Archive

Tag Archives: Hyman Minsky

By George P. Brockway, originally published November 2, 1998

1998-11-2 Learning From Russia title

THIS IS OUR learning year. At least it is a year of learning opportunities. Whether we’re capable of actually learning remains to be seen.

In January the debacle of Southeast Asia taught us, as I pointed out at the time in this space, that “In the special branch of ethics that is economics, any system built on the backs of the downtrodden will be forever unstable.” A couple of months ago I observed that Japan “is as successful a supply-side economy as the modern world has seen, and as such its difficulties should be a warning to the United States.” Today the object lesson is Russia, and what it teaches is that a sound government is the sine qua non of a sound economy.

Please note that sound government comes before sound economy. To the extent that the Soviet Union was Marxist, things were the other way around before Communism’s collapse seven years ago. They are still the wrong way around in Russia’s brave new world of privatization, plunging rubles and other economic shock treatments.

In a footnote in Capital, Karl Marx wrote, “The middle ages could not live on Catholicism, nor the ancient world on politics. On the contrary, it is the mode in which they gained a livelihood that explains why here politics, and there Catholicism, played the chief part.”

That bothered his collaborator, Friedrich Engels. “Without making oneself ridiculous,” he wrote to Joseph Bloch, “it would be a difficult thing to explain in terms of economics the existence of every small state in Germany, past and present, or the origin of the High German consonant shifts.” Nevertheless, Engels did not doubt that the “economic situation is the basis” of everything even though “the various elements of the superstructure … also exercise their influence ….”

The form of government Lenin instituted, said to be a “dictatorship of the proletariat,” was certainly some kind of dictatorship. lts civil law concerned orders and commands, but not customs and contracts. So Mikhail S. Gorbachev and Boris N. Yeltsin found no legal system in place to regulate the revolution to a market economy.

It should be noticed that the high-powered “reform” economic advisers from Harvard and MIT and the International Monetary Fund were not dismayed by the lack of a free-market legal system. They were all convinced that the vice of the Western world is excessive regulation, and that the former Soviet Union and its former Warsaw Pact allies would benefit from the shock treatment of being thrust to sink or swim in the turbulent waters of the new global economy. Although this might cause some suffering and even some inefficiency (which in standard economics is evidently more blameworthy than suffering), they contended that it would be better to get rid of the bad old ways at one fell swoop than to creep along incrementally. Once the market was freed and assets were privatized, the reformers promised, everything would efficiently fall into place.

Of course, that is not what happened. In some respects Russia may be the American West all over again, but there are significant differences. Our “privatization” was better managed as a result of long experience with land settlement, and blatant corruption was at least reined in by posses of settlers eager and able to take the law in their own hands. Furthermore, our pioneers could maintain themselves by subsistence farming and small-scale mining; in Russia there is little to fall back on when large-scale privatization misfires. Most important, our banking and taxation systems grew with the country, whereas in Russia they are struggling to be transmogrified from Soviet systems utterly unsuited for their present purposes.

Suppose for a moment that you live in Minsk and have gotten your hands on a factory that produces something used in Pinsk. Ten years ago a commissar periodically instructed you to send x amount of the stuff to Pinsk and gave good grades for fulfilling the quotas. The people in Pinsk accepted whatever they received.

Since the orders were large enough to keep the factory busy-that’s one reason you went after the shares when it was privatized-you pursue them. “Sure,” the Pinsk people say. “What do we have to do now that we’re free?” You explain that you will have a lawyer draw up a contract. It takes some time, because the lawyer never did such a document before and has trouble literally digging up a water soaked 1912 textbook. Finally, you send the contract to the Pinsk peopIe, who naturally have to get a lawyer to read it. Meanwhile, they say: “By the way, we went to some lectures on free enterprise, where we heard there are factories in Omsk and Tomsk, not to mention some in Krakow, Kinshasa, Kyoto, and Kalamazoo, that can make what we want. We were told you should be competing with them for our business.”

Well, you can see this is going to be a drawn-out affair and you may get nothing for your trouble. Moreover, you find that your bank and the Pinsk bank have no satisfactory clearinghouse arrangements (they’re working on them). Assuming you get the order, your payment will be slow and uncertain.

