A Great Economy If You're Rich

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Mr. Rees is Associate Professor of History at Colorado State University - Pueblo. He is the author of Managing the Mills: Labor Policy in the American Steel Industry During the Nonunion Era (University Press of America, 2004) and Co-Editor of The Voice of the People: Primary Sources on the History of American Labor, Industrial Relations and Working-Class Culture (Harlan Davidson, 2004).

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A few weeks ago, I was watching CNN when a guy who came on explained how I could retire rich. Apparently, if I give up my daily latte and invest those savings in the stock market, I can become a millionaire.

What struck me most about this particular proposal was not its merits (even though I don't drink coffee), but its timelessness. Although this was the first pitch of this kind that I had seen in the post-bubble era, the roots of this argument are at least seventy-five years old.

In a famous article from the Ladies Home Journal in 1929, the Chief Executive of General Motors and the head of the Democratic National Committee, John Jacob Raskob, argued that “Everybody Ought to Be Rich.” All they had to do is save $15 per month, invest that sum and the proceeds from this money in “good common stocks” and after twenty years they would be wealthy.

Unfortunately, just a few months after this article came out, the stock market crashed. I do not pretend to know what will happen to the stock market or the economy in the future, but I find it interesting that such arguments are being made again now. Perhaps the most widely acknowledged explanation of the 1929 crash among historians is the growing inequality of wealth in the United States during the 1920s, and now inequality of wealth is growing again.

The evidence for this inequality is all around us. According to the Center on Budget and Policy Priorities, in 2000, “the income gap between the very wealthy and the rest of the nation . . . was the widest it has been since 1979, and likely was the widest it has been in 70 years.” There is even an organization whose sole purpose is to compile this kind of information, Inequality.org.

But inequality by itself is not necessarily a bad thing. If everybody has an opportunity to travel up the economic ladder, to live the American Dream (so to speak), the lifestyles of the rich and famous could serve as an impetus for people to work harder.

In my research on the American steel industry, I have found that company executives were obsessed with the idea of keeping upward mobility available to deserving employees in large part for this reason. As the Chairman of U.S. Steel, Elbert Gary, put it in 1920, “Any concern, any organization, any government which seeks to promote, demote, or retain a man in position contrary to his just deserts, combats the public interest, [and] the life and growth of the nation.” Gary was directing most of his ire at trade unions, but today the biggest threat to Americans getting their just deserts is not organized labor but the President of the United States .

Writing in the Nation , New York Times columnist Paul Krugman explains how George Bush's policies have the effect of keeping the rich rich and the poor poor. Suppose you wanted to “further entrench the advantages of the haves against the have-nots,” he suggests. “What would you do?”:

“One thing you would definitely do is get rid of the estate tax, so that large fortunes can be passed on to the next generation. More broadly you would seek to reduce tax rates both on corporate profits and on unearned income such as dividends and capital gains, so that those with large accumulated or inherited wealth could more easily accumulate even more. You'd also try to create tax shelters mainly useful for the rich. And more broadly still, you'd try to reduce tax rates on people with high incomes, shifting the burden to the payroll tax and other revenue sources that bear most heavily on people with lower incomes.”

Krugman also mentions cuts in healthcare and aid to higher education, as well as the administration's efforts “to break the power of unions” as evidence of its intentions to slow class mobility.

But Krugman's list predates another important weapon in the Bush administration's war against the American Dream: immigration reform. The economist James K. Galbraith has written eloquently of President Bush's new immigration proposal which will, in his words, “create a rotating underclass of foreign workers, who never assimilate to American ways or adopt American values” because, unlike the immigrants who came through Ellis Island around the turn of the twentieth century, these workers would be denied citizenship and could be expelled from the United States if they ever found themselves unemployed.

These new immigrant workers would also drive down wages for citizens in this country since employers would inevitably prefer cheap laborers without any political or economic rights to those who continued to demand the American standard of living. As Galbraith explains, “Bad bosses drive out the good. Good bosses will turn bad under pressure. The terms of our jobs will get worse and worse.”

With the traditional avenues for economic mobility blocked, what can Americans do if they want to get ahead? “If you work for a living in George W. Bush's America , you're a sap,” argues Harold Meyerson in the Washington Post. By contrast, “Bush tax policy rewards investment and inheritance.” In other words, if you're not rich already, George Bush wants you to invest in the stock market too.

But what if you don't have a trust fund and you can't afford a latte every day to give up? Besides having the bad luck of championing the stock market right before the most traumatic moment in its history, John Jacob Raskob did not recognize that most American workers only made between $17 and $22 per week in 1929. Thanks to George Bush's policies, this same critique may trip up another argument for the viability of anyone making it to the top of the economic ladder.

