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By George P. Brockway, originally published March 23, 1998

1998-3-23 Moynihan's Social Security Hocus Pocus titleON MARCH 16 Senator Daniel Patrick Moynihan delivered a speech titled “Social Security Saved!” at Harvard’s John Kennedy School of Government. Said to be the Senate’s authority on the subject, he has addressed it many times over the years.

This time he referred to “the magic of compound interest” and presented some figures that surely seem magical at first glance. At second glance, they seem more than magical.

The Senator would cut the Social Security tax rate 1 percentage point and cut the employers’ tax (officially called “contribution”) likewise in order to “get the system back on a pay-as-you-go basis.” That is a worthy objective; unfortunately, the Senator does not say anything more about it.

According to the Moynihan plan, workers would be given a choice: They could take their 1 per cent cut and spend it on riotous living, or they could take both their own tax cut and their employers’ and put them in “voluntary personal savings accounts.” This is where the compound interest comes in, and it comes in with a roar. A table accompanying the text of the Senator’s speech shows that a worker who earns the “average wage” of $30,000 and stashes an amount equal to 2 per cent of it away every year for 45 years in a voluntary savings account compounding at 3 per cent, will wind up with a nest egg of $275,000 at retirement. And that will be on top of his or her Social Security benefits.

It sounds great, but anyone can do better. The present Social Security tax (employee plus employer) is 12.4 per cent. Suppose the whole caboodle were put in the magical voluntary savings account and compounded at 3 per cent. Then the nest egg would be $1,685,000. If the interest were compounded at 5 per cent (a rate sufficiently close to credibility for the Senator to include it in his table), in 45 years the $30,000-a-year average worker would be worth $2,790,000. At age 65 or thereabouts, he or she could retire and, leaving this lordly sum in the magical account, live on the annual interest of $139,500[1].

With astute quasi-legal advice of the sort advertised in many journals, the principal, or most of it, could be sheltered from the inheritance tax and passed along to the worker’s heirs or assigns, who could live comfortably without working at all. Indeed, since on these assumptions even the $12,000-a-year minimum-wage worker would have $1,085,000, we can safely say that after at most another generation, no one would ever have to work again. It might take somewhat longer in Bangladesh.

Now, I am enough of a Yankee to believe that honest labor never hurt anyone and is good for the soul; so I find this outcome appalling, and I would be sorry I brought it up if it didn’t reduce Senator Moynihan’s scheme to the absurd. Why does the scheme wind up in absurdity? Do you remember how, when lRAs were first peddled, banks advertised that they would make us all millionaires? There was and is nothing wrong with the mathematics. Bankers have books of tables that contain such calculations, and I assume the Senator has consulted one.

The trouble here, however, is that there are not enough ways to invest the bags full of money that would theoretically accumulate. The bags of money will therefore not exist, no matter what the mathematics says. They will not be sitting in bank vaults, waiting for a good deal to turn up, or available for some jolly use. They will not exist, tout court. They will never have existed.

If the Senator’s average worker deposits $600 a year every year for 45 years in the bank of his or her choice, and the bank can’t find people willing and able to pay interest for the use of it, the worker will reach retirement with $27,000, which ain’t hay, but is a long way from the $275,000-or $350,000 at 4 percent, or $450,000 at 5 per cent-the Moynihan table promises. Compound interest is truly magical, but the magic won’t work if there is no interest to compound.

We have now reached a point in the argument where John Maynard Keynes parts from Classical and Neoclassical economics. All three agree that saving equals investment. The conventional schools hold that saving creates investment, and they nag us about it every chance they get. In contrast, Keynes observed that entrepreneurs borrow and invest, not for the fun of it (though it may be fun), but to make money by producing things people are willing and able to buy. Accordingly, he wrote, “The propensity to consume will … take the place of the propensity or disposition to save.”

In any case, three current events teach us that there is now no use for the tremendous savings the Senator’s scheme would generate. (I) Major corporations daily announce plans to buy back sizable blocks of their own stock, thus confessing that they don’t know how to put all the money they already have to work producing goods and services. (2) Corporations of every size and shape raise and spend vast sums of money to buy and sell each other. The rash of mergers and takeovers may keep Wall Street busy scratching but ordinarily is intended to result in a contraction, rather than an expansion, of productive activity. (3) The stock market boom, again, mostly concerns Wall Street. The earnings of the companies on the Dow or the Standard and Poor’s 500 are now less than 1.5 percent of their stocks’ market value. Profits, while growing, cannot grow as fast as the market. Many actively traded stocks on the NASDAQ have never earned a profit at all.

As I have remarked before, the law of supply and demand works if, and only if, supply is restricted. The supply of stocks is indeed limited; consequently, as long as-but only as long as-Baby Boomers worried about looming retirement keep pouring their savings into the market, the market will keep rising. That is why Wall Street is eager for the commissions to be earned (“the old-fashioned way”) from handling the Senator’s voluntary personal savings accounts.

The economic sterility of capital gains, it needs to be recalled in the present context, is that they increase the price but not the productiveness of capital assets. The risk with capital gains is that when large numbers of people try to cash in their gains all at once, the market can crash very far and fast. Some day – at the latest when Boomers start cashing in their gains in order to live on them – the music will stop, and many people will find themselves without a chair to sit on.

In the meantime, conservatives hail Senator Moynihan’s scheme and urge him on. James K. Glassman of the American Enterprise Institute proposes, in the Washington Post, cutting “another few points off the payroll tax” as a step toward the happy hunting ground of complete privatization.

Complete privatization is of course what we had before we had Social Security, and it was not pretty[2]. The inadequacy of the unregulated free market was taught to all who had eyes to see in the months following October 29,1929. It was not until August 14,1935, when the Great Depression was almost six years old, that the heart-rending inadequacy of private charity was ground into the public consciousness. Then the New Deal was finally able to break through the barriers to the general welfare that had been thrown up by Republicans, Dixiecrats and a states’-rights-minded Supreme Court.

THE RESULTING Social Security Act was-thanks to the long years of wrangling and compromising-pretty much like the proverbial horse designed by a committee. It was not, and is not, ideally suited to any of its several functions. Nevertheless, it was, and remains, one of the most useful and successful and necessary public laws of the century. It was enacted because there are, in fact, limits-actual limits that we have tested more than once-to the assuredly great capabilities of private enterprise and private charity.