In the meantime, it turns out that you already have staggering taxes to pay. A trip to the tax office enlightens you: The local bureaucrats have not been paid for months. But you are confidentially told the taxes can be taken care of with a few dollars or marks (and cautious winks tell you where to get hold of some) in the proper hands, plus several samples of what you manufacture. You resist with all your patriotic heart. Then you learn that the local big-time operators (known as “moguls”), whose Mercedes and dachas you have envied, have embraced this system (and it is, after all, not unlike what you were taught to expect of capitalism). You go along.

The Harvard and IMF economists are possessed of the notion that the ruble keeps falling in value because neither the national budget nor the foreign trade account is balanced. (The same was true of the United States for decades, and our dollar remained embarrassingly strong, but let that pass.) The economists’ models convinced them that Russia required an austere tightening of the public belt that could be accomplished by downsizing the government, including the tax offices. As might have been expected, tax collections shrank further, just as they did in Nigeria and other emerging markets of the global village.

The problem with the ruble is that only suckers now have much need of them. Almost everyone else takes care of taxes under the table-or simply disregards them altogether.

Money is a funny thing. If no one has to pay taxes, it‘s not of much use for other purposes. There is no gold or anything else “behind” it, and it can hardly serve any practical purpose, even as wall decoration. The Federal Reserve bills I have in my pocket say on their face in small capitals, “This note is legal tender for all debts, public and private.” That means I can settle all debts I now owe by offering Federal Reserve notes to my creditors, including the government. It does not mean that anyone has to sell me something I want because I offer to pay in dollars.

Storekeepers could demand cigarettes or Confederate currency or a bag of barley seeds (the money of account in some prehistoric societies), or they might just say no. It’s a free country. But if they have bills and taxes to pay-why else would anyone maintain a store? -they will need dollars.

For my part, I need a good many dollars to settle things with the various tax collectors (Federal, state and local). And I don’t have much trouble getting rid of whatever dollars I have left, since the country is full of people willing to sell me things because they need dollars to pay taxes, and there are plenty of bureaucrats ready to see that they do. We’re all happy to work to earn dollars. We know that we will be able to use them to buy what we want as long as-but only as long as taxes are as certain as death.

Russia recently announced that it would print rubles to help meet the government’s payroll and bills. Commentators in the American media have expressed horror at this use of the printing press. But the question is not how rubles are manufactured, it is whether enough taxes are levied and collected to ensure that there is a great demand for rubles by both individuals and businesses. As I’ve remarked before, the notes issued during our Revolution were “not worth a Continental” because the Continental Congress had no power to collect taxes.

THE LESSON of our story is as promised at the beginning: A sound government is the sine qua non of a sound economy. Russia’s troubles are not primarily economic. Seven years ago its economic “fundamentals” were strong enough to scare us silly, as some of us are scared silly by China today. Its population was large and better educated than China’s. Its natural resources were greater. Its infrastructure was more highly developed. Russia had gone about as far as it could go peacefully, but it has a long way to go before its legal system can support a free economy.

As we review our own political campaigns of the past couple of decades, we must doubt whether we have learned the lesson. Recent slogans have included “Balance the budget by 2002,” “It’s the economy, stupid,” “Read my lips. No new taxes,” “It’s your money,” “Abolish the IRS.”

Our new slogan, greeted with cheers on both sides of the Congressional aisle, is “The era of big government is over.” Marx would have been delighted with it. The state, you will remember, was supposed to wither away.

We have recently shown our allegiance to this slogan in at least four major ways. First, we led the way for NAFTA and GATT, both of which subordinate national sovereignty, human rights, and labor and environmental protection to commerce. Second, we extended most favored nation status to China on the fanciful ground that association with our business representatives would teach the Chinese not to torture or execute an untold number of political prisoners every year. Third, we are preparing to use our long-sought budget surplus, not to repair our torn social fabric, but to cut taxes, mainly for the well to-do. Fourth, it is not improbable that majorities in both houses of Congress could be whipped up in favor of abolishing or privatizing the Internal Revenue Service.

Big government has a special and indispensable role in a free market economy. As the late Hyman Minsky pointed out, although we had three full-fledged depressions in the first third of this century (1907, 1921 and 1929), we have had none in the last two thirds, mainly because of two institutions bequeathed to

us by the New Deal and World War II: (1) The New Deal gave us bank regulations and deposit insurance that have forestalled bank runs, and (2) World War II gave us our “big government”-24 per cent of GDP as opposed to the prewar 3 per cent-that provides a solid foundation of demand on which the supply side of the private economy can build with confidence, regardless of what happens in the rest of the world.

Will we ever learn?

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.

%d bloggers like this: