To understand why the stock market continues to be bullish despite the slowdowns in American productivity and in corporate profits, you have to go back to the old law of supply and demand from Economics 101. When the supply of something decreases while the demand for it stays up, its price rises. Here, I’m talking about supply and demand in publicly-traded stocks.
In case you hadn’t noticed, corporate America and Wall Street are in the process of privatizing a growing portion of America’s stock market. It’s happening in two ways. First, cash-rich companies are finding they can boost their stock prices faster by buying back their shares of stock than by investing in new factories, equipment, or R&D. After IBM announced it was repurchasing another $15 billion of its stock last month, for example, the value of its publicly-traded shares rose.
Meanwhile, private equity firms are doing a record amount of leveraged buyouts – that is, taking publicly-traded companies private. That’s what Cerberus Capital did two weeks ago with Chrysler.
Look at the big picture. Last year, corporate buybacks and leveraged buyouts totaled about $600 billion. That was roughly 3 and a half percent of the whole value of the American stock market. At the rate buybacks and buyouts are going this year, the total is going to be close to about $900 billion. That’s another 4 and a half percent of U.S. market capitalization taken out of circulation.
With the supply of publicly-traded shares shrinking like this, and with lots of global money out there to buy the shares that remain, it’s no wonder the stock market is going gang busters.
Yet at some point this bubble will burst. You see, the whole reason for companies buying back their shares, and for private-equity firms doing leverage buyouts, is to put all these shares of stock back on to the public market at some point in the future, at a higher price than before.
But if stock prices are now rising largely because the supply of publicly-traded shares is shrinking, and corporations are not making long-term investments, what happens when all this stock comes back on the market?
The loud thud you’ll hear will be the sound of shares falling back to earth.
After suggesting a couple of weeks ago that the stratospheric earnings of equity-fund managers ought to be considered income rather than capital gains and therefore taxed at 35 percent rather than 15 percent, I was deluged with emails telling me the plan wouldn’t work: It would just drive fund managers into offshore tax havens. No less than Jon Corzine, the former chief executive of Goldman Sachs, now governor of New Jersey, admitted recently in a television interview that many fund managers would take their money out of the country before they’d pay the 35 percent rate.
Corzine and my other critics may have a point. It’s estimated that America’s super-rich already sock away more than $100 billion a year in offshore tax havens. So any attempt to get them to pay what they owe is doomed, right?
Maybe. But I’ve been thinking a lot about the immigration bill now pending before Congress – especially the conditions undocumented workers will have to meet if they want to become American citizens. One of them is to pay all the taxes they owe.
The new immigration bill may not make it through Congress, but that provision about paying taxes that are owed in order to be a citizen serves as a reminder that paying taxes is one of the major obligations of citizenship. After all, if we didn’t pay the taxes we owe, we wouldn’t have public schools, police and fire protection, national defense, homeland security, roads and bridges, Medicare and Social Security, and other things we need.
So when the super-rich use offshore tax havens to avoid paying what they owe in taxes, they’re reneging on their duties as citizens. It seems only fair to me that the consequence of that kind of tax avoidance ought to be loss of citizenship. If it’s more important to someone to avoid paying what they owe in taxes than to continue being an American, then let them keep their money. They can become a citizen of the Cayman Islands or Bermuda or wherever else they store their wealth, and come here on a visitor’s visa – if they can get one.
House Dems have just unveiled their budget. It’s a gangly, wordy, and ambitious document that – no surprise – contains lots of things all Democrats can agree on, and whose numbers don’t quite add up. The most distressing aspect is its avowed commitment to reduce the budget deficit.
Here we go again.
Shortly after Bill Clinton was elected president he asked me to head up his economic transition team. He had promised during his campaign to “put people first” by reducing America’s two deficits – the yawning budget deficit, and the growing deficit of public investment in the nation’s schools, health care, infrastructure, and environment. “To reclaim our future, we must strive to close both the budget deficit and the investment gap,” he intoned over and over again. But the economic transition team discovered the budget deficit was so much larger than expected that Clinton would have to put the investment deficit on hold. It remained on hold for the next … well, it’s now been fourteen years.
