How So-called Experts Mislead Us about



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Between 1977 and 1990, the tax bill for a taxpayer earning $50,000 a year increased 7.75%, while the bill for taxpayers with incomes of $200,000 a year had dropped 27.5%, according to a university research project commissioned by Thomas Block, president of H&R Block.

The Tax Foundation determined that for the year 1990, direct and indirect federal, state and local taxes cost the typical U.S. family a record 37.3 cents of every dollar, while the average wealthy family with a million-dollar income paid a lower rate, probably 35 or 36 cents on every dollar—and probably the lowest in sixty years.

According to Kevin Phillips the effective federal tax rate (income & FICA) for the median family rose from 11.55% in 1965 to 24.37% in 1989, but for the millionaire (top 1%) family it dropped from 66.9% to 26.7% in 1989.
Do high rates kill incentive?

Countering the progressive argument for heavier taxes on those who are best able to afford them, it is often claimed that high rates in the upper brackets kill incentive. This was the thinking behind the 1980s reductions of tax on higher incomes. When newly-elected President Clinton proposed to restore some progressivity, opponents claimed that it would stifle enterprise of those affected—that a 36% or 46% marginal rate would cause high earners to slack off.

Let’s apply a little simple arithmetic and logic to this contention. A normal work year consists of nearly 2,000 hours,

which implies that the person with over $250,000 income proposed for the 46% rate is receiving over $125 per hour of taxable income. Although such people are not usually paid by the hour, lawyers, accountants, and other professionals often value their services at hourly rates.

A discussion of marginal rates has to do with increments, which in this case could reasonably be viewed as the next hour’s effort after $250,000 income has been reached. The effect to be considered is whether taxing 46% of the $125.00 or more income from that hour, leaving at least $67.50 after tax (not counting additional income in tax shelters), would cause such a high income person to withhold further effort.

The answer would depend on the marginal utility of that net income (plus any psychic income) versus the marginal utility of an hour’s leisure or other preferred activity. Economists have numerous theories and a few measurements of marginal utility, but little measurement of psychic income, such as professional accomplishment. At high income levels, money is no longer the primary motivation, because professional devotion, prestige, and power become more important. While we shouldn’t “soak” the rich, it’s only right for them to bear a fair share of the burden, as more than a few of them have stated their willingness to do.

When Clinton‘s proposed increases were somewhat whittled down to a maximum marginal rate of 39.6% and enacted in 1993, Republicans began referring to it as the “biggest tax increase in history.” That is untrue in terms of inflation-adjusted dollars. The revision actually reduced taxes on the working poor and only increased income taxes to the extent of partly restoring the upper-bracket cuts of the 1980s. To the chagrin of the Republicans, who had predicted these tax changes would bring economic disaster, economic indicators remained favorable and Clinton was reelected in 1996.

Economist Robert Eisner derided the claims of supply-siders that the marginal effective tax rate is so high it discourages work at the high end of the income scale. He asked what to expect from corporate executives faced with increases in their marginal tax rate from 31% to 36% or even 39.6%. “I doubt many will decide not to work as hard and risk getting off the corporate

success ladder.” In fact, he said, the high marginal rates are overwhelming at the lower end of the income scale, for those on welfare, and for middle-income taxpayers on social security, where loss of benefits and tax increases can be more than the additional income from working.78
Savings and Investment

A questionable bit of conventional wisdom is that growth depends on people saving more. The idea is that the limit on economic growth is determined by savings available for investment, which, of course, does set a limit on the supply side, but is not the only determinant. More often, I suspect (especially in depressions or recessions), the effective limit to economic growth is not so much on the supply side as on the demand side (if customers don’t have the money to buy it, why would producers supply it?). On the other hand, if the growth of the American economy is effectively limited at times by savings available for investment, then it is right to consider the savings pattern of Americans.

The financial community sporadically complains that Americans save less of their incomes, on the average, than people in other industrialized countries, Germany and Japan being often cited. In such countries capital is traditionally supplied by loans from banks to a greater extent than in the United States, and those loans make use of funds deposited with the banks as savings. International comparisons seldom mention that U.S. firms depend much more on corporate savings, in the form of retained earnings, to finance their projects. Many stockholders in U.S. corporations prefer earnings to be retained, as they would rather see their stock appreciate in value than to receive dividends on which they would have to pay tax. Furthermore, in a globalized financial economy, U.S. corporations need not borrow exclusively against savings of Americans as they have the capital markets of the world at their disposal.

Saving is a luxury that only a wealthy minority can enjoy to any important extent. Many low-income families actually have negative savings—that is, using up savings from the past or going into debt. The top 10% income bracket accounts for most of the

personal saving.79 The active promotion of credit cards and home equity loans by banks and other issuers has built up an unprecedented amount of household debt, an important form of negative savings. Credit cards alone involved borrowing of more than $1 trillion in 1996, 40% of which was “revolving” and piling up finance charges, according to the Consumer Federation of America. Ruth Susswein, executive director of Bankcard Holders of America, said more than 2 billion card solicitations were being mailed each year, with 58% of households with incomes under $20,000 receiving credit offers.

