes that President Barack Obama had in store for us and I said that I hadn’t, he expressed shock at my ignorance. I explained that it just didn’t make sense for people like us to worry about such things.
When he asked why, I began by confirming that he agreed with me that there was no chance the government would enact tax changes that would threaten our ability to buy what we needed. (He and I are both authors of widely adopted textbooks, which in a town like Ithaca means we don’t spend nearly as much as we earn.)
I then asked whether he was worried that higher taxes would make us less able to buy what we wanted. Yes, that was exactly his worry! But since all our basic needs have already been met, the kinds of things that people like us want are mostly things that there aren’t enough of — say, a house with a commanding view of the lake, or a choice slip at the marina.
When attempting to assess how higher taxes might affect his ability to acquire such things, my colleague was probably employing a common cognitive rule of thumb known as the availability heuristic, which says that you make judgments about an event’s effect by trying to summon relevant examples from memory.
When smart, hardworking people strike it rich, the availability heuristic leads them to ascribe their success to hard work and talent alone
If tax increases occurred frequently, people would try to assess their effects by trying to recall how they’d felt when taxes had risen earlier. But the extreme infrequency of tax changes makes that strategy impractical. So when people try to imagine how they’d be affected by higher taxes, they probably try to recall how they felt on earlier occasions when they had experienced income reductions.
But most of the income declines that people actually experience — whether from the loss of a job or a divorce or a business reverse or a home fire — are losses that affect only them. So the availability heuristic leads people to think that tax increases will have effects similar to those other income losses. That’s misleading because a tax increase reduces not only your income but also the incomes of others like you.
If you lose your job, you really are less able to bid successfully for a home with a view. But when everyone’s disposable income declines — as happens when taxes rise — it’s a totally different story. The special things that prosperous people want are generally things that there aren’t enough of. To get them, we must outbid other people like us who also want them, people with similar tastes and incomes. So if the government raises our taxes, the taxes of those other people go up, too. And that leaves the bidding wars that determine who gets the things we want essentially unaffected. The best home sites and marina slips go to the same people as before.
In short, the effects of a decline in any one person’s after-tax income are dramatically different from those of an across-the-board decline. If you alone experience an income decline, you’re less able to buy what you want. But when everyone’s income declines simultaneously, relative purchasing power is unaffected. And it’s relative purchasing power that determines who gets things that are in short supply.
Cognitive error 2: Rich people don’t appreciate how lucky they are
Like the failure to appreciate the distinction between unilateral and across-the-board income declines, underestimating the importance of luck is also a totally understandable tendency. When smart, hardworking people strike it rich, the availability heuristic leads them to ascribe their success to talent and hard work alone.
Most highly successful people are very talented and hardworking, after all, and when they construct the narratives of their own lives, the most readily available memories are the difficult problems they’ve been solving every day for decades. Less salient are the sporadic external events that also invariably matter, like the mentor who helped you during a rough patch in 11th grade or the promotion you got because a more qualified colleague had to turn it down to care for an ill spouse.
Evidence suggests that failure to recognize luck’s role in success increases tax resistance by reinforcing the natural sense of entitlement to income produced by the fruits of one’s own labor. As the 17th-century British philosopher John Locke wrote, “Every man has a property in his own person. This nobody has any right to but himself. The labour of his body, and the work of his hands, we may say, are properly his.” With these words, Locke became the patron saint of tax resisters around the world.
This sense of entitlement to the fruits of one’s labors may owe much to the phenomenon known as loss aversion. One of the most reliable findings in behavioral economics, loss aversion refers to the fact that people will fight much harder to avoid a loss than they would to achieve a gain of the same amount. Since most successful people work extremely hard for the money they earn, it feels like they own it, and that makes taxation feel like theft.
But equating taxation and theft is difficult to defend. A country without taxes couldn’t field an army, after all, and would soon be overrun by a country that had one. Its residents would then have to pay taxes to that country. A country without mandatory taxation is the political analog of a highly unstable isotope in chemistry.
The philosophers Liam Murphy and Thomas Nagel have argued that there has never been any presumption that citizens are morally entitled to keep their entire pretax incomes. Governments provide services that citizens value, and those services must be paid for. Elected legislators in any democracy vote on what the tax rates should be, and citizens are then entitled to keep only their post-tax incomes.
It goes without saying that few people actually enjoy paying taxes. Yet a world without taxes would be demonstrably worse.
With tens of millions of baby boomers slated to enter retirement during the coming years, fiscal experts warn that we will not be able to balance our budgets and make essential investments going forward without substantial new revenue. And since most of the income gains during the past four decades have accrued to those atop the earnings ladder, most of that revenue would have to come from the wealthy. As Willie Sutton was said to have responded when asked why he robbed banks, “That’s where the money is.”
The wealthy are poised to resist. Schwarzman and others have been channeling vast sums to political action committees that lobby for still lower top tax rates and even less strict business regulation. And their political power to achieve these aims has increased significantly in the wake of recent campaign finance rulings by the Supreme Court.
