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By George P. Brockway, originally published September 9, 1988

1988-9-9 George Bush's New Trojan Horse title

GEORGE [H.W.] BUSH has the distinction of introducing the only tax issue into this fall’s Presidential campaign.

For anyone whose interest in government or economics goes beyond personalities, taxes are endlessly fascinating. The power to tax is the power to destroy – and also the power to create. It is a sign of the shallowness of our society that the eyes of so many people of all ages and both sexes glaze over when the subject comes up. It is a sign of the shallowness of Bush’s understanding – or the deviousness of his intentions – that he wants to upset one of the best features of the 1986 tax law, which treats capital gains as ordinary income. He wants to tax them at 15 per cent – the lowest rate since the grand Depression days of Herbert Hoover.

A tax – the StampTax – crystallized the colonists’ dissatisfaction with England and led to the American Revolution. Another tax – the so-called Tariff of Abominations – led to the nullification crisis of 1832, and ultimately to the American Civil War. In both cases much more than taxes was involved; yet taxes were central issues in the great wars that made and preserved our nation.

Taxation can serve one or both of two purposes: It can raise revenue to pay the costs of government, and it can encourage or discourage various activities. The Revolution was fought (in part) because the Stamp Tax did the former, the Civil War (in part) because the tariff did the latter. In 1767, John Dickinson wrote in the second of his Letters from a Farmer in Pennsylvania that before the Stamp Tax, taxes “were always imposed with design to restrain the commerce of one part that was injurious to another, and thus promote the general welfare. The raising of a revenue thereby was never intended.” In contast, in 1832, South Carolina passed its Ordinance of Secession that denounced the tariff because of “bounties to classes and individuals … at the expense of other classes and individuals,” and espoused the theory of taxation for revenue only.

A more general theory appears in Alexander Hamilton‘s classic Report on Manufactures (1791): “[T]he power to raise money is plenary[1] and indefinite, and the objects to which it may be appropriated are no less comprehensive than the payment of the public debt, and the providing for the common defense and general welfare.”

All three of these theories are involved in Bush’s tender concern for capital gains. Of the three, he has pushed most strongly the one dealing with revenue. In this he is supported by Treasury Department Research Paper No. 8801, “The Direct Revenue Effects of Capital Gains Taxation, which argues that a lower rate brings in higher revenues. There are opposing views, specifically those of the Joint Committee on Taxation and the Congressional Budget Office. And much private ink has been spilt on both sides.

On one level, the question is an extreme case of that raised by the Laffer Curve, and of Peter Peterson‘s claim that the rich pay more taxes when the rate is lower (see “In for a Penny, In for a Pound,” NL, June 13). The case is extreme because Bush’s proposal would cut the capital gains rate roughly in half, requiring capital gains “realizations” to double just to keep revenues running in the same place.

The latest figures the Treasury research paper gives us to work with are those of 1985, when the marginal rate was 20 per cent, capital gains realizations were about $169 billion, and the revenue raised was about $24 billion. Since 20 per cent of$169 billion would be almost $34 billion instead of $24 billion, it is obvious that the capital gains tax, even though admittedly mostly falling on the superrich, was paid by many whose Adjusted Gross Income was less than the $175,251 then needed to boost a married couple into the top bracket. Obviously, too, once the new tax law settles down and a married couple with an Adjusted Gross Income of $29,751 finds themselves in the top bracket (28 per cent), practically everyone with any capital gains will be paying the top rate.

Neither you nor I nor even George Bush knows what the future will bring. It is probable that realizations were up in 1986 and down in 1987. A large part of what was realized in 1986 (including everything I cashed in) was in anticipation of 1987’s higher rates, while a large part of what was realized in 1987 was losses in the stock market’s Oktoberfest (me, too). It is likely that realizations this year will be greater. No matter: For Bush’s scheme to work, they must more than double what they otherwise would be. The question I ask is: Do we want that to happen?

To answer that question we have to look at where capital gains come from. They come about in two ways: (1) a company retains and reinvests its income instead of paying it out in dividends, thus increasing its net worth and, presumably, the market value of its shares; or (2) goods (especially real estate and works of art) increase in value because of market shifts or inflation, thus tending to lock holders into property they might otherwise have wanted to sell. It is received doctrine that the first method should be encouraged, and that adverse personal consequences of the second should be mitigated; hence the special treatment of capital gains. In Britain, and generally on the Continent, they are not taxed at all, making George Bush more moderate than he may find congenial.

A company that reinvests its income grows. The more companies grow, the more the economy grows: more goods, more jobs, more profits. Assuming that for a given company expansion makes sense, the necessary capital can be raised by borrowing, by selling new shares of stock, or by retaining earnings. Interest payments on borrowings are a deductible business expense, while dividends on stock are not. On the other hand, interest payments are a fixed expense, while dividends, again, are not. Balancing the foregoing considerations, a fairly prudent and sanguine management will opt for borrowing, but a company that can satisfy its stockholders with capital gains will enjoy the best of both worlds by relying on its retained earnings.

In addition, it is said that the possibility of capital gains attracts both entrepreneurs and investors to new businesses, which are the economy’s hope for the future.

Since retained earnings are rarely enough to do the job for a rapidly growing concern, its real choice is between issuing new stock and shouldering new loans. There would be no problem at all if interest payments were not a deductible business expense. The 1986 tax law has partially eliminated it as a personal deduction. I’ve made the case for eliminating it for business, too (see, “A Tax Increase by Any Other Name,” NL, November 24, 1984[2]) and shall only outline it here. In brief, the deduction, although it seems to subsidize the borrower, in fact subsidizes the lender. Without the subsidy, interest rates would have to fall, because few could afford the raw rate.

Moreover, the subsidy is meaningful only to an already profitable company, given that a new enterprise typically operates at a loss for some time and can’t afford to borrow at all. It has no net income from which to deduct the interest expense, and therefore has to pay the usurious raw rate on whatever it borrows. In sum, if you want to encourage new enterprise, you will eliminate the deduction for interest expense and will consider the treatment of capital gains more important for personal than for business finance.

DOES IT, then, make sense to encourage individuals to seek capital gains twice as eagerly as they seek earned income? What is actually encouraged, of course, is wheeling and dealing. It is not impossible that some good enterprises are thus sponsored that would not have been undertaken otherwise; but it is quite certain that wheeling and dealing raises the cost of capital for all enterprises, new and old, good, bad and indifferent. It is also certain that, whatever the ills we have recently been suffering, they were not caused by a lack of wheeling and dealing.

Finally, it is urged that capital gains are, for most individuals, an unexpected and even unwanted consequence of inflation. The house you bought for $100,000 five years ago can be sold for $200,000 today, which is dandy. But you have to have some place to live, and an equivalent new place will cost an equivalent number of dollars, or $200,000. An ordinary tax on your capital gain (28 per cent under the new law) would leave you $28,000 poorer than you’d have been if you hadn’t moved. Bush would leave you $15,000 poorer, and that is better, but not great. (There are, to be sure, special ways to handle this special problem, and some of them are embodied in the present law.)

