Saving Capitalism From a Painful Demise

Below is my new article in the Winter 2015 issue of the Wharton Magazine. Thanks to editor Matt Brodsky for allowing me to reprint it here!

Retailers Need Consumers

American business leaders rallied around Franklin Delano Roosevelt in 1932 during his candidacy for the presidency, after which he immediately embarked on the most progressive legislative agenda in U.S. history to tackle the Great Depression. From today’s vantage point, it may seem surprising that titans of industry, executives from General Electric to Standard Oil to IBM, not only contributed to Roosevelt’s campaign but helped author many of his famous New Deal reforms. To the men who ran these companies, it was a simple matter of fiduciary responsibility — to current shareholders and to future ones — that they should ensure a more equitable distribution of prosperity, lest their own wealth be dashed to bits on the jagged rocks of a shrinking economy.

Today, we face a similar predicament. The great challenge of business in our time is reversing the destabilizing threat of inequality. While at first this may seem anathema to our profit-maximizing mission, distribution of income lies at the very heart of sustainable capitalism.

For this reason, today’s titans of industry have stepped forward to protest the growing distance between them and the rest of the country. Warren Buffett, Lloyd Blankfein, Stanley Druckenmiller, Bill Gross — legends whose lives and words are studied and idolized at the Wharton School — have all gone public with the wise advice that we steer away from those jagged rocks.

They are not alone in their concern. According to a recent analysis by the Center for American Progress, 68 of the top 100 retailers cite the flat or falling wages of the average American household as a risk to their business — a number that has doubled in the past eight years. A recent poll of small businesses similarly found a strong majority of them in favor of raising the minimum wage.

These business leaders sense an essential truth about our capitalism: Workers are consumers. They spend what they earn — or what they borrow. While the latter may work for awhile, it has limits — and calamitous risks. The only sure way to grow the economy in the long run is to grow consumer spending — and that means growing worker incomes.

In recent decades, workers’ incomes have not grown much, on average. Since the beginning of the Great Recession, the average household has lost 8 percent of its income, after adjusting for inflation. All the growth — and then some — has gone to the richest 10 percent of Americans. And most of that growth — 95 percent of total growth, to be precise — has gone to the richest 1 percent. And most of that growth has gone to the richest 0.1 percent. And so on.

Unsurprisingly, economic growth has been slower since the advent of this new trend. From 1950 to 1980, real GDP grew 3.8 percent per year, versus only 2.7 percent from 1980 to 2010. On the rare occasions when it has approached its previous faster rate, it was fueled by unsustainable borrowing. This is no coincidence. Recent work by economists Özlem Onaran and Giorgos Galanis has shown that most developed countries experience lower growth when the share of their income going to wages (as opposed to profits) declines. In the United States, for example, every 10 percent decline in the wage share causes the economy to shrink by 9.2 percent. In fact, that has been the experience of the global economy as well.

High wages are what economists refer to as a “positive externality.” They generate “spillover effects” that benefit the people who don’t pay for them. When workers receive high wages, they invest more in health and education, increasing their productivity and reducing the costs we all pay for a sicker, less-informed population. They motivate firms to invest in advanced technologies to reduce labor costs, making them more innovative and globally competitive. Workers who receive high wages are less likely to go out on strike, vote against free trade and immigration, protest in the streets, shirk on the job and commit crimes. That’s why, in an analysis of 19 developed nations from 1960 to 2004, economists Robert Vergeer and Alfred Kleinknect found that higher wage growth consistently led to higher productivity growth.

In other words, low wages may be good for one firm, but high wages are better for all firms. Yet many businesses would like to raise wages, but they fear losing ground to their competitors.

The only solution is collective action.

Economists have a collective action for precisely this sort of “coordination failure”: taxing the negative externality and subsidizing the positive. It is time that we recognize inequality for the negative externality that it is, slowing our productivity growth, roiling our markets with volatility, gridlocking our political system, and starving our economy of willing and able consumers. Inequality is a risk to our businesses, and it ought to be treated as such.

We should therefore see taxes not as penalties but as investments in a better, more equitable, more sustainable system. We should strive to prevent a “race to the bottom” in workers’ incomes; if we don’t, the day will come when no one will be left to pay the profits our shareholders demand. Business schools should teach courses about this issue, and business leaders should address it in their boardrooms. It is not merely a political issue. It is very clearly the business of Business.

Joseph Kennedy thought so when he went to work for President Roosevelt. As one of the nation’s most notorious stock manipulators, Kennedy might have been the last person we’d expect to join Roosevelt’s crew, but when Roosevelt named Kennedy as the first chairman of the Securities and Exchange Commission, he saw it as an opportunity to save the market from itself.

“We of the SEC do not regard ourselves as coroners sitting on the corpse of financial enterprise,” said Kennedy in a radio address to the nation. “On the contrary, we think of ourselves as the means of bringing new life into the body of the security business.”

As Wharton graduates, let us think of ourselves in the same manner, and act accordingly.

An Open Letter to the One Percent

Back Cover of "Letter to the One Percent"Congratulations. You are the richest class of human beings in the history of the world. Collectively, you own 26 percent of this nation’s wealth. Add in the next richest 5 percent of Americans, and you have more money than everyone else combined. Nowhere else in the world would you be able to earn so much and give back so little.