The result has been a systemic positive feedback loop of the sort that explains many instances of market success at the individual level. People succeed on a spectacular scale, then use some of their gains to win more favorable tax and regulatory treatment, which increases their wealth still further, enabling them to buy even more favorable treatment, and so on.
One solution: a clearer understanding of how little higher taxes would harm the wealthy
Because positive feedback processes gather steam over time, it’s easy for those who favor change to lose hope. But just as hopelessness makes it more difficult to surmount obstacles along individual paths to success, it also inhibits social change. So it’s important for advocates of change not to lose hope, provided any reasonable grounds for hope remain.
As President Richard Nixon’s chief economist Herb Stein once famously remarked, “If something cannot go on forever, it will stop.” But what, exactly, could stop a process that grows steadily more powerful over time? The answer is an opposing process that also grows steadily more powerful over time.
Those lobbying for lower taxes and less stringent regulation are unlikely to change their behavior in response to appeals on behalf of society as a whole. Most of them no doubt sincerely believe that their own interests coincide with society’s. Yet compelling evidence suggests that our current patterns of private and public spending have been deeply counterproductive, not just for poor and middle-income families but also for the wealthy themselves.
If the wealthy were exposed to this evidence, many would find it convincing. Fundamental policy change would surely become a much easier sell if more wealthy people realized how poorly current arrangements serve their interests.
An experience some years ago persuaded me that even small shifts in cognitive framing can dramatically transform how people think about such things. During a sabbatical year my family and I spent in Paris, our youngest son, Hayden, came home from school one afternoon in a state of high agitation. He’d been given an avertissement, or disciplinary notice, for something he hadn’t done. A playground supervisor had complained that a student had shouted an obscenity at him, but since the supervisor couldn’t identify the specific offender, he’d simply filed charges against every student playing nearby, a group that included Hayden.
I’ve seen even brief discussions of the link between success and luck temper the outrage many wealthy people feel about taxes
Insisting that he’d done nothing wrong, Hayden thought we should demand a hearing. But when I made a few inquiries, I learned that receiving a single avertissement from the school had absolutely no consequences. A notice mattered only for students who had already received three previous ones during the same school year.
I then told Hayden that the French system simply handled things differently than what we were used to at home. I reminded him that even a detailed investigation of the episode wouldn’t guarantee that the authorities would get all the facts right.
He seemed to accept that the French system would settle things justly most of the time, since students who got four disciplinary notices in a single year had probably done something wrong. Applying that new cognitive frame to the problem completely defused his moral outrage.
In similar fashion, I’ve seen even brief discussions of the link between success and luck temper the outrage many wealthy people feel about taxes. At an intuitive level, it’s not puzzling that successful citizens like Schwarzman might view mandatory taxation as unjustified confiscation of what’s rightfully theirs. But extensive public investment was an essential precondition for the economic prosperity of those very same tax protesters, and we can’t have public investment without taxes.
Sensible views about taxes or any other subject do not reliably triumph over less sensible ones in the short run. But we should all take comfort in the fact that the long-run historical narrative bends toward truth. One reason is that when evidence for a particular view becomes compelling, the number of people who embrace it tends to snowball. Beliefs are contagious.
Public opinion shifts one conversation at a time. In my own recent conversations with highly successful people, I’ve seen opinions change on the spot. Many who seem never to have considered the possibility that their success stemmed from factors other than their own talent and effort are often surprisingly willing to rethink. In many instances, even brief reflection stimulates them to recall specific examples of good breaks they’ve enjoyed along the way.
So I hope you’ll talk with your friends about their experiences with luck. In the process, you may persuade them to support a more ambitious program of public investment. But even if not, you’ll almost surely hear some interesting stories.
For example, a college classmate with whom I recently shared a draft copy of Success and Luck sent me this:
You may not know that I was struck by lightning back in ’85 and was really dead. (It fades to black, with no lights, music, or angels.) If there hadn’t been a man there with CPR and leadership skills, I wouldn’t be here. Also, as a small child I ran in front of a 1940 car on main street in Jemison, Alabama. The driver never did see me, so I was hit right in the chest by the bumper. Fortunately, the blow caused my arms to reflexively wrap around the upright member that cars of that era always had. That allowed me to be dragged along without being thrown under the wheels. People on the street saw what happened and chased the driver to get him stopped.
This friend is a highly successful entrepreneur who has always been deeply skeptical about government. Lately, however, he has become refreshingly more willing to talk about specific public investments that he might be able to support.
Robert H. Frank is the Henrietta Johnson Louis professor of management and professor of Economics at Cornell’s Johnson Graduate School of Management and the co-director of the Paduano Seminar in business ethics at NYU’s Stern School of Business. His latest book is Success and Luck: Good Fortune and the Myth of the Meritocracy. Follow him on Twitter @econnaturalist.
Excerpted from Success and Luck: Good Fortune and the Myth of Meritocracy by Robert H. Frank. © 2016 Robert H. Frank. Published by Princeton University Press. Reprinted by permission.
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