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By George P. Brockway, originally published August 9, 1999

1999-8-9-lessons-from-the-depression-titleTHE NEW Congressional committee created ostensibly to reach a nonpartisan solution to the Social Security “crisis” may not really be intended to do anything, except perhaps issue a report calling for further study of the problem. In fact, I think it is probably a device for changing the subject whenever some humorless member of Congress tries to make an “issue” out of Social Security. “We must wait until the committee reports,” will be the ready response. If I’m right, Social Security will be effectively eliminated from the front lines of the November general election campaign, and no one will have to take a possibly unpopular stand either for or against any of the myriad “reform” schemes lurking on the horizon.

My junior high school civics teacher would be saddened to hear of my lapse from her innocent teaching, but I, for one, am enthusiastically in favor of another do-nothing committee on Social Security. A little over a year ago the much larger National Commission on Retirement Policy, made up of presumed experts business leaders, academics, Congressmen- managed to split three ways on which reform should be endorsed; so nothing was done. That was fine, because all of them would have gotten Social Security mixed up with the stock market in one way or another. Since the stock market is still dangerous, our need for a do-nothing committee is still great.

Nevertheless, I have not forgotten all I learned in those dear, departed civics classes, where we were taught to analyze legislation under three headings: (1) the need for the law, (2) the constitutionality of the law, and (3) the proper taxation to pay for it. That continues to strike me as a good, systematic approach, and I hereby suggest that the committee spend its time looking at the existing Social Security Act accordingly. This will give it something to do that no prior committee has done and keep the matter bottled up until after the balloting. Let me demonstrate.

1. Why was the Social Security Act needed? Well, there was a jim-dandy depression on. There being no official or semi-official definition of “depression,” one has to be supplied: A depression is a massive, comprehensive and persisting breakdown of the economic system. The economy does not recover without major changes or a major shock or both.

In the 1930s, millions and millions of people were out of work; the municipal poorhouses and charity soup kitchens were overwhelmed; beggars were everywhere; bands of hobos hitched long journeys on freight trains, tracking the seasons or wandering aimlessly. In most towns, near the freight yards or in the gashouse district, there appeared “Hoovervilles” of shacks made from old cartons and discarded (or stolen) boards, furnished with broken furniture from the town dump. In many cities a portion of the local jail was used as a temporary shelter for the more respectable homeless. I myself spent a night as a guest of the Hudson, New York, jail in the course of a hitchhiking journey to search for a job that I didn’t find.

The Great Depression was not a pretty time. Millions suffered, despite having worked long and hard and faithfully. Their dependents, of course, suffered along with them. So did young people coming fresh to a labor market that had no place for them. The society had failed, not a particular individual or group or class. Thus the Social Security Act was needed to deal with at least one aspect of the collapse of the social system-namely its effects on the elderly, the disabled and the orphaned.

2. Was the act constitutional? That proved to be a tough question for a Congress dominated by Southern Dixiecrats and Northern Republicans, and for a Supreme Court possessed of states’ rights notions that had become obsolete at Appomattox Court House on April 9, 1865. It took six years of depression for Congress and the Supreme Court to follow the election returns and take the general welfare seriously. Follow they eventually did, and our second question was answered in the affirmative.

3. Is the taxation appropriate? That question is still with us. The dispute today concerns the adequacy of the present payroll tax. No one wants to increase the rate. Some want to increase the income by putting a portion of the money in the stock market; others argue that income will be more than sufficient as long as the economy remains robust. The real trouble, however, is in the method of taxation itself.

A payroll tax has nothing going for it. It is comparatively easy to evade, especially by those in domestic or casual work. It also discourages employment. If you have a job, that laudable fact triggers a tax on you or your employer or both. On the other hand, if you are a professional gambler, or if all you do for a living is clip coupons and play the market, you don’t pay any payroll tax.

To be sure, aid for the needy is a responsibility of the state; and all businesses-manufacturing, wholesale or retail –owe their existence to the state. In some cases the state licenses or charters or franchises them; and in every case the state protects the society that is the source both of their work force and their market. Consequently, it is reasonable for businesses to be taxed to help pay for the general welfare of the government that nourishes them.

