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How to Topple the American Oligarchy (Part One)

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My fervent hope is that 2015 be the year that the American people begin to reclaim their country. For the past 35 years, we have been subjected to the most brutal kind of class warfare: and we have lost. We have lost control of our economy, we have lost control of our government, we have even lost control of our perspective under assault from the never-ending torrent of 24/7 corporate media. We are locked into a series of eternal and unwinnable wars like the War on Drugs and the War on Terror; only the War on Poverty has been abandoned as being uncongenial to our masters. The tax code has been transformed into a sieve of loopholes, breaks and subsidies that benefit corporations and the wealthy, while starving the government of the funds needed for even the most basic of public services.

In 2014, our great Republic suffered the humiliation of having the government shutdown because it would not kowtow to its oligarchical masters. During our last Gilded Age, President Woodrow Wilson declared:

“A little group of willful men, representing no opinion but their own, have rendered the great government of the United States helpless and contemptible.

The government, which was designed for the people, has got into the hands of the bosses and their employers, the special interests. An invisible empire has been set up above the forms of democracy.”

This description is as true today as it was in Wilson’s day. Many Americans have even applauded the shutdown; which only shows how foreign and unpopular our own government has become, how alien to its own people. When government functions properly, it is the people; once it is captured by elite interests, it becomes a tool of the domination. That is the simple reason people have lost faith in their public institutions: they no longer serve the public[1].

govtapproval

But hope remains; a tiny minority of 30 thousand cannot hold sway forever over 300 million. Even as the gross excesses of the Gilded Era barons led directly to the Great Depression and the New Deal, so too our current crops of Masters of the Universe will go too far. America is a nation that was founded as a revolt against distant, unaccountable masters: it is in our DNA to rebel.

The following ideas are only vignettes; some have been more fully developed in previous posts, while I will be developing others in the coming months as separate pieces.

Dig out the roots of aristocracy and oligarchy

  1. Raise the inheritance tax

As Thomas Piketty[2] has very convincingly demonstrated, income and wealth inequality has grown to fantastic proportions and not only in the United States, but around the world. This is not necessarily a problem in and of itself: we Americans have a natural affinity for self-made wealth and it is very difficult to argue that a Bill Gates or Steve Jobs earned their fortunes and the right to enjoy them. The problem with such wealth is two-fold. First, it is too often used to corrupt public officials, distort government policy and subvert the public interest to its own private ones. Adam Smith, who was a moral philosopher before we turned him into an economist, stated this clearly enough:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public. We rarely hear of the combinations of masters, though frequently of those of the workman. But whoever imagines, upon this account that masters rarely combine, is as ignorant of the world as of the subject.”[3]

Second, it is too often passed on to those that have done nothing to earn it. The wealth is not transmitted alone: along with it go the privileges that great wealth has accrued over a lifetime of its exercise, or several lifetimes. If oligarchy is bad enough, aristocracy is a far worse evil: for with an oligarchy there is always at least the hope of breaking into it while aristocracy is jealous of its exclusivity. Americans ought to have an abhorrence of aristocracy, that cancer of the Old World from which our ancestors fled.

The wealthy have been hammering estate tax rates and raising exemptions since Ronald Reagan took office, before that they had remained remarkably stable since 1946. The biggest changes have come in the 2000’s, when elite capture of Congress really took hold[4]:

estatetax

The solution: reduce the total exemption to a total of $2 million, divided in any way the benefactor wishes (estate tax exemption, lifetime gift, or annual gift); and raise the estate tax and gift tax rates back to their pre-Reagan levels of 70%.

  1. When income is not income

Just as changes to the estate tax and lifetime gift exemption disproportionately favor the wealthiest Americans, by creating a wealth shield far in excess of what anyone in the middle class might ever transmit to their progeny, so too does the differential rate of taxation on capital have a far greater effect on top earners. Although a large percentage (72%) of returns reporting capital gains were for middle income households (AGI < $100,000), 87% of the actual value of gains from capital benefited households with an adjusted gross income above $100,000 – and 74% of the total went to filers earning more than $200,000[5].