You worked hard for that money. No one can deny that. You have been rewarded for your talent, your intelligence, your risk-taking, your creativity, and your good fortune. The notion that you should change a system that has worked so well must seem downright stupid.

But, as the philosopher Amartya Sen reminds us, “What we can see is not independent of where we stand in relation to what we are trying to see.”

From where you’re standing, things must look pretty good. In the world you live in, economic growth is strong. Unemployment is brief, rare, and softened by ample savings. Health insurance is affordable. Education is among the best in the world. Food, shelter, and transportation are never hard to come by. And retirement will surely be comfortable.

It’s not perfect. You may get fired. You may lose money. You may experience stress and sacrifice and sorrow. But you will not struggle to survive. You will not be denied the American Dream.

So it’s only natural that you believe this path is open to everyone. But this could not be further from the truth.

In the world outside the One Percent, economic growth is sluggish — and has been so, on average, for more than thirty years. For most Americans, in fact, it has been nonexistent. Unemployment is a common and devastating threat. Retirement is an uphill battle. Education is a crapshoot. Food, shelter, and transportation strain the budget. And until recently, health insurance was a luxury afforded to some but not nearly all.

You’ve read these complaints before. You’ve heard the voices shouting outside your office windows. You’ve seen the faces protesting on your television screens. But, in all likelihood, you haven’t seen the world through their eyes. And that makes all the difference.

Adam Smith, the father of modern economics, taught that we cannot know what is the right thing to do until we have looked at a situation through the eyes of an “impartial spectator.”

“In solitude,” wrote Smith, “we are apt to feel too strongly whatever relates to ourselves… The conversation of a friend brings us to a better, that of a stranger to still a better temper. The man within the breast, the abstract and ideal spectator of our sentiments and conduct, requires often to be awakened and put in mind of his duty.”

That duty is great, for you wield immense power.

A few years ago, the political scientist Larry Bartels studied the voting record of U.S. Senators on issues where the rich, the middle class, and the poor disagreed. He found that the Senators sided with the rich 50 percent more often than they sided with the middle class, and they always sided with the rich and the middle class over the poor.

In a sense, they’re protecting their own. After all, the average legislator is six times richer than the average citizen.

They also have more reasons and more opportunities to hear what you have to say. Corporations, which you own and run, spend significantly more money lobbying and have significantly more high-level government allies than their opponents. The result is that corporations win lobbying battles far more often than unions or citizen groups.

You have an obligation to use that influence responsibly. Since the 1970s, you have failed in that duty. By tilting the playing field away from the 99 Percent, you siphoned an increasing share of the nation’s resources, until the country was drowning in debt, struggling to keep up, and unable to fuel the recovery it so desperately needed. Once you had climbed the ladder of success, you pulled up the ladder so no one could come up after you.

I don’t believe you did so with malicious intent. After all, many of you are my friends and colleagues. Rather, I believe you were practicing what the late economist John Kenneth Galbraith called “innocent fraud.”

“It is innocent,” explained Galbraith, “because most who employ it are without conscious guilt. It is fraud because it is quietly in the service of special interest.”

As opposed to general interest, the interest of all Americans. There is a way to become rich without impoverishing everyone else — and we as Americans celebrate that sort of success — but that’s not what has happened in recent years.

To be clear: It is not your accumulation of wealth per se that lies at the root of our problems. It is the manner in which that wealth was accumulated: through the systematic demolition of the tax code, regulations, public spending, and labor market institutions that created the greatest prosperity the world has ever seen.

The good news is, all that wealth gives you the ability to undo the damage. You are the most powerful citizens of the most powerful country in the world. Your country needs you. You have the influence, the means, and the brainpower to turn this economy around, but you must know the facts. You must hear the cold, hard truth.

No, I’m not trying to start a class war. Quite the opposite. I’m asking you to end the class war. I’m asking you to construct an economy where everyone benefits, rather than the few at the expense of the many.

“There’s class warfare, all right,” said Warren Buffett in 2006, “but it’s my class, the rich class, that’s making war, and we’re winning.”

You probably don’t see it that way. “War” is a strong word. But that’s because it’s not your standard of living that’s been under near-constant attack for thirty-plus years. Your piece of the pie has been growing. Your voices have been heard. And that’s why you’re the ones who have to step up.

Nothing less than what Sen calls “the freedom to determine the nature of our lives” is at stake. That’s something that you have and most of the 99 Percent doesn’t. That kind of freedom only comes with a good job with good benefits in a growing economy where good schools and a safe neighborhood in a clean environment create real opportunity. Not only is that kind of freedom at the heart of the American Dream; it’s also our natural birthright as human beings. Yet it’s been slipping out of reach for more and more Americans with each passing year.

Things can get worse. Let us hope they do not. Of course, it’s one thing to hope; it’s quite another to act. But act you must. In my new book Letter to the One Percent, I explain why. To learn more, visit www.LetterToTheOnePercent.com.

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This op-ed is an excerpt from my new book Letter to the One Percent, published this month by Lulu Press, Inc.

