Forbes, December 28, 2010, Tuesday

Forbes

December 28, 2010, Tuesday

Forbes

The Bitter Fruits Of Equality

By BRIAN DOMITROVIC

The tax cut extension set to take hold on New Year’s Day has one weird feature. It expires in two years, on Jan. 1, 2013. Political strategists say that the 2012 election is now poised to be a referendum on getting the rich to pay their fair share.

It’s quite something to hear all the loose talk about the George W. Bush era – it was the “age of inequality,” a “new Gilded Age.” For while tax rates on top earners and estates were indeed moderate in this period, there were immense countervailing statistics, such as the evaporation of tax obligations on the lower middle classes and the stunning share — 40% — of income taxes paid by the top 1% of earners.

What is it like when tax policy is “equitable”? What happens to society’s class system when the maximum rate of a progressive income tax is, say, double what it is at present? This was the case, after all, in the 1970s, when that rate was 70%, compared with today’s 35%.

Let’s set aside the effect on the government. If the government can’t get by with tax rates at that level, let alone use the receipts bonanza to procure equality straight away, the fault is all its own. How did the real sector do in the 1970s, against the touchstone of equality?

Very poorly, as it turned out. The rich spent the 1970s trying to figure out how to hide their money. If you bring in a pile, and the next dollar of income will net you 30 cents, you will strive to look for cracks in the tax code to get a bit more out of that dollar.

The 1970s were the first heyday of “alternative investments.” Gold, oil, land, straddles, these exotica had been the preserve of a small group of specialists before 1969, when high earners got hit with a triple tax increase. The top capital gains rate got upped to an effective 49%, there was an income-tax surcharge, and the millionaire’s minimum tax (the AMT monster of today) began. This is not to mention “bracket creep,” whereby real tax rates go up with every increase in the price level. For the record, inflation was 200% from 1969 to 1982.

In this environment, the rich simply stopped what they were doing and focused all attention on preserving capital and avoiding confiscatory rates. They asked OPEC to let the price of oil float, so that western investors could buy that commodity and not pay tax on the unrealized gain in price. Same thing with gold, the private ownership of which was made legal in 1974 in the face of public pressure. Oil went up 14-fold in this period, gold 20 times.

These hard assets made for excellent collateral, so as their price shot up in the 1970s, the rich did not sell — and get subject to that nasty capital-gains tax — but used the holdings as stakes for loans. Mortgage interest can be written off against earned income, an especially valuable thing in the context of a 70% marginal rate. So there was a land boom too.

Private money piled into this all this inert stuff, meaning that the real economy was starved of investment for not just job creation, but job perpetuation. Unemployment went up by half to a new normal of 7% by the late 1970s, only to crest at 11% as the crisis peaked in the early 1980s.

Rich corporations followed suit. In 1978, General Electric noticed that its simple natural resources business accounted for 5% of the company’s revenue but somehow 15% of profits. Executives at GE contemplated diverting investment capital from jobs-intensive industrial projects (such as work in nascent Magnetic Resonance Imaging) to mines in South Africa. U.S. Steel bought Marathon Oil and laid off 160,000.

So be careful what you wish for, equality-seekers. A new book (by Cornell historian Jefferson Cowie) calls the 1970s The Last Days of the Working Class for a reason. On paper, under high tax rates, the rich do their fair share and get their comeuppance. The lessened “inequality” statistics that show this are based on taxable income — which the rich artificially deflate in periods of onerous taxation. But in reality, what happens given high taxes is that the rich see themselves through very well enough, while good livelihoods for the rank-and-file become ever more elusive.