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The Nonsensical Notion of ‘Unearned Income’

The "labor theory of value" used to justify taxing capital gains fails to take into account that investment income is the product of exacting thought and effort.

by
Amit Ghate

Bio

April 17, 2010 - 12:00 am

Last March, in a midnight deal to save union health care plans from taxation, Nancy Pelosi amended the notorious ObamaCare bill to levy a new 3.8% tax on “unearned” income.  In a follow-on PR tour designed to put a positive spin on this disastrous piece of legislation, President Obama lauded the new tax, saying:

Right now, if you’re on salary, … you’re paying your Medicare tax on all of that … it’s part of your FICA. But if you’re Warren Buffett and you get most of your money from dividends and capital gains, you don’t pay Medicare tax on that. You’re eligible for it.  You’re going to get the same Medicare benefits as anybody else. But because your source of income is what’s called unearned income — capital gains and dividends — you don’t have to pay this.

Leave aside the obvious breach of Obama’s campaign promise to not levy new taxes on those earning less than $200,000.  Forget too the Democrat’s Orwellian wordplay in transmuting  a “Medicare tax” into an “unearned income Medicare contribution.” Instead, consider what is meant here by “unearned,” for it reveals much about the Obama/Pelosi worldview — including insights into how to combat it.

The concept of “unearned” income is the remnant of a long-refuted economic theory known as the “labor theory of value.”  Though first proposed by classical economists such as Smith and Ricardo, today it is most closely identified with Karl Marx, who was its last — and most consistent — advocate.

Essentially the labor theory of value holds that values are determined by the (physical) labor it takes to create them. Thus physical exertion becomes the measure of an item’s worth. According to  Marx — and to his modern adherents like Obama, Pelosi et. al. — any values created in ways other than by brute force are “unearned.” (J.S. Mill originally coined the term “unearned increment” to characterize the appreciation of property  “without exertion or sacrifice.”)   So while today’s politicians generally fail to protect the individual’s right to property, they’re openly hostile to so-called “unearned” income and property.  Hence their unabashed support for these new taxes.

But does their Marxist view represent an accurate description of the productive process? Certainly physical labor is often required to convert the raw material of nature into the specific forms we need to live.  Yet increasingly, productivity stems from our abstract knowledge of the world (science) and our imaginative methods of putting this knowledge to use (technology). The value of inventing a transistor or discovering a polio vaccine simply cannot be measured in labor units. But this doesn’t mean that the years of dedication and the unyielding independence of spirit that such accomplishments demand should somehow be discounted. On the contrary: doing so is patently unjust.

To further appreciate the travesty of characterizing certain income as “unearned,” let’s consider where capital gains, dividends, and interest come from. Essentially they’re the product of thoughtfully deployed capital or savings. To obtain them requires many arduous steps, the first of which is to produce more than one consumes. Given today’s consumer mentality, this in itself is something most are unwilling to do. (Note too that in the initial savings phase, income from production is typically taxed, such that future taxes on savings amounts to double taxation.)

For those who manage to save, the next step is to assess the various fields of human endeavor to determine not only what types of production are likely to be profitable in the future, but also what types of people are likely to be dependable and productive.  On the basis of these judgments, savers may elect to risk their savings to either lend to, or invest in, an enterprise. If their assessments aren’t sufficiently cogent or foresightful, their money is in real jeopardy. Not just from fly-by-night operations, but by the very nature of capitalism — where change is ever-present, or in Schumpeter’s terms, where “creative destruction” reigns.  Investing in video rental stores, unionized car companies, or poorly run retailers can cost savers their entire nest egg.

Thus far from being “unearned,” returns on investment are the product of exacting thought and effort. Indeed, given the importance of properly investing and allocating savings, whole professions, e.g., banking and investing, have arisen.

But the labor theory of value, and its false distinction of “unearned” and “earned,” is really just an aspect of a much wider flaw in Marxist ideology — one which so many of our politicians still unthinkingly accept. At root, Marxism is strictly materialistic: it leaves no room for man’s mind. Yet without the mind, Marxists and socialists can’t account for anything beyond the immediate results of physical labor. As a result, they treat modern wealth as some sort of magical occurrence. It has no source, it is not “earned,” and the only question it raises is one of “distribution.”   See today’s economic, social, and tax policies for the consequences.

More importantly still, by denying the role of man’s mind in life, Marxists eschew any need to protect the individual’s right to think for himself. This explains why every Marxist state throughout history has used massive force and indoctrination to achieve its ends.

Though President Obama, Speaker Pelosi, and the rest of our leaders may not be explicit Marxists, unfortunately they still fall sway to Marx’s guiding ideas. If we’re to rescue the country from the damage they’re doing,  it’s this deeper ideology we must challenge.

Amit Ghate began his career as a mechanical engineer but now trades stocks for a living. In his free time, when he’s not rock climbing or at the gym, he writes and maintains his blog Thrutch. He currently resides in Southern California.
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