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By George P. Brockway, originally published January 17, 1995
1995-1-30 The Phantom Tax Cut title

TWO YEARS AGO, reporting on the Little Rock “economic summit” (remember that?), I wrote sadly: “It was a dismal performance. For it was the supply side all over again. To be sure, the words ‘supply side’ could be read on no one’s lips; no one traced a laughable curve on a cocktail napkin; and the ideas were restated less breathlessly than Jack Kemp does it, and with a profundity beyond the capabilities of the Great Communicator. But if you had your eyes closed, there were times you could easily have imagined you were listening in on a planning session of Ronald Reagan’s early advisers.”

I was nevertheless confident that common sense and common decency would prevail more often in the Clinton White House than during the Reagan and Bush years, and that this would “make the Clinton Presidency worthy of being remembered.” Cheering the reiterated plea for full funding of Head Start, I concluded that the low-tech (and hence demand stimulating) operation would quickly get significant amounts of money circulating, and therefore would “do more to stimulate the economy this year, and every year of the program’s existence, than the schemes to restore the investment tax credit, to rehabilitate IRAs, and to cut taxes for the middle class-all of which are bum Reaganesque ideas we have already tried and found wanting.”

Well, the Reaganesque ideas are back again and are likely to be re-enacted by supply-side Republicans and “New” Democrats – none of whom is as stylish as the Bourbons, but all of whom, as Talleyrand said of the Bourbons, “have learned nothing and forgotten nothing.” In the process, what is represented as a version of the GI Bill of Rights for retraining downsized workers will be corrupted by a doctrinaire eagerness to support proprietary education mills.

Since anyone who is curious can look up the sorry record of previous investment tax credits and IRAs, let’s talk a bit about the tax cut for the middle class, arguably a demand-side action. The media have already noticed it will not amount to much – the equivalent of another couple of pizzas a month for every family. Still, the sheer number of pizzas is mindboggling and may result in supply-side expansion in the bakery industry as well as demand-side pressure for more laxatives and anti-gas pharmaceuticals, which will, in turn, inspire the creation of more sick-making television commercials. Although I am not now and never have been a pizza man, I have no great objection to any of that.

Nor do I have a strong objection to the elastic, not to say formless, definitions we are being given of the middle class. After all, speaking sociologically, as I occasionally do (“The Golden Mean,” NL, November 2, 1987), in any stable society the middle class is the society, the ultra-rich being exclusive and the infra-poor excluded.

Speaking economically, though, I find it hard to believe the Republicans believe anyone earning $200,000 a year (that is, snugly in the top 1 per cent of the population) needs a handout for an extra pizza. And I am sure everyone making $8,850 a year (the full-time minimum wage) should have a handout for more than that.

The President’s tax cut proposal presumes $75,000 a year is the top of the middle class (still almost 95 per cent of the population) and is estimated to cost $60 billion over five years – or something less than two-tenths of 1 per cent of the gross domestic product. That’s not even pizzas; that’s peanuts. It is barely a third of the woefully inadequate Clinton “stimulus package” the Republicans filibustered to death a year and a half ago.

So what’s all the fuss about? The fuss is about the votes of the small percentage of the American electorate that is not too lazy to go to the polls. Specifically, about its fear and loathing of the way things are going in the country; its stouthearted determination not to try to understand why the prospects aren’t brighter; its puerile anger against imagined tormentors; and its desperation for a quick fix, especially one that is mean to somebody else. An electorate with such qualifications can be bought and sold and made dizzy by spin doctors – who are undoubtedly a growth industry, but beyond the normal purview of this column.

For this column, the question is, What difference does all the fuss make to the economy? And the answer is, Precious little, and most of that counterproductive.

The tax break for the middle class (whether Clinton’s, Minority Leader Gephardt‘s, or the Republican Contract‘s) will of course be paid for by the middle class. Who else is there? Indeed, the paying will undoubtedly come to more than the cutting, particularly for those in the bottom half of that protean middle class. There are two principal reasons for this.

First and most important (constant readers may be certain) is the Federal Reserve Board, which considers itself entitled to frustrate every program, especially every promising program, of the constitutionally elected Executive and Legislature. In the notorious black wit of former Chairman W M. Martin, the Reserve’s aim in life is “to take away the punch bowl just when the party gets going.” It is sure as shooting going to raise the rate again if the talk about a tax cut continues. A tax cut at least pretends to give people money to spend, and people with money to spend give the Federal Reserve Board goose bumps.

When the Board gets goose bumps, it raises the interest rate. It can’t be bothered with the fact that this increases both the cost of producing and the cost of consuming, and consequently is doubly inflationary. It’s all the Reserve can think to do, even though inducing inflation while pretending to fight it makes the Reserve look silly.

Something more than silliness is involved. If the prices of consumer loans are raised, borrowers have less money to buy things with. ‘But where does their money go? It goes to the banks, of course. For example, I have a little adjustable rate mortgage. As a result of the Board’s recent maneuvers, my interest charges this year will be about $700 greater than they were last year. That won’t break me; but if the Board keeps it up (and you can bet it will), my pizza-size tax cut will disappear – roughly 10 times over – into the shining coffers of my friendly banker.

As Deep Throat said, follow the money. The famous middle-class tax cut, assuming there is one, will mean the United States of America will have less money to spend (and I’ll get to that in a moment). Congress will dangle that money before our eyes; but when we try to get our hands on it, the Federal Reserve Board will whisk it away and give it to our bankers, along with some money we thought was safely ours.

Every time the Reserve raises the interest rate to “head off inflation,” it effects a massive transfer of wealth and income from mostly middle-class borrowers to mostly rich lenders. Never mind what Polonius advised about borrowing; he was a Renaissance courtier, and not an over wise one. Borrowing is what modern capitalism is all about. Today’s borrowers have done nothing to deserve having their money taken away from them, and today’s lenders have done nothing to deserve being given it. You can forget about your pizza; your banker will be eating cake.

So much for the first reason why the middle-class tax cut will cost the middle class money.

THE SECOND REASON is that most of the “savings” proposed to pay for the cuts are fake, illusory, smoke-and-mirrors. I suppose it is true that, as Vice President Gore said the other day, there is an Agricultural Department field office within a day’s horseback ride from every farm. That sounds worse than it is; it doesn’t take many 50-mile radius circles to cover most farm country.

Schemes like turning air traffic controllers over to a government or private corporation (and there are a lot of such schemes) amount to nothing more than getting the costs off the Federal budget. The costs won’t vanish; they will reappear in the form of local taxes or user fees to be paid directly or indirectly by the middle class. Either that, or the airlines’ insurance premiums will take off into the wild blue yonder, and will have to be covered by higher fares.

Then there are all the truly vicious notions to eliminate or underfund programs that are already underfunded, like housing (as though there weren’t a million or more homeless fellow citizens in the streets), and school lunches and food stamps (as though ill nourishment were not a fact of life in the United States), and Medicaid (as though we have solved our health problems by yakking them to death). Not to mention Head Start, which was so promising two years ago. Or ending welfare as we know it by sending kids to orphanages and putting their mothers to work at jobs that won’t get them out of poverty, but will violate mainstream economists’ theory of a natural rate of unemployment and so give the Federal Reserve Board another excuse to raise the interest rate to head off inflation.

“Saving” by dumping on welfare and relief programs is what will cost the middle class – and the rich, too-many times more than their tax cuts will be worth. Supply-side Republicans and New Democrats are sensible enough not to like our decayed inner cities and rural slums, and they are reasonable enough to be afraid of the sullen, desperate people who live there. They seem to think there is an underclass, and that it can be cowed with long mandatory prison sentences and the death penalty. They shouldn’t count on it.

But they should count on having their household expenses and local taxes increase to pay for more guns and locks and burglar alarms and insurance and police and judges and prisons, some of which will have to be in their backyard for lack of anyplace else to put them. This being the case, they would be wise to take a long, straight look in the mirror and ask themselves if they really are or want to be as self-righteous, callous and mean-minded as they are in danger of becoming.

 The New Leader

By George P. Brockway, originally published October 4, 1993

1993-10-4 Health, Wealth and Taxes title

IT SAYS LITTLE for the presumed intelligence of American citizens that the opening dispute over President Clinton’s health care plan turned on whether it will be mainly financed by a payroll tax or a compulsory insurance premium paid by corporations. The fact of the matter was not at issue – only the name.

By any name, the probable method of financing will impede business enterprise, discourage hiring entry-level workers, encourage hiring part-time workers, put a damper on pay raises for full-time workers kept on the payroll, deepen the stagnation of our economy, and reduce our longed- for ability to compete in the new global village with Mexico and South Korea. Since these unpleasant consequences will be debated ad nauseam, it is almost certain that the tax (as House Minority Whip Newt Gingrich of Georgia is right-a first!-in calling it) will be kept low, that the system will be inadequately funded, and that therefore it will be better than what we have now only in details, many of which might have been managed with less uproar.

You will note that the troubles mentioned will flow from the system of taxation, not from the way medical “suppliers” are paid or from the way medical care is “delivered.” It may be that these elements will be faulty, too, but those are separate questions.

We Americans talk endlessly about taxes, yet all we understand about them is that they are an expense. They cost money. Other things being equal, we are better off the fewer expenses we have to pay. In the case of taxes, of course, things are seldom equal. Not even Jack Kemp, who is opposed to all taxes in principle, could get along in a world without police and courts and armed forces and paved roads and the myriad other necessities taxes provide. It would be nice if we could enjoy these services without paying for them, and a few of us do manage to avoid some taxes. On the whole, though, the folk saying is correct, and taxes are as certain as death.

Since it does no good to sulk and stamp our feet and sob that we don’t like taxes, it would be the better part of wisdom to inquire what kinds of taxes are best for what purposes. One of President Bush‘s most irresponsible acts was his promise of no new taxes, and one of the electorate’s most irresponsible acts was the single-issue voting against him for breaking that promise. Some level of taxation is unavoidable, and we will surely need more funds to pay our medical bills. Still, some new taxes would be preferable to others.

In general, there are three kinds of taxes: (l) taxes on what exists, such as property taxes, estate taxes and poll taxes; (2) taxes on what is done, such as sales taxes, payroll taxes, excise taxes, franchises, and tariffs; and (3) taxes on income, such as personal income taxes and corporate profits taxes.

The Clinton medical plan will be paid for by taxes of the second sort-payroll taxes and excise taxes (a.k.a. sin taxes). All taxes on doing something can be avoided by doing nothing. But if you have a job, or hire someone to do a job, or buy something, then you pay a tax.

Such taxes have the virtue of being relatively easy to collect, but that’s about their only virtue. They are plainly and inescapably costs of doing business. The fewer people you employ, the lower your payroll taxes, so you are slow to hire additional employees. The less you buy, the less you have to pay in excise taxes that are invariably passed on to the consumer. It is a sad fact that most economists think it’s good and, indeed, “natural” to reduce employment (it improves “productivity”), and that it’s good to discourage consumption (it encourages “saving”). We have examined these professional delusions before and shall no doubt do so again; here let’s merely observe that payroll taxes will not constitute an improvement on, or even much of a change from, our current system of financing health care.

At present, medical insurance is a fringe benefit in most medium and large businesses. Because of skyrocketing costs, benefits are generally being reduced. Rising insurance premiums are also a factor in businesses deciding to rely as much as possible on part-time employees who don’t get the fringe benefits. There is no question that medical insurance is a tremendous load for businesses to carry, and that it operates like the Social Security tax as a cost of employing people. American automobile company executives claim medical insurance adds $2,000 or more to the cost of a new car, making it hard for them to compete in the global economy everyone talks about. Substituting some form of payroll tax for the insurance premiums will merely guarantee that every American enterprise is carrying the same burden; it will not reduce the weight.

Moreover, payroll taxes are passed back to the employee – not literally, perhaps, but effectively in the form of an argument against pay raises. And that’s not all. Businesses usually try to set prices to cover costs (including payroll taxes), plus a planned or “normal” profit (figured as a percentage of costs). If costs go up 10 per cent, and if “normal” profit is I0 per cent, prices must go up 11 per cent. Granted, no one can calculate that closely, because no one can tell what the future will bring; nevertheless, both profits and prices tend to move up faster than costs.

Now, you might think that spokesmen for industry would be 100 per cent opposed to taxes that make them raise prices and become less competitive. As it happens, they are about 50 per cent opposed – and it is this ambivalence in their opposition that gives the Clinton plan a chance to be enacted. What industry spokesmen are 100 per cent opposed to is the third kind of tax: a tax on personal income or corporate profits.

At first glance, the corporate tax seems ideal. You don’t have to pay it unless you have a profit.  It won’t interfere with your plan to start a new enterprise or expand an old one. It won’t bankrupt you. It is the next-to-the-last payout you make-and there’s the hitch. For the last payout you make is profits. It is a simple arithmetical fact that your after-tax profits will be lower than your before-tax profits.

THIS IS WHERE the morale of our system often breaks down, because the interests of the owners of an enterprise diverge from the interests of the enterprise itself and of most of its employees. The enterprise and its employees want to stay in business. The owners – the vast majority of them don’t even have a clear idea of what the enterprise does. They simply got touted onto it by their stockbroker and added it to their portfolio. Their connection may be more abstract than that: A mutual fund they own a few shares of, or a pension plan they participate in, may have a position in the enterprise.

1993-10-4 Health, Wealth and Taxes End of Economic Man advertThe situation calls to mind John Kenneth Galbraith‘s observation in Economics and the Public Purpose. Especially in big business, he pointed out, the corporate objective had changed from profit maximization to protection of “the planning system and its technicians.” In the 20 years since Galbraith’s groundbreaking book was published, another shift has occurred, largely as a result of the takeover and buyout frenzy of the 1980s.

Control of both the directors and management of many a big corporation now rests with investment bankers or their representatives, who, knowing little about the day-to-day operation of the business they have acquired, rely on a handful of executives to see that their cash cow is properly milked or, it may be, bilked. To ensure the devotion of the executives, the bankers generously reward them with absurd salaries, fantastic stock options, and even the last word in medical insurance, making them multimillionaires too.

There is one thing that is hated by multimillionaires like these: the personal income tax. They are rich, they congratulate themselves on their richness, and they think it unfair that they should be soaked for it. This sense of unfairness or isolation from the rest of us further alienates investors and their executives from the companies they control and helps account for the puzzling acquiescence of many of them in payroll taxes that can only hurt American business.

That they clearly understand how payroll taxes hurt is apparent from their vehement arguments against raising the minimum wage, which also affects prices, though to a lesser degree. But they have supported increases in the regressive Social Security tax, because it doesn’t much bother them personally. For the same reason they will support a payroll-based health care tax in preference to using the income tax, which might force them to pay their share of the load.

The final irony is that the true-blue believers in laissez-faire will attack President Clinton’s plan as the proposal of a liberal. Actually, it is the middle-of-the road proposal of a middle-of-the-roader. The President’s program is certainly better than what his opponents have proposed, but my mother always warned me that it wouldn’t greatly improve my health to play in the middle of the road.

The New Leader

By George P. Brockway, originally published December 2, 1991

1991-12-2  Taxing Our Credulity Title

EVERYONE seems to agree on two things. First, the economy is in a mess and something should be done about it. Second, neither the President nor congress did anything this year (beyond a belated extension of unemployment benefits), and nobody will want to do anything fundamental next year because of the election. If the second thing is correct, the first is moot: At least from now to 1993 we will have to test how we run on an automatic pilot that does not seem a whole lot more competent than the one in Airplane.

In the meantime, you and I can work off our frustrations by talking about them. We might as well start by talking about taxes, which can always generate heat on a wintry day. Several tax proposals are floating around Washington. All of them provide for reductions of one sort or another, most of them claim that they “target” the middle class, and some of them pretend to improve our productivity and beef up our international competitiveness.

The longest-running of the tax-cut schemes is Housing and Urban Development Secretary Jack F. Kemp‘s undismayed conviction that the way to balance the budget is to cut taxes à outrance. Kemp got us to go along with him on this scheme 10 years ago, when he was a New York Republican Congressman. He promised that savings and investment and tax collections would all increase, and we (present company excepted) believed him. None of his promises was fulfilled; instead we got an instant recession, followed by still burgeoning deficits. There is no reason to expect that what contributed to a recession yesterday will end a recession today.

The next longest-running notion is the President’s steadfast passion for a capital gains tax cut. The Education President told the children about it the other day when he visited a grade-school class. No one gave him an argument, but the best that can be said for the idea is that it might result in a modest one-time increase in tax collections as speculators rush to cash in old gains they’ve been sitting on.

Until 1987, when capital gains became taxed as ordinary income, executives with an eye to the main chance devoted endless time and ingenuity to schemes allowing them to take their compensation as capital gains. The use of stock options, a fairly routine dodge, could have gaudy results. One Donald A. Pels (whom you never heard of), CEO of LIN Broadcasting (which you never heard of), cashed his options in 1990 for $186,200,000 (which looks like a thousand times the speed of light). After paying taxes he had only $134,064,000 (plus a few millions in regular salary) left to show for 10 years’ work. If Bush had been able to get his tax cut through, Pels would have had $158,270,000 left, and his incentive wouldn’t have been so sapped.

Returning to a more mundane level, we find several Senators, Texas Democrats Lloyd Bentsen and Phil Gramm among them, eager to stir up lRAs again. You probably remember the commercials of a few years ago that had sports stars and movie actors earnestly urging us to join them in planning for a wealthy old age.

The beauty of it was that our self-serving endeavors would have the incidental effect of increasing the national saving rate and consequently the national investing rate. What happened, of course, is that those who participated merely switched their savings from one account to another. I can’t think why it would prove any different the second time around.

Finally, there are at least two proposals for reforming the income tax, both advanced by Democrats. A group led by Senator Albert Gore of Tennessee and Representative Thomas J. Downey of New York is pushing a plan they call (in pointed contrast to the President’s) the Working Family Tax Relief Act. This would reduce the taxes of 95 per cent of all families with children. Cuts would range from roughly $875 at the bottom of the income scale to $185 at the top; singles and families without children would continue to pay the present rates. The reductions would be paid for by increasing the taxes of the richest 1 per cent of taxpayers (whose average income is $676,000) by an average of $21,600, and of the next 4 per cent (whose average income is$132,000) by an average of $530. These increases are about 3.2 per cent and 0.4 per cent of the respective incomes. You will note that the Working Family Tax Relief Act is intended to be “revenue neutral” and so doesn’t upset last year’s budget agreement.

The simplest proposal has been made by Representative Dan Rostenkowski (D.-Ill.), Chairman of the Joint Committee on Taxation, who would allow a tax credit equal to one- fifth of Social Security and Medicare taxes. He would pay for it by boosting the tax on the richest 1 per cent; so he would be revenue neutral, too.

The effects of his plan on individuals look like this: The median family had an income in 1989 (the latest figure I can lay my hands on) of $35,975. Assuming that the entire income is from wages, the family pays $2,752.09 in Social Security taxes (which is an outrage, as Senator Moynihan says). One-fifth of that tax is $550.42, or $10.58 a week-not enough to make a difference in financing a new car or a new home or even a new video camcorder, but certainly welcome as a help in covering expected increases in bus and subway fares.

Chairman Rostenkowski’s average cut is about the, same as Senator Gore’s for a $75,OOO income. Since the Chairman’s plan is tied to Social Security taxes paid, the benefit for the lowest quintile of taxpayers is dramatically lower – $161, as opposed to the Senator’s $875. Also, of course, the cap on Social Security taxes puts a cap on Rostenkowski’s benefits – about $8S0, which would apparently be available to everyone right up to whoever succeeds Donald Pels as leader in the income sweepstakes.

Speaker Tom Foley of the state of Washington says he expects the House to pass Rostenkowski’s plan. Congressman Newt Gingrich of Georgia, the Republican whip, sneers that the plan would merely redistribute the wealth but would not make more money available for investment. For my part, I don’t think redistributing the wealth is such a bad idea. After all, those at the top of the income pyramid had wealth redistributed to them by the Kemp-Roth tax law 10years ago. As Jeff Faux of the Economic Policy Institute puts it, the bill should be sent to those who went to the party and are thirsting for another one.

If the purpose is to jump-start the economy, the trouble with all these plans is in the timing. Even if we could get Congress and the President to agree on one of them, could run it successfully past the House Ways and Means Committee and the Senate Finance Committee, and could manage veto-proof majorities in both houses (in case the President noticed at the last minute that the cost of an abortion would still be a deductible medical expense} – even then little good would come of it in our winter of discontent.

With luck we might put our 1040s in order by April 15 and begin getting our hands on the increased disposable income a week later, with spring already a month old. The economy would no doubt be startled, but the time for jump-starting would be past. This is not to suggest that the tax schedule should not be changed, and right quickly. As I’ve said before (see “The Evils of Economic Man,” NL, July 9-23, 1990), our economy and the society it supports are in for a long decline unless we correct our present course toward increased polarization.

So the correct answer to the multiple choice question asking which scheme will end the recession seems to be “None of the above.” None of the proposals on the table is likely to do much to get the economy out of the doldrums. Furthermore, they are not self-sufficient. Each silently assumes that a further step will be taken, yet that depends on whether their beneficiaries will be of a mind to take it. If they are not psychologically ready to spend their benefits with enthusiasm, the effects on the economy will be tentative and minimal.

WHAT IS needed is something positive to get money circulating – to get people working, to get consumers consuming, to get producers producing. I can think of two ways to achieve these results.

The first is the way we’ve done it for the past decade: Damn the deficit and go ahead with a military buildup. The effectiveness of defense spending has been demonstrated repeatedly over the centuries, from Periclean Athens to Reaganite America. Not the least of its virtues is its dramatic size. It is plainly visible. Its impact on localities and industries and job classifications can be calculated and counted upon, and so can the multiplier effects that spread throughout the economy. Plans can be made to get a piece of the action. Things start stirring very quickly.

Happily, there is another way. We are not doomed to waste our wealth and energy on devices we hope will never be used. Again we can learn from Periclean Athens, which is remembered now less for the power of the Delian League than for the wonders of the Acropolis, the most glorious public works project the world has yet seen.

American public works projects have hitherto been hampered by the lack of ready plans; consequently, they have been viewed as too slow-starting to be useful in ending a recession. But it happens that this is not true today of the states and municipalities.

Partly because of the niggardliness of the Reagan-Bush “New Federalism,” and partly because of the current recession, state and local governments have been in trouble for a couple of years and are in grave trouble now. Caught between constitutional requirements that they balance their budgets and the blind frenzy of taxpayers’ revolts, they have had to abandon capital improvements, emasculate services and fire thousands upon thousands of employees.

These draconian measures could be reversed in a moment. New York City alone has a list of several hundred bridges it needs to repair. Work on many of these could start tomorrow if money were available. In almost every city and suburb, library hours have been reduced and branches closed; what only a year ago was a marvelously helpful and rapid system of inter-library loans currently operates only sluggishly. The people who used to make that system function could be rehired overnight. The second cop who used to man patrol cars is also ready to return to duty in a flash. A year’s volume of this magazine could be filled with examples from every corner of the land.

If Federal grants to state and local governments were restored merely to the same proportion of Federal expenditures as in 1980, a sum of $63.1 billion would be available to fund such projects and break the back of the recession-peacefully. Could we do it? Well, we spent a lot more than that trying to drive Saddam Hussein from office. We could do it, all right, if we had the sense and the will.

 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.

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I think these people know very well what they do.

The New Leader

By George P. Brockway, originally published April 4, 1988

1988-4-4 On the Matter of Consumption Title

 

 

THREE AND A HALF years ago, in THE NEW LEADER of November 26, 1984, to be exact, I made a prophecy that is remarkable among my prophecies in that it has come true. I said we would “start hearing a lot more about the value-added tax-how it is widely used in Europe, how invisible it is in comparison with the sales tax, how comparatively easy it is to collect, how it taxes consumption rather than production …. What we get won’t be called a value-added tax, but what’s in a name?”

Well, the name that seems to have been settled on is consumption tax, and the chorus in support of it is tuning up with a vengeance. For some reason no one bothers to explain, the stock market crash of last October 19 is thought to have provided a suitable occasion for taxing consumption. Everyone from Pierre DuPont to Peter Peterson has solemnly warned us that Wall Street won’t be satisfied with anything else. (If you asked me, I’d say Wall Street has a problem satisfying the rest of us. Who laid the egg, anyhow?)

As a distinguished example of consumption- tax thinking, I cite Robert M. Solow of the Massachusetts Institute of Technology, who gave the following advice to the next President in a recent issue of the New York Times: “If there is no recession, the first order of business is to make a start on reducing the deficit…. And [the President] should do it by increasing taxes on consumption, not investment …. Because a consumption tax means spending will fall, he must do something to offset that like lower interest rates.”

Now, Solow is not a fool; I don’t think you get to be an MIT professor by being a simpleton. Nevertheless, and putting aside a question of fact (hasn’t a “start on reducing the deficit” already been made?), I ask you to look closely at his two-step policy recommendation. First step: He would tax consumption. In other words, he would reduce the standard of living of the middle class (the poor will presumably not be taxed, at least not much, on necessities, which is what they mostly consume; and the rich won’t be much bothered). Second step: He would lower the interest rate. If the middle class stops consuming there will be a depression, so he would keep them consuming by making it easy for them to borrow. (When liberals propose lowering the interest rate, Wall Street insists that only the impersonal unregulated market can do it, but let that pass.)

Let us suppose Solow’s scheme works. What will the next President have accomplished? (1) The deficit will have been reduced, at best, by the amount of the consumption tax. (2) Since nothing will have been done to stimulate the economy, it will, at best, continue to languish in its present “prosperity.” (3)

Some indebtedness will have been shifted from the nation as a whole to the middle class as individuals. (4)The money borrowed by the middle class will have been lent them by the rich, whose extra dollars will have been left untaxed to better enable them to make this “investment.”

Solow’s scheme is, as the mathematicians say, elegant in its simplicity. But I don’t think it will work, at least not if its purpose is anything other than a transfer of wealth from the middle class to the already wealthy. The scheme would bring about such a transfer; there’s no doubt of that. There would also be some leakage, as the economists say. Because the middle class’ spending money will in effect be taxed twice (once by the consumption tax, then by the interest paid on the borrowed money), spending will be reduced after all, and the proceeds of the consumption tax will be correspondingly reduced. Depending on the new interest rate, the reduction in spending could be very large-large enough to bring on another recession (if you’re timid about saying “depression”).

Now I ask: We already did this, didn’t we? Do we have to go through it all again? We did it in 1981, and we got the depression (I’m not afraid to use the word) of 1982, not to mention the deficit everyone talks about. Those whose attention span is very short may have forgotten about the Laffer Curve, which purported

to show that you could increase tax collections by reducing the rates, and the Kemp- Roth tax bill, which promised to increase investment by cutting taxes, especially of the rich. Those were the heady days of the supply-side theory, but investment didn’t respond as promised. What actually happened was that tax collections fell far below expectations, creating the mega deficit that was covered by bonds paying usurious interest rates, purchased by the rich with their tax-cut windfalls. In effect the rich were given the bonds, just as Solow’s scheme would give the rich the promissory notes of the middle class. It is deja vu.

 Indeed, it is, if Yogi Berra will pardon me, deja vu all over again: The Great Depression was also preceded by tax cuts for the rich. I do not think this is mere coincidence, or mere post hoc, ergo propter hoc. For I am persuaded that there is a fatality about economics that in the end chokes any society making too great a distinction between the rewards of the favored and of the disfavored. It is a commonplace of legal theory that a law must not only be just but also be seen to be just. It is the other way around with economics, where it is more important for a policy to be fair than for it to be accepted as fair. This is particularly true when it comes to policies determining the distribution of a society’s rewards.

As near as we can tell, the Roman mob was appeased, if not altogether satisfied, by bread and circuses; but in the imperial city alone, upwards of 150,000 lived on the dole, while uncounted thousands waited upon the whims of the favored few. Labor power is the ultimate power-and Rome threw it away. In 1928, a year we look back on as a period of idyllic prosperity, almost 60 per cent of American families lived in poverty; then calculated at less than $2,000 a year. Now we have an underclass, and we have a large class of the underemployed. This costs us, and may finally destroy us; yet it would seem that substantial majorities of American voters have been satisfied with current policies. The policies are seen to be fair, but their actual unfairness may be our undoing.

The rich have always had a problem knowing what to do with their money. In times past it could always be invested in land and in improvements thereon. The improvements, whether in the shape of stately homes or scientific agriculture, were craft industries. Each staircase or mantelpiece designed by Grinling Gibbons and carved by him or his apprentices was the subject of an adhoc contract between him and the lord of the manor. There certainly was demand for his work, and this certainly affected how much he could charge; he did not produce for a market, however, nor was he himself an important outlet for what was produced on the estates where he worked.

The problem of today’s rich is different. In the first place, they have not become rich by investing in land-speculating in land, maybe, but accumulating rents, no. In the second place, their riches are vastly greater than the sums necessary to recreate a Chatsworth or a Montacute, should their fancy happen to take that turn. In the third and most important place, industry today is built on mass production: Giant corporations serve giant markets.

The giant markets are crucial; without them the giant corporations cannot exist. Giant markets are masses of people willing and able to buy. Such masses need to include the employees of the giant corporations, and the employees are able to buy only to the extent that they are well paid. Henry Ford talked as if he understood this, but even his shockingly high wages were not enough to raise his employees out of the ranks of the working poor. In any case, his has remained a minority view among American businessmen. The majority view, in recent years embraced by the electorate at large, is that consumption should be curtailed and investment should be encouraged.

IRONICALLY, consumption has nevertheless expanded as the banks have discovered profits to be made in personal loans at usurious interest rates. There are limits, though, and they have been reached in many an industry. Automobile companies struggle to maintain their share of the market, because the market is limited, and because the industry’s present capacity is much greater than the market. Steel mills, all over the world, are closed down or running at a fraction of capacity. Agriculture produces more than could be consumed even if somehow the idiocies that permit widespread starvation could be overcome.

The inevitable consequence of limited markets is limited opportunities for productive investment. Hence, as we’ve remarked here before, the rich have more money than they know what to do with, and so do the massive pension and charitable funds. Besides, the glittering gains from speculating in a churning stock market are enormous. In the eventual crash the too-much money of some of the rich and of some of the funds disappears; on October 19 perhaps as much as a trillion dollars disappeared forever. The Reagan revolution created a deficit to give this money to people who couldn’t use it.

The appalling fact is that practically everyone seems to want a repeat performance. It would appear that the first eight months of 1987, when the Dow went from under 2,000 to over 2,700, was the happiest period in millions of tawdry lives. Every day the “financial” news was a joy. Individuals with a few shares of a mutual fund and college presidents with great fortunes in their care were equally delighted. Economists, who gave the stock market a prominent place in their models, looked upward. Brokers stood tall. Arbitragers stood taller. Tens of millions more, although not directly involved, shared in the euphoria.

Despite the shock of October 19, these people seem determined to do it again. More stridently than ever the claim is being made that the stock market is both the heart blood and the brains not only of the national economy but of the whole free world; that our liberty as well as our prosperity depends on its ineffable wisdom; that any attempt to control it would, in the tasteless cliché, throw out the baby with the bath water.

Worse, we hear again the cry to tax consumption, with the deliberate purpose of destroying the mass market modem industry depends upon-which would foreclose rational investment opportunities and bring on a new fever of speculation. Some of this can be explained as simple greed. But beyond that there is a pathological psychology whose etiology I can’t even imagine.

The New Leader

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

1987-10-5 Of Deficits and Taxes Title

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader


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

Originally published March 24, 1986

INTHE 1920s, bond salesmen were admired and envied. Later, when Wall Street laid its egg, they became butts of bitter jests (“Where are the customers’ yachts?” asked a book by Fred Schwed Jr.). In the end, they were objects of opprobrium and scorn. Today’s bond salesmen seem to be following in their grandfathers’ footsteps.

Salesmanship is now marvelously subtle, combining an ancient rhetorical device with an even more ancient childhood game. Long before Aristotle wrote his Rhetoric, Greek sophists found that an appearance of frankness could help them win a bad case; openly admitting a superficial weakness or two could get them good marks for sincerity. And since long before the sophists, children have known how to tempt their peers with the challenge, “I dare you.”

The device and the game are joined in the term “junk bonds.” The immediate connotation is of shoddy goods or a tangle of broken machinery, old plumbing fixtures and wrecked automobiles, partly hidden by a tumbled-down board fence as unsightly as what it pretends to hide. A secondary connotation is of junk mail, which almost everyone hates. The junk bonds metaphor boldly accepts both connotations and thus disarms criticism. No one, it winks, is trying to fool anyone.

At the same time, these negative connotations are modified by some that are at least ambiguous.  Those who send out junk mail presumably think well of it. Paraphrasing Abraham Lincoln, one might conclude that God must love churches and charities that raise money by mail, since He made so many of them. For another example, junk food is eaten by an awful lot of people, who apparently have a tolerance, if not taste, for it; and purveyors of junk food make an awful lot of money, something the purveyors and buyers of junk bonds hope to do, too.

In addition, the term admits risk and so suggests sport. I dare you to run the risks that may lead to a big killing. Are you big enough to afford such risks? You say that the capitalist system depends on risk taking: Do you dare put your money where your mouth is?

Yet just as a paranoiac may have real enemies, junk bonds may be really bad. They may not necessarily be bad for the new owners of the corporations that issue them or for the purchasers or for the underwriters, but they are almost invariably bad for the corporations themselves; they are also undeniably bad for the morale of our society (see “The Faith of Fiduciaries,” NL, December 24, 1984) and for the tax collections that support our society.

In spite of all the present hype, junk bonds are not new. Practically every railroad issued bonds at usurious rates – and ultimately paid the penalty. Neither are junk bonds the first securities of “less than investment grade” to be widely marketed in the United States. Most of our giant corporations – including many of those now being raided – were originally papered together with such securities. The chosen instrument was different, and the metaphor was different, but the results were similar. Stock was issued instead of bonds, and the stock was said to be watered like cheap whiskey.

In Other People’s Money, Louis D. Brandeis, later a Supreme Court justice, told how the United States Steel Corporation was formed in 1901: “The steel trust combines in one huge holding company the trusts previously formed in the different branches of the steel business. Thus the tube trust combined 17 tube mills, located in 16 different cities, scattered over 5 states, and owned by 13 different companies. The wire trust combined 19 mills; the sheet steel trust 26; the bridge and structural trust 27; and the plate trust 36 …. Finally, these and other companies were formed into the United States Steel Corporation, combining 228 companies in all …. ”

The tube trust, when it was put together a few years earlier, had been capitalized at $80 million. Half of that was common stock, and half of the common “was taken by J.P. Morgan & Co. and their associates for promotion services; and the $20 million stock so taken later became exchangeable for $25 million of Steel Common.” The tubes plainly held a lot of water, as did the other trusts that went into United States Steel. Nor was this all. The rest of Steel Common was watered in its turn, with nearly one-seventh issued directly or indirectly to the promoters.

Although Brandeis doesn’t give all the gory details, I would wager that at least half of the original 228 companies were enticed to sell out at greatly inflated (or pumped up) prices. Some of the others may have been squeezed a bit, but the total paid for the 228 was almost certainly far greater than their entire net worth. Once you add it together you have United States Steel, the first corporation capitalized at a billion dollars, and pretty close to half of it was water.

In Morgan’s time, high-flying corporations were overcapitalized. Currently they are undercapitalized, a.k.a. leveraged. The shift is a function of the tax laws, though you may read many an analysis of takeovers without coming across a mention of the part played by taxes.

When U.S. Steel was floated, there was no corporation tax. Since earnings were not taxed, interest paid on bonds was obviously not deductible. Interest was a fixed expense. Dividends, on the other hand, were not fixed (except for some on preferred stock). You paid dividends when you were flush; otherwise not.  Therefore a prudent company got its money from stock, rather than bonds. Today, with the corporation tax at 46 per cent (assuming a corporation pays any taxes at all), and with interest payments deductible, a clever company will issue bonds instead of stock, and a clever raider will happily issue junk bonds paying 14-15 per cent in order to buy up stock earning 5-6 per cent. (For reasons why no interest should be deductible, see “The Bottom Line of Tax Reform,” NL, November 26, 1984) After the deduction, the new load on the company is only about 6-8 per cent, and before it becomes oppressive, the raiders will be long gone.

That the debt will eventually become oppressive, there is usually little doubt. The interest payments will have to continue in bad times as well as in good. As profits fall or disappear, so will the benefit from deductibility. The corporation’s cash flow will be soaked up by the high interest. Even a sluggish cash flow can quickly lead to bankruptcy. Of course, bankruptcy may now be sought to break a labor contract, whereupon the company may become solvent again. Guess who’s left with the short end of the stick?

This result of undercapitalization is, you may be astonished to learn, not substantially different from the result of overcapitalization. How was the water in Big Steel paid for? As the man might say, there’s no such thing as a free drink. If the capitalization was half water, Steel’s earnings on its real assets would have had to be twice “normal.” Without a research assistant, I can only suggest the outline: First, the owners of the original 228 companies were well paid. Second, J.P. Morgan and his fellow underwriters were very well paid. Third, those who bought the watered stock received “normal” dividends. Fourth, the price of steel was not grossly exploitative (steel rails stayed at $28 per long ton for more than 10 years).

Here someone is sure to cut in with the claim that U.S. Steel was more efficient than its 228 components had been. Evidence for this is the fact that most of the 228 were shut down, while the surviving units were expanded. But if those shut down were inefficient, why were they bought in the first place? The competitive system is supposed to let inefficient companies die.

The case for technological efficiency is, if anything, worse. In 1911, 10 years after the emergence of U.S. Steel, Engineering News reported: “We are today something like five years behind Germany in iron and steel metallurgy, and such innovations as are being introduced  by our iron and steel manufacturers are most of them following the lead set by foreigners years ago.” (That might have been written yesterday.)

The question remains: Who paid for the water? Those who didn’t immediately answer “Labor!” will stay after class and be given a quick review of the effects of mass immigration, Taylor System management, and courts that issued injunctions against labor unions as conspiracies in restraint of trade.

THE Federal Reserve Board’s new rule limiting the use of junk bonds to 50 per cent of the price of a takeover may put a momentary hitch in a few raiders’ plans. And some say the present run-up of the stock market will put an end to takeovers by increasing the amount of money needed. The run-up, however, has been caused by the drop in interest rates, which increases the capitalized value of every income-earning asset. (An asset that earns $10 is worth $100 when the interest rate is 10 per cent, and jumps in value to $200 if the rate falls to 5 per cent.) For this reason, the bond market has been rising, too; the interest that investment-grade bonds must pay is falling-and so are the requirements for junk bonds.

Should President Reagan be successful in cutting corporation tax rates (as seems likely), the deductibility of interest payments will become less important and watered stock will tend to displace junk bonds in takeover schemes. In other words, look for an upsurge in new blue-sky issues. R.R. Palmer tells us in A History of the Modern World of an 18th-century promoter who issued shares in “a company ‘for an undertaking which in due time shall be revealed.” Does anyone doubt that if Carl Icahn made such an offering today it would be oversubscribed tomorrow? Whatever happens, the financing of the American economy will still be largely an incidental function of speculation, or as Keynes said, of running a casino.

My first “Dismal Science” column (NL, September 7, 1981) was entitled “Speculation Will Undo Reaganomics.” The title displays an innocence on my part. I did not imagine that the Reaganauts’ intention was to make paupers and millionaires. Speculation continues to have the effects I discussed; I still find it hard to believe that decent people think it’s grand.

Since the Civil War days of “Betcha Million” Gates and Jay Gould, speculation has resulted in American enterprises paying too much for capital. Andrew Carnegie observed in The Empire of Business (1902) that “railway managers today are … directed to obtain a return on more capital than would be required to duplicate their respective properties.” It matters little whether the capital is paid for with dividends on watered stock or with interest on junk bonds. Either way, it is the working man and woman-the people who put that capital to work – who do the ultimate paying.

The New Leader

Originally published September 9, 1985

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The New Leader


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

Originally published November 26, 1984

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What then?

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

What would it be?

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

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

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

The New Leader


[1] Editor’s emphasis

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