The issue with the capital gains tax is that while it does promote inequality, it is also serves an important role in financing for companies. Increases in the capital gains tax in the US as well as in various countries have demonstrated that investors are quite sensitive to this tax, especially if they perceive that the increase might be repealed in the short-term: by a Republican Congress or President, for example. Since the tax is only charged when an asset is sold, investors would just as soon hold on to their assets until the rate is again lowered, and this has the effect of shrinking markets, reducing liquidity and slowing economic growth. There is nevertheless considerable argument between economists as to the size of the impact for any given change in the capital gains tax, as well as whether the impact is short-term or long-term[6].

capitalgains

The most reasonable course would appear to be to encourage middle income households to continue or even expand their investments in all forms of assets by eliminating the tax on their holdings altogether: it is proportionately a very small portion of the total tax income received, yet it would bolster middle class earnings as well as encouraging savings over debt and consumption. A boost in investment by middle class households would also mitigate, at least somewhat, any impact that a reduction in investment by the wealthiest households from the second part of the measure, which is to equalize the capital gains and the earned income tax rate. This is not an extraordinary suggestion; for assets held less than 1 year, the tax code already attributes a capital gains tax rate equal to that of the income tax.

capitalgains2

Ideally, the gains from capital should be treated in the same way as the gains from labor: there is no reason to discriminate against them. No less a Republican than Abraham Lincoln once said:

“Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.”

While Republicans have successfully sold the myth of the heroic “job creator” as the self-made capitalist who goes on to create hundreds or thousands of new jobs, the fact is that capital cannot operate by itself. It requires labor to work in its factories, markets in which to operate, consumers to buy its goods and services, and – yes – government to provide the laws and infrastructure that protect and enable the functioning of capital. It is beholden to many, yet it ascribes to itself special privileges which are the modern equivalents of the feudal droits du seigneur.

The Solution: Eliminate the capital gains tax. For incomes below $150,000 simply eliminate it. For those earning above $150,000, eliminate the difference between “earned income” and “capital gains, interest and dividends”. All income would be treated as “earned income” and taxed at the same rate.

  1. The 5-minute income tax

In 1913, the people ratified the Sixteenth Amendment authorizing the establishment of an income tax, and before the year was out, Congress had established it through the Revenue Act of the same year. The first individual income form was four pages long and only one page of instructions. In 2013, the 1040 form was 181 pages long and the tax code had tripled in size between 1975 and 2005. It is now 70,000 pages long and there have been 10,000 changes in the past decade alone. As a result, Americans spend approximately 6.1 billion hours and $160 billion in lost productivity preparing their tax returns, the equivalent of 1% of GDP.[7]

Beyond the unnecessary loss in time, effort and money for both the public and the IRS, so much complexity contributes directly to greater inequality. The progressivity in the tax code is undermined by the sheer number of loopholes and subsidies that are available to those with the wherewithal to hire a competent tax service. Many of these disproportionately benefit the wealthy: after all, you have to have wealth in order to bother shielding it. What’s even better? Most Americans support these tax breaks because they too benefit from them.

But the upwardly redistributive effect of these breaks, known as tax subsidies, is large. Consider the following table:

itemizers

The US middle class pretty much ends at an AGI of $100,000[8], which means that less than half of middle class Americans actually take full advantage of the available tax subsidies (either through lack of knowledge or because it simply isn’t worth the effort to replace the standard deduction). On the other hand, it is very hard to find anyone in the upper income bracket filing the 1040EZ. I might comment that the Republican Party fights hard against redistributive policies only when the money flows down rather than up, but in fact, the Democratic Party has put forward precious few leaders who have seriously discussed eliminating these loopholes.

Complexity is the enemy of fairness, and so is the large reduction in marginal rates that were pushed through in the 1980’s. These declines were minimally reversed during the Clinton years after ferocious opposition. The wealthy, and their army of hired lobbyists, argue unceasingly that any increase in top marginal rates would be the death of the economy because they are the “job creators”. Perhaps they are creating jobs overseas, but precious few in the US. Nor can they explain how it is that the American economy grew so rapidly and so consistently from 1950 to 1970 without a vast increase in inequality when top rates were far higher than they are today. The fact is room remains for moderate increases in the tax rates for the wealthiest Americans.

topincometax

The Solution: Simply the tax code, eliminating or severely capping most tax subsidies, while maintaining progressivity in brackets. Reflecting the growing disparity in income ranges, add one or two additional brackets at the very high end of the income range with marginal rates above 50%.

  1. Fix corporate governance

As early as 1980, the average American CEO earned about 30 times the income of the average worker. Since then, and especially since 1990, that ratio has increased tenfold so that in 2013 the average CEO was earning 300 times the income of the average worker. This is clearly not a case of CEO’s adding a revolutionary amount of new value to their enterprises; they did not suddenly become vastly more intelligent and capable than the ordinary mortal. No, this is a text book case of parasitic economic skimming of value by insiders. It is classic agency theory: the agents (CEOs) have placed their interests before those of shareholders and are siphoning off a great deal of money for themselves.