But a payroll tax is a poor way to do it. It is an up-front cost that must be met with the first employee hired, that increases with each additional employee and each wage increase given, and that continues until the last hour of the last employee’s employment. In his book The Next Left, the late Michael Harrington argued that French President Francois Mitterrand‘s bold, popular and promising social policies resulted in economic stagnation because he financed them by levying payroll tax after payroll tax. Instead of expanding, French industries cut employment to the bone in a largely vain attempt to keep their prices competitive with those of neighboring countries. The failure of Mitterrand’s programs had nothing to do with the fact that he was a Socialist. Their effect would have been the same even if the programs had been private fringe benefits.1999-8-9-lessons-from-the-depression-tight-money

OUR Social Security system, although in many respects the most successful legacy of the New Deal, has twice the vices of an ordinary payroll tax, since both employee and employer are taxed. Wage negotiations are rendered more difficult because the employees’ present value of any wage is reduced by the 6.2 per cent Social Security tax plus the 1.45 per cent Medicare tax, while for employers labor costs are increased by the same 7.65 per cent (called, no doubt to spare their delicate sensibilities, a “contribution”).

In addition, the Social Security tax has the extraordinary effect of being a radically regressive tax on the nation’s workers, especially the working poor. It is, to begin with, a flat tax–even flatter (as far as it goes) than the various flat tax proposals of current Republican politicians. It has no exemptions or credits, and starts with the first penny a worker earns. It continues at 7.65 per cent on both employee and employer until the employee earns $72,600, whereupon only the Medicare portion remains. A Fortune 500 CEO who pulls down $10 million a year therefore pays a rate that is less than one ten-thousandth of the rate paid by the charwoman whose job it is to clean up after him.

Nor are these the only indefensible unfairnesses of the Social Security tax. More important in the long run is the fact that the tax has been used to eliminate the higher brackets of the personal and corporate income taxes, and hence exacerbates the widening gap between the rich and the poor in the United States.

The Social Security system is said to be a pay-as-you-go plan, but of course it isn’t. It is a pay-years-before you go plan. The Trust Fund that is being paid for now will not be used up before 2029, and probably much later, if ever. In next year’s budget, the total of employee taxes, employer contributions, and interest earned by the Trust Fund is $636.5 billion, while the entire cost of Social Security (beneficiaries, bureaucrats and all) is only $408.6 billion. The $227.9 billion Social Security surplus not only goes to make possible the budget balance everyone is so proud of, but also accounts for the entire budget surplus that Congress is squabbling about.

The trouble with Social Security; in short, is the method of meeting the costs. A payroll tax is adverse to national employment and investment, and is unreasonable in its incidence. Moreover, the present payroll tax may be incapable of paying the bills. It is anticipation of the last that has caused today’s uproar. But speculating on the stock exchange, whatever else may be said for or against it, is almost guaranteed to fail at the most critical moment. A booming stock market does not guarantee a booming economy, but a crashing market is sure to bring the economy down with it.

Again I can offer a personal reminiscence. My father put together a satisfactory nest egg by playing the boom market of the 1920s. When the ’30s began he believed President Herbert Hoover and did not “sell America short.” In August 1933 he died broke. As the HMO lobby’s ads say, “There must be a better way.” And there is: The Social Security Act addresses a national need and it should be funded by a national tax. The income tax does not inhibit employment and investment, because it falls only on persons and enterprises capable of sustaining employment and investment.

It is often argued that the income tax is too subject to the cold and shifting winds of politics to be the support for something as vital as Social Security. But the raucous history of the present debate has surely demonstrated that Social Security is in any event buffeted by the very same winds as the rest of our political life.

The New Leader

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

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

[2] Editor’s emphasis

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader

[1] Do the math, the author is correct

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

[3] Uncle Sam, in this case

By George P. Brockway, originally published February 8, 1993

1993-2-8 Social Security on the TableTHEY SAY THAT Social Security is on the table. I hope the table is spacious and sturdy, for Social Security is like the proverbial horse designed by a committee. It is part employment tax, part endowment, part life insurance, part social welfare. It doesn’t fulfill any of these functions well, especially since it embodies a scheme of family values that would ordinarily be thought archaic even by members of the 1992 Republican Platform Committee.

The best thing to do with Social Security is start over again. All citizens should without question be entitled (that’s right, “entitled”) to decent protection of their dependents and a decent retirement. Since everyone should be covered and the claims can be closely anticipated, it is foolish to try to build up trust funds of one kind or another. The benefits or entitlements should be treated as ordinary expenses of government and paid for out of current income taxes, not out of taxes on employment.

Actually, of course, that is already the case. In 1992 the Social Security tax brought in $126 billion more than had to be paid out. The 1993 surplus is estimated to be $131 billion, and the surplus is expected to continue to increase for another decade or more. These billions of dollars make up the Social Security Trust Fund, but they aren’t stuffed in a bank vault somewhere, as our gold reserves used to be at Fort Knox. Instead, the Fund buys U.S. Treasury bonds, and the money thus lent to the government is used to pay bills.

Twenty or 30 years from now[1], when the baby boomers are enjoying their golden years, the smaller succeeding generation, though paying the same Social Security tax rate, will not pay in enough to cover their parents’ entitlements. So the Trust Fund will annually redeem some of its Treasury bonds. And where will the Treasury get the money to meet its obligation? Out of current taxes. Where else?

As the detective stories say, follow the money. When you do, you will see that under the present system the Federal government collects 38 per cent of its revenues by a grossly regressive tax that takes 15.3 per cent of her pay from the mite of a widow housekeeper but only 0.6 per cent (or less) of the pay of the millionaire executive who employs her, and nothing at all from those whose sole quasi-economic function is to clip coupons and cash dividend checks. Furthermore, you will see that the surpluses generated by this regressive tax will not in the slightest lighten the burden of future generations.

What can be done about this? Probably nothing. A couple of years ago New York’s Senator Pat Moynihan tried to get the Social Security tax lowered to a rate that would simply cover the outlays. He said, in what still seems to me a measured observation, that if the Democratically controlled Congress failed to adopt the proposal, it would be difficult to see what the party stood for. He got nowhere (although the publicity he generated probably derailed President Bush’s drive for a reduced capital gains tax). Indeed, the Senator was accused of planning the rape of generations yet unborn, of financial ignorance, and of much else.

Moynihan is now chairman of the Senate Finance Committee, the third or fourth most powerful man in the country when it comes to taxes, but I doubt that he will have more success with his proposal than he did earlier. And I’m sadly certain that he would have no success whatever, even if he was of a mind to, in persuading the good citizens of the Republic of the virtues of my proposal. So I retreat to a prepared position with suggestions for treating the sores exposed by Nannygate, bearing in mind the fact that we’re talking about provisions of the law that ‘are violated at least three-quarters of the time by otherwise law-abiding citizens-provisions, moreover, that everyone who thinks about them for even a minute recognizes as unjust.

Consider first the case of a nanny (I thought the word went out when Peter Pan grew up) or a cleaning lady (as the job description used to have it) who is a married woman, perhaps a widow, perhaps a senior citizen. The odds are that she will be or is entitled to Social Security benefits as her husband’s spouse. In addition to her regular income tax, 15.3 per cent of her earnings will be collected by the Internal Revenue Service simply to swell the Social Security Trust Fund. She will almost certainly receive no retirement benefit or social welfare or anything except what she would have received if she hadn’t done a lick of work in her life.

That’s where the family values I mentioned at the outset come in. A man and his wife are not individuals but a couple in the eyes of the Social Security system. After the principal bread winner retires, the couple gets one and a half times his benefit. In the statistically unlikely case that the wife is the principal breadwinner, the couple’s entitlement will be based on her earnings. Because the Social Security tax is levied only on the first $57,600 of a person’s income, it may happen that both husband and wife have paid the maximum tax. If so, the benefits will be paid on the husband’s tax even where the wife’s total earnings are many times greater. That, I imagine, will one day be the case of corporate lawyer Zoe Baird and her academic husband.