Any attempt to offset the general effects of inflation, however, winds up by encouraging it. Conservatives of Bush’s school colors are quick to see that wage increases tied to the cost of living are inflationary. The same is true of capital increases. As a matter of fact, capital increases are even more inflationary for reasons we’ve previously discussed (see “Vale, Volcker,” NL, June 1-15, 1987). The very possibility of capital gains stimulates the frenetic search for more of them; it’s easier than working.

Indeed, it is precisely this frenzy that Bush wants to stimulate. As the Treasury has told us, capital gains realizations in 1985 were $169 billion. On the same realizations, the present rate of 28 per cent would yield $47 billion, and Bush’s rate of 15 per cent would yield $25 billion. For Bush to bring in more revenues than the present rate, he would have to push realizations beyond $340 billion, or more than twice the highest they’ve ever been before.

Since 1966, capital gains realizations have steadily increased, from $31 billion ($67 billion in 1985 dollars) to the present. It happens that, as Professor Hyman P. Minsky points out in his recent book Stabilizing an Unstable Economy, since 1966 “the American economy has intermittently exhibited pervasive instability.” While not necessarily conclusive, the association of these facts is at least suggestive, especially when you remember that instability is another name for the volatility that comes with wheeling and dealing.

Bush deserves a good mark for daring to talk about taxes. But he has offered us another Trojan Horse to make the rich richer. Let’s suppose he succeeds and manages to boost capital gains realizations to $340 billion. Then the after-tax income from capital gains would leap to $289 billion-more than double that of any previous year. As we said in discussing Peter Peterson’s ideas of taxation, this is the way multimillionaires are made.

The New Leader


[1]complete in every respect:  absolute, unqualified

[2] Editor’s note:  The name of this article in print is “The Bottom Line on Tax Reform.” From time-to-time the New Leader replaced the author’s title with another.  This is one case.

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By George P. Brockway, originally published June 13, 1988

1988-6-13 In For a Penny, In For a Pound Title

 

                LAST OCTOBER, just before the stock market crash, one Peter G. Peterson had an article in the Atlantic that caused a lot of talk on commuter trains. Peterson was President Nixon’s Secretary of Commerce in 1972. He astutely left the Cabinet the following year, and since has been an investment banker as well as a tireless agitator in the press and on TV. He was as responsible as anyone for the 1983 boost in Social Security taxes and the partial tax on Social Security benefits. He continues to talk darkly about “entitlements,” to warn that universal medical care will be the death of us, and to plead for a tax on consumption.

After reading Peterson’s article, I started to do a column on what’s wrong with it, but it would have taken a year’s worth of this space. One sentence has nevertheless kept nagging at me. I quote: “We now know, for instance, that a maximum tax of 50 per cent actually generates more revenue from the wealthy than a maximum rate of 70 per cent, and provides real incentives for budding entrepreneurs.” This claim was in furtherance of the claim that it would be a mistake to ask the wealthy to pay for their share of the deficit. It calls to mind an Artemus Ward saying I have cited before: It ain’t so much the things we don’t know that get us in trouble. It’s the things we know that ain’t so.

By an aberration of my W. C. Fields like filing system, I can lay my hands on one, but only one, set of old tax instructions. We can make do, however; it’s the top bracket Peterson is talking about, so we’ll talk about that too. When we mention the incomes of the wealthy, we’ll mean just the part of their incomes that is taxed at the top rate-70 per cent or 50 per cent, as the case may be.

It will be convenient to have a standard of wealth. Peterson doesn’t give one, but let’s guess that to count as wealthy in his book, one has to have $200,000 in the top bracket.

We also need some ground rules. I’ll name two: (1) The differences we’re going to consider will not have anything to do with tax shelters, because Peterson speaks only about the tax rate, and anyhow shelters are greatly restricted by the new law; and (2) inflation won’t have anything to do with our calculations either. We want a level playing field, as the Wall Street Journal would say.

Now, as I read Peterson, he seems to be saying that if you take all the $200,000-and-up incomes as above defined, add them together, and tax them at 50 per cent, you will collect more taxes than you would if you taxed them at 70 per cent. That’s too preposterous for anyone to believe; surely Peterson must have meant something else. Let’s explore the possibilities, for he seems to think he’s hit upon a great social truth.

We’ll start with a little algebra. We will call x the amount taxed at 70 per cent, and y the amount taxed at 50 per cent. Then if taxes paid in the two years are equal, our equation would be .7Ox = .50y. Solving the equation for y, we have y = .70x/.50, or l.4x. In other words, the amount taxed at 50 per cent would have to be at least two-fifths greater than the amount taxed at 70 per cent.

The mathematics is unimpeachable, but perhaps Peterson is focusing on something different. Low rates are often said to take the incentive out of cheating on taxes. I’m no economic determinist, so I don’t hold with that. Indeed, in spite of recent studies funded by the IRS, I’ll stand right up and say that half of the wealthy taxpayers are honest. And why not? As the chorus sings in Iolanthe, “Hearts just as pure and fair/May beat in Belgrave Square/ As in the lowly air/Of Seven Dials.” Then for every honest wealthy taxpayer who reported an income of $200,000 in both years, there would have to have been a wealthy cheat whose income was really $360,000, who didn’t report $160,000 of it when the rate was 70 per cent, but who cheerfully reported it all when the rate fell. In that way, the wealthy as a class would report 1.4 times as much at the lower rate as at the higher, and the total taxes paid by them would remain the same.

Is Mr. Peterson telling us that many of the wealthy are dishonest? And if he believes that, does he believe the cheaters would suddenly become honest once the marginal rate dropped? Having spent even a year in Nixon’s Cabinet, he can’t believe that. To quote Iolanthe again: “In for a penny, in for a pound.”

Let’s try another approach. It has been said at least since the New Deal days that high taxes sap the incentive of producers to produce. After a certain point, they are supposed to get tired of working for Uncle Sam; so they quit working, or maybe take longer lunch hours. This is thought to be bad for everyone because these people are, by definition anyway, the most productive among us. We should try to get them working again by allowing them to hold on to more of what they get their hands on.

To keep a level playing field, we’ll consider only what is called earned income, for increased interest or dividends or rents would go also to remittance men, who know nothing of incentives since they do nothing anyhow. To be sure, our big- time producers are used to getting much of their income from stock options and such, but the 1986 law, by taxing capital gains as ordinary income, has largely eliminated that particular incentive.

Although the morals are slightly different, the mathematics of the incentive argument is the same as the mathematics of the cheating argument. So I ask: Does Peterson mean that our can-do people will increase their doings by 40 per cent just because the tax rate has been cut? Does he want us to believe that they’re doing whatever it is they do without half trying? Does he think it honorable of them to have done this (quoting Iolanthe yet again) “By taking a fee with a grin on [their] face/When [they] haven’t been there to attend to the case”? Or put it this way: If they lack incentive to do what they’re supposed to, why don’t they get out of the way and let someone else do it?