One of the arguments in the 1980s for easing tax rates on the upper brackets was that they would save and invest money they would otherwise have paid the federal government in taxes, thus financing an increase in production and in jobs. In fact, Treasury Secretary Donald Regan helped sell the big tax cuts to Congress in 1981 by arguing that about 40% of the personal tax reductions would be saved.

Not only did the beneficiaries of tax cuts seem to prefer financial manipulation over business expansion, but the population as a whole registered an unexpected decrease in savings. Net savings of Americans amounted to about 7% or 8% of disposable income in most years from the 1950s through the 1970s, but declined sharply from 1981 to 1987 and averaged just 5.4% of disposable income for the decade of the 1980s.

Eisner‘s 1994 book, having established that national savings are equal to investment, except for external capital flows, referred to the $530 billion of federal, state, and local government capital expenditures previously cited in connection with deficits and debt. When added to private investment, he calculated it raised the total of gross investment by more than 71%. He added: “This account still excludes household investment and intangible business investment, however. I have estimated elsewhere that net private domestic investment of the official accounts is no more than 21% of appropriately defined, fully comprehensive net capital accumulation in the U.S. economy.”

What really counts, according to Eisner, is not “the amount of private saving as currently measured.” What is critical, to use his examples, is the extent to which households are

spending to buy durable goods, new houses and children’s education versus gambling in Las Vegas; businesses are spending on research for better products and processes versus leveraged buyouts; and government is spending on investment in people and technology at home versus stationing troops in Europe.80

Whenever it is important to encourage saving, the method tried in the 1980s is not the right way to go. Economic growth did not improve, and if the savings of the wealthy did increase at all, they were offset by negative savings of the less fortunate.

11. THE STRANGE HISTORY OF CAPITAL GAINS


I don’t see any truth to the claim that taxing capital gains stifles growth. Politicians, economists, and editors who worry about taxes killing incentive argue for reducing the tax on capital gains. Supposedly the prospect of making a huge, lightly taxed profit will encourage captains of industry to launch new enterprises that will add to the nation’s economic growth. The sales pitch also promises that many new jobs will be created in the process. None of this, however, is supported by any credible evidence.

Ordinary taxpayers have little to do with capital gains, and most find the subject very puzzling. Some found, years ago, they had to pay tax upon selling a home that had gone up in price, but tax relief eliminating that problem in almost all cases has been on the books for many decades. Capital gains from stock trades are mostly a concern of upper-bracket taxpayers, although others may be affected to some extent through mutual funds and pension plans.

As Republicans in Congress during the 1990s proposed to reduce the federal income tax on capital gains, Democrats said the benefit would go mostly to wealthy individuals and corporations, at the expense of programs for the elderly and the poor. Republicans, on the other hand, presented it as a boost to the economy and provider of jobs.
The mystery of capital gains and losses

Historically, little attention has been paid to the difference between a real profit and an increase in price that is due only to inflation. Taxes on ordinary income take no account of inflation because receipts and expenditures are all in the same year. In the case of businesses, of course, inflation can have an effect on the valuation of inventories.

Long-term capital gains (when the asset was owned for a holding period of, say, six months or a year) have been treated

differently from ordinary income, being justified either to offset inflation or to provide an inducement to invest. When an asset is sold, there is a capital gain if it brings more than it cost, and a capital loss if it is sold for less than it cost (allowing for improvements, expenses of sale, etc.). How should these gains or losses affect one’s taxes?

Politics aside, there are questions of fairness. What if the supposed gain is fictitious because the higher selling price merely reflects inflation? Then the seller has gained no purchasing power from holding the asset and should pay no tax. This was especially clear to many people when required to pay tax on selling their homes.

As so often happens, Congress dealt with this in response to political pressure rather than logic. Instead of providing an inflation adjustment, they enacted complex rules that enabled one to escape tax on the gain by always trading up to a higher-priced home—a solution approved by the real estate lobby. For many years this largely removed the problem for homeowners, until the 1997 law provided a more general exemption.

A Republican plan was offered to address the problem for other assets by phasing in an adjustment for inflation, and it hard to see why anyone should object to this. On the other hand, if there is a real gain after adjustment for inflation, such income should be taxed at the same rate as “ordinary income,” which includes interest, dividends, salaries, and workers wages, as well as profits of unincorporated businesses. Fairness would seem to require the same tax rates for all kinds of income.

As for the neglected issue of capital losses, it seems fair that when they exceed gains the difference should be deductible from other taxable income, and there is no logical reason to limit the deduction. There apparently was a revenue reason, however, and for some 60 years there has been a limit (currently $3,000) that can be deducted in one year, with provisions to apply any excess to certain past and/or future years.



Tax changes over the years

The first tax on capital gains, enacted in 1921, was effectively 40% of the tax on ordinary income. Capital loss limitations were started in the 1930s. In the 1950s and 1960s capital gains on assets held for more than six months were taxed at 50% of the tax on ordinary income. Capital loss deductions were limited to $1,000 in any tax year.

These tax provisions remained remarkably stable for decades until the turmoil following the Arab oil embargo and OPEC price shocks. Conservatives would have preferred the former British practice of no tax at all on gains, while liberals would have preferred the tax on earned and unearned income to be the same. Other inequities existed that were hardly ever discussed.