For the Bairds the situation is merely ridiculous. They will not have to rely on Social Security in their retirement; and given the lack of much progressivity in the present income tax, they are taxed little enough as it is. The cases of the cleaning lady and the nanny are of a different order. There are undoubtedly many who love babies and even some who like housework and enjoy the gossip that often goes with it. But the great majority of women who do this sort of work do it because they need the money. For them the Social Security tax is a cruel hoax. It would be surprising if most did not pressure their employers to join them in breaking the law. Once Social Security is on the operating table, it shouldn’t be too difficult to remove this diverticulum, preferably by increasing the benefits payable to a second wage earner in a family.

Now consider the kid next door who mows your lawn or baby-sits for you. While we’re at it, let’s consider all part time workers under the age of, say, 21. Suppose that instead of filling out forms and withholding taxes and all that, you gave such claimants, along with their pay, a voucher worth approximately 15 per cent of the money due. You’d buy the vouchers at the local post office, where they would be available in several convenient denominations. Banks and even grocery stores might want to sell the vouchers as a public service. The vouchers would earn interest in the same way and at the same rate as series E bonds, with these provisos: They would have to be used to finance some approved form of education, and they would have to be cashed before the holder’s 26th birthday. The vouchers would be required for all paid work by youths that is, no records would have to be kept to see whether the present $50 minimum was reached.

I MENTION VOUCHERS because that is a popular word today in educational circles, but stamps would be better. You are probably too young to remember the Postal Savings stamps one used to be able to buy at the post office or the Defense Stamps of World War-II, but I’m sure you can imagine how easy stamps would be to handle. Each worker would be given a little booklet with spaces to stick them on and instructions on their use.

Not only would this scheme free employers of annoying paperwork, it would free the government of expensive record keeping. Moreover, it would be largely self-enforcing. The present system is widely evaded because the supposed beneficiaries are unlikely to get any benefit from the Social Security taxes they pay as teenagers. Upon retirement, their benefits will be calculated on their highest 35 years of earnings. Under my proposal, young workers would get the benefits almost immediately, and those benefits would go for a purpose most employers strongly approve of. The nation would give up the relatively small taxes it now collects and will get in return a much larger contribution toward a cause its future depends on. Last but not least, good citizens who hire teenagers will both feel a public pressure to pay the tax and be relieved of the guilty conscience and anger that go with breaking a bad law.

Finally, let’s look at the COLA problem that at this writing is still teetering on the edge of the table. Cost-of-living adjustments, or COLAS, seem to derange the minds of many worriers about the deficit. Bankers are peculiarly susceptible, perhaps, because they enjoy the most refreshing COLA of them all. They don’t call theirs a COLA, of course. They call it an inflation premium. The interest they charge you for a loan is, they figure, made up of two parts-the real interest and a premium to offset inflation. Well, my Social Security benefit is also made up of two parts-the base benefit and the cost-of-living adjustment. Same thing exactly, except for the amount of money involved.

The Social Security COLA last year came to about $12 billion, while the Banker’s COLA came to about $800 billion. The Banker’s COLA was, in fact, more than double the budget deficit that upsets bankers so. And mark this: Inflation last year ran at a rate of 3.1 per cent, costing the economy about $186 billion. The Banker’s COLA that theoretically makes up for inflation happens to have cost the economy 4.2 times as much. If there had been no Banker’s COLA, there would have been no inflation.

On the other hand, if there were to be no Social Security COLA next year, some 500,000 senior citizens would be pushed down below the poverty line. The same fate would await hundreds of thousands more in every subsequent year that the Social Security COLAS were frozen. Very few retired people can survive on Social Security alone, yet for many millions it is the difference between modest comfort and penury.

In the past 10 years (as the Federal Reserve Board was being congratulated for inducing two recessions in fear of inflation), the cost of living has increased 47.2 per cent. Without the COLAS, a 1O-year retirement (the present expectancy) inexorably becomes very bleak indeed.

Well, it’s fine to have Social Security on the table. But if your problem is reducing the deficit, the way to do something about it is by increasing the taxes of those who benefited from the ’81 and ’86 tax breaks. Or, as Jeff Faux, president of the Economic Policy Institute, put it: “Send the bill to those who went to the party.”

