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By George P. Brockway, originally published January 1, 1993

1993-1-1 Clinton's Supply Side title

THE LITTLE ROCK “economic summit was one of the most moving and inspiring and uplifting events in recent public life.  Earnest men and women dedicated to serving their fellows, some of them obscure, were able to explain their goals and difficulties to a President-elect who plainly shared their goals and had a sympathetic understanding of their difficulties.  Nothing like this has occurred before in our history.  Few of our Presidents would have been capable of it.  (Face to face with an ordinary citizen during the campaign, President Bush was puzzled.  “I don’t get your question,” he said.)

At the same time, and from the point of view of this column, the economic summit was one of the most depressing and disheartening – and dismal – events in recent public life.  There was remarkable agreement among the business executives, bankers and economists present.  I wasn’t able to watch the complete proceedings, but while I watched I heard only two bankers and three economists interpose objections to the mainstream that was rushing by.  To be sure, there were ripples in the mainstream – quibbles about details – yet the fundamental message was clear.

In fact, if you closed your eyes, there were times you could easily have imagined you were listening in on a planning session of Ronald Reagan’s early advisors, or perhaps a meeting of the Business Roundtable. One after another, the bankers wailed about regulation and boasted cheerily of what they could do if government could be gotten off their backs. One after another, the business executives and economists hailed the glories of investment (especially in the interest of “productivity”) and excoriated the seductions of consumption.  With a few exceptions, all the business and economic people fretted over the perceived necessity to stimulate the economy and the corresponding horror of failing to reduce the deficit.  Saving was soberly praised, and a word or two was said in favor of reduced capital gains taxes.

It was, as I say, a dismal performance.  For it was the supply side all over again.  The words “supply side” could not be read on anyone’s lips; no one traced a laughable curve on a cocktail napkin; and the ideas were restated less breathlessly than Jack Kemp does.  Nevertheless, it was the same old story.  A few spoke scornfully of trickle-down economics, and several spoke approvingly of the middle class.  I imagine most of the speakers would be shocked to be called supply-siders.  They should listen to the tapes.  The rhetoric was different, but the theory was substantially the same.

So where is the change that Candidate Clinton promised us so tirelessly?  Well, unpaid compassionate leave will be available to corporate employees; there will be less overt or covert endorsement of racial, sexual and ethnic cleansing; in close calls, the decision will usually go to the otherwise disadvantaged; the environment will not be a dirty word; family planning will again be a virtue; and something will be done about medical insurance.  In issues like these (except, perhaps, for the last named[1]), we can expect common sense and common decency to prevail. Common sense and common decency are no small things; we have lived without them far too long.  Their recovery will make the Clinton Presidency worthy of being remembered.  But I fear that the economic rebirth we long for will continue to elude us.

The rebirth will be aborted because the new supply-siders have, so to say, a monetarist side.  Speaker after speaker warned against over stimulating the economy.  It was explained that, whether by stepping up spending or reducing taxes, stimulation would increase the deficit, which would scare the “market” into increasing long-term rates, which would spur short-term rates, which would renew or deepen the recession.

Either way the deficit had to be reduced; and any way the deficit was reduced, the economy could not be stimulated.  That’s a dilemma for you. The proposed solution was twofold: First, the economy should be stimulated, but cautiously.  Second, a long-term, foolproof deficit-reducing program should be enacted to convince the market that the deficit is on the road to reduction; so renewed inflation will not be a danger, and interest rates need not be raised.

Let’s look at the stimulation, to be produced by expanded public works (I don’t believe in the second part of the solution any more than I did in Gramm-Rudman.) The largest sum I heard mentioned was $50 billion, with most of it going to state and local governments to restore services and repair infrastructure neglected under Reagan-Bush.

I can’t say that’s a bad idea because a little over a year ago in this space (“Taxing our Credulity,” NL, December 2-16, 1991) I wrote, “If Federal grants to state and local governments were restored merely to the same proportion of Federal expenditures as in 1980, a sum of $63.1 billion would be available to break the back of the recession.”  You will note that I proposed spending at least 26 per cent more than did the most spendthrift speaker at Little Rock.  Even so, I would not have been satisfied, as I made clear in subsequent columns, for $63.1 billion may seem like a lot of money, but it is only about 1 per cent of our gross domestic product (GDP).

As our economy is now organized, wages and salaries are about 80 per cent of GDP.  The median income for full-year male workers over 15 years old is about $30,000; the corresponding figure for females is about $20,000.  Beneficiaries of an economy-stimulating program might be paid less than the median – say, $20,000 as the average for both sexes.  And of course much of the stimulus would go to people who are employed.  Putting all these guesstimates together, I conclude that a $50 billion stimulus would directly create about 2 million jobs, while $63.1 billion would directly create about 2.5 million jobs.  Factoring in the “multiplier,” these totals might double, although not at once.

That’s not bad – provided you’re not one of the 6 or 7 million who would still be unemployed.  Please read and reread the previous sentence until its meaning in human suffering starts to become real to you.  I fear that it is not real to most mainstream economists, especially those who believe in the “natural rate of unemployment.” (See “Are You Naturally Unemployed?”  NL, August 10-24, 1992.[2])

A couple of the Little Rock economists pointed out – as I have done here many times (thus showing how obvious the point is) – that the debt and deficit ratios to our gross national product (GNP) were about twice as high in 1947 as they are at present, yet we proceeded to save Europe with the Marshall Plan and enjoyed a quarter-century that never saw the unemployment rate come close to what it is today.  The interest rate also was lower than today’s in every year except 1968, ’69 and ’70, and the inflation rate was lower in every year except 1948, ’51 and ’70.  One of the mainstreamers o9bserved that the postwar prosperity was driven by the demand for consumer goods pent up during World War II.  He did not seem impressed by the counter-observation that a lot of demand for consumer goods would be released now if the unemployed had jobs.

A CURIOUS FACT about the conference was the virtual absence of any reference to the Federal Reserve Board.  It was almost a case of the dog that didn’t bark.  There was a good deal of talk about the interest rate, but I heard only two participants refer to the agency that sets it.  One of the references suggested that things would change when we got “our” Board (unhappily, not an immediate possibility).