Beginning in 1970, only 50% of long-term losses were deductible. The 1976 Tax Reform Act closed a loophole that allowed appreciated assets to be passed to heirs without taxing the gain (but this was repealed in 1980). The Revenue Act of 1978 (Steiger Amendment) reduced the effective top rate from 49% to 28% on long-term capital gains. Beginning in 1978, long-term capital gains were taxed at only 40% of ordinary income (losses still deductible at 50%), and the annual limit on losses was increased to $3,000. The Economic Recovery Tax Act of 1981 further reduced the long-term maximum rate to 20%.

The Tax Reform Act of 1986 removed the favorable treatment of long-term capital gains, treating all capital gains as ordinary income. An exception was made in the Revenue Reconciliation Act of 1993, that excludes 50% of gain on small business stock issued after August 10, 1993.

I was astonished when the bi-partisan 1986 tax bill provided for full taxation of capital gains, a proposal that had failed even during liberal administrations. The capital gains change must have been a political trade-off for taking away some of the favorite deductions of the middle class, such as interest paid, state taxes, and various employee expenses. As Republicans agitated to repeal the capital gains change, they made no offer to restore the deductions taken away from the middle class.

Although, generally speaking, the distinction between long and short-term gains became meaningless, Form 1040 still required them to be reported separately. The holding period was one year, except that for assets acquired after June 22, 1984, and before 1988 it was six months.

In 1997 the law was amended to require a holding period of 18 months, while reducing the maximum rate to 20%, with complicated transition rules and lengthy computations required in tax returns (another demonstration that Congress tends to complicate rather than simplify the tax code). The holding period went back from 18 months to one year effective for sales of assets after January 1, 1998, keeping the 20% reduced rate, in a provision included in the IRS overhaul bill passed in July 1998.81 In all of these changes, the equitable proposal to use inflation adjustment in calculating capital gains was lost and apparently forgotten.


How the rules favor the prosperous

Capital gains have always offered advantages to the wealthy that applied even under the 1986 law when the rate was the same as for ordinary income: they continued to be able to avoid paying tax on appreciated assets either by donating them to a charity (with the contribution counted at the higher value) or leaving them to their heirs. (The latter loophole having been closed in 1976 but reopened in 1980.) These advantages were not affected by the 1997 law.

There has also been a less obvious advantage for the wealthy whenever capital gains are taxed less than earned income. You can benefit from the lower rate on capital gains only if you gain more than you lose because losses have to be offset against gains, but small investors typically are lucky to break even. Thus the tax law favors the winners over the losers in the stock market, and, by definition, the wealthy are the winners in the economic contests of life.

Conservatives would, of course, prefer to pay little or no tax on capital gains but find it hard to counter the liberals’ argument that income from inherited wealth should bear the same tax burden as income earned by mental and/or physical work. The

argument they fall back on is that the tax savings from lower capital gains rates will be used for further investment that will be good for the economy, as proclaimed in the “Job Creation and Wage Enhancement Act” of the 1994 Republican “Contract with America.”

Unfortunately for that theory, the record shows that most of those who profited from tax cuts in the 1980s didn’t invest in building U.S. industry. Instead, they invested abroad, engaged in financial speculation, or bought U.S. government bonds. A better way to stimulate investment and job creation would be to encourage small independent businesses, who have been shown to be much more effective for new products and new jobs than the corporate giants. That could be done by appropriate tax incentives and by enforcing the anti-monopoly laws to protect small business from unfair competition.


12. SHOULD CORPORATE INCOME TAX BE ABOLISHED?
It has been argued that taxing corporations just adds to consumer prices. Whenever a company has to bear a burden, whether pollution control expenses costs of meeting health and safety standards, or taxes, it is likely to take it as an excuse to raise prices. Experience tells us that when burdens are removed, companies do not always reduce prices. In regard to the corporate income tax, economists disagree on the extent to which the burden ends up with the corporation’s shareholders or is shifted to consumers. This question comes under the heading of “tax incidence.”

A monopolist, having already selected the quantity of production and price to return maximum profit, cannot gain from raising prices in reaction to a tax that takes a percentage of his profits. In the case of a monopoly corporation the stockholders are stuck with the corporate income tax. Other degrees of competition make the result harder to determine. Economists must consider such complications as elasticities of supply and demand (that is, how responsive supply and demand are to price changes). The burden may fall partly on shareholders and partly on consumers.


The inequity of double taxation

One argument against corporate income tax is that stockholders are taxed twice. When the profits that have already been taxed at the corporate level are distributed as dividends, the stockholder is taxed again. This objection is quite valid, but political solutions, as usual, attack the problem in the wrong ways. For many years prior to the 1986 tax revision, taxpayers were allowed to exclude some dividends from their taxable income. Also, over the years, there has been considerable reduction of the corporate income tax, partly by rate reductions and partly by rules changes.