Well, I’ll make another guess at what Mr. Peterson meant. Maybe he’s saying the incentive of a lowered tax rate will boost thousands of people from the $150,000 class to the $200,000 class, which would now have more members and consequently a higher total income.

This explanation is more plausible than the others, and there actually was a highly unrepresentative sample of its possible effect in the sports pages of the Times the other day. Last year, when the tax on the wealthy was, well, too complicated for me to explain, there were five ballplayers with annual wages in excess of $2 million. This year, when the rate is somehow lower, there are 10 in the golden circle. With twice as many making $2 million, their rate could fall in half, and the total taxes paid by those poor chaps would remain about the same. Is this what Mr. Peterson meant?

If so, he didn’t mean much. The five new boys were all making well over a million last year; so it took only raises of a few hundred thousand to double the number of players in the $2 million bracket and thus double the taxes paid by the superstars. This is what is known, among less exalted players, as bracket creep and is mostly due to inflation, which we agreed to rake out of our playing field.

BUT IT DOESN’T really make any difference what reason Peterson gives for the behavior of the wealthy. The fact remains that if they paid more taxes after a 50 per cent rate than they did after a 70 per cent rate, their marginal-rate income had somehow to go up at least 40 per cent. A $200,000 income taxed at 70 per cent had to become at least $280,000 taxed at 50 per cent. And that’s not all. Their pretax income went up at least 40 per cent. But their after-tax income jumped 233 per cent, from $60,000 to $140,000 (and under the new tax law will jump again -to $190,000 or more).

Peterson is a great sleight-of-hand artist. He wants us to keep our eyes on the taxes paid, and not notice the jump in disposable income. This is the way multimillionaires are made. As the tax rate was cut, there came a great leap forward of executive salaries and perks, of lawyers’ fees and doctors’ fees, of tax shelters and arbitrage deals, of interest rates and capital gains. These leaps account for the tax collections Peterson celebrates. There weren’t any million dollar-a-year ballplayers before the cut, and few others with that kind of income. By 1985 (the latest figures in Statistical Abstract of the United States) there were some 17,000 Americans in that fast-growing class. As Phil Rizzuto would say, that’s not too shabby.

On another level, it’s very shabby indeed. For if Peterson is right in his figures even though vague in his reasons, the maxitax cuts gave enormous gifts to the wealthy and nibbled away at the incomes of everyone else. Now, I’m going to throw a lot of figures at you to show you what’s happened in the past 10 years, and I beg you to be careful how you use them. They come from Economic Report of the President, 1988. Some are in 1986 dollars, some in 1977 dollars, and some in current dollars, but within each category the figures are comparable.

First, remember the poor. In 1977 there were 5.3 million families, or 31.7 million people, living in poverty. By 1986, the numbers had risen to 7 million and 34.6 million, respectively.

Next, look at average weekly nonagricultural, nonsupervisory earnings (1977 dollars). In 1977 they were $189.00 and had fallen to $169.28 by 1987. The average annual earnings of the lucky ones who worked a 52-week year were $9,828 and $8,802, respectively. The 1977 figure was slightly above the poverty level, the 1987 figure considerably below it. Of course, those who didn’t work full time didn’t do so well.

Then consider the median family income (1986 dollars). This was marginally up, from $28,966 in 1977 to $29,458 in 1986 (latest figures available). Note that a two-earner family, working full time, wouldn’t come close. Finally, consider the after-tax income of the median families (this is where the wealthy shone like burnished gold). In 1986 dollars it fell, from $25,443 in 1977 to $24,095 in 1986. When you include the increase in Social Security taxes (largely engineered, as aforesaid, by Peterson), the fall was much greater.

In short, from 1977 to 1986, poverty was up a third; weekly earnings were down 10.4 per cent; the median income was up 1.7 percent; but the after-tax income of the median family was down 5.3 per cent. And the after-tax incomes of the wealthy more than doubled. This is what Peterson and his ilk are fighting for. They profess to be very worried about the deficit and are ready even to admit that it grew because of the tax cuts. But they don’t propose to give up those cuts. No, they want us to put all that behind us. They want us to look ahead to a sales tax (which they call a consumption tax), because such a tax falls very little on them but very much on the middle class, especially the lower middle class, and on the poor.

I think these people know very well what they do.

The New Leader

By George P. Brockway, originally published October  5, 1987

1987-10-5 Of Deficits and Taxes Title

ANOTHER BUDGET deadline has come and gone and that old devil deficit is still there. What can we do about it? First, we had better consider briefly what would happen if Gramm-Rudman- Hollings were successful in getting the annual deficit down to zero. For we’d have a crashing depression, that’s what would happen. Whether the miracle were achieved by reducing military expenditures or by cutting off the poor or by raising taxes or by all three, somehow $160 billion (more or less) would be abstracted from the economy.

Actually, “abstracted” is the wrong word. The $160 billion would not be taken from the spendthrift government and put in your thrifty pocket to be used in a more propitious time. No, all that lovely money would not exist. Moreover, the possibility of its existence would be gone forever, and with it the goods and services the money might have bought, plus the goods and services that might have been bought by those who would have earned money by producing the first lot, and so on ad infinitum. R.F. Kahn‘s multiplier works both ways.

Or look at it this way: One hundred and sixty billion dollars is about 4 per cent of our gross national product. The average fall in GNP for depressions since World War I has been about 6 per cent. The possibility is more ominous when you consider the unemployment rate. In 1929, the rate was 3.2 per cent. Today, it is officially stated to be 5.9 per cent-and this counts part timers as fully employed, and doesn’t count at all those who are too discouraged to look for work. In other words, we have a head start on any depression we decide to bring about.

Mention of unemployment reminds us of the real point: The vice of depression is not the loss of potential goods and services but the loss of jobs and self-respect. No one can spend much time in the labyrinths of a shopping mall without concluding that we already have more goods and (perhaps) services than we-literally-know what to do with. Our basest beggars are in the poorest thing superfluous. Personal dignity and self-respect depend on the right to contribute to the common wealth. Even without a depression too many of us are denied that right. We are all demeaned by that denial.

Does this mean we are doomed to run deficits forever? Won’t all that debt bring double-digit inflation back again? And isn’t it irresponsible to pass on to our children the consequences of our fecklessness?

When you look at the record, you wonder how these staples of campaign oratory and editorial punditry get taken seriously. In 1980, the deficit was $73.8 billion (or 2.7 percent of GNP), and the gross Federal debt was $914.3 billion (or 33.47 per cent of GNP); the inflation rate was 12.4 per cent. Last year the deficit was $220.7 billion (or 5.2 per cent of GNP), and the gross Federal debt was $2,132.9 billion (or 50.68 per cent of GNP); the inflation rate was 1.1 per cent. There is no way these figures can be tortured to support the claim that a deficit causes inflation (see editor’s chart below).

1987-10-5 Of Deficits and Taxes Editor's Chart of 1980 - 1986 data

Well, the states balance their budgets, so why can’t the Federal government? Of course, it could-provided we accepted one of two outcomes: Either private businesses and private individuals would have to increase their indebtedness to match the Federal decline, or we would have to have that depression. The reason for this is simple: The flip side of debt is credit, and credit is money. (If you want to be fussy: not all credit is money, but all money is credit.) Without debt, no credit; without credit, no money; without money, no business. That’s the way the capitalist system works. That’s the golden-egg-laying goose that myopic conservatives want to kill.