The other reference was a brief but remarkably comprehensive paper by a former governor of the Board.  He made two main points:  First, the long-term rate remains high because the Board keeps hinting the short-term rate will be pushed up to meet it (although there is plenty of room for the short rate to come down further). Second, the long-term market is effectively merely the market for 30-year Treasury bonds.  If there were no 30-year Treasuries, there would be scarcely a long market at all.  The Treasury raises only about 7.5 per cent of its funds long term and would save money if it gave them up.  Why not do so?  I regret to report that Secretary of the Treasury-designate Lloyd Bentsen did not respond, nor did President-elect Clinton.

Taking one thing with another, my sorrowful conclusion is that the Clinton economy is not going to be sensationally better than the Bush economy.  The National Bureau of Economic Research (not an “official” body, regardless of what the New York Times says) thinks you can have a recovery with both wages and profits falling and 10 million unemployed.  The awesomeness of this organization and the power of the Federal Reserve Board practically guarantee that the economy will get only a minimal stimulus, and that for only a minimal length of time.

Practitioners of economic science have dismally short memories.  In 1937 the GNP jumped up 7 per cent, where-upon the New Deal rushed to mollify Wall Street by cutting relief programs.  The budget deficit, which had reached the vertiginous height of $3.1 billion in 1936, was converted to a surplus (yes, surplus) of $300 million in 1937.  The result was a sharp recession within the Depression.  I fear that we’re getting ready to do it all again, and with far less excuse.

But one sound proposal, calling for full funding of Head Start, was generally endorsed at the economic summit.  Some of the economists saw Head Start as an “investment” in future productivity.  Their supply-side bias blinded them to its certain contribution to economic recovery.  Nonetheless, most of the money – and it will not be a trivial amount – that goes into Head Start will immediately go out to teachers’ or leaders’ salaries, to snacks and lunches, to consumable supplies like finger paint and soap, and to low-tech and expendable furniture and decorations.  At the end of a year there will be little or nothing tangible to show for these expenditures.  In the eye of an accountant the whole thing will seem like consumption of the most profligate sort.

Yet such profligate consumption (if it actually happens) will do more to stimulate the economy this year, and every year of the program’s existence, than the schemes to restore the investment tax credit, to rehabilitate IRA’s, and to cut taxes for the middle class.  All of those are bum Reaganesque ideas that we have already tried and found wanting.

The Clinton-Gore book title had it right:  We should be Putting People First.

The New Leader

[1] True enough, no action until the Affordable Care Act, aka ObamaCare

Ed: [2] We do not have a copy of this.  If you have one, PDF or in print, please share

By George P. Brockway, originally published November 2, 1992

1992-11-2 The Illogic of Leanness and Meanness Title

1992-11-2 JK Galbraith                EDITORIALWRITERS and speech makers are fond of the expression “lean and mean” (or, sometimes, “mean and lean”). I suspect it is the rhyme that appeals to them. They can’t possibly be allowing themselves to think about what happens to people who work (or used to work) for lean and mean corporations. They can’t possibly give a satisfactory answer to the question John Kenneth Galbraith asks in Affluent Society: “Why should life be intolerable to make things of little urgency?”

Nor can they possibly be wondering whether lean and mean corporations make this a better world to live in, even for their customers and their stockholders. St. Augustine wrote: “Every disorder of the soul is its own punishment,” and meanness is certainly a disorder of the soul.

Yes, I know: We are told we will have to be lean and mean to compete in the global economy of the 21st century. Some commentators say that the global economy and the competition are already here.  President Bush inclines to this view; President-elect Clinton inclines to this view; and I suspect that Citizen Perot had something similar in mind. At any rate, he had a lean and hungry look.

Fifty years ago another self-made man, Wendell L. Willkie, had a vision of One World in which we would all help each other. Willkie was a lawyer and CEO of a giant utility holding company before he became the 1940 Republican Presidential candidate (Harold Ickes, Franklin D. Roosevelt’s Secretary of Interior, called him the “barefoot boy from Wall Street”); he was no starry starry-eyed innocent. Yet his touchstone was cooperation, not competition. The world seems to be different now, and not as nice. What happened?

It is, I think, a case of Samuel Johnson being right again: “Hell is paved with good intentions.” The economic situation we find ourselves in is mean enough to have at least some of the attributes of hell, and it is paved in part with free trade, a theory whose intentions were the best in the world. I say “were” because I’m not so sure they’re all so good today.

Practically every economist is in favor of free trade, and the fraternity has been joined by a broad range of right-thinking, public-service citizens groups, from the Council on Foreign Relations to the League of Women Voters. The argument for free trade is simple and strong: All of us are consumers, and therefore benefit from cheap consumption goods. Tariffs, subsidies and the like increase the costs of consumption goods, and therefore are bad. A less materialistic reason for open international trade is that it is said to make for peace, although perhaps not in the Middle East.

The foregoing arguments, including Willkie’s, may be classified as general or ideological. There are also technical arguments in support of free trade – for example, the theory that cheap imports are both anti-inflationary in themselves and anti-inflationary in their competitive pressure on domestic prices. This notion was a favorite of former Federal Reserve Board Chairman Paul A. Volcker. The most famous technical argument is David Ricardo‘s so-called law of comparative advantage. Unhappily, there isn’t sufficient space here to discuss this “law,” except to say that it consists mostly of exceptions[1].

For the moment I merely want to register the point that each of the arguments, the ideological and the technical, depends – as does standard economics generally – on three assumptions: that full employment actually obtains here and now, that chronological time does not matter, and that all public questions are, au fond, economic questions (or, as Marx had it, that the state will wither away and need not be taken seriously).

Free trade as an ideal has had a long run on the American political stage, starting at least as early as the Boston Tea Party. What has happened recently is not inconsequential. Even as late as 1950, imports were less than 5 per cent of our GNP (exservices): currently they are running at about 16 per cent. Until 1977, American exports generally exceeded imports; I don’t have to tell you that the situation is different now. Nor do I have to read you a list of American industries that have been decimated by foreign competition. Those who say that the global economy is upon us are not far wrong. I am persuaded, however, that what they propose to do about it is indeed far wrong.

Essentially, they make two proposals. The first is the lean and mean thing, to which I will return. The second involves empanelling a committee of government officials, bankers, businessmen, economists, engineers, scientists, and the obligatory representatives of the general public (but not including Ralph Nader) to recommend research and development projects to the government, and then to pass judgment on the results of the research and propose ways of implementing the development of approved ideas. The government’s role would be crucial, because of the antitrust laws and because the research is thought likely to cost more than any corporation, regardless of its size, could afford. In addition, it is observed that the largest corporations tend to devote less and less money to research.

The scheme has both practical and theoretical flaws. The chief practical flaw is that whatever good ideas the committee might come up with would be immediately available worldwide. Just as the American television set industry quickly slipped into the Pacific sunset, so would the new wonder industries.

It is inconceivable, for instance, that giant American corporations would be excluded from the marvelous new industries thought up by the committee. Our giant corporations, however, are not really American; they are multinational. They are motivated by the self-interest of the stockholders (in the conventional theory) or of the managers (in Galbraith’s view); in either case, their devotion is neither to the nation nor to the nation’s workers.

Consequently, upon learning of the miraculous new product along with everybody else, if it is truly miraculous, the responsibility of these corporations to their stockholders or to themselves would require them to start producing it in the least expensive way. And where would they do that? Wherever in the world they found the most stimulating subsidies, the most alluring tax rates and the cheapest labor.

Wherever in the world that might be, it would not be in the United States of America, for the inescapable reason that, at least so far, the American standard of living is higher than that of any other first-rank country. The cheapest labor will not be found here unless we destroy ourselves. On the MacNeill Lehrer Newshour a few months ago, U.S. Trade Representative Carla Hills seemed to believe the Mexican poverty rate was only about 11 per cent (ours was 13.5 per cent two years ago and has undoubtedly risen since). She must have been thinking of some Mexico other than the one I’ve visited.

A MINOR practical flaw in the committee scheme is inherent in the very idea of creating such a group. Schumpeter counted the mature corporation’s addiction to committee decisions a prime reason for decline, and we all know the absurdity that would result if a committee tried to design an animal. Perhaps more important, we know from experience that a committee is quickly co-opted by those with the liveliest immediate interest in the outcome of its deliberations.

In the proposed body the industry and banking representatives may not be the smartest or the best informed, but they surely will have their minds concentrated on the fate of their sector of the economy, and they will certainly wield the direct and indirect power that comes with enormous wealth. In Japan, captains of industry respect the authority of even minor bureaucrats; in the United States, money talks.

Beyond this, the committee approach has a serious theoretical flaw in that it contradicts the very reasons for its formulation. These, it should be kept in mind, are (1) the decline of American industry because of foreign competition, and (2) the presumed impossibility or unacceptability of self-protection in any form.

The conventional charge against self protection is that it interferes with and distorts the natural course of trade, thus making for inefficient if not altogether wasteful use of resources. Publicists reinforce the charge with the cliché that a man knows better what to do with his money than does some bureaucrat in Washington. Yet if the charge and the cliché were valid, there would be nothing to be done about the decline of American industry. It would be natural and inexorable. Further, it would assure the “efficient” use of resources and be a necessary contribution to the wealth and happiness of mankind. Some people would no doubt be hurt by it, but you can’t make an omelet without breaking eggs.

On the premises, there is no more place for a reindustrializing committee than there is for self-protection. If the committee wouldn’t interfere with the natural marketplace, what would it do? Its whole purpose is to interfere in a large and comprehensive way. The logic of the scheme is absurd. Major premise: American industry is being ravaged by foreign competition. Minor premise: Self-protection is unacceptable because it interferes with the free market. Conclusion: A committee should be empaneled to interfere with the free market. What kind of logic is that?

The lean-and-mean logic is similar. Major premise: The American standard of living will be ravaged by foreign competition. Minor premise: Self-protection is unacceptable because it interferes with the free market. Conclusion: We should make corporations lean by firing people, make them mean by working the surviving employees harder for less pay, and thereby make ourselves miserable without help from anyone else.

I find it odd that standard economics, based as it is on self-interest, should find self-protection invariably reprehensible.

The New Leader

[1] This link includes references to the Law of Comparative Advantage in other Dismal Science articles

By George P. Brockway, originally published September 21, 1992

1992-9-21 The Malignity of Capital Gains Title

THE RECURRING wrangle over the fairness or unfairness of capital gains taxation, while certainly not irrelevant, has distracted attention from the malign effects on the economy of the search for capital gains.

We hear on the one side that they are largely the concern of the rich, and of their pursuit by rapacious business executives. On the other side we are told tales of young men enabled to realize a great invention with the help of a timely investment by some capitalist with vision. We learn, too, of family farms and family businesses, of personal art collections, and of great tracts of unspoiled wilderness that would not be put to their best social uses if equitably taxed.

We hear all of these things, and most of them are true, or could be true. But we hear little or nothing about the influence of the search for capital gains on the stock market and, through the stock market, on the efforts of the Federal Reserve Board to stimulate the economy.

It is a source of much puzzlement that the Reserve’s well publicized three-year long assault on short-term interest rates has done, if anything, the opposite of what it was intended to do. Since the summer of 1989 the Reserve has cut short term interest rates more than 20 times. The expectation, of course, has been that lower rates would encourage producers to borrow and invest in plant expansion and modernization. The resulting increased employment, coupled with lower rates on consumers’ loans, would encourage consumers to buy, thus validating the producers’ expansions and setting the economy on a sustainable upward curve.

The plan made sense from almost every economic point of view, yet its failure is manifest. Producers are shutting down plants instead of opening new ones; unemployment has risen painfully; corporate profits and personal savings are both down; retail sales continue to be disappointing.

For most of the economy 1991 was a bad year, and 1992 is worse. But one sector flourished, and continues to flourish. Nearly all brokerage houses are prosperous, some of them more so than ever before. The stock exchanges, despite waffling between their January and July peaks, have been buying and selling at a record rate.

It has been a long time since Wall Street was primarily concerned about the business prospects of the firms whose shares the exchanges trade in the hundreds of millions every business day. Two statistics dominate the thinking of speculators. The first is unemployment, which is a worry because there is supposed to be a trade-off between unemployment and inflation. But in only three of the 46 years since the end of World War II has unemployment been higher than it is today; so regardless of the validity of the supposition, there is little fear of an imminent resurgence of inflation.