In fifty years the share corporations pay of all federal taxes dropped from 35% to only 11%, according to the Economic Report of the President, Feb. 1995.82 Looking at just federal income taxes, Treasury Department figures for fiscal 1995 show that corporations paid only 21% and individuals 79%.83

In 1991, according to the General Accounting Office (GAO), 37.2% of large U.S.-controlled multinational corporations having assets greater than $100 million did not pay a single dollar in federal taxes. An additional 30.2% of these companies paid less than $1 million. The most common way for them to avoid tax is to claim that costs of their foreign subsidiaries are U.S.-related, thus reducing their reported U.S. profits.

Another example: in 1983 the chemical industry had an effective tax rate of minus 1% giving them a credit for future tax years. according to the House-Senate Joint Tax Committee, which also reported a mere 0.7% tax paid by the construction industry on its earnings. As of 1985, General Electric had not paid a dollar in federal corporate income tax for three years, despite earnings of $5 billion during that period.84

But then, what about the unfairness of double taxation? Should corporations pay any income tax at all? Wouldn’t it be fairer just to collect tax from stockholders as the income is distributed to them in the form of dividends? There are at least two problems:

1. Corporate earnings are routinely reinvested in the business, especially in closely-held corporations, and these retained earnings are reflected in the stock price. The stockholder, who would not have been taxed for dividends from those earnings, can also avoid tax on the capital gain by such maneuvers as donating the stock to a charity and deducting its full market value, or simply leaving it to his heirs, who also escape tax on the gain according to current rules.

2. Partly or wholly foreign-owned corporations could operate in the United States without either the corporation or its foreign stockholders paying tax, unless the government could enforce a claim against dividends paid to the foreign stockholders.

Decades ago when the dividend exclusion was introduced, a better solution had been proposed, but Congress has still not listened. The fairest treatment would seem to be to collect corporate income tax as a withholding tax, just as employers withhold tax from workers’ wages. Each stockholder’s share would then be a credit against the individual tax at his bracket on his dividends, just as employees take credit for tax withheld against tax due. This, together with proper reform of the taxing of capital gains, would be fairer than any rules we have had so far.

Another remedy was proposed by David Korten in a 1996 interview: “I favor an elimination of corporate income taxes in conjunction with the requirement that corporations pay out their profits each year to shareholders, who would pay taxes on the dividends at their established marginal rate. These corporations would then have no incentive to shift profits around the world to the jurisdiction with the lowest tax rate....”85

13. CAN YOU TAKE TAX SHELTERS WITH YOU?


Advocates of abolishing the inheritance tax greatly exaggerate the problem when they blame it for wiping out family fortunes and destroying family businesses. There are many sad accounts of heirs inheriting little or nothing from parents who had considerable wealth. In fact, this has happened often enough to be a matter of concern, although it is not the general rule. The worst examples usually involve lawyers who have looted the estate either by direct theft or by exorbitant charges allowed by friendly probate court judges. In some cases the bulk of the estate has been used up in litigation by parties attempting to break the will.

Many other instances have been recorded of trustees, such as banks, who failed to act in the best interests of the heirs, keeping trust funds in bank accounts that paid little interest, or churning investments until they were eaten up by transaction costs, all the while charging large fees for managing the trust. In other cases, a going business became worthless because of problems of management due to the death of the owner.

It is also true, when considerable wealth is left to the heirs, that the assets may be reduced by federal estate tax and/or state inheritance tax, and if liquid assets are insufficient some property may need to be sold to cover taxes. Unless the estate has been depleted by unreasonable probate fees, litigation by heirs, mishandling by fiduciaries, or problems of transferring business ownership, however, the heirs generally end up with most of the value left by the deceased.

Whether children of privilege should have an advantage over other children, and if so to what extent, is a philosophical and ethical question. President Franklin D. Roosevelt said in a 1935 message to Congress, “Our revenue laws have operated in many ways to the unfair advantage of the few, and they have done little to prevent an unjust concentration of wealth and economic power.”86 Congress then passed the Revenue Act of 1935 (Wealth Tax Act) that affected estates of more than $40,000 (a

large amount then), and also included income tax increases for high-bracket individuals and large corporations.

The importance of inheritances is not trivial in the national economy. In 1973, 56% of the total wealth of persons 35-39 years old was given to them by their parents and by 1986 the figure had risen to 86%, with higher ratios still to come.87 Exemptions have kept the federal estate tax from affecting modest fortunes, and estate planners have been quite effective in setting up schemes for large estates to avoid much of the tax by such means as gifts, life insurance, and trusts. This is a far cry from the death duties in England so deplored by the landed aristocracy, some of whom have married American heiresses desirous of titles and others have deeded their ancestral homes to the National Trust or opened them to visitors for a fee.

Many loopholes have been provided in U.S. tax laws. For example, to prevent family farmers from having to sell their land to pay taxes, the value of farm land may be computed for estate tax purposes by a formula that, on the average, cuts the value by half. Heirs may postpone payment up to five years and then pay in ten installments at only 4% interest. Until 1980 farmers had to pay tax, when selling the land, on the gain over the purchase price, but Congress then changed it so they need only pay taxes on any increase in value since the land was inherited.88

In 1981 Congress created a flat $600,000 exemption (effective in 1985) to the estate tax, further limiting its application so that it is now imposed only on the largest inheritances, slightly more than 1%.89 Only 31,500 of the 2,300,000 Americans who died in 1995 owed any estate taxes, according to the Joint Committee on Taxation, and only 4% of farmers leave taxable estates, according to the IRS.90

For those fortunate people with large estates there are significant escape hatches. How one of them works was described by a wealthy attorney in a fund-raising letter to alumni of his college. By donating stock worth about 40 times what he paid for it he escaped thousands of dollars of capital gains tax, took an income tax deduction in the thousands of dollars, avoided estate tax on the value of the stock, and received an annuity from the

college paying twice what the stock was yielding. His wife got a similar deal from her college. He declared it works like magic!