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Eric D Green - 4/16/2004

Wrong. The Bush admin's policies do not do much for those making "in the 40's", so my guess is most Dem's don't consider that rich. Try a lot higher, you know the really rich who actually pay very little in taxes.

Of course the Bush admin and Repub congress has outspent the Clinton admin by huge margins, so how are you enjoying your "fiscally conservative" gov't these days? And your tax dollars are being well spent, to repair Iraq infrastructure we blew up. Enjoy…

David Battle - 2/11/2004

How do Democrat demagogues define "rich"? anybody who isn't on the dole is "rich"? Middle class joe blow and his wife who make a combined salary of $75,000 are "rich"?

David C Battle - 2/10/2004

To a Dem, anybody making in the 40's would be "rich".

Andrew D. Todd - 2/5/2004

This kind of financial advice is curiously skewed. Unlike the very rich, people of modest means usually have abundant outlets for capital in their own lives.

The classic workingman's investment strategy has traditionally been to build his own house, with his own hands, using scrounged materials, and adapting the design to the available materials. The workman commonly built his house during intervals of unemployment, so the opportunity cost of his labor was minimal.

For an example, see Douglas Harper, _Working Knowledge: Skill and Community in a Small Shop_ (1987). On pp. 104-106, there is an account of how the author's mechanic-hero built his own house for about $4000 out-of pocket-expenses.

Of course, we are shifting to an information economy, and the choice of investment outlets also changes. For example, the use of the internet as vehicle for self-education without paying tuition would be a modernized version of the workingman's economic strategy.

In the course of assembling reading lists, I have come into contact with another type of internet self-investor. When I got a book on Bookfinder, it turned out surprisingly often that the bookdealer was a housewife who descended on the local garage sales, bought all available books, and resold them quickly over the internet. This worked out to a nice little home business, with a required capital of perhaps $1000 (mostly a computer).

Thomas W Hagedorn - 2/4/2004

We are in basic agreement on the philosophy of your thoughts. I do not favor unfettered, laissez faire capitalism. Nor do I favor the faux capitalism of the Fortune 500, which seeks regulatory and tax advantages and protections over its its smaller competitors who are without the representation of lobbyists. But if economic systems are on a dial from 0 (socialism) to 10 (capitalism), then I would prefer a system closer to 10 than 0.

I am not intimately familiar with the proposals to "privatize" social security. I thought that one could elect that only part of someones social security could be diverted to an investment account. Even that part would have controls put on it, to protect people from doing stupid things. If that would be the plan, it would probably work OK. I hate to admit it, but the advice would range all over the lot from bad to great. It would probably be mediocre, but the average results would probably beat the current internal returns of social security which are pretty poor. If they go that route, they had better be very careful. The brokerage firms will LOVE it! Think of the revenue.

Politicians may feel forced to try this. Social security is still headed for the same train wreck that was a big news item a few years ago. There is only two differences now. We have big deficits (We had a balance budget). And no one is talking about the problem. With all us boomers retiring, there are only three ways out of the problem (combination of any of the three):(1) raise taxes, (2)cut benefits, and (3)the privatization/personal account approach. The first two will almost certainly both happen. The third option could be used to make the first two less onerous. (1)and (2) could be done in some sneaky ways and politicians would be likely to go that route. For example, more of social security benefits could be made taxable. Eligibility ages could be extended further into the future. I'm sure there are other "creative" plans they can come up with.

Jeffrey Davis - 2/4/2004

Mr Hagedorn wrote:

"This world will almost always reward courage, wise calculation and patience..."

The race is not always to the swift, eh?

GK Chesterton wrote of communism that it wasn't necessary to demonstrate that it isn't poison: it's enough to show that it isn't wine. We prefer capitalism since captialism is simply the freedom to do what we want. My only quibble is with the kind of capitalist -- all too common -- who ascribes magical potencies to that freedom. We shake our heads over our neighbors choice in cars, athletic teams, spouses, etc. We don't ascribe magical potencies to those kinds of choices. (Not that we'd want to circumscribe them.) So, let it be with capitalism. We should defend that freedom for its own sake so that we don't turn against in those times when our choices turn out to have been duds.

Tim Rhea Furnish - 2/4/2004

Would folks who write articles using the term "rich" please define it? Give me a range of income or something. As it is, "rich" seems to mean--to the Democrats--anyone who makes more than you do.

Oscar Chamberlain - 2/4/2004


I did appreciate your longer answer.

A thought and a question:

I do not see the sharp dichtomy between the capitalist and the socialist models implicit in you last response. That is, in part, because even in our society we have a sense that there are limits beyond which competition (and therefore winning and losing) should not logically go.

For example, we don't expect the internal economy of families to be capitalist (which is why borrowing or lending money to relatives other than children can be so perilous).