The other number that concerns Wall Street is the interest rate, because the capitalized value of any income-earning asset goes up as the interest rate goes down. The reaction of the secondary market for short- term bonds and notes is almost automatic. The long bond market, being congenitally fearful of inflation, follows at a more circumspect pace. As the prices of bonds rise, common stocks become more attractive investments, both for income and for capital gains.

Therefore, as the Federal Reserve Board has lowered the interest rate, the stock market has climbed. Investors especially speculators eager for capital gains-have rushed to take advantage of the quick profits. Money has poured into the stock market.

Now, that money obviously had to come from somewhere, and its ultimate source had to be the producing economy, where things are made and sold and services are performed and paid for. It may be old money from CDs and money market funds and bonds, or it may be new money borrowed at the new interest rates. In either case, it is money that the rising stock market denies to the producing economy. The lower interest rates, instead of stimulating the producing economy, have caused money to be drained away from it. Hence the deplored credit crunch.

Unfortunately, there is nothing the Federal Reserve Board can do about this. A continuation of the policy of lowering the interest rate will lead to a continuation of its consequences. A determination to stand pat will leave us in our present doldrums. A reversal of policy, raising the interest rate, will not only deepen the recession but very likely cause the market to crash. Moreover, when the market crashes the money that is lost simply disappears. It is not returned to the producing economy, nor does it reappear as cash in someone’s pocket.

Gross private domestic investment, as a percentage of GNP, was practically unchanged in 1986, 1987, and 1988 (the year before the crash, the year of the crash and the year after the crash). The percentages were 13.5, 13.1, and 13.8, respectively. As for cash, M1, which includes it, fell in 1987 as the market fell. The lost money was gone forever.

Was the Reserve wrong, then, to reduce the interest rate? Certainly not. Usurious rates are largely responsible for the recession, and still lower rates will be necessary to end it. It is true that the discount rate is now lower than it has been for 30 years. It is also true that it is three times what it was in 1947 and six times what it was on special advances in 1946.

Although the Reserve Board’s recent intentions bay be good, they have been, and will continue to be, overwhelmed by the altogether understandable rapacity of seekers after capital gains. It’s easy to make money on a rising market, but you have to risk a dollar to make a dollar. The dollars that you risk are dollars you might have risked in buying a new machine for your factory or in replenishing the inventory of your store. Your broker will try to tell you that by buying a share of stock you are producing goods just as much as if you were buying a machine for your factory. But of course the stock and the machine don’t both produce goods and it takes time to make money with the machine, while you can do that on the stock exchange very fast. So if you’re smart, you will play the market, and the Federal Reserve Board will be frustrated.

If the Federal Reserve cannot get us out of this mess we are in who can?  Unwittingly, President Bush has pointed the way – even though, characteristically, he was looking in the other direction. He has proposed a low capital gains tax, and a still lower tax on gains on some assets held more than five years. It won’t take you very long to see that his proposal would merely make more attractive the speculation that drains money from the producing economy.

Yet a sliding tax scale could take the profit out of speculating. If I had my druthers, I would have a capital gains tax that went something like this: Gains on some assets held more than five years would be taxed at 95 per cent, gains on assets held more than a year but less than two years would be taxed at 90 per cent, and so on, with the rate falling 5 points a year for 10 years.

Some changes in the tax law should be made regardless of the rates. Gains certainly should be taxed when assets change hands by gift or bequest as well as by sale. Capital gains of otherwise tax-exempt institutions should be taxed, because such institutions are responsible for much of the current market churning. On the other hand, it would be desirable to exempt principal family residences that fall below a certain value, along with small family farms and businesses.

Capital gains are an archaic form of profit. Despite their name, they are typical not of the capitalist system, but of mercantilism and more primitive economic systems. Likewise, the speculation that gives rise to them is an archaic form of economic enterprise. In the Renaissance the merchants of Venice organized each commercial voyage as a separate affair. Their personal experience taught them the sorts of goods most likely to be wanted on the Golden Horn. They stocked their outward bound galleys accordingly, and they brought home the sorts of things they could sell quickly and profitably at the quayside. The system was a series of speculative ventures, making the most of ad hoc opportunities to buy cheap and sell dear. When the selling was ended, the enterprise was ended, too. Capital gains are realized only when an investment is withdrawn and ceases.

In contrast, a modern corporation is a continuing enterprise. The basic concepts of classical and neoclassical economics are irrelevant to it. It could not continue if its market were “cleared. Since its market is not cleared, the “law” of diminishing returns is obviously violated. If the law of diminishing returns does not apply, there is no “margin,” and marginal pricing is impossible. If marginal pricing is impossible, “equilibrium” is neither necessary, likely, nor desirable. (And this is a good thing, for as all theorists from Leon Walras to Gerard Debreu acknowledge, economies of scale – the ideal mode of modern business enterprise – are impossible under equilibrium.)

Four years ago it was argued (fallaciously) by candidate George Bush that reducing the capital gains tax would increase tax collections (see “George Bush’s New Trojan Horse,” NL, September 19, 1988). His lips seem to be buttoned shut on that one today. Now we are told that reducing the tax would stimulate business, a notion dear to the far Right, which nevertheless mysteriously mistrusts him. But surely the Federal Reserve Board has had enough experience in the past three years to prove that to encourage capital gains is to encourage speculation, and that to encourage speculation is to induce a credit crunch that throttles productive enterprise.

A low capital gains tax is unfair because it is for the principal benefit of the rich. It is also economically counterproductive.

The New Leader

By George P. Brockway, originally published March 13, 1992

1992-3-9 The Key to Consumption Title

 

 

 

 

 

 

 

 

LAST TIME I reported why our present economic muddle should be called a “contained depression.” The term is the coinage of S Jay Levy and David A. Levy of the Jerome Levy Economics Institute of Bard College. It distinguishes our present situation from the five or six recessions we’ve had since World War I, and also from the Great Depression of the 1930s.

The earliest recessions were temporary gluts of unsold consumer goods-relatively easy to slip into and correspondingly easy to recover from. Hence President Bush‘s long mad posture of “What? Me worry? Hence the frigid, almost insolent objections of Chairman Michael J. Boskin of the Council of Economic Advisers to extensions of jobless benefits. Hence the plaintive repetitions of Chairman Alan Greenspan of the Federal Reserve Board that the present recession will be short and shallow, and that recovery will start about six months from the date on which he happens to be speaking.