The private foundation provides another way of avoiding estate tax. In an interview published in the December 1995 Multinational Monitor, Sol Price, of the “Forbes 400” list of the wealthiest individuals in the United States, explained: “Warren Buffett [plans] to sink his whole fortune into his own private foundation...which works on population control. Many people think this is a worthwhile thing. But of this whole $12 billion that he has accumulated in his lifetime, none will ever by taxed....

“There is a guy named Arthur S. DeMoss who died a few years ago and left maybe $300 million or $500 million to a private foundation that opposes abortion. So the government collects no estate tax from this. And the perks the family has when they set up these private foundations are almost the same as though they retained the money directly. Our law has allowed people to take what should go to the government and use it for their own purposes, some of which we may agree with and others that we may not....”

In addition to the federal estate tax there is a gift tax intended to prevent a donor from circumventing the estate tax by making large untaxed gifts to prospective heirs during the donor’s lifetime. The extent that these taxes (estate and gift) have been reduced or avoided is shown by the fact that they accounted for more than 5% of all federal receipts in 1940, but dropped to 1.7% in 1950 and 1.1% in 1990.91

14. THE FLAT TAX AS THE ULTIMATE SIMPLIFICATION


I don’t know how many people believe it possible to have a flat tax that would really be flat—and fair—although politicians keep on proposing it. Wouldn’t it be great to deep-six the whole tax code and regulations, put the tax lawyers and accountants out of work, and report your income on a postcard-size form? You wouldn’t even have to pay any income tax on the first $20,000 or so, and then everyone would pay a flat 19% according to one version. Some proponents have claimed it would eliminate “loopholes, dodges and any chance to cheat” and that “liberals who see a flat tax as regressive are wrong.”

If you think this sounds too good to be true, you are right, for the following reasons:

1. Politicians will never enact this scheme, whatever their party, because they are all under obligation because of campaign contributions and other favors to protect the loopholes of their benefactors. They might pass something with the title of “flat tax,” but it would be as phony as the “tax reform” of 1986.

2. Even if the flat tax could be enacted, total income without deductions or write-offs is not a simple concept. Most of the over five million words in the tax code have nothing to do with people who live on wages and salaries. They have to do with how business and investment income are calculated. Take an example:

Suppose you own a store. If you collect $1,000,000 from your customers, that is not your income. Perhaps you had to pay 80% of that to your suppliers for the merchandise, so you keep $200,000. But you also have to pay rent, insurance, local taxes, wages to employees, etc., so you could be very lucky to have $100,000 left. Paying 19% of the million dollars ($190,000) would put you into bankruptcy! The place that loopholes are created—not usually by accident, but by lobbying power—is in the rules for what is to be included or deducted in figuring taxable net income.

3. It gets even more complicated for the corporate income tax, which brings up the valid argument already discussed against

double taxation (of corporate income and of stockholders’ dividends). Income is not simple and obvious.

4. That $20,000 exemption for everyone would lose purchasing power over time unless increased to offset inflation.

5. While a flat tax, if a fair one could be enacted, would be roughly proportional rather than regressive, the sum of all taxes (federal, state and local of all kinds) bears most heavily on people of ordinary means and is therefore regressive. When the federal income tax is somewhat progressive, as intended, it helps to balance the regressive nature of other taxes.

6. Some of the same politicians who favor a flat income tax also have been recommending a value added tax (VAT) along the lines of the ones in Europe that add 15% or more to the price of most items. This is in the nature of a national sales tax—a regressive tax—and is in addition to the income tax.


Tax deduction for contributions

Getting rid of unwarranted exemptions and deductions would, of course, be desirable. One simplification that would help to clean up politics would be to abolish income tax deductions for charitable contributions. This suggestion will certainly make some people fighting mad, but remember that many tax-exempt contributions are far from charitable, nor educational, nor religious.

The problem is that the Internal Revenue Service and the courts have difficulty deciding what is or is not a legitimate tax-deductible contribution. Examples include matters currently in litigation such as donations by individuals and corporations to ostensibly non-partisan educational or religious organizations that the Federal Elections Commission claims were used to help political candidates and parties.

Then there are the many “think tanks“ which produce some useful research but also release propaganda for the views of the corporations that supply much of their funding. For example, the National Center for Public Policy Research attacks state attorneys general for their efforts to hold tobacco companies responsible for the damage they have done and denounces clean air regulations.

Also, the American Enterprise Institute, the Cato Institute, the Competitive Enterprise Institute, the Heritage Foundation, the Hudson Institute, the Progress and Freedom Foundation, and the Washington Legal Foundation led an attack on the Food and Drug Administration, having received at least $3.5 million in contributions from corporations interested reducing the agency’s efforts to protect public health. Some other non-profit organizations attack Social Security and environmental protection laws.