You Haven’t Heard the Last of the Buffett Rule

A battle is coming. A battle for America’s future. A battle for her soul.

The opening salvo came earlier this week when the Buffett Rule died in the Senate at the hands of a corrupt minority who refused to even let it come to a vote.

The Buffett Rule was advertised as a minimum tax rate of 30 percent for households earning more than $1 million a year, but that’s not quite right. The minimum rate actually started much lower for those earning $1 million and gradually increased to 30 percent for those earning at least $2 million.

The Buffett Rule would have raised $16 billion per year over the next decade — a measly 1.2 percent of this year’s budget deficit.

Thus it was not a solution. It was a shot across the bow, a warm up for the decision we will face in November, a test run for the expiration of the Bush tax cuts in December. It was the beginning of a battle to reclaim this country as a democracy for the 100 percent, rather than a plutocracy for the 1 percent. A beginning, not an end.

For if there’s one thing the government desperately needs, it’s tax revenue.

Relative to the size of the economy, the federal government is collecting less tax revenue than it has since the Great Depression, less than any of the other wealthy “G-7” countries, and way below the average for so-called industrialized countries.

The average family of four is paying less of its income in taxes than at any time from 1955 to 2006. The richest 1 percent have seen their average tax rates fall even farther, from 58 percent in the 1950s, to 35 percent in the 1970s, to 29 percent in the 1990s, to 23 percent today. Corporations, which are supposed to pay a top statutory tax rate of 35 percent, actually pay only 12.1 percent of their profits in taxes, the lowest since 1972.

Any way you measure it, taxes are low. (And, let’s not forget, the economy performed better when they were higher.)

So it should not come as a surprise that the federal government will only receive $2.5 trillion in tax revenue to pay for $3.8 trillion in spending this year, leaving a deficit of $1.3 trillion.

If this is a major problem — and the majority of politicians on both sides of the aisle agree that it is — then, as a matter of simple arithmetic, we must raise taxes or face draconian spending cuts. Since Republicans are so insistent on cutting taxes and thus increasing the deficit, they have chosen the latter course of action.

A couple weeks ago, I pointed out that it was unfair, unwise, and unusually cruel to force this kind of pain on low-income Americans, who would bear 62 percent of the burden under Paul Ryan’s latest budget proposal. Several readers replied that it’s unfortunate but necessary.

Is it necessary to slash taxes drastically for the rich? Is it necessary to leave the capital gains exemption intact? Is it necessary to increase defense spending? Is it necessary to foist hundreds of billions of dollars of subsidies on American corporations and the richest 1 percent?

None of these things are necessary. In fact, they are all counterproductive and quite dangerous if it is necessary to reduce the budget deficit. Yet we can find them all in the House Republicans’ budget.

What we don’t find in that budget is more tax revenue.

It is a mathematical fact that we can reduce the budget deficit by hundreds of billions of dollars simply by returning to the tax code that we used to have two or three decades ago — when, by the way, the economy was growing faster, wages were rising faster, and income inequality was lower.

It is also a mathematical fact that the top 1 percent captured 93 percent of the income gains in 2010. The recession has done all that the recession can do. The plutocracy is back.

It is up to us to wrest control of this country back from the grips of concentrated wealth and corruption. It will take time. It will take guts. But mark my words: The Buffett Rule will be back. And next time, it will be a heck of a lot bigger than $16 billion.

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This op-ed was published in today’s South Florida Sun-Sentinel.

Reader Requests: How Do Corporations Do-Do That Voodoo?

A reader asks: You claimed that the United States has an average corporate tax rate of 13.4 percent, despite a statutory tax rate of 35 percent. How did you calculate the “average” corporate tax rate?

Actually, I didn’t calculate it. The Bush Treasury did. They divided corporate taxes by corporate capital income.

Another reader asks: Do small corporations pay the same “average” or “effective” tax rate as bigger corporations?

Technically, small corporations are supposed to pay less in taxes. Like individual income tax rates, statutory corporate tax rates are progressive: 15 percent on the first $50,000 of income, 25 percent on income from $50,001 to $75,000, 34 percent on income from $75,001 to $10 million, and 35 percent on income above $10 million. (It gets way more complicated, but the details aren’t relevant here.)   Continue reading “Reader Requests: How Do Corporations Do-Do That Voodoo?”

$63 Billion? Chump Change!

When Professor Mishra and I debated the Bush tax cuts last week, he made the following point:

Should we let the Bush tax cuts expire for those who earn more than $200,000, in order to rein in the current budget deficits, at an all-time high, to pay for government spending? It would bring in revenue of only $630 billion over the next 10 years, according to the Office of Management and Budget.

In other words, we have a chance to reduce the budget deficit by $63 billion per year, but we shouldn’t do it. Not because anything bad would happen. Just because it’s “only” $63 billion.

“Because it’s too small” is not a good reason. There is no magic bullet. If you’re looking for an economically neutral way to cut $1.3 trillion all at once, it doesn’t exist. You cut $50 billion here, you raise $100 billion there, and eventually you’ve reduced the deficit significantly.   Continue reading “$63 Billion? Chump Change!”