James Galbraith Tells Us What Everyone Needs to Know About Inequality

By Polly Cleveland

Inequality has surged in the U.S. over the last forty years; many observers now blame the deregulation and tax cuts for the rich starting with the presidency of Ronald Reagan in 1980. In his new short book, Inequality: What Everyone Needs to Know, James Galbraith explains how this happened through the change in U.S industrial structure:

“In the early postwar period, the dominant American industrial corporation–such as General Motors, General Electric, American Telephone & Telegraph, International Business Machines–was an integrated behemoth that contained within itself not only production, but every phase of basic research, product design, and marketing that was relevant to its mission. Therefore incomes were distributed within the corporation by administrative decisions, governed by the bureaucratic imperatives and prerogatives of those in charge, and strongly responsive to the incentives of a highly progressive income tax structure. Top scientists and engineers, as well as top executives, were paid salaries, and salaries were regulated by the corporation. Tax structures also gave strong incentives for the corporation to retain profits, rather than pay them out as dividends, and to reinvest the proceeds–whether in factories or in the palatial towers that grew up in Manhattan, San Francisco, and Chicago in those years.

All of this changed with the tax “reform” movements of the 1970s and 1980s, which pushed for lower top marginal tax rates, fewer special exemptions from the tax, and for a “shareholder-value” model of corporate compensation. And a special feature of this change was that it created strong incentives to restructure the corporation itself.

“In particular, as the digital revolution came into view, the top technologists in the big corporations realized that they would be far better off if they set off on their own, incorporated themselves as independent technology firms, and then sold their output back to the companies for which they had formerly worked in salaried jobs.…

The effect of this structural transformation on the distribution of household incomes in the United States, as recorded in the tax records, is astonishing. For there were created, mainly in the 1990s, a handful of citadels of stratospheric incomes, previously unknown in the country and concentrated in the tiny handful of locations. One of these was Manhattan, the home of Wall Street and the source of finance. A second was Silicon Valley, a cluster of counties in Northern California. And the third was Seattle, Washington, and its near suburbs.”

Galbraith is describing the same phenomenon that Barry Lynn documented at length in his chilling 2010 exposé: Cornered: The New Monopoly Capitalism and the Economics of Destruction. That is, the transformation from vertically integrated firms to horizontally-integrated monopolistic trading companies, buying inputs from all over the world, squeezing both their suppliers and their customers. But Galbraith adds a new insight: not only did the postwar high-tax regime induce corporations to keep executive pay in check, it also induced them to retain profits and reinvest them in the corporation. With the 1980’s “greed is good” transformation, rates of reinvestment slowed as executives started taking more for themselves—surely helping slow the overall rate of growth.

Wait a moment! High taxes on income and profit produced more investment and growth? That’s the exact opposite of today’s Republican, and often Democratic, mantra that high taxes kill investment and growth. But the postwar taxes that tamed the corporate behemoths were in fact high marginal rates, top rates in a steeply progressive system. These were the very taxes imposed at the beginning of World War II to prevent war profiteering. These were taxes designed to capture the “unearned income” or “economic rent” of powerful corporations and wealthy individuals. It was perfectly logical for such corporations and individuals to “avoid” such taxes by investing money they would otherwise lose.

If high marginal income and profit taxes are so beneficial, is there any prospect—given the political will— of returning to such tax levels? Unfortunately, now that so many multinational corporations and wealthy individuals are registered or domiciled in tax haven countries, any simple effort to impose truly high marginal rates on profits or income will simply lead to more creative evasions, corruption (see Panama), and tax wars.

But, assuming the political will, are there other approaches? Galbraith proposes:

A much older and yet, to this day, still more promising alternative to taxing financial wealth is to tax land value, including the value of mineral and energy resources in the ground. The economic concept behind this idea is that of Ricardian rent–the argument that rents (which are inherently unproductive) flow to the owners of the fixed and non-reproducible asset, namely land. By taxing land and minerals, one reaches the least defensible forms of accumulated wealth, while at the same time doing the least to distort market decisions as between capital investment and hiring of labor. And there is another advantage: unlike financial wealth, land stays put. It exists in fixed jurisdictions with registered ownership; all the taxing authorities need to do is to send an appraiser, and then a bill. Local property taxes already work this way; however, in the United States landowner opposition to land taxes has been fierce, and many states are barred by their constitutions from levying property tax on a statewide basis. In California, notoriously, even local property taxes were capped in the late 1970s by a ballot measure strongly supported by wealthy landholding interests.