Despite this record, conservatives are likely to push for complete privatization of Social Security benefits. They are not likely to want to eliminate the system, though, and especially not the tax that supports it. Since Social Security accounts for almost a quarter of what makes ours a big government (which conservatives pretend to be scared by), and since the Social Security tax, including the employers'”contribution,” is indubitably a tax (which in principle conservatives object to), it may seem surprising that they wouldn’t want to abolish the whole shebang.

The reason for this inconsistency is simple. The various flat tax schemes that Congressional Republicans are busy devising have for them the charm of being resolutely regressive. Anatole France observed that rich men, as well as poor, could sleep under the bridges of Paris. Flat-taxers boast that they will give poor men the honor of being taxed at the same rate as the rich. Yet regressive as the flat tax is, it is nowhere near as regressive as the Social Security tax.

The two systems are similar in that each taxes only earned income. Malcolm Forbes probably pays himself and his office boy a fair salary. The two of them pay Social Security taxes at the same rate, and they would both be flat-taxed at the same rate, but they wouldn’t pay any tax on their incomes from the fortunes they inherited, no matter how large or small. David Rockefeller and I, being retired, now pay no Social Security tax (except as employers of servants, if any) and would pay no flat tax at all.

But the Social Security tax is more regressive than the flat tax on two counts: (I) The Social Security tax is levied on the first dollar you earn, while the flat tax proposals, like the present income tax, exempt the first few thousand dollars you get your hands on. (2) The Social Security tax does not tax at all earnings over $68,400, while the flat tax goes to the last dollar. (Moynihan proposes to increase the “cap” to $97,500 by 2003, still leaving the top 13 per cent of wages untaxed.) In short, the Social Security tax is a flat tax that is extra hard on the poor and extra easy on the rich.

At least since the Social Security system was “reformed” in 1983 by Senator Moynihan and others, it has been running a surplus that has been used to bring the “unified budget” closer to a balance. Even in this alleged near-balance year for the budget and near-crisis year for Social Security, the near-balance depends on an actual Social Security surplus of about $40 billion.

For reasons I advanced in this space last September 22, I contend that “A zero deficit means failure,” and for reasons I have advanced here many times, I contend that the Social Security Trust Fund is a serious error. Putting these two mistakes together, we have compounded them, for we have been using the proceeds of a most regressive tax to avoid increasing the income tax, which is moderately progressive, to achieve an unnecessary and wasteful balance.

Senator Moynihan’s scheme continues these injustices, as well as his erroneous attack on the Consumer Price Index. Reactionaries will rejoice.

The New Leader

[1] Ed:  I have tried and tried using the financial functions in Excel, and have asked others to do so.  We cannot replicate these numbers.  We’d be happy to see how they are calculated.

[2] Editor’s emphasis

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By George P. Brockway, originally published January 13, 1997

1997-1-13 Milking the Social Security Cash Cow titleTHE BEST that can be said for the Advisory Council on Social Security is that after two years of study, its 13 members could not agree on what to do about the allegedly ailing program. They did agree about some of the “facts,” and that agreement is enough to make one relieved they didn’t agree about much else.

Somehow they got into their heads the notion that the program’s surplus, which goes into a “trust fund” invested in long term government bonds, earns only 2.3 per cent interest. They say that rate is “adjusted for inflation,” but I have my doubts. According to the latest figures available, at the end of 1994 the fund contained $415 billion, and in 1995 it earned $31 billion. I make that out to be 7.5 per cent[1]. Taking into account the change in the Consumer Price Index (2.7 per cent), we arrive at a real return of 4.64 per cent[2] more than twice the rate assumed by the Advisory Council.

A point to notice is that there was almost no trust fund until Social Security was “reformed” in 1983. After all, the actuarial problem is not complicated. Even in the BC (before computer) era, the number of people reaching retirement age in any year could be accurately foretold, and reliable estimates could be made of those who would die or become disabled.

In such circumstances it is ridiculous and wasteful to maintain a trust fund. The businesslike thing to do with regular costs is, as the accountants say, to expense them-that is, to pay them as they become due, just as the rent and wages and interest are paid. It is prudent to put aside an amount equal to a few months’ expenses in case another nut imagines he has a contract to shut the government down. Otherwise, in a population as large as ours the risks are as level as can be, and the nation can and should be a self-insurer.

In 1981 David A. Stockman, President Reagan‘s Director of the Office of Management and Budget, worked up some figures purporting to show that the “most devastating bankruptcy in history,” namely that of Social Security, was imminent. A bipartisan National Commission on Social Security Reform was duly appointed. Alan P. Greenspan, then a private citizen, was chairman.

For a year the commission dithered, apparently convinced that Stockman was born for strange sights, things invisible to see. Then, as Senator Daniel Patrick Moynihan later told the story in a newsletter to his constituents, he and Senator Bob Dole put together a semisecret unofficial group to take action. “In brief,” he wrote, “in 12 days in January 1983, a half-dozen people in Washington put in place a revenue stream which is just beginning to flow and which, if we don’t blow it, will put the Federal budget back in the black, payoff the privately held government debt, jump start the savings rate, and guarantee the Social Security Trust Funds for a half century and more.”

The Senator’s circular letter was dated June 10, 1988-less than nine years ago. How did the supposedly magnificent “revenue stream” it describes dry up so quickly? Why must we find a new one now? We hear a lot about the size of the Baby Boomer generation as compared with the size of the succeeding generation. But in 1983 the Boomers were all grown up, and their children were mostly born; so there were no big demographic surprises. It is also said that the Boomers’ life expectancies are longer than those of their parents’ generation. This is certainly true, but just as certainly it should have been obvious to the architects of the 1983 solution. The World Almanac could have told them that life expectancies in the United States have increased every year since at least 1900.

If a blue-ribbon commission somehow got it wrong in 1983, is there any reason to expect that another blue-ribbon commission, perhaps with Mr. Greenspan again as chairman and Messrs. Dole and Moynihan again as members, could get it any better in 1997?

No, there is not. The Social Security Act Amendments of 1983 set up a system of increased taxes and reduced benefits in order to build a trust fund that was expected to take care of things until 2030.  Now we are being told by prophets of doom (some of whom were members of the 1983 commission) that we must do something drastic about Social Security entitlements today or the trust fund will run out in 2030, inciting an intergenerational war.