In the late 1990s, when the budget deficit turned into a fat budget surplus, Clinton ignored his original investment agenda. By then Alan Greenspan’s interest-rate cuts had buoyed the economy enough for most Americans to forget the long-term problems that lay behind the business cycle. Clinton was worried Republicans would try to turn the surplus into tax cuts, so he used the ever-reliable scare tactic of telling the nation to “save Social Security first.” By 2000, as budget surpluses continued to mount, candidate Al Gore demanded they be put in a “lock box.” When the surpluses overflowed even the lock box, Gore said they should be used to reduce America’s national debt.
Thus did Clinton and Gore tee up a $5 trillion surplus for George Bush to give away mostly to America’s very wealthy – without the nation ever considering it might be used to finance what Clinton and Gore were elected to do in 1992. While Republicans continued to spout the nonsense of supply-side economics, Democrats became the official party of fiscal austerity. The choice became either trickle-down economics or Calvin Coolidge economics.
Fast forward. The nation’s investment deficit is now much larger than it was in 1992. The “No Child Left Behind Act” raised school standards but didn’t provide enough money to implement them. Meanwhile, almost all the net growth in the labor force has been from immigrants, many of whom lack the basics. There’s less money for job training, and it’s harder for families of modest means to afford college for their kids. Millions more Americans lack health insurance than in the early 1990s. And according to a recent report from the American Society of Civil Engineers, America’s roads, bridges, transit and drinking water systems, and power grids are in worse shape than they were fifteen years ago. On top of all this, the nation will need to invest tens of billions to cope with global warming.
George Bush has put rich people and big corporations first – spending like mad on fat contracts for military contractors, price supports for big agriculture, bloated subsidies for oil companies, and subsidized research pharmaceutical companies. Yet measured as a percent of the gross domestic product the current budget deficit is still less than it was in the early 1990s. Cut the corporate welfare, raise taxes on the top, allow the deficit to move up to 3 percent of GNP, and there would be plenty of money to invest in the nation’s future.
Yet the Democrats don’t seem to know how to let go of Calvin Coolidge economics. Somehow, they got it in their heads that cutting budget deficits and balancing budgets – and maybe, if everything goes really well, creating budget surpluses that can be used to reduce the debt – is a sure-fire formula for prosperity. Flush from their mid-term victory, congressional Democrats have flung themselves headlong into the guillotine of fiscal austerity. They’ve promised to shrink the deficit, and enacted “pay-go” rules that make it impossible for them to do much of anything without raising taxes, yet they’ve been unwilling to commit themselves to raising taxes on the rich. Democratic presidential candidates, meanwhile, have been assiduously vague about how to finance their plans for affordable health care or anything else. John Edwards has suggested he’s not overly concerned about budget deficits but hasn’t given any details. Hillary Clinton and Barack Obama have so far avoided bold ideas that will cost real money. All are careful to sound as if they believe that fiscal privation is the road to salvation.
Bill Clinton had it right in 1992. Inadequate public investment in the nation’s future will condemn us to slower growth and shrinking prosperity. It’s already happening.
One of my former students who graduates from business school next week has already landed a job with a private-equity firm paying him $240,000 next year, which I can tell you is a lot more than the salary of his former professor who’s more than three decades older. My student tells me with a smile he’ll be able to pay off his student debt way ahead of schedule. But that’s not his real reason for taking the private-equity job. He wants to make gobs of money.
On the other hand, several of my students who will graduate next week tell me they would have liked to go into social work or into the non-profit sector or provide legal services to the poor. One had his heart set on becoming a painter. Another became passionate about archeology and had wanted to go on a dig in the Sahara. But they can’t do any of these things because they have tens of thousands of dollars of debt. They need jobs that pay the rent while they repay their loans.
When they begin their university studies and take out college loans, most students don’t know exactly where their interests lie. That’s what college is all about – discovering what you want to do with your life. But America’s increasing reliance on student loans to pay for higher education is directing millions of young people away from what they really want to do – from careers that could contribute a great deal to their communities and to the nation as a whole, but don’t get them out from under their college loans.