Land taxation has been for a century the program of the followers of the 19th century American economist Henry George, whose influence was vast around the world a century ago. One of his followers was the Chinese revolutionary Sun Yat-Sen, founder of the Republic of China in 1911. And Maoist China, by conducting an early war against landlords, ended up having the world economy most like the Georgist program in the modern age. But instead of taxing land value, the Chinese state actually owns it, and collects the land rent for itself. By doing this, Chinese municipalities and provinces have enjoyed ample revenue from which to make capital improvements, which is why Chinese cities have been able to grow like weeds in the reform era…

To this I would add that land taxes weren’t new in China: they financed Chinese empires as early as 2000 BC. Stiff land taxes of four shillings to the pound of assessed value financed the transformation of British finance in 1688; Adam Smith deemed them “the most equitable of all taxes.” Taxes on high profits and incomes and on land values all capture unearned income, or rents, forcing taxpayers to invest productively to pay the tax.

David and Goliath, or Why the One Percent Has to Rig the System

By Polly Cleveland

Malcolm Gladwell’s bestseller, David and Goliath, asks how and why the weak win far more often than we expect. What characteristics of the weak can sometimes make them strong? What characteristics of the powerful can often make them vulnerable? For a long-time inequality buff like me, Gladwell provides some new insights.

Gladwell tells the story of a girls’ basketball team coached by one of the fathers. The girls were small and not much good at dribbling or shooting. So the father, who had no prior experience with basketball, had his girls engage in a “full court press”, constantly running up and down the length of the court, blocking the opponents. This unorthodox behavior enabled the little girls to win again and again against better trained, taller and stronger teams – much to the resentment of their opponents. But as Gladwell points out, underdog strategies like this are very hard work.

What characterizes successful individual underdogs? A much higher than random number have overcome a traumatic childhood. For example, David Boies overcame severe dyslexia to become a prominent trial attorney. Emil Freireich, who lost both parents as a small child, bucked the medical establishment to develop effective chemotherapy for childhood leukemia.

I know personally two such underdogs: my husband Tom Haines and his daughter Avril. Tom’s father deserted when he was three; shortly afterwards the courts removed him from his mentally ill mother and placed him in an orphanage. He worked his way through high school and City College of New York as a live-in houseboy and baby-sitter. Before even completing his PhD in chemistry, he became an assistant professor at City College, and landed the College’s first NIH grant. Still in his thirties, he founded the Sophie Davis School of Medicine at City College. No conventional medical school, Sophie Davis begins European-style at the undergraduate level, to make it easier for minorities to enter medicine. When Tom’s daughter Avril was eight, her mother developed emphysema. Tom and Avril nursed her until she died when Avril was fifteen. Later, as an attorney, Avril rose rapidly in the U.S. State Department Legal Division, becoming Director of the Treaties Division, moving on to Counsel to the U.S. Senate Foreign Relations Committee, then to several top jobs for President Obama, including a year as Deputy Director of the CIA. A senior law professor at Columbia recently recommended her for the U.S. Supreme Court. She’s still only 47!

What’s with Tom and Avril? Both are supremely self-confident and optimistic, obsessively hard-working, skilled in personal relations, yet ready to buck convention. Did the trauma in their lives help make them this way?

Of course, as Gladwell points out, a rough childhood crushes more people than it empowers. However, oppression of an entire community—Gladwell gives examples of the Catholic communities in Northern Ireland during the Troubles, and the South Vietnamese peasants during the Viet Nam war—such oppression can strengthen resistance. Herein lies a major weakness of the powerful: they easily assume that the weak will give up in the face of overwhelming force. If a little force doesn’t work, just apply more.

Near-death business experiences can empower as well—as I discovered when my first husband took over his dad’s failing small health and beauty aid business. We made and marketed a variety of products, starting with Ezo Denture Cushions to stick in your false teeth and Zip Wax to peel the hair off your legs. We had $7 million annual sales and 30 employees. With my ex as CEO, I wore multiple hats: controller, purchaser, computer programmer, new product designer. It was an exhilarating nightmare: 12 hours a day, seven days a week, panic at payroll time, hours on the phone soothing vendors we had to pay late. Moving from Manhattan to a cheap old warehouse in New Jersey, and cutting back advertising, slowly we dug ourselves out.

But that’s the nature of small business: grueling hard work, over-optimism, constant crises, innovations born of desperation. And that can make small business enormously productive. Consider just one simple statistic: According to the U.S. Census, in the first quarter 2016 businesses with under $25 million in assets generated 48c in sales per dollar of assets, while those with $25 million and over generated only 13.4c, a ratio of 3.35 to one.

So what keeps us small business Davids behind fences? As Joseph Stiglitz points out in his recent book, Rewrite the Rules, over the last forty years the tax system has become much less progressive, monopolists have been given free reign, unions have been busted, the minimum wage hasn’t risen, corporate criminals have gone unpunished. Most significant, the giant banks, fattened by free money from the Federal Reserve Bank, more and more refuse to lend to small business.

So, applying Gladwell’s themes, why does the One Percent need to rig the system against the Ninety-nine Percent? Why can’t the One Percent live happily with the wealth and privilege they already enjoy? Because if they did, the more entrepreneurial members of the Ninety-nine Percent would soon do to them as David did to Goliath.