The New Leader

[1] This article is being loaded into the blog 21 years after it was originally published

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 February 6, 1989

1989-2-6 The Truth About InflationTitle

1989-2-6 The Truth About Inflation Dollar Sign

THERE ARE supposed to be two kinds of inflation, cost-push and demand-pull.  A benevolent

Providence is supposed to have provided them with the same cure: raising the interest rate or – if you prefer to do things indirectly – restricting the money supply. Last time out (“Bankers Have the Classic COLA,”NL, January 9), we looked at the panacea macro-economically and came up with the heretical conclusion that it caused inflation, rather than cured it. This should have occasioned no surprise, since medicine is a lot older than economics, and it was not until about a hundred years ago that your odds were better if you consulted a doctor than if you didn’t. Neoclassical economics has about caught up with Paracelsus.

The interest-rate panacea is, nevertheless, so solidly fixed in everyone’s pharmacopoeia that we’d better look at it micro-economically to try to discover its supposed merits. I should confess, at the outset, though, that having once met a payroll, as they used to say, I can’t imagine how raising the interest rate is expected to inhibit or prevent businesses from raising prices in response to the increased cost.

Every business must have money, and it therefore has to consider the cost of money, which is interest, whether it is a borrower or not. If it needs to borrow, interest is obviously a cost of doing business. If it is cash rich and doesn’t need to borrow, interest is an opportunity cost. By investing in its own business, it passes up the opportunity of lending its money to someone else and thereby earning the going rate of interest without working; so unless its own business can earn at least that much, it’s not worth continuing.

Interest is thus an inescapable element in doing business, and hardly a trivial one. Moreover, raising the rate not only affects every business, it does so geometrically. An increase in the interest rate is continuously compounded; the push is to an upward slope that becomes steadily steeper. Consequently, if the problem is cost-push inflation, upping the rate makes it worse.

In contrast, an increase in the price of oil is a one-time affair: It pushes most costs (not all, but most) up to a higher plateau, because oil is essential for the contemporary economy. At any given moment – now, for example – a certain quantity of it is used in myriad ways. At another moment – tomorrow, for example – the price may be doubled, thus doubling the economy’s outlay for oil and of course the percentage of total costs devoted to it. Producers, faced with the new cost, will raise their prices. They could maintain their profits if they just covered the increased cost of oil. In all probability, however, they will have been brought up to set their prices as a percentage markup on costs, and workers will have been brought up to expect their wages to be a certain percentage of costs.

Whether or not the new prices are enough to restore the balance among the factors of industry, they pretty quick-1yr each a new level and settle down there. Some industries and companies and workers may make out better than others, especially in the short run, yet by and large business soon goes on about as before. Prices are somewhat higher, to the detriment of people living on fixed incomes and of people who have lent money-and to the benefit of people who have borrowed money. But there is no reason for prices to rise above the new plateau unless the interest rate is tampered with.

When the Organization of Petroleum Exporting Countries (OPEC) made its successful moves, the Federal Reserve Board characteristically reacted in precisely the wrong way. OPEC raised costs for almost all businesses, and they now needed more money to continue. The Reserve Board perversely tightened the money supply, hiking the interest rate. I suppose they thought that by hurting business they would reduce the need for oil and OPEC would then be forced to lower the price. If so, they forgot that we had, as Art Buchwald wrote, encouraged the sheiks to send their sons to Harvard Business School rather than to Bowling Green State to learn basketball. At any rate, OPEC’S response was the standard one of a modem business faced with falling demand. Instead of cutting the price (as a neoclassical economist would have done), they cut production (as a modern businessman would do).

To be sure, the Reserve Board did manage to induce a recession, and that did, after eight years of trying, eventually result in an oil glut and lower oil prices. Just as in Vietnam some of our more thoughtful military leaders occasionally destroyed a village in order to save it, the Reserve Board caused massive unemployment, widespread bankruptcies, a growing Federal deficit, disaster in Latin America and the Third World, and a loss of much of our overseas business – all in the effort to control the price of oil. It was not a rational trade-off; and micro-economically the fact remains that raising the cost of any of the factors of production, of which interest is one, is not the way to inhibit cost-push inflation.