What, I wonder, is all the excitement about? The trust fund was planned to run out in 2030. If the end of the fund in 2030 is expected to signal the end of the Republic, why didn’t the 1983 commission Senator Moynihan was so proud of attend to it, instead of pushing the problem off on another generation? And why should the present generation be saddled with solving a crisis that won’t occur until long after Senator Strom Thurmond has retired? Why shouldn’t the generation of 2030 be expected to solve a problem that will occur, as they say, on its watch?

There are answers, but they’re not what you read about in the papers. The thing is, the Social Security system is what Wall Street calls a cash cow-by far the biggest cash cow, public or private, there’s ever been. Greedy men and women-exemplars of homo economicusdream about her and can’t keep their hands off her.

Several schemes are being floated simultaneously. Some want to increase Social Security taxes to preserve and increase the trust fund. They want to do that not for any actuarial reason, but because the Social Security surplus is used to reduce the Federal deficit, and there is the possibility (remote yet real) some deficit hawk will get the shocking idea of levying progressive income taxes to control the deficit.

Since Social Security taxes are as regressive as taxes get, an increased Social Security tax is a valuable trade-off for the benefit of the rich and famous. It’s even better for them than the Forbes flat tax, because the tax starts with the first dollar anyone earns (that sticks it to the lower classes!) and ends at $65,400 instead of continuing on to tax every last megabuck reaped. In addition, it is a tax only on those who are employed and those who employ them. If you are an economic specialist and restrict your activity to clipping coupons and cashing dividend checks, you don’t pay any Social Security tax at all.

As it happens, Senator Moynihan understood the ploy in 1990 and tried to forestall it by reducing Social Security taxes and returning the system to a pay-as-you-go basis. When he couldn’t persuade his fellow Democrats to go along, he asked why we needed the Democratic Party. It was, and too often still is, a good question.

Another greedy scheme yields an additional motive for wanting the Social Security surplus to be ever larger. Brokers and investment bankers have long had their eye on the trust fund. For them it presents a charming opportunity. Think of it! Imagine your rich and doting uncle[3] turning over to you a fund of half a trillion dollars, now growing at the rate of close to $50 billion a year, and instructing you to churn the market and make it grow faster. Wouldn’t that be fun?

It would, in fact, be unadulterated fun. You wouldn’t have to weary yourself persuading tens of millions of timorous senior and pre-senior citizens to entrust their savings to you; your uncle would handle that. Nor would you have to maintain tens of millions of separate accounts and draw and mail tens of millions of checks every month, together with resolutely upbeat letters explaining why benefits are less than expected. Your uncle would handle those chores, too. A very handy and efficient fellow, that uncle, regardless of what you may hear on the radio.

MOST OF THE “reformers” put great stress on the questionable assertion that an individual citizen knows better what to do with his or her money than some faceless and indifferent bureaucrat in Washington. This tired old wheeze goes back at least to Adam Smith, whose faceless and indifferent bogeys were, Smith-quoters may be astonished to learn, not government employees, but members of the boards of directors of private corporations, some of which were remarkably similar to today’s mutual funds.

Let us try to foresee what would happen if some privatization scheme-say, investing 25 per cent of the trust fund in the stock market-should be adopted by Congress and signed by the President. Since, as we noted in “Caught in a Boom Market” (NL, September 9-23, 1996), the number of available shares is limited, the influx of something more than $125 billion would send prices shooting up. But it would have taken a while to get the “reform” bill through; consequently, much-if not all–of the rise would have been anticipated by smart money pulled out of other investments. The trust fund would not participate in the initial boom. Also, the source of the cash needed to move into the market would be a problem. The trust fund would have to redeem some of the government bonds it is holding, the Treasury would have to sell other bonds to get money to pay these off. In other words, the deficit would be increased by the amount invested in Wall Street.

Where would the money to buy the new bonds come from? All the smart money would already be in the stock market’ but perhaps there would be some timid money eager to shift from stocks to bonds, especially if the new bonds were priced low enough to yield an attractively high rate of interest. The high interest would send stocks down as more money shifted from stocks to bonds; then some would shift the other way, just as money sloshes from technology stocks one day to nursing homes the next. Where would the turmoil end? It would not end. As Ring Lardner might have said, that would be part of its charm.

Both the stock market and the bond market are always churning, because traders are constantly evaluating and reevaluating possible investments, trying to determine their comparative future earnings, capital gains and risk. When the market is volatile, the vital question is what the various stocks and bonds are going to sell for tomorrow. In the end, this all is guesswork, even when mainframe computers spew out charts of many colors: What’s to come remains unsure.

If the stock market is now “outperforming” the bond market, it is because the stock market is considered riskier, and the claimed difference in performance is a measure of the perceived risk. The very term “social security” suggests that the program is correct in its present stance of being risk-averse.

Some claim that investing Social Security funds in the stock market would send prices even higher, and that high stock prices make it easier for new companies to be launched and old companies to be expanded. Other things being equal, as economists say, this claim may be sound enough, but there is another side to it. When the market is really soaring, it becomes much simpler to make money by speculating in stocks and bonds than by producing commodities for people to use and enjoy. Things apparently are not equal at the present time, for leading American companies seem to have more cash on hand than they know what to do with. Why else would IBM and so many others be buying back their own stock instead of investing in new or expanding enterprises?

All that would be accomplished by putting Social Security funds at risk in the stock market, it can safely be said, would be a steady upward redistribution of income and wealth. The rich would in general become richer, and the poor poorer. Try as they may, some people seem never to be near a chair when the music stops.

Stockholders and bondholders (both new and old) would, as a group, be likely to prosper about as fast as, but no faster than, the Gross Domestic Product. The only way they might have the illusion of prospering more grandly would be if inflation accelerated. Brokers and investment bankers would be the big winners in fact, taking them as a group, the only winners. The cash cow would be lavish with commissions and fees and interest on margin accounts.

The costs of moving the Social Security trust fund into the market-particularly the increased deficit and the interest bill on the new bonds-would be borne by the government. There would be a furious struggle to decide whether to increase the debt or to downsize the budget. No matter how it was resolved, those at the bottom of the income scale would be pushed lower. Almost all bonds are necessarily bought by the rich; the interest they receive is, in our present tax system, disproportionately paid by the lower middle class-the same people who typically suffer when the budget is shrunk.