But what about our children and theirs? As Keynes observed, it is no favor to our children to neglect our natural and civic and domestic environments and thus save our children from the perils of indebtedness in their adulthood at the expense of forcing them to spend their childhood in squalor.

The foregoing merely suggests ways in which the anti-indebtedness argument is false. It does not claim that the present is the best of all possible worlds, that the level of our current deficit is exactly right, that we might not better buy different things with our money, or that we might not do better by financing the deficit differently.

Let it be said at once that the appropriate level of the deficit is a matter of trial and error. In spite of the most sophisticated programs run on the most powerful computers, Pandora’s box remains closed to us. Consequently, to say that we can fine tune the economy is an exaggeration. It is, however, a fact that we have, in the record of the past 40 years, proof that some kind of tuning can have significant results.

This brings us to the probability that at some time-perhaps tomorrow, perhaps the day after-we may want to tinker with the new tax law we hailed so proudly only yesterday. We may, in any case, want to remind ourselves that taxation is not necessarily for revenue only. Attending a debate in the Academy of Laputa[1],  Lemuel Gulliver was struck by a proposal “to tax those qualities of body and mind for which men chiefly value themselves …. The highest tax was upon men who are the greatest favorites of the other sex; and the assessments according to the number and nature of the favors they have received, for which they are allowed to be their own vouchers …. But, as to honor, justice, wisdom and learning, they should not be taxed at all; because they are qualifications of so singular a kind that no man will allow them in his neighbor, or value them in himself.”

That excellently bitter proposal is not explored in the 291-page Description of Possible Options to Increase Revenuesrecently prepared by the staff of the Joint Committee on Taxation with the staff of the Committee on Ways and Means. Part I examines what it discreetly calls” Revenue Areas [it would be lese majeste to call them tax increases] Addressed by the President’s 1988 Budget Proposals.” Adopting all of them would increase 1988 revenues by about $3.7 billion-scarcely noticeable in the shadow of a $160 billion deficit. Part II, taking up the document’s remaining 257 pages, examines “Other Possible Revenue Options,” most, if not all, having been suggested by members of the Committee on Ways and Means. These naturally reflect the various members’ interests and capabilities, and many are nutty (as are some of the President’s), while others are politically impossible, at least for now. Though it is likely that, as a whole, they exceed the magic $160 billion goal, there is no point in adding them up because many of them would work at cross purposes, and because nowhere in the pamphlet is there a discussion of the leading weakness of the 1986 tax law.

This weakness is the almost complete abandonment of progressivity. The great strength in the new law is that the grossest shelters were blown down. But, as is well told in Showdown at Gucci Gulch by Jeffrey H. Birnbaum and Alan S. Murray, the Senate Finance Committee grudgingly accepted the strength in order to achieve the weakness.

The attack on progressivity has been going on for several years. It was not so long ago that the top bracket in the personal income tax was 85 per cent. Then it was reduced to 50 per cent on “earned income.” Then to 50 per cent on all income, except for capital gains, which were taxed up to 35 per cent. Then capital gains were dropped back to 20 per cent. And now the top rate is 28 per cent across the board, with a complicated proviso that need not be of concern to you unless your taxable income exceeds $200,000. (The proviso, allowing for certain deductions at the lowest rather than at the highest rate, was one of the few good ideas of the original Bradley-Gephardt proposal. See “A Cautionary Tale of Tax Reform,” NL, January 27,1984.)

HOPE OF CHANGING the tax law’s rate of progressivity was abandoned by everyone who entered the Congressional conference rooms. It was insisted from the start-by Bradley-Gephardt in 1983 as well as by Reagan- Regan in 1986- that a reformed tax law would be revenue neutral. This shibboleth meant not merely that the total revenue raised under the new law would be the same as that under the old, but also that the various quintiles of income recipients would pay the same proportions of the total tax under both laws. An exception was that certain of the poorest of the poor, who had been added to the rolls in the reactionary surge of 1981-82, would now be dropped again.

The new law is certainly better than the old in that whatever is unreasonable or unjust in it is plainly stated rather than shoddily sheltered. But that is not to say it is more reasonable or just. It may, in fact, lead to greater injustice. It is probable that throughout the corporate world executives will demonstrate an increased eagerness for high salaries because they will be able to keep a higher proportion of them. It is probable, too, that the kind of investment banking that leads to raids and takeovers and greenmail will be stimulated, and that so will the securities and commodities and futures markets. It is even probable that the changes in the corporation tax will encourage many companies to increase executive perks, on the ground that the tax collector would get the money if it weren’t spent on limousines and Lear jets.

It will be noticed that the foregoing probabilities are to some degree contradictory. It is something of a paradox that lower personal and higher corporate taxes can be expected to result in both higher executive salaries and perks as well as higher winnings from speculating in the securities of the companies whose earnings are reduced by paying the salaries and perks.

This can happen all at once through an accentuation of the polarization of the American economy. The rich can become richer by keeping the poor in their place and by pushing more of the middle class down to join them. The trend can continue for a damnably long time without arousing much political reaction. The possibility of an economic reaction is more immediate. As Jean Baptiste Say, in one of his acuter moments, wrote, “There is nothing to be got by dealing with people who have nothing to pay.”

Our economy is bad because our morale is bad. For too many years, greed has been admired in high places and doing good has been sneered at. A steeply progressive income tax would be a sign of a shift in morale-which would be far more important than whatever increased revenue might be raised, and vastly more important than the size of the deficit.

The New Leader


[1] Readers with a bent for trivia may recall that one of the targets of Major Kong’s B-52 in the movie “Dr. Strangelove” was Laputa. According to IMDb, “Major Kong’s plane’s primary target, is an ICBM complex at Laputa. In Jonathan Swift‘s 1726 novel ‘Gulliver’s Travels’, Laputa is a place inhabited by caricatures of scientific researchers.”

Originally published September 9, 1985

 

As I WRITE, the great deficit debate is out of the headlines, and it may still be out when you read this. The news of the fall season is tax reform, and a determined effort is being made to separate the two issues. In a more rational world, one might expect taxes and the deficit to be intimately related, but in the lame-duck Presidency of Ronald Reagan the sloganeering calls for a “revenue-neutral” tax bill. Though convinced that the Republic hangs in the balance because the deficit doesn’t, even the Senate Majority Leader, Bob Dole of Kansas (perhaps reflecting on what happened last November to Fritz Mondale’s campaign for fiscal responsibility), is muting his austere determination to raise some taxes somehow.