Such are clearly not the charitable, educational, or religious activities for which tax exemption provisions were created. Yet where does one draw the line? Should we have thousands of pages more of laws and regulations to define what is legitimate or not?

Most people would think it is a good thing for the government to encourage charitable contributions by allowing tax deductions, but is it necessary? A possible tax deduction is not the reason, in most cases, that millions of people contribute to their churches, local charities, colleges, youth organizations, etc. According to a study by John S. Barry of the Heritage Foundation, “donors earning less than $20,000 give more...as a percentage of income than those earning between $50,000 and $100,000.” The giving of low-income taxpayers is all the more impressive because there is no tax benefit unless contributions combined with other itemized deductions total more than the standard deduction. This usually means that people with modest incomes can get no benefit unless they have mortgage interest and real estate taxes to itemize.

Tax savings are more likely for families grossing $1 million or more, but a study of their tax returns for 1986 showed that only $7 billion out of a total of $82 billion went to charities.92 The officers of tax-exempt organizations can be expected to oppose any change in deductions, as they would be reluctant to give up inducements for donations they can offer under the present rules, but legitimate charities really need have little fear.

Tax incentives did not enter into it when some of the greatest contributions were made by the wealthy in the 19th century, such as Andrew Carnegie, who established public

libraries throughout the United States and gave away $350 million in his lifetime (about $7 billion in 1996 purchasing power).93 In the 20th century the Rockefeller Foundation, the Ford Foundation, and many other charitable enterprises founded by the wealthy supported vast worthwhile efforts, while the alumni of the best colleges endowed scholarships that opened up first class education to young people of modest means. It unfairly diminishes these good works if they appear to have been done for tax avoidance.

If it would solve the problem of separating real charity from scams and propaganda mills, wouldn’t it be worthwhile to abolish the income tax deduction and take this small but important step toward tax simplification?

15. THE GROWING GAP BETWEEN RICH AND POOR


When anyone points out the extreme inequality of wealth and income that has been developing in the United States since the late 1970s, the favorite retort is “class warfare!” or “politics of envy!” followed by a sermon on the merits of capitalism versus communism. One may object to the widening gap between rich and poor, however, without going to the opposite extreme.

Many examples suggest that the wealthy are not always happier than other people (although they are spared the discomforts of the poverty-stricken). They appear to be envied because of the fascination of millions with stories of the “life-styles of the rich and famous.” Yet there is an interesting quirk of human nature that contradicts this impression.

Envy is most strongly revealed against people much closer to the same social level who seem to be getting advantages at the expense of the individual concerned. For this reason, a worker may become much more resentful against a penny-ante welfare chiseler than against a savings and loan executive who has stolen millions. Those who speak for the wealthy take advantage of this trait by deflecting resentment away from them and toward the poor.

Donald Kaul of the Des Moines Register declared: “We are now engaged in an experiment in government of the corporation, by the corporation and for the corporation. Those of us who oppose that...are hooted down with shouts of class warfare....

“Not content with getting the lion’s share of the hunt, the people on top demand (and get) lower taxes and argue for fewer government benefits for the most needy, lest those unfortunates be corrupted by getting something they don’t deserve.

“The truly odd thing about this is that the people in the middle, who are treading water as fast as they can, have bought into this system. They think the wretched—immigrants, welfare mothers, the homeless—are taking bread from their tables.”94

The main reason for avoiding an undue concentration of wealth, income, and power, in my view, is not a matter of loving or hating those on top. History has shown, in more than one country, that prosperity occurs when the people have enough money to buy the goods and services that suppliers want to sell. For this reason businessmen should favor many programs that they often tend to denounce as “liberal” or “left-wing.”

Perhaps the most important concern about concentration is the power that goes with wealth, and, as Lord Acton accurately said in 1887, all power tends to corrupt, and absolute power corrupts absolutely. In the many dictatorships of this world, members of the small ruling class live in luxury behind fortified walls that protect them from the general population living in squalor. We are beginning to see that tendency in America, as business tycoons hire bodyguards and make their homes in well-guarded enclaves. Further movement in that direction would weaken democracy. Already the U.S. has a greater disparity in incomes than other industrial nations.95 This leads to domination of government by those who can afford to buy political favors.

Statistics on income distribution are notoriously unreliable, so the following data should be viewed skeptically, but bear in mind that the gaps are greater than the figures reveal. Some statistics are self-reported to survey interviewers, and the wealthy are traditionally reticent. When the statistics are from tax returns, there are opportunities to cheat (especially for proprietors whose incomes are not subject to wage withholding) and, even more significantly, tax rules exclude some items from taxable income. Wealth is even harder to measure than income as it is not reported regularly on tax returns.