As the thing drags on, I’m reminded of the Elaine May- Mike Nichols skit in which a patient complains that she has been sick for a couple of weeks with what was diagnosed as 24-hour flu. “Well,” responds the doctor after carefully thinking the matter through, “this may be something of longer duration.”

Indeed it may. What we are now trapped in is not a consumption goods glut but a capital goods glut. We have too many factories, too many warehouses, too many office buildings, too many shopping malls, too many retail chains, too many too expensive apartments, too many too expensive vacation resorts, and especially too many banks and insurance companies and pension funds with too much of the foregoing as collateral for loans.

This sort of glut is not easily worked off in the modern world. Regardless of what the Cassandras say, we’re marvelously productive. If you want more steel, we certainly can turn it out for you. Or more automobiles, refrigerators, escalators, computers. Or more houses and highways. Or more cough medicines and handkerchiefs. Or more magazines and books. Or, when the President’s four new pair wear out, more sweat socks.

We are not oversupplied with any of these things – well, not with many of them. Our inventories are mean and lean and all that, but there’s no danger of serious shortages of anything for very long. What we are oversupplied with is the capacity to make more of almost anything. We have factories and machinery and office equipment and distribution systems and office managers and workers and know-how aplenty. No problem with any of that, except that we have too much and, like the sorcerer’s apprentice, the manic capacity to make more.

An inventory glut can be handled by shutting down the factories for a few weeks or months. But what can be done with a capital goods glut? There are two principal solutions: (1) We can let the unneeded capacity stand idle until it rusts out, or enough currently used capacity wears out, to bring our capacity to produce down to the level of our capacity to consume. Or (2) We can bring our capacity to consume up to the level of our capacity to produce.

The first solution, in its more benign form, is what Joseph Schumpeter called creative destruction. Schumpeter saw the economy driven by a succession of new industries, whose birth and growth led to the destruction of large existing industries. The most familiar example is the automobile industry, with its subsidiary industries of steel, glass and so on, and its ancillary industries of highway construction, petroleum and parking facilities. The new industry gradually overwhelmed industries built on the power of horses.

That did not happen all at once. As late as the 1920s, many cities still had horse-drawn fire engines whose pumps were powered by dramatic coal-fired steam engines. As late as the outbreak of World War II, the Boston Globe discovered to its surprised delight that it had not gotten around to completely dismantling its capability to deliver newspapers by horse-drawn wagon. A few carriage makers were able to convert to the production of automobile bodies. Many livery stables became garages. But manufacturers of buggy whips provided a metaphor for progress and quietly went out of business.

As Schumpeter pointed out, the new industries were bigger and in most ways better than the ones they destroyed. Or as folk wisdom has it, you can’t make an omelet without cracking eggs. The trouble now is that there’s no great new omelet industry on the horizon. The computer industry, which many expected to save us, is itself stumbling[1].

In fact, our situation is dauntingly similar to that of 1930. The unneeded or unwanted capacity is not limited to a single doomed industry. It is universal. Its destruction – if it occurred-would not be creative. It would be merelv destruction: wasted money, wasted resources, blighted hopes. And perhaps most important of all: wasted time. Once again Bessie in Clifford Odets’ Awake and Sing! would be speaking a bitter truth: “On the calendar it’s a different place, but here without a dollar you don’t look the world in the eye. Talk from now to next year – this is life in America.”

It would take a long time for the bright new assets to rust out or the good old assets to wear out. It would take a long time for banks and insurance companies and pension funds to become solid again. It would not be a pleasant time. For millions of citizens it would be a hopeless time, made more bleak by the deterioration of their surroundings both social and physical.

It took World War II, with its enormous stimulation of governmental and then personal demand, to pull us out of the Great Depression. The New Deal had moved painfully slowly, hamstrung by a coalition of Northern Republicans and Southern Democrats, and hampered by its own emotional commitment to classical economics. (A “responsible” effort to reduce the minuscule deficit in 1937 caused an instant recession.) Yet the New Deal was open, eager, hopeful, vigorous, experimental, caring. New Dealers didn’t have to make speeches about how they cared; they showed it. In their place we have Boskin, Brady and Darman and their trickle-down schemes.

So much for the first solution to our troubles. It is no solution at all.

The second solution (bringing our capacity to consume up to the level of our capacity to produce) would seem, on its face, to be easy as pie. Consuming is what we’re supposed to do best. Shopping malls are where we shine. But all the wise men kept telling us not to consume-until Bush bought those socks. Unfortunately, now that they are telling us consuming has become patriotic, we either haven’t any spare money or are afraid we soon won’t have any spare money.

The problem is, the wrong people have what spending money there is. Worse than that, practically nobody in public life says it is the wrong people who have money to spend – except Senator Tom Harkin, and look what happened to him in the Democratic Presidential primaries.

Somehow it has become conventional to believe that the distribution of wealth or income is not the issue. Or that redistribution is not practicable. Or that it wouldn’t make any difference, anyhow.

LET ME INTERPOSE a little story. The other evening I was a dinner guest at the home of some liberal friends. There were eight of us around the table, and none of us was afraid of what the President calls “the ‘L’ word.” We are liberals, possibly even knee-jerk liberals, and proud of it. After all, some injustices are so flagrant, and some events so sudden, that decent people must respond to them semi-automatically. A liberal response is surely more honorable than a reactionary withdrawal.

Anyway, there we were, and we got talking about the very subject of this article. You will not be surprised to learn that I argued in favor of restoring steep progressivity to the income tax. And I was not surprised to be told that Robin Hood was a seductive medieval myth, that taking from the rich and giving to the poor would simply make everyone poor because the rich are so few and the poor are so many, and that soaking the rich would not much improve revenues because tax avoidance would then increase.

We have all heard that line of talk before, very likely first meeting up with it at our father’s knee, if not at our mother’s. The line may actually have been true back then (though I doubt it), but it’s certainly not true today. The average of all family incomes in the United States is somewhere between $70,000 and $80,000.  It’s difficult to be more precise, because it’s hard to agree on exactly what a family is. In any case, it’s obvious that the Robin Hood myth is not impossible today.