It would be a mistake to consider the deficit merely a nuisance. It will continue to pop in and out of the news because it has us in what Gregory Bateson termed a “double bind.” Our situation is not so obvious as the classic example (“Have you stopped beating your wife?”); nonetheless, it is binding. If we do something effective about the deficit (such as raising taxes or cutting expenses across the board), we will almost certainly turn the current” growth correction” into a full-fledged depression. If we don’t do anything effective about the deficit, we will almost certainly induce a rate of inflation (and, probably, stagflation) far worse than anything we have yet experienced. That, in turn, simply because of our size, will place the entire free world at risk, not to mention those nations that former UN Ambassador Jeane Kirkpatrick taught us to view as authoritarian but not totalitarian.

Bateson developed the idea of the double bind in connection with his studies of schizophrenia. The pathology takes three recognized forms: paranoia (e.g., Secretary of Defense Caspar Weinberger’s and the Russians’ suspicions of each other), hebephrenia (endless absurd chatter, such as President Reagan’s call for a constitutional amendment mandating a balanced budget), and catatonia. The last has two states: agitated

(New York Republican Congressman Jack Kemp’s manic insistence that there’s no taxes like no taxes), and stuporous (Vice President George Bush’s silences on his best days). The periodic alternation of paranoia, hebephrenia and catatonia is what causes the deficit to be a media event one day and a nonevent the next. But the pathology remains.

It must be recognized that we are in a true double bind. We are damned whether we do or not. One has only to listen carefully to the pronouncements of Federal Reserve Board Chairman Paul Volcker to appreciate how hopeless our situation is. To be sure, Volcker continues to voice confidence that we will pull through. He bases his confidence on Congress’ success in cutting $50 billion from the 1986 budget. This is what he asked for as a signal to the financial markets (a.k.a. the speculators of the Wall Streets around the world) that we are serious about putting our house in order. He got his $50 billion plus a bit more, depending on whether you believe Bob Dole or House Speaker Tip O’Neill of Massachusetts. But now in September it is expected that the 1986 deficit, with the cuts, may be greater than it was predicted to be last January, without the cuts. Nevertheless, Volcker remains cautiously hopeful.

What can a rational man or woman make of that? I think you and I have two choices: We can head for the storm cellar because disaster is about to strike, or we can conclude that Volcker and the rest were in some way mistaken in their understanding of the significance of the deficit. Speaking for myself, I will confess that I am at least taking the precaution of scouting my route to the storm cellar. I’m allowing myself the dim prospect, though, that the almost universal misunderstanding of our distressing situation may suggest a way out of the double bind.

A double bind cannot be broken so long as you wrestle with it on its own terms. As Paul Watzlawick, Janet Beavin and Don Jackson put it in their classic Pragmatics of Human Communication, you have “to step outside the frame and thus dissolve the paradox by commenting on, that is, metacommunicating about, it.” Let us, therefore, do a little commenting on – or metacommunicating about – our predicament and the reasoning behind it.

Judging from the actions of our leaders and the dicta of our opinion makers, it would appear that our economy has three points of reference. One is a high gross national product, the second is a low rate of inflation, and the third is a high rate of saving. It would appear, further, that the rate of saving is understood to control the other two. On the first point, saving is assumed to lead to investment, which leads to increased production. On the second point, whatever is saved is seen to be withheld from consumption, thereby decreasing the number of dollars chasing whatever goods are produced. Hence the rate of saving is, as the mathematicians say, the independent variable: save that and you save all.

It will be observed that practically everyone who counts (with the possible exception of Tip O’Neill) believes this. The spectrum of believers stretches from Jack Kemp and his supply-siders, through Bob Dole and the sound money men, through Paul Volcker and the bankers of every size and shape, through the surviving New Frontiersmen and their investment tax credits, to Gary Hart and the New Industrial Policy of the Atari Democrats. And over them all arches the rainbow of President Reagan’s smile.

Let’s metacommunicate first about the rate of saving, that allegedly independent variable that is supposed to make the system go. We have, constant readers will remember, commented on this before, prophesying in “Why Deficits Matter” (NL, March 8, 1982) that the Kemp- Roth tax cuts and the associated accelerated depreciation allowances would not have the intended effect of increasing the rate of saving. Then, in “The Savings Bust” (NL, October 17, 1983), we diffidently called attention to the fact that our prophecy had come true. Now, as Coach Lombardi used to say, let’s get down to basics.

To illustrate the importance of saving, standard textbooks note that someone has to save seed corn if we are to have a crop to eat next year. This is surely true, and it seems to make saving prior to production. It is true as well that someone has to have harvested this year’s crop if we’re to have any seed to save, and that makes production prior to saving. It’s also true that no one would have planted this year’s crop (farming being uncompromisingly hard work) if we weren’t experiencing diminishing returns from hunting and gathering, so that someone could anticipate a strong demand for a substitute food. And anthropologists show that the demand was increased by an increase in population resulting from our prior success at hunting and gathering.

We have here four truths, independently valid, and they seem to be arranged in a straightforward cause-and-effect order. Accordingly, it would follow that if we want to grow more vegetables, we’d better stimulate hunting and gathering.  No one, however, is likely to see much sense in that, except perhaps the National Rifle Association[1]. Where’s the fallacy?

IN FACT, there are several fallacies here. For our purposes the most important lies in the assumption that living systems – systems composed of people – operate in the same way as the systems of classical physics (see “On Political Arithmetic,” NL, April 4, 1983). The idea of independent and dependent variables – a supremely powerful idea in its own domain – simply does not apply. With living systems you cannot learn much from experiments where you vary one factor, holding the others unchanged, and observe the outcome. The rate of saving depends on the GNP, as much as the other way around; moreover, a high rate of saving often depresses the GNP, while a rising rate of inflation may have a favorable effect on the GNP and on the rate of saving, too. But in other times and places it may not. Everything depends on the historical conditions of an actual place and time.

In a 1928 article that was a significant precursor of Keynes’ General Theory, Professor Allyn A. Young argued that in order to understand economic progress, “What is required is that industrial operations be seen as an interrelated whole.” (Or, in the terminology of the communications theorists, the economy is a system of interrelated feedback loops.)

In this connection Young made an observation that would have saved us all a lot of grief if it had been taken to heart by the late Mohammed Reza Pahlevi (and by Messrs. Richard Nixon and Jimmy Carter, who backed him, and George Shultz and David Rockefeller, who did business with him). “An industrial dictator,” Young wrote, “with foresight and knowledge, could hasten the pace somewhat, but he could not achieve an Aladdin-like transformation of a country’s industry so as to reap the fruits of a half-century’s ordinary progress in a few years.”

Although Young concluded that Adam Smith was right in emphasizing the importance of the division of labor, he cautioned: “The division of labor depends on the extent of the market, but the extent of the market also depends on the division of labor.” In short, in a living system it is nonsense to wonder whether the chicken comes before the egg.

What is not nonsense is to be concerned with people. All three of the points that define our double bind – the GNP, the rate of inflation, and the rate of saving – are measures of things. To break out of our double bind, we will have to shift our attention to measures of people: the number of unemployed; the number of men, women and children living below the poverty level; the spread of living conditions between the poor and the rich. If we did this, we would take a vastly different attitude toward Social Security, Medicaid, Medicare, and all the now-denigrated hopes of the New Deal, the Fair Deal and the Great Society. We would even find that we could afford these decencies once we abandoned the notion of a revenue-neutral tax law that leaves unchanged the taxes paid by the various levels of our society.