Demand-pull inflation is described by the popular cliché of too much money chasing too few goods. What is in the back of everyone’s mind is either an auction where millions of dollars are unexpectedly bid for a painting, or the hyperinflation that occurred in Weimar Germany, or the bread riots of pre-Revolutionary France. Briefly let us note that modern business is nothing like an auction, that hyperinflation occurs only when a nation has un-payable debts denominated in a foreign currency, and that the failure of the bread supply caused, not general inflation, but a deflation of all other prices as desperate people sold whatever they could at distress prices in order to pay for bread.

Putting to one side the probability that there is no such thing as demand pull inflation, we may doubt whether raising the interest rate will prevent too much money from chasing too few goods. A high interest rate no doubt chills the ardor of borrowers and thus may be thought to hold down the amount of money in circulation. Not all borrowers, however, are chilled equally. Speculators find high rates stimulating. Of course, money that goes into speculating doesn’t go into consuming; it chases paper, not goods; as far as consumption (or production, for that matter) is concerned, it might as well not exist.

Consumers, for reasons thought important by Professor Franco Modigliani and others, are said to try to maintain their accustomed or desired standard of living. They will shoulder heavy debts at usurious rates to do so. Hence their readiness to assume mortgages at more than double the maximum legal interest rate of a few years ago; hence the cavalier expansion of credit-card borrowing; and hence the failure of high interest rates to impede the chase for goods. In fact, because high interest rates have proved acceptable to consumers, the consumer loan business, once left to frowned-upon outsiders, has become attractive to banks-with the paradoxical probability that high rates have resulted in more money chasing goods, not less.

The famed bottom line, on the other hand, forces a more circumspect demeanor on businesses; few of them find it profitable to expand when the cost of financing is well up in the double-digit range. Many find it impossible to go on (right now, in this supposedly prosperous time, corporations are going bankrupt at a greater rate than at any time since the Great Depression). So high interest rates, while having only a minor effect on demand, have a major effect on supply. Whether or not there is more money in the chase, there are fewer goods in the running. To put it more generally, there are fewer goods than there might have been otherwise.

OUR HALF-CENTURY-LONG preoccupation with inflation is a sign of a profound confusion of American-even of global mind and will. Since World War II, inflation has been regarded as a pandemic disease, and a panacea has been sought. But social ills are specific, not universal, and corrective policies must be similarly specific.

If inflation were all prices going up together, a few people would be befuddled, but no one would be hurt much. As early as David Hume it was recognized that moderately rising prices stimulate the vital juices of entrepreneurs. As recently as the current “prosperity” it has been evident that business can readily accommodate itself to pretty steep inflation if it is fairly steady.

The trouble is that even moderately rising prices can be devastating to people living on fixed incomes, because they have no way of protecting themselves. This is a specific ill (there are others). Specific treatments are available, and some of them have been successfully applied. In 1966 Medicare began to protect the aged from one of the most crushing burdens of old age, and at the same time to provide millions with health care that otherwise would have been denied them. Since 1972 the Social Security COLAS have done much to prevent many of the retired from falling into poverty.

Some now say that the aged have it too good. This is a dubious proposition, but it is not to the point. The point is that the mentioned policies have had an effect. A specific ill was perceived, a specific treatment was devised, specific cures were effected, the cures may be judged, and specific improvements in them can be made. In contrast, the conventional theory of inflation that regards it as a pandemic ailment can propose only the panacea of a growing underclass of the chronically unemployed, and a narrowing overclass of those who have been able to make the Bankers’ COLA work for them.

Because interest payments are made pursuant to contract and continue years, often decades, into the future, the heavy hand of the Bankers’ COLA will be upon us, no matter what we do, for years to come. In the meantime our urgent task is to free ourselves, our politicians and our bankers from thralldom to the most dismal view of this dismal science.