I don’t suppose that anyone advocates perfect equality. (Even Engels called equality “a one-sided French idea which was justified as a stage of development in its own time and place but which now should be overcome.”) Nevertheless, it is important to understand that the present distribution of income is not an aspect of the universe that we, like Margaret Fuller, had better accept. It is not the unalterable consequence of some mathematical or psychological or perhaps theological law.

A second point must be made: Any attempt to change the distribution of income will certainly give some people, including those whom Shaw’s Mr. Doolittle called the undeserving poor, some money for nothing. I’ll let you compile your own list of why something for nothing is bad-psychologically, socially, ethically-and I’ll even grant the validity of most of your reasons. But then I’ll ask you to compile a list of the Astors and Morgans and Fords and so on who got something for nothing. A wit on the New York Times a couple of years ago noted that most of the richest people in America got their money the good old fashioned way-they inherited it. Something for nothing is, Nelson Rockefeller might have said, in the mainstream of Republican thinking.

Once we have mastered the message of the two preceding paragraphs, we have earned the right to consider ways of building demand worthy of our productive capacity. We all know the most obvious ways: First, massive public works, massive support for education, comprehensive national health care insurance.

Second, an almost vertically progressive inheritance tax, a steeply progressive income tax, probably a negative income tax at the bottom, and possibly an income limitation tax at the top.

We don’t have to do it all at once. But unless we get started soon, it will be a long time before happy days are here again.

 The New Leader

[1] Ed:  OK, so even this author gets it wrong from time to time….

By George P. Brockway, originally published February 11, 1991

1991-2-11 Don't Bet On The Banks Title

I CAN’T THINK of a single good reason why the rest of the financial sector, led by the commercial banks, should not eventually follow the S&Ls to the woodshed. In a few cases the usual arguments about “the others” being more experienced or diversified may carry some weight, but in general their problems and those of the S&Ls have similar causes and will have similar consequences.

There is more than a trace of poetic justice here; the commercial banks lobbied hard for the deregulation that did in the S&Ls, and the same deregulation has returned to plague its champion.

Only 11 years ago, the states had usury laws that set the maximum interest rates for different loans. There were, of course, exceptions of various degrees of complexity, but the important point is that there were limits to what could be charged. The Federal Reserve Board set limits in the other direction, the most discussed being Regulation Q. To give the S&L’s a chance to survive, and to offset their being restricted essentially to home financing, Regulation Q allowed them to pay savings accounts a fraction of a point more than the commercial banks.

That system was a casualty of the Federal Reserve Board’s sensational and long-running battle with inflation (see “Who Killed the Savings and Loans?” NL, September 3, 1990). It took almost 30 years for the system to start to break down, and the collapse is not yet complete.

The reason for the long Untergang is the inherent stickiness of finance. In any 12months the nonfinancial sectors (public and private) make new borrowings equal to less than one-twelfth of their total indebtedness. The other eleven-twelfths includes 30-year mortgages still paying 4 per cent interest, 20-year Treasuries paying 15.75 per cent, credit card freaks paying 19.9 per cent, and all sorts of things in between.

With this big backlog (currently about $8.3 trillion), even very large shifts in the interest rate on new loans have only a lethargic effect on the nation’s overall interest rate. The overall rate was 9.55 per cent in 1979-when former Reserve Chairman Paul A. Volcker took well publicized command of the inflation battle-and reached 10.61 per cent a year later. As a result of Volcker’s policies, however, the average prime rate on new loans jumped from 12.67 per cent in 1979 to 15.27 per cent in 1980 and topped out at 21.5 per cent that December and the following January. Since what is comparatively slow going up is also comparatively slow coming down, the average interest rate is higher today than it was in 1980, although the prime is less than half its 1980 peak.

The stickiness of finance enabled the S&Ls and the commercial banks to withstand the surge of interest rates as long as they did. It is probable that the bankers (of all kinds) do not yet know what hit them; certainly the Federal Reserve Board (called the nation’s central bank by its present chairman, Alan Greenspan) does not know. So I’ll give them a hint. If they pay high interest to attract funds, they must charge high interest to cover their costs. And if businesses must pay high interest, they must charge high prices for their goods. At this point, the bubble gets very thin. Consumers do not have money to pay high prices, particularly if many have lost their jobs.

You can charge whatever amuses you for a book or a loaf of bread or a new broom to sweep things clean. Only the book or bread or broom business will be affected. But when you charge too much for the use of money (and it is the Federal Reserve Board that ultimately sets the rate), all businesses, all banks and insurance companies and “institutions,” and all men, women and children are affected.

The S&Ls were driven to the wall first, but the death march of the commercial banks is gathering momentum. Both S&Ls and commercial banks cheered when the state usury laws were suspended, and rushed to expand their real estate business. They are now suffering from a surfeit of residential condos, motor inns, office buildings, and shopping malls. The commercial banks greedily participated in the Great Recycling of OPEC’S profits and as a result will have to face up to their losses in the Third World. Many S&Ls and commercial banks have stuck themselves with junk bonds. How many will survive the recession?

Well, the Bush Administration proposes to help them by getting rid of two of the few remaining New Deal banking reforms. The most important of these keeps commercial banking separate from investment banking, insurance and especially ordinary business. The other restriction keeps commercial banks from branching out beyond a state’s borders.

In the cheery days of President Ronald Reagan, these regulations were anathema simply because they were regulations, and because, as some sports-minded journalist noticed, not one American bank ranked among the top 10 in the world. Even more shameful, most of the giant banks were Japanese. Once again it seemed that they knew something we didn’t know.

In the drearier economic days of President George Bush, less is said about the Japanese banks, for they have fallen on harder times. The index of leading stocks on the Japanese exchange fell 38.7 per cent in 1990, and the Japanese banks (this is one of the secrets of their size) have long positions in those stocks. They have long positions, too, in a rapidly falling real estate market, which they can speculate in (unlike American banks) as well as lend money on.

A few years ago, proposals to permit interstate Banking and to allow banks to own brokerage houses and insurance companies (and vice versa) would have caused a considerable hullabaloo. The large banks were in favor of changing everything; they wanted to get on that top 10 board with the Japanese. Likewise the big stock brokerage houses and insurance companies and all-in-one companies such as Sears, Roebuck. Smaller operators (except those who wanted to sell out for capital gains) preferred the existing conditions-although some would not have objected to dabbling in additional financial services, provided that other financial servers couldn’t dabble back.

Today, the Bush banking moves are not stirring much controversy. A professor of finance suggested recently in the New York Times that this is because they don’t go far enough, that there is nothing to shout about. But commercial banks are in trouble, and since the trouble is no longer confined to Texas and Oklahoma, there is little reason to expect greener pastures in other states. Nor is the solution to be found in putting them together with the problem plagued brokerage houses, insurance companies, pension funds, investment banks-and Sears, Roebuck. A couple of dozen such financial smorgasbords would likely result in a couple of dozen concentrated headaches, if not hemorrhages.

To be sure, the Administration promises to supervise the banks closely to prevent their making more bad loans. Does that mean they are not supervised closely now? Yes, it does. You see, supervision costs money, and you’ve heard about the deficit. Increased costs will have to be matched by increased taxes-in this case, Federal insurance fees. Higher insurance fees will mean lower interest on deposits, and that means money-market funds and Treasury bills will attract cash away from the banks. To keep their deposits, banks will have to pay higher interest, and to do that they’ll have to make more loans at high rates. Sound borrowers won’t pay high rates; so the banks will have to hunt for riskier deals (see “Big Is Ugly,” NL, September3, 1984). And that’s what got them where they are.

In short, interest rates aren’t innocent.  If you refuse to control them, you destabilize the financial sector-and the whole economy. If you manipulate them in a fallacious attempt to contain inflation, you bring on recession (See “Bankers Have the Classic COLA,” NL, January 9, 1989). And that’s what the Federal Reserve has done.

A GOOD DEAL of the trouble lies in the fact that few bankers understand how the capitalist system differs from the mercantilist system. In Legal Foundations of Capitalism (one of the neglected great books),

John R. Commons explains the shift from property as use-value to property as exchange value. This did not start in the United States until the first Minnesota Rate Case a century ago, and most bankers are still out of date. They remain mainly interested in fixed assets that can be attached, not in going concerns that generate cash flow and profits. Hence their fatal fascination with real estate and the idiotic recycling that transformed OPEC profits into loans that are in effect gifts of American money to rulers of Third World nations.

Willard Butcher, when he was chairman of Chase Manhattan, once delivered himself of a perfect example of bankerly thinking: “Is Mexico worth $85 billion?” he asked rhetorically. “Of course it is. It has oil, gold, silver, copper. … “All these assets are physical. You can touch them, and you can attach them. But they aren’t worth much if they can’t be sold at a profitable price, and when usurious interest rates are charged profitable prices are impossible.

On an arguably more modest level, I came up against this sort of thinking at another bank while I was in the publishing business. The bank examined our balance sheet and advised us that our inventory was too low. Did we have an unusually large number of titles out of stock? I asked. No, on that point our record was exceptionally good. Did we allow titles to go out of print too quickly? No, rather the contrary. Were we slow to fill orders? No, again. Our record here was the best the bank knew of. Did our practice of printing in relatively small quantities (this was before the Japanese made “just in time” inventory control famous) result in significantly higher unit costs? No, yet again.

You’d have to say that we were managing our inventory as well as anyone in publishing. Nevertheless, the bank insisted it was too low. The unspoken (or unrecognized) reason was that our low inventory meant we did not have much for the bank to attach if we got in trouble. It never crossed the bank’s mind that too much money tied up in inventory might get us in trouble, and that if we couldn’t sell the inventory profitably, the bank certainly would be unable to do so.

Commercial bankers aren’t the only people still living in a precapitalist world. Our financial system as a whole (S&Ls, banks, insurance companies, pension funds, “institutions” and supervisors) continues to be essentially mercantilist. Its ideal profit, like Bush’s, is a capital gain. In this understanding it is joined by mainstream economics, which analyzes business as a disconnected series of market-clearing ventures, not as a going concern. Until these two powerful sectors of our society are brought into the modern world, stagnation, punctuated by bankruptcies, is likely to be our lot.

 The New Leader

By George P. Brockway, originally published February 5, 1990

1990-2-5 Social Gains and Capital Security Title

TRYING TO UPSTAGE New York’s Democratic Senator Daniel Patrick Moynihan, who wants to stop using the Social Security Trust Fund to reduce the budget deficit, the Bush Administration has concocted something it calls the “Social Security Integrity and Debt Reduction Fund.” This is supposed to do part of what the Senator is urging, but in 1993 instead of now. The Senator, of course, had a pithy comment: “It is well known that the Federal budget is always in balance three years from now. Never, however, now.” It is equally well known that the Administration’s sudden action is motivated by fear that Moynihan’s proposal of a tax cut for everyone will show up President George Bush’s proposed cut in capital gains taxes as the rich man’s scam it is.

1990-2-5 Social Gains and Capital Security Daniel Patrick Moynihan

Among the many things wrong with the Social Security tax, the two principal ones are, first, that it is regressive; second, that it is a tax on employment and both adversely affect the distribution of income. The regressiveness is generally recognized, except by those who have come to believe that all taxes must be regressive. Budget Director Richard G. Darman, for instance, claims the Moynihan tax cut would have to be replaced by some new tax that would fall on the same people and therefore be just as regressive. But that is nonsense.

Not very long ago the Federal income tax had a progressive schedule that exempted the lowest incomes and then ran from 11 per cent to 70 per cent. The top brackets were knocked off under Presidents

Richard M. Nixon and Jimmy Carter, with a 50 per cent maxitax substituted. For a brief period, a 35 percent bracket was added to the capital gains tax, making it somewhat progressive. This was soon dropped, unfortunately, and opportunities for tax shelters were so expanded that when they were largely eliminated by the current tax law it could be claimed that lowering the top bracket to 28 per cent or 33 per cent was revenue neutral. (“Revenue neutral” was Ronald Reagan’s educated way of saying Read my lips.”)