Of course, it may be nearly impossible for us to make the necessary moves to break or even weaken the double bind. That is a political problem, and a public opinion problem, and it would be pretty to think that our politicians and our opinion makers will rise to the challenge. Yet, as matters stand at the moment, they are, with a few exceptions, part of the problem.

The New Leader


[1] In the original it was the “American Rifle Association.”  The editor has decided this was an error.

Originally published November 26, 1984

I SUPPOSE I should say something about Secretary of the Treasury Donald T. Regan‘s recent Federal tax simplification proposals. As it happened, I was vacationing in Florida when they were announced and for a couple of weeks thereafter, so my initial information was limited to the local newspaper’s reports and the charismatic pronouncements of NBC’s Tom Brokaw.

The story filtering through to me and my neighbors was sufficiently vague on the interest-expense question to allow me to hope that one of my private ideas had a chance of becoming public law. It seemed that interest expense (with the exception of that on a primary-residence mortgage) would no longer be deductible. This certainly exercised the Sunbelt real estate operatives. It seemed, too, that the change would cover the interest expenses of businesses as well as of individuals. The latter, I have since discovered, is not the case. But I was briefly delighted for the following reasons, which I now offer in the event anyone asks you how the law should be revised.

Contrary to general opinion, the interest-expense deduction works mostly for the benefit of people with money to lend. It does nothing much for those with the need to borrow – especially not for those in the lower tax brackets. The first fact to bear in mind is that the interest rate is in one respect like other prices: It can’t go higher than the market will bear. You can’t get blood from a stone. If lenders attempt to set the rates too high, they will be left with idle money on their hands. If they do nothing with that money, they will be like the unfaithful servant in the Parable of the Talents. To get their cash out and working, they must lower the rates to levels that businesses and individuals are able and willing to pay.

Although borrowers are subject to euphoria, businessmen are restrained by the necessity to make a profit, or at the minimum to make ends meet. For some months now, despite the well -advertised recovery, profit rates have been falling. And so have interest rates. The connection between the two is indirect, not direct. Interest rates have been coming down partly because the Federal Reserve Board has slightly relaxed its control of the money supply, but mainly because there has been a declining demand for loans. Many businesses have not been pursuing loans for the simple reason that business isn’t good enough for them to afford the rates asked.

The second fact is that the corporate tax deduction for interest expense cuts the cost of business borrowing roughly in half, at least for the bigger borrowers. In other words, at the present time some businesses are able and willing to borrow money effectively costing them, say, 6 per cent, not the 10.75 per cent (or a point or two more) they pay their friendly bankers before taxes. It is consequently reasonable to foresee that, if the interest-expense deduction were abolished, the demand for loans at 10.75 per cent would truly plummet, callable bonds would be called, refinanceable loans would be refinanced, lenders would be drowning in money to lend, and the interest rate would have to drop until solid ground was reached again. For various reasons (including, we may be sure, inappropriate reactions of the Federal Reserve Board), the rate would probably not fall quite to the present effective rate of 6 per cent. Nevertheless, observe the outcome: Abolition of the interest-expense deduction would leave borrowers about where they were, while the take of lenders would be cut almost in half. To repeat for emphasis, the interest-expense deduction mainly subsidizes those with money to lend, not those eager to put it to work[1].

Obviously, introduction of the change in a hurry would hurt many individuals, businesses and banks. The suffering of most individuals and businesses would be assuaged by the promised reductions in the tax rates, but the crisis in banking might be acute. Don’t get me wrong.  If it were not for possible damage to the economy (and this could be mitigated by phasing in the change-over two or three years), I could regard a pit full of squirming bankers with a fair show of equanimity. My point has nothing to do with my feelings for bankers, some of whom are my best friends (though not always when I need them). My point is that the interest-expense deduction makes usurious rates seem tolerable. It is a prop holding up those rates for the enrichment of money lenders. I therefore thought Regan was absolutely right in trying (as I mistakenly understood it) to knock out this deduction.

Of course, I feared there wasn’t a prayer that he would prevail, despite the fact that everyone -everyone in the whole wide world (except for big lenders) – is longing for interest rates to come down. Last year, even with a more docile Congress and strong support from a not-yet-lame-duck President, the Secretary couldn’t get the banks to withhold taxes on interest – a measure that would have hurt only cheaters and the people who encourage cheating.

ALSO DOOMED (I thought, and still think) is Regan’s proposal to get a rein on the charity deduction. The churches and the colleges, the foundations and the funds, the museums and the libraries, the clinics and the think tanks – all the eleemosynary institutions in the land – are up in arms about this one. It is very sad and disillusioning. Many undoubtedly worthy, dedicated and, yes, necessary citizens have been tricked by the issue into making fools or hypocrites of themselves. Two pitiable examples turned up in the Florida paper I read.

An official of the local United Way observed that the median income thereabouts is $17,000, and he worried that the vast majority of its contributors would not be able to continue their generosity if the law were changed. The United Way does its supporters an injustice. For it is surely true that practically all taxpayers with a gross income of $17,000 take the standard deduction and make most of their contributions because they want to, not because it is a way of diddling the tax collector.

A local parson had a clearer under-standing of finance – and of his parishioners. He argued that Secretary Regan’s proposal to cut the top tax rate from 50 to 35 per cent would greatly reduce the value of the charity deduction to those in the top bracket. He is certainly right. Rich people are in (if the parson will forgive me) a hell of a fix. We’ve been told since New Deal days that high taxes sap their incentive to work and save. Now we discover that low taxes sap their incentive to be charitable. Of such is the Kingdom of Heaven.

The local Salvation Army made a more responsible observation. It noted that the talked – about budget cuts (a.k.a. “freeze”) in welfare programs would increase the calls on private charity, while the tax changes would reduce contributions. Indeed, one wonders (to introduce a little of the spice of argumentum ad hominem into the discussion) what the President himself might be expected to do in these circumstances. You will remember that the Treasury proposes to count only contributions in excess of 2 per cent of adjusted gross income. You will also remember that the President’s tax returns have rarely (if ever) shown contributions up to or much beyond that level. Add to this the fact that he promises to cut his own pay, and I am led to suspect that his favorite charities won’t be able to count on him (and on many like him) as they have in the past.

There is no doubt that the charity deduction is grossly abused (mostly in ways I haven’t discussed). There is little doubt that Secretary Regan’s modest proposals for its reform will fail. Then we have the matter of no longer allowing the Federal deduction for state and local taxes. Here I think the Secretary has his best chance of succeeding.

The proposal has drawn fire from New York’s Governor, Mario Cuomo, as well as from both of its Senators, Democrat Daniel P. Moynihan and Republican Alfonse D’ Amato, and it is easy to rally the rest of the country in opposition to the Empire State. I’m opposed to this part of Regan’s plan, too, however. As I have argued in this space (“Eliminating Frictional Unemployment,” NL, March 7, 1983), the most rational approach would make state and local taxes a 100 per cent offset against Federal taxes. In brief, that would put an end to the game of beggar my neighbor states now play as they try to lure corporations away from each other with inadequate taxes. No chance.