The best survey of American’s wealth was conducted in 1963 by Projector and Weiss for the Federal Reserve System, according to Who Gets What from Government by Benjamin I. Page (1983), who noted: “Many respondents, especially those of high income, refused to give financial information, so efforts were made to adjust for nonresponses. Projector and Weiss found that distribution of net wealth was...more unequal than the distribution of income. The top 1% of wealth-holding consumer units held

about 33% of the total wealth and 62% of the corporate stock. About one-quarter of the population, on the other hand, had a net worth (including value of cars and equity in homes) of less than $1,000, and nearly half had less than $5,000.”96

More recent Federal Reserve figures for 1989 showed that the richest 1% of American households, each having net worth of at least $2.3 million, accounted for nearly 40% of the nation’s wealth. The top 20%, having $180,000 or more, accounted for 80% of the wealth, a greater degree of concentration than in any other industrial nation.97

Turning from wealth to income distribution, according to 1996 data the top 5% of U.S. families received 20.3% of total money income, and distribution by population fifths was: 98

Top fifth 46.8%

Fourth fifth 23.1%

Middle fifth 15.8%

Second fifth 10.0%

Bottom fifth 4.2%

Another measure of income gaps was calculated in a publication of the Russell Sage Foundation, which found that in 1988 American men in the bottom 10% had earnings equal to just 38% of the median, compared to 68% in Japan and 61% in West Germany, and their earnings were only 45% as much as Germans and half as much as Italians.99
Greed in the board room

Some of the most powerful Americans are chief executive officers (CEOs) of major corporations, who usually are also well compensated to serve on the boards of other corporations, as well having private fortunes. According to a study of the 300 top companies by Graef Crystal, who teaches the facetiously nicknamed “Greed 259-A” course for MBAs at the University of California at Berkeley, CEOs earned 145 times more in 1992 than the average worker, up in 1993 to 170 times and in 1994 to 187 times.

“We are creating a wealthy and privileged corporate aristocracy,” Crystal declared, “at a time when a lot of people are losing their jobs or seeing their wages decline. If you extrapolate those numbers to the year 2010, the ratio will correspond to the gap that existed in France in 1789 between the aristocracy and everyone else. And we all know what happened to the aristocracy in France.”100

Another estimate for 1992 put the compensation of the average CEO of a major company at 157 times that of the average worker, compared with a 40 to 1 ratio in 1960. The average pay for the CEOs of the 1,000 largest corporations in 1992 was $3,840,000, up from $625,000 in 1980. This comment appeared in Business Week: “At a time when the incomes of 90% of corporate employees are barely growing...these multimillion dollar windfalls are arrogant. They imply that no one else but the CEO is responsible for the good performance of the company.”101

By 1996 the average CEO pay had risen to $5,800,000. By 1997 Business Week estimated the ratio of CEO pay to workers pay was 209 to 1.102 In 1997 Michael Eisner, CEO of the Walt Disney Company, received more than $575,000,000 compensation in the form of $10,000,000 salary and bonus plus stock options cashed in of $565,000,000.103 In 1993 the compensation package of $203,100,000 received by Eisner had equaled 68% of the company’s $299,800,000 total profits for the year.104

Although corporate management claims the huge salaries and bonuses of CEOs are earned, there are many cases that are hard to justify. For example, ITT Chairman Rand Araskog raked in $4,255,000 in 1986, despite a 14.2% corporate sales slump, and Robert Forman of E. F. Hutton got a 23% cash raise in 1986, while company earnings dropped 17%.105 When Lone Star Industries took a $271 million loss in 1989, its CEO James E. Stewart ordered layoffs, sold off $400 million of corporate assets, cancelled the dividend to stockholders, and cut his managers’ expenses, but kept a $2.9 million expense account for himself and commuted in a corporate jet from his Florida home to Connecticut.106

By 1997 the rewards of failure at the top had multiplied. The New York Times reported in July that John R. Walter failed to measure up to the job of president of AT&T but left after only 8 months with a $26 million goodbye present, Michael Ovitz lasted 14 months as a top executive at Walt Disney Company and got $90 million in severance pay, while Gilbert F. Amelio received a mere $7 million when dropped as head of Apple Computer.107
Confusing capitalism with democracy

Some people act as if democracy and capitalism meant the same thing. While celebrating the collapse of Communism in the Soviet Union, the mass media, as well as most politicians, confused the elements of capitalism and democracy that were replacing it and treated democracy and capitalism (or “free markets“) as tantamount to synonyms.

Thurow explained the difference this way: “Democracy and capitalism have very different beliefs about the proper distribution of power. One believes in a completely equal distribution of political power...while the other believes that it is the duty of the economically fit to drive the unfit out of business and into economic extinction....To put it in its starkest form, capitalism is perfectly compatible with slavery....Democracy is not compatible with slavery....

“Capitalism generates great inequalities of income and wealth....Driving others out of the market and forcing their incomes to zero...is what competition is all about....Accumulated wealth leads to income-earning opportunities that are not open to those without wealth....”108

Soviet Communism, as generally understood in the West, was a term that incorporated two intertwined systems: economically, it was characterized by public ownership of almost all factors of production ostensibly for the benefit of the common people but actually permeated by corruption and special privileges for the powerful; politically, it was an authoritarian regime ruled by a single political party without free speech or free elections—in other words, a dictatorship, a tyranny, the kind of repressive

government that unfortunately exists in many nations that have been officially categorized as anti-Communist. The economic and political systems were tied together but not logically inseparable.