It all comes down to this: Individuals can, and many do, make out like bandits on Wall Street, but society as a whole cannot be more comfortable or more secure without producing more goods and services. Whatever it is that Wall Street produces, it is good neither to feed you if you’re hungry, nor to clothe and shelter you if you’re cold, nor to heal you if you’re sick.

The New Leader

[1] Do the math, the author is correct

[2] The author appears to have subtracted 2.7% from 7.5%… Ed. I don’t follow why that’s the right calculation

[3] Uncle Sam, in this case

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 January 23, 1984

SOMETHlNG over a year ago, Senator Bill Bradley of New Jersey and Congressman Richard A. Gephardt of Missouri put forward a new scheme for the Federal Income Tax. Last summer they unveiled a revised and more thoroughly worked out version of their proposal. It should now probably be taken seriously because it has been substantially incorporated in a document entitled “Renewing America’s Promise,” released by a group calling itself the National-House Democratic Caucus. In any case, what has happened to Bradley-Gephardt during its gestation period is an instructive and cautionary tale.

First off, let it be stipulated that Bradley and Gephardt are men of good will – probably of liberal will – and that their plan is less harmful than many others that are being noisomely noised about. Among the latter is one by Republican Senator Jesse Helms of North Carolina, who would tax everyone at a flat rate of 11-12 percent. Another, by Democratic Senator Dennis DeConcini of Arizona, would be more generous with exemptions and therefore would have to set its flat rate at 19 percent. Various banker-sponsored proposals would abolish the income tax altogether, substituting sales taxes or the more sophisticated (and insidious) value added tax. Then there are nutty ideas like those of Robert Nozick, a professor of what passes for philosophy at Harvard, who thinks you ought to be allowed to choose the government activities you want to support, if any, and how much.

Bradley and Gephardt start with the premise that the present law is unfair and overcomplicated; on this no one is likely to say them nay. The current tax code, Senator Bradley observes, “spans more than 2,000 pages” and has more than 100 major loopholes that “will be worth at least $250 billion this year.” He doesn’t tell us how many of those pages and loopholes and billions are attributable to the personal tax and how many to the corporation tax, nor does he estimate how many of the loopholes he will close. If he closed them all, we’d be worrying about a surplus of $50 billion instead of a deficit of $200 billion. Don’t count on it.

In their original scheme, the Senator and the Congressman proposed to throw out practically the whole shooting match – medical deductions, veterans benefits, interest deductions, charity deductions, local tax deductions, shelters, the works. In place of the existing rates (which aren’t so progressive as they were a few years ago), they offered a three-step schedule: zero up to certain income, 14 per cent to another point, and 28 per cent thereafter. (I don’t remember – if I ever knew – what they planned to do with the corporation profits tax.)

The new version of their scheme isn’t quite so radical. Let’s let Senator Bradley explain it as he explained it last summer to the National Press Club: “For individuals the simple progressive tax would have three rates-14 per cent, 26 per cent, and 30 per cent. Roughly four out of five taxpayers will pay only the bottom 14 per cent rate. The only people paying the higher rates will be individuals with adjusted gross incomes above $25,000 and couples over the $40,000 mark.

“Our bill makes another significant change which is directed primarily at low-income people. Putting it simply, we want to increase the amount of money that a person can earn before having to pay any taxes at all ….

“To make this approach politically possible, we recognize that it is necessary to preserve certain deductions, credits and exclusions generally available for many years to most taxpayers. We thus propose to retain the $1,000 exemptions for dependents, the elderly and the blind. We also want to permit deductions for home mortgage interest, charitable contributions, state and local income and real property taxes, payments to IRAs and Keogh plans, some medical expenses, and employee business expenses. Lastly, we favor continued exclusion of veterans’ benefits, Social Security benefits for low and moderate income persons, and interest on general obligation bonds. These personal exemptions and itemized deductions would apply against the 14 per cent rate.”

As I look at the two versions, I see three main differences: (1) The new rates are slightly higher, though still far less progressive than even the present law; (2) practically all deductions and exclusions and exemptions are back in; and (3) regardless of your tax bracket, the deductions are limited to 14 per cent.

The first difference is no great shakes. The third is a grand idea that could and should be incorporated in the law. But the second difference gives the game away.

It is plain that Bradley and Gephardt have heard the insistent drums of The War March of the Priests – and of the college alumni associations and veterans’ organizations and senior citizens’ lobbies and real estate operators and IRA bankers and municipal bond holders and all the rest. Having heard that stern impassioned tread, and being practical politicians, they have fallen back on what they call “the best means available” and have surrendered-before the committee hearings-the issue of the complicatedness of the tax law as it relates to the ordinary taxpayer. H. & R. Block and all the tax accountants and tax lawyers, great and small, have nothing to fear from Bradley and Gephardt.

I hasten to stress that their bill includes provisions I’m ready to cheer. One is the abolition of special treatment for capital gains, which, as they point out, is scarcely necessary, since their regular rate is so low. They would also repeal indexing, another thing I’m always grumbling about. On the other hand, it seems to me that their treatment of depreciation is as cozy, for tax sheltering purposes, as anything now going, although it may be a slight improvement on the corporation side.

Now, you may wonder what the net effect of all this coming and going would be. The answer, in a word, is nil. At least that’s its declared effect, and one that the New York Times has (typically) praised it for. The sponsors themselves say that each “income class” will carry” approximately the same tax burden as under the present law.” I’m not sure how they square this statement with their claim that they “want to increase the amount of money that a person can earn before having to pay any taxes at all.” I further note that the proportion of Federal taxes paid by corporations would be unchanged, staying at the present 5.9 per cent (down from 26.5 per cent 30 years ago).

The exemptions and the loopholes and the corporate provisions of the present law are important because they exacerbate the unjust and uneconomic distribution of income in this country. Everyone knows that the Reagan-Kemp-Roth ironically entitled Economic Recovery Act of 1981 was intended to make the rich richer and the poor poorer, and that it succeeded in its intention. Yet Bradley and Gephardt, in what they called the Fair Tax Act of 1983 (now necessarily some other year), ultimately proposed to confirm this brutal unfairness and, by the title of their bill, to certify that it really is fair after all.