Some argue that while the Social Security tax is regressive as it is collected, it is progressive as it is paid out. The examples usually given are not encouraging. They show people who evidently lived in constant poverty, paid a high percentage of their minuscule incomes in taxes, and retired to receive benefits exceeding the taxes they had paid. But they were below the poverty level all their lives nothing to cheer about. Anyway, there is no reason on earth why Social Security should not be progressive when it collects as well as when it pays out.

Furthermore, from the point of view of the Social Security system, there is no reason to replace the Moynihan tax cut. When Bush says, “The last thing we need to do is mess around with Social Securiity,” he implies that the Moynihan tax cut would reduce benefits either now or in the future. I’m sorry to say that Senator Moynihan allows us to make the same inference when he quotes a newspaper’s opinion that using the Social Security surplus to balance the budget is “thievery.” I’ll grant that it is skulduggery, that it is intellectually dishonest and economically counterproductive and unjust. People are conned into paying an unfair tax and liking it. Still, it is not thievery. No one gets away with anything, except politically. Neither present nor future benefits are at risk-at any rate, no more at risk than they will be no matter what happens.

Budget Director Darman suggests that the Moynihan tax cut would make it necessary to raise taxes a couple of decades down the road to pay the baby boomers’ benefits as they reach the golden years. Yet taxes will have to be raised for that purpose then whether they are cut now or not. What is the Social Security surplus anyhow? It is not a bank vault stuffed with crisp Federal Reserve notes. It is simply some entries in a ledger showing that the Social Security Trust Fund owns some Treasury bonds.

Once the boomers’ benefits have to be paid, the Treasury will be asked to redeem the bonds for cash. The Treasury doesn’t have a bank vault full of Federal Reserve notes, either. To get the money, it will have to ask the President and Congress to use some of that year’s taxes to make good on the bonds. This will happen regardless of the size of the surplus, just as the benefits I am now receiving come out of current taxes, regardless of what and when I paid in.

People talk about Social Security as a sacred trust, and it’s pretty close to that. There is no doubt that millions of citizens depend on the benefits and are scared whenever they hear talk of changing them. Actually, changes are made every year as the cost-of-living allowance is adjusted, and there have been changes several times for other reasons. The present growing surplus is a consequence of comprehensive revisions made in 1983. Because I own some municipal bonds, half of my benefits are now subject to income tax. I didn’t agree to that; the President and Congress just hauled off and did it, and it costs me over $2,000 a year. I don’t object in principle, because I think all Social Security benefits should be taxable, and I think all municipal bond interest should be taxable. (But I do feel it is a mite unreasonable not to tax everyone who has one or the other. Why me?)

Besides being regressive, the Social Security tax is a tax on employment. It taxes workers for working, and it taxes employers for hiring them. In addition, because production is achieved solely as a result of work, the Social Security tax is a tax on production.

Yet the Chamber of Commerce and the National Association of Manufacturers and the Business Roundtable have not rallied around Senator Moynihan. That’s rather remarkable. Half of the Social Security taxes are paid by businesses, from the smallest to the largest. And the half paid by employees is a drag on business, too, because it contributes to costs. Moreover, the paperwork involved is bothersome and expensive (or so they used to complain).

It would appear that business associations are more interested in the capital gains tax, which is paid by their members as individuals, than in the Social Security tax, which is paid by the businesses they supposedly are acting for. Well, we shouldn’t be surprised. Very little of what is reported as business news has anything to do with producing goods or services. Takeovers, buyouts and the like make big headlines – and big changes (usually unpleasant) in the lives of workers and the cities they live in. If there is evidence of these shenanigans having a positive effect on the production of goods and services, it is a well-kept secret. Nevertheless, that is the sort of activity the President is eager to encourage by reducing the capital gains tax.

IRONICALLY, the same sort of activity would be encouraged should Senator Moynihan succeed in the second half of his ambition: to use the Social Security surplus to buy up all the public debt. The private funds released would, he reasons, be saved. Since it is a widely propagandized faith that our troubles are caused by our failure to save, the Senator imagines that prosperity would be around the corner.

I have previously discussed John Maynard Keynes‘ theorem that saving equals investment (see “Much Ado about Saving,” NL July 13-27, 1987). What I overlooked in my discussion (and what Keynes overlooked in his) is that “investment” covers many noble works and a multitude of sins. If you have saved some money and want to invest it, you can buy a factory (fixed capital), goods to sell (working capital), some common stock (claims on future profits), bonds (which will pay fees for the use of your money). You can also put your money where your mouth is in Las Vegas or Atlantic City or any of several state-run lotteries. You can buy land or a collection of beer cans or rare stamps or a painting by some pseudo-Monet. That is not all, but it gives the idea.

When you come right down to it, only the first two items (fixed capital and working capital) are investments certainly intended to result in production of additional goods and services. A company issuing stock gets its money from the first sale; no subsequent sales have any effect on production. In some instances, even the proceeds from the first sale may be intended merely to finance the purchase of another company, whose takeover may not in any way expand total production. As for the other kinds of investments, it is plain that they are speculations and have nothing whatever to do with production.

Consequently, although saving may equal investment, as Keynes argued and as most economists today agree, and although production requires investment, it by no means follows that all investments are productive of goods and services. In the present state of our economy, there are not enough sound productive investments for the money already available. The lack of attractive investment opportunities is frequently cited as the reason banks became involved in the Campeau fiasco. When productive investments are scarce, money runs to speculation, as it has been doing in a turbulent stream for the past decade.

In spite of the irrelevance of any hoped-for encouragement of saving, Senator Moynihan’s proposal offers a big step toward solving the fundamental problem of the maldistribution of income. If the Senator’s Democratic colleagues were as wise in statesmanship as he (and as astute politically), they would rally to his standard instead of sulking on the sidelines pretending to be “responsible.”

After all, a very strong case can be made for the proposition that the Reaganomic shift of the tax burden from the rich to the poor is largely to blame for the stagnation of the economy and (if you want to fuss about it) the escalation of the deficit. This case is, indeed, far stronger than that for the Bush myth that cutting the capital gains tax would stimulate productive investment and increase tax collections (see “George Bush’s New Trojan Horse,” NL, September 19, 1988). If the Democrats were not determined to self-destruct still another time, they might combine the Moynihan and Bush proposals in a single bill, and let the President worry about being “responsible” for a change.

 The New Leader

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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