This is possible because of the ludicrous and incestuous state of corporate governance in America, if it what goes on in boardrooms can even be dignified by the term “governance”. It is more like “sharing the booty”. Corporate boards vote on executive management’s pay and perquisites; increasingly, the same people are on many corporate boards and they are usually executive managers or former ones themselves. It is precisely like politicians in Congress voting their own pay raises, except that the politicos must face public wrath and the possibility of being voted out of office, whereas executive managers almost never have to do so. The consequences are easily predictable:

ceopay

American corporate governance needs a complete and radical overhaul. There are many potential fixes and some or all of them should be tried:

  • Have states pass laws requiring shareholder votes on all executive level pay packages or increases;
  • Limit the number of board seats any one person can occupy at the same time;
  • Strengthen laws against board members who are negligent or culpable of dereliction of duty or worse;
  • Require board diversity by including representatives of the employees and potentially local community leaders;
  • The carrot-and-stick approach: provide tax discounts for companies where the CEO-to-worker compensation ratio is between 20x and 50x (the carrot); impose a special surcharge corporate tax on companies where the CEO-to-worker compensation ratio is above 100x (the stick).

There are many additional proposals, what is indisputable is that the existing situation is intolerable; it is essentially legal robbery. Strangely, Republicans are silent as the tomb on the subject. You would think that a party that is so zealous of the rights of owners would be especially incensed at the massive expropriation of wealth by management from shareholders, who are in the end the actual owners of the companies. Yet there is no support for limiting CEO pay in conservative circles, perhaps because executives are numerous and turn some of their wealth towards campaign contributions that keep these same politicians in power.

In subsequent articles this year, I will continue building on these themes. Some will be broad brush strokes, like this post; others will delve deeper into the individual topics and recommendations.

Next articles: Saving Government and Rebuilding the Middle Class…

  1. The free university
  2. Universal health care
  3. The apprenticeship program
  4. A world class parenting system
  5. Raise the minimum wage
  6. Fix the penal system

Saving Government

  1. The 28th Amendment and public campaign finance
  2. Expand Congress
  3. Impose term limits
  4. End gerrymandering
  5. Reform the voting system

Sources and Notes:

[1] Pew Research Center

[2] Thomas Piketty, “Capital in the 21st Century,” Harvard University Press, 15 April 2014 (English  version)

[3] Adam Smith, “An Inquiry into the Nature and Causes of the Wealth of Nations,” W. Strahan and T. Cadell, London, 1776

[4] “Federal Estate and Gift Tax Rates, Exemptions, and Exclusions, 1916-2014,” Tax Foundation, 04 February 2014

[5] “Individual Income Tax Returns, Tax Year 2003 Preliminary Data: Selected Income and Tax Items, by Size of Adjusted Gross Income,”, Internal Revenue Service, 2004

[6] The Laffer Curve, often referenced by conservatives, is not actually a curve in the sense of an equation that allows us to plot an output for any given input; it is a theoretical construct. Furthermore, many economists predict that any short-term economic impact from an increase in the capital gains tax rate will eventually disappear as investors become used to the “new norm” and eventually continue conducting their business. What all economists agree on is that increases in tax rates inevitably lead to increases in tax avoidance (legal) and tax evasion (ilegal).

[7] OECD. 2008. “Value Added Taxes Yield, Rates and Structure.” Consumption Tax Trends 2008: VAT/GST and Excise Rates, Trends and Administration Issues.

[8] Jeff Mason and Andy Sullivan, “Factbox: What is ‘middle class’ in the United States?,” Reuters, 14 September 2010

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Discussion

2 Responses to “How to Topple the American Oligarchy (Part One)”

  1. Congratulations Fernando. This is the kind of stuff why I keep coming back to your site. I started coming here because I appreciated the informed and balanced way in which you portrayed the situation in Catalonia. But now I need to read everything else. It is just not possible for me to find this level of depth and analysis in the regular media out there. Thank you.

    Posted by Carles | January 13, 2015, 23:31
    • Thank you Carles, that is very kind of you! I greatly appreciate your feedback; this blog is a labor of love – not gain – so this is the sort of encouragement that makes it all worthwhile!!

      Kind regards,

      Fernando Betancor

      Posted by fdbetancor | January 14, 2015, 11:39

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