THIS IS, as I said at the beginning, a cautionary tale. What started out as a drive for reform (perhaps a misguided drive, but still an honest one) has become a desperate search for something some sort of majority will somehow agree to. Thus the really important reform – a redistribution of the tax burden – was abandoned at the outset: The gains rich individuals and corporations have made in the past 30 years – and particularly in the past three – are not to be disturbed, while for a few they will surely be increased. Thus the arguably useful reform of eliminating special exemptions and deductions was abandoned. Thus the certainly needed reform of deroofing tax shelters was scarcely attempted. In trying to get a comprehensive law that might be passed, Bradley and Gephardt have come up with one not worth passing – and this before being ground down by the legislative process.

The conclusion must be that comprehensive liberal revision of the tax laws is not possible in the present – or foreseeable – political climate. It will be hard enough to get piecemeal reform, as has been shown by the inability of President Reagan to muster even a Republican majority in favor of the innocuous withholding of taxes on bank interest, and by the inability of House Speaker Tip O’Neill to muster even a Democratic majority in favor of limiting the windfalls the rich got from the third round of Kemp-Roth.

On the record, the scary probability is that any enacted” reform” of the income tax will be in the direction of abolishing it altogether. If you’re not scared, ask your friendly banker what he hopes for, and remember that Treasury Secretary Donald Regan has already opined that “A move toward consumption taxes will probably be an absolute necessity.”

Senator Bradley and Congressman Gephardt have, as I’ve mentioned, a handful of good ideas that are worth trying to incorporate into the present law. Let them concentrate on those and forget their grandiose scheme. In any case, let Senator Bradley reflect on the fact that no sponsor of major tax legislation has ever been elected President, though there would be a certain piquancy in a race between a former professional basketball star and a former professional quarterback[1].

The New Leader


[1] For those who’ve forgotten, the author refers here to Jack Kemp, he of Reagan-Kemp-Roth

Originally published June 13, 1983

I HAVE BEEN rereading, 25 years later, John Kenneth Galbraith’s The Affluent Society, Galbraith is one of the great economists of our time, and this is one of several great books he has published. It has changed our way of looking at things. Even those who affect to sneer at the author for being funny must take it seriously. Attempts to dispute its thesis, such as F.A. Hayek‘s essay “The Non Sequitur of the ‘Dependence Effect,’ ” end by missing the point.

Galbraith’s attack on what he calls the conventional wisdom moves against its unquestioning acceptance of two propositions: (1) that production is per se desirable, and (2) that consumer choices, through the market, guide production into channels that society values. The first proposition leads to the current worship of the GNP, some of whose absurdities I mentioned in this space last month. Exposure of the second proposition’s failure, in an affluent society, is the great contribution of Galbraith’s book. He writes that “our concern for goods … does not arise in spontaneous consumer need. Rather … it grows out of the process of production itself. If production is to increase, the wants must be effectively contrived. In the absence of contrivance, the increase would not occur. This is not true of all goods, but that it is true of a substantial part is sufficient.”

It is sufficient for his argument, because if advertising or other means of persuasion have any effect at all, they must increase demand at the margin. And “since the demand for this part [of production] would not exist, were it not contrived, its utility or urgency, ex contrivance, is zero.” Hence “the marginal utility of present aggregate output, ex advertising and salesmanship, is zero.” From this it follows that private production is not sacrosanct, and it becomes possible to consider the likelihood that a clean environment may be more valuable than a newly packaged detergent.

In his attempted rebuttal, Hayek grants that “the tastes of man, as is true of his opinions and beliefs and indeed of his personality, are shaped in great measure by his cultural environment.” That is not exactly Galbraith’s point, yet on the basis of it, Hayek finds it impossible to judge some tastes less urgent than others, though he himself puts great store by “the novels of Jane Austen or Anthony Trollope or C.P. Snow.” Thus he undercuts his own position. If there is no way of judging relative wants, then there can be no way of judging the success of the economy in satisfying those wants, nor any way of making things either better or worse. Economics becomes a waste of time – as much of what passes for economics certainly is.

Although many are uneasily aware that The Affluent Society is a book on morals, few note that it is a history book. Consequently, those who think that economics is an immutable science of unchanging laws have trouble with it. Galbraith observes, for example, that “bad kings in a poorer world showed themselves quite capable, in their rapacity, of destroying or damaging the production of private goods by destroying the people and the capital that produced them.” In such circumstances, laissez faire was a reasonable response. Galbraith shows, however, that what was reasonable then is not reasonable now. The world moves.

The world continues to move, and as a result one of the minor or incidental arguments of The Affluent Society has been superseded. It is not central to the main thesis, but is a recommendation of a particular strategy for practical politics.

Galbraith contends that many measures for the public good are lost because liberals insist on raising “the essentially unrelated issue of equality.” In the debate over progressive vs. regressive taxation, for instance, a coalition of conservatives and simon-pure liberals defeats the socially desirable program. As Voltaire said, the best is the enemy of the good. Galbraith therefore urges liberals to get on with the programs and live to fight another day on the equality question.

Whether deliberately or not, the Democrats did in effect follow Galbraith’s strategy in 1981. The Republicans were encouraged, even outbid, in “reforming” the tax laws to their liking. Did they then acquiesce in the expansion of national programs for the public good? Not that anyone noticed. The sight of blood drove them mad. Even Budget Director David Stockman was shocked at their greed. It would appear that at some times and with some people a civilized accommodation is impossible.

A convenient and scary summary of what has happened to the tax laws is given in a booklet by Robert S. McIntyre and Dean S. Tipps of Citizens for Tax Justice. The study, entitled Inequity and Decline, is published by the Center on Budget and Policy Priorities, 236 Massachusetts Avenue NE, Washington, DC 20002. (I give the address because you won’t find the booklet in regular bookstores; the publishers will send you a copy free, though they wouldn’t object to your making a modest donation.)

One of the virtues of this booklet is its demonstration that what happened in 1981 was not an isolated event but had a history stretching back to the Nixon years and in several respects earlier. Especially illuminating is the analysis of the tax “revolt” that broke out in California in 1978 and spread throughout the country, contributing, probably decisively, to the Reagan election and to the Reagan-Kemp-Roth tax laws that followed.

As Mclntyre and Tipps show, the revolt had legitimate grievances that were skillfully misdirected. In California, homeowner property taxes had increased 61 per cent in the three years from 1975-78, the year of Proposition 13. In the same period, taxes on business, industrial and agricultural property were down 5 per cent (for reasons for this decrease, see Eliminating Frictional Unemployment,” NL, March 7).  The revolt, though, was not against the shift of the tax burden; it was against taxes in general, accompanied by vague cries of “waste” and “fraud.” The upshot was a greater movement away from business taxation.