Perhaps the most important single change advanced by the Treasury would eliminate most of the corporation investment credits and rapid-depreciation dodges. These allow companies like General Electric to have profits in the billions and pay no income tax at all, but instead receive rebates of a hundred million or more. The change was not deemed worth mentioning by my Florida paper. Maybe the editor foresaw that lobbyists would not have much trouble explaining to the President that his major campaign contributors would hardly be amused.

THE FOREGOING are only the principal ways the Secretary of the Treasury has gotten people mad at him. An indicator of the wrath he has incurred is that as staunch an Administration ideologue as William F. Buckley Jr. finds the program a disaster. This being the case, why did Regan make his irritating tax proposals?

In answer, I’ll venture the guess that he is playing the game perfectly straight, yet that the result will neutralize the Democrats. For the Regan plan is very close to (actually more liberal than) the one put together by Senator Bill Bradley of New Jersey and Representative Richard Gephardt of Missouri (see “A Cautionary Tale of Tax Reform,” NL, January 23), which has wide verbal support, especially among neoliberals. It would thus seem that with a substantial majority of Republicans and a scattering of Democrats, a melding of the plans – including the somewhat similar scheme of Republican Representative Jack Kemp of New York – might have a good chance of sailing through.

If it does, the new law will certainly have the nice low rates that have been proposed. You should not be surprised, though, if the lobbyists manage to keep most of the loopholes open. For my part, I’d not be surprised if Republicans and Democrats started bidding against each other, as they did in 1981, to see who could give the lobbyists more of what they want. The not impossible result could be both lower taxes and wider loopholes.

What then?

The first consequence would be, as in 1981, an upward surge of the deficit. The second consequence would be, as in 1982, a move (over the obviously sincere opposition of President Reagan) to increase Social Security taxes (although they have no bearing on the budget deficit) and reduce Social Security and Medicare benefits. The third consequence would be, as in 1983, the realization that controlling the deficit requires some brave new taxes. It would be explained that the campaign pledges of no tax increase have after all been honored, since the income tax rates actually were lowered. But something had to be done.

What would it be?

Few fortunes have been made by people acting on my prophecies. Still, if I were a betting man, I’d wager that we would start hearing a lot more about the value added tax – how widely it is used in Europe, how invisible it is in comparison with the sales tax, how comparatively easy it is to collect, how it taxes consumption rather than production (a fallacy I have discussed more than once).

I know the smart money says that former Democratic Representative AI Ullman of Oregon was defeated in 1980 because he supported a value added tax; that references to it in the last campaign drew a strongly negative response; and now even the Treasury has come out against it. Nonetheless, with the income tax rates down and the loopholes wide open the pressure to act would be very great. On other occasions Secretary Regan has argued for a tax on consumption, and so have people as far to his left as Senator Gary Hart of Colorado. The American Enterprise Institute and the Brookings Institution similarly want to tax consumption.

My prophecy stands. What we get won’t be called a value added tax, but what’s in a name?

The New Leader


[1] Editor’s emphasis

Originally published October 29, 1984

NOW, about that deficit: Ronald Reagan was quite correct, during the first Presidential debate, in insisting that there is no connection between the deficit and the interest rate. If he had been more precise, he would have said that there is no invariant connection between the two. Walter Mondale, too, was quite correct in insisting that the deficit presents a threat to the economy, to the nation and to the peace of the world, although again there is no invariant connection.

There are, in fact, few (if any) invariant connections in economics, but it would be lèse majesté[1] to expect Mr. Reagan or Mr. Mondale to understand that, especially since most economists don’t either. There are few (if any) invariant connections in economics, because every economics question has to do with money. As I said in this space last time (” ‘Trust Funds,”’ NL, October 15), without money you have physiology and engineering and so on (all necessary parts of our life), but you don’t have economics (also a part of life, like it or not). And as I said here two and a half years ago (“Let’s Put Indexing on the Index,” NL, April 5, 1982), there is no invariant connection between any good or service and money. The mere fact of inflation is enough to settle that question, even if there were not sound metaphysical considerations (which you may not take so seriously as I do) on the same side.

So we seem to have a dilemma. Reagan and Mondale are both right, and they’re both wrong. At the root of the dilemma is money – well known to be at the bottom of much else. At the root of money is the banking system, and in the United States the Federal Reserve Board is at the root of the banking system. Since neither Reagan nor Mondale dared or cared to mention the Federal Reserve Board, there was an air of irrelevance to their debate.

Before digging to the root of the matter, let’s consider the causes for and the effects of the exponential surge in the deficit. The principal causes are not in dispute: a tremendous increase in military spending, the vast and varied tax cuts of 1981 and the high interest rates. Of these, the military spending had a positive effect on the business recovery, the tax cuts were neutral and the interest rates were negative.

The economic virtue of military spending is that there is no end to it. In a famous example of his irony, Keynes writes: “Ancient Egypt was doubly fortunate … in that it possessed two activities, namely, pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one, but not so two railways from London to York.”

Military hardware likewise does not “serve the needs of many by being consumed,” so it can be added to forever. And like pyramid building it increases aggregate demand. Demand is what stimulates business activity. Businesses produce things if they foresee a demand for them. Any expenditure is stimulative, yet government expenditure, being both large and highly visible, is especially stimulative. As Keynes suggests, building housing would be as stimulative as building pyramids or armaments. Or as John Ruskin (a better economist than you may have realized) exclaims, “What an absurd idea it seems, put fairly in words, that the wealth of the capitalists of civilized nations should ever come to support literature instead of war!” It would, in short, not be difficult to conjure up better uses for our money, and hence better ways of stimulating the economy; nonetheless, the military build-up-foolishness, highmindedness, viciousness, waste, and all – has in fact been the motive power behind the recent business recovery.

The tax cuts were, as I say, essentially neutral. If you wisely keep a file of THE NEW LEADER, you will find the reasons set forth in the issue of March 8, 1982 (“Why Deficits Matter”). For those who can’t lay their hands on back issues, I’ll summarize the reasons briefly. The tax cuts were, you will remember, intended to stimulate the supply side, on the theory that saving is the cause of investment. The theory is fallacious. Not even Representative Jack Kemp (R.- N. Y.) can imagine that the industrial half of President Eisenhower’s Military – Industrial Complex would build a factory to produce cruise missiles before the military half placed an order.

The supply-side theory turned out to be fallacious in still another way. In accordance with its logic, the 1981 personal income tax favored the rich, and the corporate tax favored the prosperous, the hope being that those who didn’t need the money would save it. This hope was disappointed, and for a simple reason. Since the Federal budget was already in deficit, the tax cuts necessarily increased that deficit. The increased deficit had to be funded; that is, bonds to cover it had to be sold. To whom were they sold? To those who had money to pay for them, of course, and they were, in general, the people who had benefited from the tax cuts. The upshot was that the rich and prosperous were given money to buy government bonds. In effect, they were given the bonds. The maneuver accomplished as extraordinary a transfer of wealth – albeit to the wealthy – as America has seen.