The New Leader

By George P. Brockway, originally published January 9, 1989[1]

1989-1-9 Bankers Have The Classic Cola Title

IN “The Fear of Full Employment” (NL, October 31, ’88) we examined some of the fallacies behind the almost universally held doctrine that full employment makes for high inflation. This time we’ll look at another almost universally held doctrine, namely that raising the interest rate is the cure for whatever inflation exists. An astonishing thing about the latter doctrine is that no one bothers to say why it should work. The New York Times, which never mentions the prime interest rate without pedantically explaining that it is the rate banks charge their most credit-worthy borrowers, regularly reports without question that if the Consumer Price Index (CPI) starts to rise, the Federal Reserve Board will have to raise the interest rate.

Economists divide what they call the nominal or “money” interest rate (which is what you pay) into two parts: “real” interest (what they think you’d pay if the economy were in equilibrium) and an allowance for inflation. The allowance for inflation is what in other sectors of the economy is called a Cost of Living Adjustment, or COLA. People with money to spare are said to be enticed into lending by the prospect of getting back their money at a stated time with stated interest. What they want back is not the money, but the money’s purchasing power; and in inflationary times the only way to get back the same purchasing power is to get back more money. Hence the Bankers’ COLA.

Of course, bankers don’t call it a COLA. They have, in fact, been unremitting in propagandizing the notion that COLAS are bad and greedy and inflationary and likely to cause the downfall of the Republic. The COLAS bankers talk about are those that appear (or used to) in labor contracts, where they are manifestly an increased cost of doing business for companies with such contracts, and those that appear in Social Security and other pension payments, where they are manifestly an increased cost of running the government. (Another COLA, seldom mentioned, is the indexing of the income tax.) Since increased costs of doing business increase prices, and increased costs of running the government increase taxes (or the deficit), it is argued with some reason that COLAS are inflationary.

The propaganda against them (coupled with high unemployment and underemployment) has pretty well knocked cost-of-living clauses out of labor contracts. The Social Security COLAS are somewhat more secure because there are more worried senior citizens than alert union members. Even so, the steady cacophony from Peter Peterson and other investment bankers (when they take time off from promoting leveraged buyouts, which they evidently don’t think inflationary) has put the American Association of Retired Persons on the defensive. The Bankers’ COLA, however, is accepted as a natural law and discussed matter-of-factly in the textbooks, while the others are deplored as the work of greedy special interests out to line their own pockets at the expense of the nation and its God-fearing citizens.

One way of stating the Banker’s COLA is that it is the difference between the interest rate now and that of some earlier, less inflationary time. The prime rate at the moment is 10.5 per cent, and may have gone higher by the time this appears. In the 4O-oddyears since the end of WorId War II, there is one stretch, from 1959 through 1965, when the CPI and the prime were both substantially stable. In those seven years the CPI varied from 0.8 per cent to 1.7 per cent, and the prime from 4.48 per cent to 4.82 per cent. (Readers with a political turn of mind will note that the Presidents in this period were a Republican and two Democrats- Dwight D. Eisenhower, John F. Kennedy and Lyndon B. Johnson.). The Bankers’ COLA was evidently no more than 1.7 in those years, and the “real” interest rate was somewhere between 3.5 per cent and 4.5 per cent.

Let’s accept the higher figure, even though it is substantially higher than, for example, the rate in the years when the foundations of the modern economy were laid. Subtracting 4.5 per cent “real” interest from the current prime, we determine that the current Bankers’ COLA is, conservatively, 6 per cent.

But only about a tenth of outstanding loans were written in the past year, and many go back 25-30 years. Over the past 10 years the CPI has increased an average of 6.01 per cent a year. That is remarkably (and coincidentally) close to our estimate of the current Bankers’ COLA.  The average gets higher as we go back 15 and 20 years, and falls slightly if we go back 25 years. Consequently if the Bankers’ COLA has been doing what it’s supposed to do, we are not overstating the case in saying that today it is running at about 6 per cent.

Now, the present outstanding debt of domestic  non-financial sectors is about $8,300 billion. This figure includes everything from the Federal debt to the charge you got hit with when you didn’t pay your bank’s credit card on time; excluded are the debts banks owe each other and, for some reason, charges on your nonbank credit card. The cost of the Bankers’ COLA for this year therefore comes to about $498 billion (6 per cent of $8,300 billion).