THE SAME THING happened on the national level. A number of big-business lobbyists known as the Carlton Group (because they met for breakfast at the Sheraton-Carlton in Washington) had headed a loose coalition in blocking President Carter’s tax-reform proposals and in widening various loopholes. This preliminary success encouraged the group to refine its strategy and led to its devastating victories in 1981. Here are some of the results of its earlier and later lobbying, as culled from the booklet:

Item: In the years 1969-80 average hourly wages went up 6 per cent in constant dollars, while top executive salaries went up 71 per cent.

Item: “By 1981, one-quarter of all taxpayers had more Social Security taxes withheld from their wages than they paid in Federal incomes taxes.” Social Security taxes are, of course, regressive, and of course this year’s “reform” has increased them.

Item: The Reagan-Kemp-Roth tax cuts, coupled with the 1983 Social Security tax hike, have produced a tax increase of 22 per cent for those whose income is less than $10,000 and a tax decrease of 15 percent for those whose income is more than $200,000. (For those with incomes between $20,000-$30,000, the situation is about a stand-off.)

Item: The rate on capital gains is now lower than the marginal income and Social Security tax rate paid by a wage earner with a family of four earning $20,000.

The main concern of Inequity and Decline is with corporation taxes and their loopholes. You are probably aware that corporations – especially the Fortune 500 and the Forbes 500 – pay a smaller share of the Federal taxes than they used to. Back in 1950, when Harry Truman was President, the corporate income tax produced 26.5 per cent of the Federal revenue; by fiscal year 1983 the figure had dropped to 5.9 per cent. The fall has been steady, in response to growing pressure from businessmen and bankers and their publicists, who have been careful to insist that they really are not greedy but are anxious to increase investment in productive enterprise, for the advantage of us all.

Long before President Reagan’s ironically entitled Economic Recovery Tax Act of 1981, United States business was taxed much more lightly than that of Japan or of any Western European nation – with one exception. This fact and its exception should give pause to hard-nosed, pragmatic men of affairs accustomed to judging things by how they really work rather than by how someone who has never met a payroll says they ought to work. For the exception was Britain, which was also the only one of all those nations whose productivity grew less than ours in the 1970s.

That brings us back to The Affluent Society. Our recent experience shows that the question of progressive vs. regressive taxation cannot be postponed to some more propitious time, nor can it be safely separated from wider social concerns. Conservative tax policies are as destructive as conservative social policies; one leads to massive and degrading unemployment, the other to an impoverished society.

When he wrote The Affluent Society, even when he published the third edition in 1976, Galbraith could not imagine that the conservatives would be so blind and so brutal as to throw 14 million of their fellow citizens out of work and complacently plan to keep them there. Although sarcastic and witty at the conservatives’ expense, he was more generous in his opinion of them than that. He was, in fact, generous to a fault, the only fault in his great book.

 The New Leader

Originally published October 4, 1982

LAST MONTH, in this space, in the course of an argument against a flat-rate income tax, I offered some reflections on the way a chief executive officer’s high salary tends to produce high salaries down the line, with inflationary results. Let’s now start at the other end, toward the bottom, and look up, to see if we can find justification for the high CEO salary in the first place.

Suppose (that is what economists do) a bright and well educated young man of 21, who was thought to have “management potential.” He started work in 1952 for a Fortune 500 company, not as an apprentice sweeping the factory floor, nor even as a clerk running errands in accounts receivable, but as a management trainee. Although he was by no means at the bottom of the ladder, it was still a long way to the top, and at every rung he was in head-to-head competition with others like himself, many from outside his company. When he got to be CEO at age 51, he had survived perhaps 10 such contests.

It may be noted that this competition, while stiff, is not so stiff as that of a tennis tournament, which would require 512 starters to produce a winner after 10 rounds. It is more like a club ladder, where one periodically challenges the player above or is challenged by the player below.

At any rate, our man finally made it to the top. The question now is how much better was he than his competitors? The difference may be thinner than a double-edge razor. Jimmy Connors is undisputed Wimbledon Champion, but he and John McEnroe won the same number of games in the final match and even scored the same number of points. Beyond that, it is, as the announcers like to say, a game of inches.

Let’s grant our man all the credit we can by assuming that at each rung of the ladder he showed himself 10 per cent better than his competition. That is, one must admit, a pretty big margin if he ran into any competition at all. Considering the vagaries of personnel interviewing and executive recruitment, his margin of superiority is likely to have been greater in the early years than in the later, just as Connors could beat a hacker like me with his right hand, but had to use both hands to subdue McEnroe. So if we give our hero an even 10 percent superiority at every stage, we’re not understating his attainments.

On this assumption it is reasonable to claim that when he finally pulled himself to the top, he had proved himself l.1¹º, or 2.59 times-better than the losers in the first contest. Thus it would seem proper for his pay to be 2. 59 times better than theirs: If the first losers, with modest seniority raises, got themselves up to $30,000 at age 51, the winning CEO should be earning 2.59 times that, or $77,700. Giving him the breakage, it would be $77,812.

That’s right: we’ve justified a salary of $77,812 for the CEO of a Fortune 500 company. Good grief, they’ll be jumping out of windows all over town.

I haven’t bothered to check, but I’ll wager that there isn’t a Fortune 500 CEO who doesn’t pull down a good deal more than twice that. And as we noted last month, at least a dozen men rake in $2 million a year or more, counting only “earned” income. That makes these miracle-men 25.7 times better than our winner, or 66.7 times better than our losers, who were no fools to begin with.

Does anyone really believe that?

Well, I’m afraid that a great many do. Their reasoning goes something like this: As a man climbs the corporate ladder, several important things are being tested beyond his ability to calculate sums in his head and his cheerful willingness to do what his boss tells him. Perhaps most important of all, he is exhibiting his ability to learn, and especially his ability to understand at a glance how things work. If he’s going to get ahead, he’s got to have a quick ear and a sharp eye.

Having had some experience in business, once even with a Fortune 500 company, I’m ready to acknowledge that the quick ear and the sharp eye are far from common. At the same time, it occurs to me that we may have here another of those nature vs. nurture problems, like the debate over whether women are naturally slow at mathematics or merely are brought up that way. One’s genetic composition (whatever that may mean), home environment, and formal education may be of the most promising, but a few years in the lower reaches of a large organization that happens to be riddled with office politics can be devastating. I know, because I’ve been there. The winner in such contests proves himself adept at politics; and if he’s good at his job, too, that’s a plus. The losers’ talents never have a chance to develop.