So here’s an idea that might allow more students to pursue their real interests when they graduate: Make repayment of government-subsidized loans depend on how much money they earn. Say everyone has to pay ten percent of their income for the first ten years of their full-time work. And then the loans are considered paid off.
My student who’s landed that private-equity job would pay ten percent of his income for ten years, which would be a hefty sum. My students who go into social work or become artists would pay ten percent of theirs, which would be far less. The private-equity guy would in effect subsidize the social worker and artist. And why not? This way all of them can follow their callings.
This week, Senators Max Maucus and Charles Grassley, the chairman and ranking minority member of the Senate Finance Committee, are holding “informal meetings” to consider whether the stratospheric incomes of private-equity partners ought to be treated as compensation rather than as capital gains, for tax purposes.
Way back in the 1970s, newly-minted MBAs with dollar-signs in their eyes wanted to be CEOs. Then in the 1980s wanted to go into investment banking, because the money was even better there. In the 1990s, they went into high-tech venture capital and dot coms. Now it’s private equity. Becoming partner in a private equity firm is also the new dream of every CEO in America.
That’s because the average big-company CEO has to do with a measly $7 million a year, taxed at 35 percent. But private equity partners are raking in hundreds of millions a year, taxed at 15 percent – less than the tax rate paid by middle-class Americans.
What exactly do private-equity partners do? They use the investment money of pension funds and college endowments and wealthy investors to buy up publicly-held companies and turn them briefly into privately-held companies. Then they do what you might do when you want to resell your home – redecorate, refurbish, knock out some walls, apply fresh paint, sell the furniture.
Sometimes they keep the same CEO of the publicly-held company, give him some private equity too, and tell him to apply the good ideas he’s stored up but never implemented when he was just earning $7 million a year as CEO because now he can really cash in.
Then a few years later the private-equity partners resell the company to the public, usually at a big profit. And they take 20 percent of the profits for themselves.
We’re talking billions of dollars here, folks. And it’s only taxed at 15 percent because even though it’s most of their compensation it’s treated as a capital gain. And courtesy of the Bush tax cuts, capital gains are taxed at 15 percent. Of course, those billions are what these guys pay themselves for their work. It’s their compensation.
When capital gains are taxed at less than half the tax rate the rich pay on their incomes, you can expect this sort of gamesmanship.
Now that the tax-writing committees of congress are taking a look at this giant loophole, they’re besieged by private-equity partners who are, of course, screaming: No! You can’t do this to us! If you treat the money we’re making as compensation, you’ll reduce our incentives! We won’t work as hard if we’re taking home only 60 million dollars a year instead of 80 million! And that will cripple the American economy.
The Record-Breaking Dow and the Supply Side Fallacy
I’m spending my spare time these days debating supply-siders who are convinced that the record-breaking Dow proves the correctness of the Bush tax cuts.
Yes, the Dow did reach a record high last week. But the Commerce Department also reported that economic growth slowed to its weakest pace in four years. How can investors do so well while the real economy is doing so poorly? My supply-side friends don’t have an answer, but I do.
It’s because of two great decouplings that have occurred in recent years. First, the rest of the worlds’ major economies have decoupled from the United States economy. China, India, Japan, and Europe are now such large markets they can grow briskly even as America slows.
Second, America’s largest corporations have decoupled from the United States. Their overseas subsidiaries are booming even as their American operations stagnate. General Electric expects more than half its revenue this year to come from outside the US for the first time. More than half of Boeing’s new orders are from overseas. Ford is struggling in America but doing well in Europe.
In other words, the President’s supply-side tax cuts are great for America’s global investors, who have been investing their extra money around the world - either in foreign companies or in global American-based ones.
But little or nothing is trickling down to average working Americans. Half of U.S. households do own some shares of stock, usually through their IRAs or 401-Ks. But the vast majority own less than $5,000 worth. Their equity is in their homes, whose values have slumped. They’re paying far more for health insurance and fuel. And their wages haven’t kept up.
Bottom line: The Bush tax cuts have delivered for Wall Street but done zilch for America’s Main Streets