As the late Senator Everett McKinley Dirksen would have said, we’re talking about real money. Let’s try to put it in perspective. At the moment the CPI is said to be about 4.5 per cent (less, you will have noticed, than the Bankers’ COLA, because bankers expect inflation to get worse). Since the GNP is currently about $4,500 billion, inflation is currently costing us 4.5 per cent of that, or $202.5 billion. The Bankers’ COLA is thus costing us almost two and a half times as much as the inflation it is claimed to offset.

So we come to Brockway’s Law No. 1: Given the fact that outstanding indebtedness is greater than GNP (as is always the case, in good years and bad), the Bankers’ COLA costs more than the total cost of inflation, at whatever rate.

Another comparison: The Bankers’ COLA costs close to three times as much as the Federal deficit the bankers moan about. (If there were no Bankers’ COLA, we’d be running a surplus, not a deficit.)

Also: The Bankers’ COLA costs many times more than all the other COLAS put together, and about 50 times – repeat 50 times – more than the Social Security COLA that so exercises investment banker Peter Peterson. (If there were no Bankers’ COLA, none of the other COLAS would exist, because the cost of living would not be going up.)

Also: The Bankers’ COLA costs more than giving every working man and woman in the land, from part-time office boy to CEO, a 10 per cent raise. (So much for the fear of full employment.)

SINCE THE Bankers’ COLA costs the economy more than inflation does, without it there would in effect be no inflation. Other things being equal, there would actually be deflation. And of course very great changes would follow if so large a factor as the Bankers’ COLA were eliminated. Reducing the interest rate to its “real” level would quickly and powerfully stimulate investment in productive enterprise, with a consequent growth in employment. It would trigger a one-time surge in the stock and bond markets, followed by a gradual tapering off of speculation.

1989-1-9 Bankers Have The Classic Cola Factory

As matters stand now, the Bankers’ COLA is an incubus of terrible weight depressing the economy. That this is so is revealed by the statistics whose subject is people rather than things. The standard of living of the median family is falling, even with two earners per family much more common than formerly. The number of people living in poverty is growing, and within that group the number of those who work full time yet are poverty stricken is growing still faster. The rate of unemployment – even counting part-timers as fully employed, and not counting at all those too discouraged to keep looking for work – would have been shocking a few years ago. These are signs of recession, of bad times.

The interest cost is the only one that has a general effect on the economy. We used to hear a lot about the wage price spiral, but a wage increase in the automobile industry (for many years the pundits’ whipping boy) works its way through the economy slowly and uncertainly. Initially it affects only the price of automobiles, and it never brings about a uniform wage scale. Wages of grocery clerks remain low, and all wages in Mississippi remain low. A boost in the prime rate of a prominent bank, on the other hand, immediately affects the rates charged by every bank in the country; and while it is possible for borrowers to shop around a bit for a loan, they find that rates vary within a very narrow range.

More important, interest costs affect all prices, because all businesses must have money, even if they don’t have to borrow it, and the cost of money is interest.

Vastly more important, the Bankers’ COLA is a forecast, a prediction, a prophecy. The figures we have been working with are from the past, but bankers – including, especially, those who make up the Federal Reserve Board – set rates that will have to be paid decades into the future. Well into the 21st century, for instance, we will be paying up to 15.75 per cent interest on a trillion dollars’ worth of Treasury bonds sold in the wonder-working days of former Fed Chairman Paul A. Volcker.

So we come to Brockway’s Law No. 2: Raising the interest rate doesn’t cure inflation; it causes it.

The New Leader

[1] Editor’s Note:  For those who are too young or forget the Coca Cola company came out with the “New Coke” in 1985, and it bombed.  Under-duress they kept the New Coke on the market, for a while, and re-issued the product people wanted to buy as Coca-Cola Classic, or the “Classic Cola.” http://en.wikipedia.org/wiki/Coca_Cola_Classic. Thus the gentle wit of the title of this article.

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