The winner, in fair contests as well as in foul, gains something more than a pay raise. He gains experience. He has increased opportunities to practice the use of his eyes and ears. He learns by doing. Perhaps more important, he joins C. Wright Mills’ “Power Elite” and gradually expands his business connections so that he is eventually on familiar terms with the most “useful” people among his firm’s customers, suppliers and competitors. All of this makes him many times more valuable to his firm than the inexperienced, dispirited, though almost equally talented, losers and is said to justify the enormous difference between his salary and theirs.

There is also, in the minds of the directors who set the high CEO salary, another justification. They argue that they must pay their CEO well or he will decamp for some more generous rival, thereby subtracting his skills from their company and adding them to the competition. It is altogether probable that this reasoning is sound, especially since an extra $100,000 is a drop in a Fortune 500 bucket. Moreover, if he can increase his firm’s profit by $100,001, or prevent the loss of $100,001, or some combination of the two, he will have proved, as neoclassical economists say, the marginal utility of his raise.

This logic may remind you of the free agent auction in baseball; and indeed the same principles operate, with the same results: astronomical salaries for a few, whopping raises to keep the most important and most powerful of the rest in line, and higher prices for the paying customers.

ASSUMING that enormous pay differentials are a weakness in, if not a threat to, democracy (I refer you, as I did in my previous column, to Wallace C. Peterson’s Our Overloaded Economy), what can be done to change the situation? First, it must be recognized that the situation, being indeed rational, is not likely to change of itself. Second, it must be recognized that raising the consciousness of the losers might improve their self-respect (or perhaps the contrary), but is not likely to do much toward improving their lot. In this regard the problem is again analogous to that of women, who, even after overcoming their math anxiety, still need the ERA if they’re to get a fair shake.

There are, I think, two practical possibilities. Since we already set a minimum wage, there would seem to be no reason in principle why we might not set a maximum. Nonetheless, there are good reasons for avoiding rigidities where possible. That leaves the possibility of a steeply progressive income tax, coupled with the elimination of deductions and shelters, and probably with radical reform of inheritance taxes.

Now, it will be protested that a steeply progressive income tax – especially one frankly intended to rein in the drive for high executive salaries – is an interference in the workings of the free market. If there is a demand for a man’s services, it will be said, he should be rewarded with what the market will bear.

This objection has a fatal flaw, for it assumes that labor is a commodity like any other, and like the others is subject to the law of supply and demand. Marx, of course, charged that the capitalist mode of production depended on making labor-power a commodity. To fit the scenario of Capital (Chapter VI), labor-power had to be “free” (by which Marx meant unrestricted) and the laborer had to be “free” (that is, unconnected and without resources). It may be doubted that such a drama was ever staged in its pure form. In any event, since Marx’s time, the capitalist nations have all enacted not only minimum wage laws, but also laws governing hours and conditions of work, vacations, unemployment compensation, old age security, freedom to join labor unions, and much else; and all these laws implicitly recognize that labor is different from, and should be treated differently from, ordinary commodities.

It is, to be sure, a sad fact that those to whom we have entrusted present control of our economy actually think of labor as a commodity, just as they think of money as a commodity. Consequently, they vainly try to reverse inflation by raising the “price” of money to force the “price” of labor down. (For a justifiably caustic refutation of their theories, see Sidney Weintraub‘s Capitalism’s Inflation and Unemployment Crisis.)

But neither labor nor money is a commodity. Both are essential – primary, original – to our social and economic system. Neither can be explained in terms of something else. (See “Let’s Put Indexing on the Index,” NL, April 5.) We do with labor and money what we will; it is a moral act. It is a flaw in us – an ethical failure – that our current tax laws encourage greed. A low flat-rate tax, regardless of its ease of collection and all the other rationalizations of the editorial writers, is subject to the same indictment.

[Editor’s note:  For more on this subject read Executive Salaries and Their Justification in the Journal of Post-Keynesian Economics]

The New Leader

Originally published September 6, 1982

THE NEW tax law[1] is, by and large, a wonder. Wall Street evidently was excited by the revenue-raising aspects of it, but that euphoria is not likely to last. We’ll still have the highest unemployment and bankruptcy rates since the Great Depression, and we’ll still have the largest deficits in history. The market will churn; some people will take a whirlpool bath, and more important, most of the new money that the Fed is expected to relax into the economy will go into that churning market rather than into production or consumption. It takes a lot of money to float a record 455.1-million-share week like the one we had August 16-20.

Nevertheless, the new tax law is a wonder, and Senator Robert Dole of Kansas is a wonder man. Among other things, as chairman of the Senate Finance Committee he demonstrated that lobbies can be licked. The double reverse he pulled on the restaurateurs was a beauty. They thought they had him stopped in his attempt to withhold taxes on waiters’ tips. But he had in his pocket the three-martini-lunch measure that got laughed to death when President Carter proposed it. In the nature of things, there are more people eating on expense accounts than there are waiters serving them. The waiters lost, and Bob Dole must have had a good chuckle.

Other and more significant loopholes were narrowed. I would not have given a wooden nickel for the chance to withhold taxes on interest and dividends, especially with Walter Wriston of Citibank bleeding over the astronomical sums he claims it will cost his little depositors. Nor could I have imagined the registration of Treasury and municipal bonds, impeding what is certainly a significant amount of hanky-panky. Nor would I have expected that high rollers would be required to call attention to their questionable tax shelters.

These are substantial reforms, and they’re expected to capture $21 billion of the $87 billion the IRS estimates the government was cheated out of in 1981 on legally acquired income. Joseph Pechman of the Brookings Institution and some others think the figure too high, but if you add in the cheating on state and local taxes, it will do well enough. Put it in perspective: Demagogues in high places love to make up anecdotes about welfare cheats, yet income tax cheating last year was more than 10 times [editor’s emphasis] the entire cost of the Aid to Families with Dependent Children program-the entire cost, including all the alleged graft and bungling.

Even with the new law, there will remain $66 billion of cheating, and we’re going to hear a lot of talk about how much more effective it would be to simplify the tax law and just have a low, easy-to-understand, flat-rate tax. There are already several such schemes on the table.