But if this transfer had any effect on the Gross National Product, it was merely a distortion of priorities. The disadvantaged were somewhat less able to buy food and housing, and the fall-off was balanced by a surge in the sale of Cadillacs and Lincolns. Aggregate demand, and hence aggregate production, were not substantially affected one way or the other. (Do you wonder why I’m disrespectful of the GNP?)

The third factor in the deficit, the high interest rates, was of course a drag on the business recovery. Mind-boggling though the fact is, this was intended to be a drag. The idiocy of the intention is not, however, what interests me at the moment. It is the effectiveness of the intention that gets to the root of the matter, for the policies of the Federal Reserve Board are thus demonstrated to be not irrelevant.

Empirically, Reagan was perfectly right. In 1980 the deficit was much lower than today’s, but the interest rate was much higher. How, then, can one claim that the deficit is the cause of high interest rates? But Mondale was perfectly right, too. The present deficit is indeed the cause of the present high interest rates, and these in turn contribute to continuing high unemployment, the strength of the dollar, the decline in exports, and the increasing trade gap.

The reason why the deficit is the cause of high interest rates is very simple: The Federal Reserve Board says it is. On this subject Board Chairman Paul A. Volcker is a cracked record, going around and around, saying the same thing endlessly.

To be sure, it is not literally what the Federal Reserve Board says that is of consequence. Persuasive though he is, Volcker does not run the rates up or down simply by jawboning. His speeches have an impact on the rates only to the extent that they are taken as hints of what the Board will do. It is what the Board does that matters. For the Board controls the rates, partly by setting the rediscount rate, partly by determining margin requirements, and mainly by controlling the money supply. Money earns interest in rough proportion to its scarcity, and for a third of a century now the Federal Reserve has been making money scarcer and scarcer. It has been doing this under the misapprehension that it was thereby containing inflation. It obviously wasn’t. The record is clear here, but that is another story.

WHETHER THE deficit causes the high interest rates directly by scaring Wall Street or indirectly by scaring the Federal Reserve Board, there is no doubt that the high rates increase the deficit. The bonds that were sold to finance the 1981 tax cuts and are now sold to finance the deficit offer a fantastic return -12 to 14 per cent or more. I have some that will pay me 14 per cent yearly until November 15, 2011. I should live so long.

The interest payable on the Federal debt is an incubus of daunting weight that will smother the economy for generations to come. Even now, as Senator Daniel P. Moynihan (D.-N.Y.) has shown, the annual interest payments are approximately equal to the annual deficit, and the compounding of that interest will more than offset any savings that might be made elsewhere in the budget. The compounding, moreover, is not of the ordinary sort. Thirty-year bonds that were sold in 1954, paying an average rate of 2.4 per cent, must be paid off today with money raised by selling bonds paying more than five times the old rate. Look at this another way: If the old rates were still in force, the deficit would be less than one fifth of what it is.

Continuing the observation, we see that the world according to Volcker is upside down. He says it would be fine to have low interest rates, if only the deficit could be reduced to manageable size. But the deficit would have been manageable if the Federal Reserve Board had kept interest rates low. The interest rates have no life of their own, any more than the deficit has. Even on Volcker’s theory, it would appear that high interest rates swelled the deficit, and not the other way around.

As things are, the only way to reduce the deficit-the Federal Reserve Board’s price for lowering the interest rates is to raise taxes. That is what Mondale promised to do. But Reagan (good Keynesian malgré lui[2]) said raising taxes threatens to send the economy into a new depression, because increased taxes mean a reduction in aggregate demand, and a reduction in demand is followed by a depression as surely as an increase in demand is followed by a boom.

This dilemma could have been avoided if the tax cuts had gone to those who would spend them. It could have been avoided if the Treasury and the Federal Reserve Board had cooperated in holding down the interest rates, as they did during World War II. As it happened, both fiscal and monetary policies were fatefully misdirected. If the President does not look good in the history books, the reason may be that he did not have the wit – and we did not give him the power – to beat some sense into the Federal Reserve Board.

The New Leader


[1]  a : a crime (as treason) committed against a sovereign power b : an offense violating the dignity of a ruler as the representative of a sovereign power

[2] despite himself <extraordinary talents, which somehow always crop out to show him at his best malgré lui —Saturday Rev.>

Originally published September 17, 1984

Between Issues

PRAISING Anthony Burgess’ A Clockwork Orange in THE NEW LEADER of January 7, 1963, Stanley Edgar Hyman declared: “Perhaps the most fascinating thing about the book is its language. Alex [the protagonist] thinks and talks in the ‘nasdat’ (teenage) vocabulary of the future, a remarkable invention by Burgess …. It has a wonderful sound, particularly in abuse, when ‘grahzny bratchny’ sounds infinitely better than ‘dirty bastard.”

Before the issue had been out a week, the phones were humming and the letters were pouring in: Didn’t Hyman know that the “amazing vocabulary” he was so taken with consisted largely of adaptations from Russian? At the NL, readers rarely write to praise; they seem to feel (rightly, in our view) that good or even excellent pieces should be the norm. But a goof will soon bring guffaws. And among those who could not resist at least a smile was Burgess’ publisher, George P. Brockway of W. W. Norton-who nonetheless thought so highly of Hyman’s essay that an emended version became the Introduction to the paperback edition of Clockwork.

We were reminded of all this when the phones began ringing and the letters started arriving about a blooper by Brockway- now an NL columnist-in “Big is Ugly,” his cover piece for our September 3 issue. One representative letter, from Lloyd McAulay Esq., will suffice to illustrate: “George Brockway’s original comments on the economic scene are interesting to read, for they certainly make one think. However, one would like to believe that he presents his proposals with some care. His example of financial alchemy in the 50 per cent tax bracket is amiss. He suggests that borrowing $100,000 from Bank Aat 15 per cent interest, and investing it in Bank B at 13.6 per cent interest, will provide an annual after tax net of$ 3,050. That is just not careful arithmetic. True, the $15,000 interest on the loan from Bank A will only cost the borrower $7,500 after taxes. But the $13,600 interest on the Bank B deposit is taxable income. At the 50 per cent bracket’ this will mean net earnings of $6,800. Since the loan cost $7,500, the taxpayer would have a net loss of $700.”

Apparently Brockway remains a careful reader, because we had not yet had a chance to get in touch with him when he sent along the following:

“Oops! I of course slipped in my column of September 3 when I parenthetically outlined a rich man’s scheme for borrowing money and buying CDs. For the dodge to work, you have to buy tax-exempt bonds and take your chances on the market. In other words, you have to do a little laundering, but it’s so simple that you don’t even have to go to Miami for the purpose. Sorry.”·

Readers may reasonably wonder why the editors were not more careful readers. To that we can only reply, rather lamely, that the games the rich play are Russian to us.

OUR COVER drawing of Israel’s Prime Minister Shimon Peres is by Claudia Fouse.

The New Leader

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