Billionaire George Soros declared in the February 1997 Atlantic Monthly that the main enemy is no longer Communism but “the capitalist threat,” because the world is relying too heavily on free markets and unregulated capitalism to create prosperity and protect individual freedom under the pure laissez-faire theory that society benefits from everyone’s “uninhibited pursuit of self-interest.” Abolishing Communism is not enough, he said, if it is replaced by galloping greed that concentrates wealth in ever fewer hands. “If there is no mechanism for redistribution the inequities can become intolerable.”109
Concentration of wealth hurts the economy

Concentration of wealth leads to the stagnation that characterized the Great Depression of the 1930s and is the lingering condition of oppressed countries throughout the world. The pet economists and politicians of the financial elite proclaim that tax reductions for the upper brackets will encourage them to invest and thus stimulate the economy. The relatively simple but little recognized fact is that producers will keep increasing their output only if they find markets for their products and services. The cause of a recession or depression is not lack of funds for investment but a shortage of money in the hands of consumers. Among the few voices pointing out that supply cannot grow indefinitely without lower income groups being allowed enough purchasing power to consume the goods and services produced under the control of the financial elite, is that of William Greider.

During recessions unsold goods pile up because customers lack the money to buy them, but more idle savings are available for investment than business can profitably use, resulting in lower interest rates. According to old-fashioned economic theory, those low interest rates should stimulate business and lead to a recovery. But it doesn’t work. The Federal Reserve has proved again and again that by raising interest rates it can convert a boom into a bust, but the reverse is not true.
Perverting the American Dream

In recent years, influenced by pervasive advertising, the misconception has arisen that acquiring wealth is the American Dream. For the settlers who fled religious persecution in the 17th century, as well as 18th and 19th century victims of autocratic oppression and fugitives from Hitler and lesser tyrants in the 20th century, the American Dream has been about freedom, despite the stories about streets paved with gold.

However, in today’s welter of television advertising designed to pull all the emotional strings and create a compulsion to buy, it is easy to get the impression that wealth is everything. Ads and publicity for lotteries and sweepstakes proclaim the worship of mammon. One gets the impression it is un American to be short of cash for the latest fancies. Such promotion of greed may contribute to many of the social problems and to the decline of morality so greatly decried. It certainly encourages people to blame the unfortunate poor rather than to help them.

Ironically, many prosperous people support policies that are not good for their own interests. I once found myself among corporate presidents, bankers, and stockbrokers at a reception in Chicago. This was in 1960 and, learning that I was from my company’s head office in New York, these Nixon supporters asked me how his campaign was going in the East. I put on a sad face and revealed that his race against Kennedy was in trouble. How odd it was that these people, whose businesses had historically been more prosperous under Democratic than Republican administrations, were emotionally drawn to the Nixon candidacy against their own interests.

Of course, it is true that a powerful financial elite can enrich its members by robbing the poor. Such can be seen in many of the poorest nations of the third world, where a tiny ruling class lives in luxury beside the misery of the many. Enlightened societies, however, share the national wealth more equally, resulting in a better educated, more motivated work force, and more affluent customers for business. The most prosperous industrial economies have grown from such conditions.
The advantage of general prosperity to everyone is clear, including the rich as well as people of middle and lower incomes. In a poor country with a handful of wealthy rulers, only those at the very top might be better off, and then only in terms of money and power.
Income disparity throughout the world

The 20% of the world’s people who live in the world’s wealthiest countries receive 82.7% of the world’s income; only 1.4% of the world’s income goes to the 20% who live in the world’s poorest countries, according to figures compiled in 1992 by the United Nations Development Programme (UNDP). The ratio of average income in the wealthiest countries to that in the poorest jumped from about 30 in 1950 to 60 in 1989. Based on individual incomes rather than national averages, the average income of the top 20% was 150 times that of the lowest 20%.

Even in Sweden income disparity has grown. The Swedish Social Democratic Party, in power from 1932 to 1976, had built Sweden’s elaborate social welfare system and brought working people into the middle class with greater equity between the wages of women and men than in any other capitalist country. What happened? When Sweden’s transnational corporations took a global rather than national view of their interests, the alliance between blue-collar workers and capitalists began to disintegrate, and in 1976 the Social Democrats lost the election to a center-right coalition government.5455

When they returned to power in 1982, chastened by their defeat, they followed a road later taken by Bill Clinton’s “New Democrats” in the U.S. and Tony Blair’s “New Labour” in the U.K. Their policies allowed Sweden’s industrialists greater profit margins on domestic investment, thus increasing the share of the national product going to profits compared with wages, so that Sweden’s industrialists would find it worthwhile to invest at home.

Swedish investors drove up the prices of real estate and other speculative goods. The Swedish banking system lost $18 billion and the bill was passed on to the Swedish taxpayers (like

the U.S. savings and loan bailout). The Swedish Employers’ Federation bankrolled think tanks promoting right-wing economics and denouncing the Social Democratic state. While the average Swedish household grew poorer from 1978 to 1988, the top 450 households doubled their assets. Unemployment rose from less than 3% in 1976 to 5% in 1992, not counting another l7% of the workforce engaged in retraining and public employment projects.56



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