Now, $66 billion is real money, and we should really try to collect it. But we don’t have a country just for the fun of collecting taxes; so we shouldn’t design our tax policy with only ease of collection in mind. I fear that is all some of the “reformers” do have in mind. They seem to argue that the way to reduce tax cheating is to reduce taxes. This is a realistic view-as realistic as the notion that the way to get rid of mob-controlled gambling is to legalize gambling. (You can tell that one to Atlantic City.)

I can, nevertheless, see much virtue in simplification. I don’t know of a’ single deduction or exemption I’d not be happy to see go, but I’m a reasonable fellow and ready to compromise. If you’re unwilling to give up the “charity” deduction altogether, I’ll settle for one based on cash only. If you want to hold on to interest expense, I’ll agree if it’s only for a mortgage on one owner-occupied dwelling. As long as your federalism (new or old) makes for wildly various state and local taxing, I’ll go along with deduction of taxes paid. If you push me very hard, I’ll grudgingly assent to some slightly special treatment of long-term capital gains-provided you agree to define “long term” as at least 10 years. Although I’m a little tender on the subject of interest on municipal bonds (I have some laid away for my old age), I can imagine satisfactory solutions here, too. In short, if there’s a tide in favor of simplifying the income tax, let’s take it at the flood.

It by no means follows that a flat rate is a desirable simplification. It’s all very well to dramatize the subject by saying that if there were no deductions or exemptions or tax shelters, the government’s needs would be covered by a flat rate of 16 per cent or whatever. Yet progressive tax rates are not hard to figure out, even without a pocket calculator. That’s not the kind of simplification we need. We can-and should-have progressive rates even after simplifying all the rest, and the progression should be steep, not at all like the 28 per cent maximum proposed by Senator Bill Bradley of New Jersey.

There are two reasons for this, one broadly social, the other narrowly economic. The broad reason-which really should be conclusive-is among the many important issues examined in detail in a powerful new book by Wallace C. Peterson,  Our Overloaded Economy[2] (See Robert Lekachman’s review, “Challenging Corporate Efficiency,” NL, June 14 [pdf link below]). Peterson demonstrates the mischief caused in a democracy by such irrational spreads in income and wealth as we now tolerate.

The narrower reason turns on the indirect inflationary effect of high salaries. The direct effect is of course minimal. The economy is so large that it doesn’t matter much whether the president of Mobil gets $1.5 million a year or twice that or half that. The indirect effect is enormous and pervasive. The second level of Mobil executives cannot be expected to make do with salaries too far below their chief’s, and the third level has to be not too far below them, and so on down to the level of the working stiffs, whose union observes all those dollars up the line and quite reasonably demands a penny or two for its members. Thus to the extent that pay scales are a factor in productivity, and that productivity is a factor in inflation, the top pay scales are a factor – not the only one, but highly significant – in inflation.

If, as some say, take-home pay is what matters (this is what linguists might call the deep structure of the Laffer Curve), you would think that lower taxes would result in lower wage demands. The present law requires the president of Mobil to pay a tax of almost $750,000 on his $1.5 million salary. Under Dollar Bill Bradley’s scheme, the tax on $1.5 million would be something below $420,OOO-a windfall of $330,000. What would the president of Mobil then do? Would he work harder and make Montgomery Ward (conglomerated into Mobil at a loss) finally profitable and thus deserve even a higher salary? Since he probably works right now just as hard as he knows how, would he pocket the $330,000 with a grin on his face? Or would he insist on giving himself a pay cut to $1,041,658 (thus leaving his take-home pay at $750,000 and saving his stockholders and perhaps their customers-almost half a million?

Well, I don’t even know the man’s name so I can’t tell what he’d do, and it may not be fair to single him out for all this attention. His $1.5 million is by no means the highest salary in the country. Last year, according to Mark Green (Winning Back America), there were at least 35 executives who took down a million or more, and even a dozen who made off with $2 million. The CEO of Cabot Corporation (not a household name in most households) led all the rest in the book of gold with $3.3 million for one year’s work. How this happy few would react when brought face to face with a tax cut, I have no idea.

BUT I DO know what happened in the United States of America in a similar situation – when the maxitax of 50 per cent on earned income went into effect. Prior to that time, the tax went as high as 70 per cent, and I knew some people who paid it. The maxitax gave them a pretty plus. You might have expected – possibly some people really did expect – a nationwide reduction of executive salaries to hold their after-tax level more or less constant. What actually occurred was just the opposite – a great leap forward in executive salaries. When the tax was as high as 70 per cent, there possibly didn’t seem too much point to an extra hundred thousand; after the maxitax, a hundred got you fifty. That was more like it. In fact, it was better than the proportion of her earnings a working welfare mother was allowed to keep.

Before the maxitax, it was suspected that the higher a man got, the more time he spent wheeling and dealing, setting up capital gains situations through stock options and mergers, and devising new and more imaginative perks. With the “reform,” you might have expected a renewed and intense devotion to business, resulting in the kind of increases in industry and productivity that only good, old-fashioned American hard work and no-nonsense management can produce.

Again you would have been wrong. The sole industry stimulated by the maxitax was that of lawyers and accountants searching for tax shelters. After all, more executives had more to shelter. And perks expanded. Company limousines clogged the streets; company airplanes clogged the runways; and exhausted executives dried out (or not) in company suites at Sun Belt resorts. I myself have, over the years, had lunch four times at Lutece and twice at Four Seasons. It wouldn’t be hard to get used to.

On the basis of the record, it is easy to guess what would happen if Senator Bradley’s 28 per cent maxitax-or worse, Senator Jesse Helms flat 10 per cent tax were in effect. It is well to remember that the truly indecent American fortunes were gathered in when there was no income tax at all. A future danger in tax reform is that some men who think of themselves as liberals, and who are touted (or attacked) by the media as liberals are taken in by the supposed realism of a low flat tax. Liberals may need more realism; but whatever America needs, it is not more encouragement of the greed that no doubt lurks in all of us.

The New Leader

1982-6-14 Challenging Corporate Efficiency


[1] rescinded some of the effects of the Kemp-Roth Act passed the year before… as created in order to reduce the budget gap by generating revenue through closure of tax loopholes and introduction of tougher enforcement of tax rules, as opposed to changing marginal income tax rates

[2] The original text reads “OurOverburdenedEconomy” but Amazon says “Our Overloaded Economy”

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