Those of us who believe that a certain degree of redistribution (to use a catchall term for a variety of specific programs) see a certain amount of social sharing as being just as essential to the larger society as it is to families.

To use a family analogy, a parent wants even the least sharp child to have a decent chance to do well, and the same parent wants the most talented to have the chance to do superlatively. In both cases that takes a certain amount of support: education, a chance to start, and sometimes buffereing against unexpected blows.

Social programs should not be paternalistic in tone and in limiting freedom, but the best provide similar services.

The question I alluded to above. If we do shift more to individual responsibility for retirement, then the role of brokers and other financial advisors becomes critically important. You have long experience in these areas. What is the likelihood of getting good long-term advice from the average broker?

Thomas W Hagedorn - 2/4/2004

This world will almost always reward courage, wise calculation and patience, whether the economic system is capitalist, socialist or some "third way". The difference is that under capitalism each person can captain his own ship and reap his own rewards (or suffer the effects of his bad decisions).

Under socialism, the ship is driven by a committee and the rewards are supposedly split "fairly" according to the committee's decisions. This invites endless critisism that the committee's decisions are not fair (sometimes they are not and are done to benefit committee members - see the former Soviet Union for examples). This leads to less innovation and less incentive to work. This results in less production, less wealth, and a lower standard of living. Of course, slave and forced labor can overcome this (see Stalin's Soviet Union, Mao's China and todays North Korea for examples).

I'll take the chaotic freedom of capitalism over the bleak security of socialism. Immigrations patterns appear to second my preference.

Jeffrey Davis - 2/4/2004

What Mr Hagedorn's scenario sounds like is that capitalism acts like a big ship which pulls doughty investors along in its wake. (Amplify that analogy as needed.)

Some of us are not as tempermentally buoyant as those doughty investors and their advisers. At our backs we always hears "Malthus waits" hurrying near.

Thomas W Hagedorn - 2/4/2004

Sorry for the "flip" answer. I worked for 3 years for a mutual fund company and 20 years as an investment consultant (broker) for a major Wall Street firm, working primarily with middle class investors. I have an MBA and CPA. Over that time I developed a very strong belief from my own experience and from my study of successful investors. My belief was that the markets and economy can not be predicted (the bad news), but that such prediction was not necessary for most people to meet reasonable investment goals (the good news). What is required is setting reasonable goals, deploying an asset allocation that matches those goals, avoiding excessive concentration in individual sectors or securites (to avoid big losses), resisting the emotions of fear and greed and the mistakes they can lead to and, most importantly, PATIENCE.

Luck or chance is certainly involved in the short run in investing. In the long run (which most people should be interested in), it is not a factor.

Oscar Chamberlain - 2/3/2004

That's not an answer, and I think you know it.

I am asking you to what extent, in your choices of investments and investment timing, you anticipated events or trends, and to what extent favorable (or unfavorable) events and trends took you unawares.

Thomas W Hagedorn - 2/3/2004

The harder I work and the more I study something the luckier I seem to get.

Oscar Chamberlain - 2/3/2004

A lot of people made a killing in real estate in California by combining some intelligence with a great deal of luck.

That combination, in varying degrees, is present in any investing strategy.

What was the balance between intelligence and luck in your strategy?

Thomas W Hagedorn - 2/3/2004

Only a 20-30 yr old should have been close to 100% in equities in 1999. Your hypothetical unwilling retiree, being close to retirement age should have maintained a "balanced" account (say 60-65% stocks and 35-40% bonds) if he or she followed standard investment practice. Bonds have done quite well over the last 3-4 years due to falling interest rates and that would have taken some of the sting out of the precipitous decline in equity prices. Meanwhile, we have had a very nice recovery in the stock market. No, a reasonable investment plan would have worked even for your hypothetical retiree. I retired in April, 2003 and it did for me. I got hurt by the "dot-bombs" but I was careful not to have too much in that area of the market.

Oscar Chamberlain - 2/3/2004

But people do not plan to retire at convenient 10-year intervals. In fact, for many people, retirement may be "forced" by shifting job force needs and early retirement offers.

Think of it this way. Someone in stocks who retired in early 1999 probably did very well. However someone who stayed in stocks through the dot com bust on the assumption that he/she would retire in 2009 could be in deep trouble if circumstances forced a 2003 early retirement.

On average the stock market works better that other investments. On average.

Jeffrey Davis - 2/3/2004

"What did 1929 and 2000-2001 have in common?"

A 26 year hiatus before the stock market recouped its losses?

Thomas W Hagedorn - 2/3/2004

Financial professionals look at ALL 10yr periods, to attempt to arrive at a reasonable picture of past returns. If you look at that statistic, common stocks have provided very good returns, substantially in excess of bonds or money market(cash). I am able to research and write full-time now, at age 55, because I followed a regime similar to that recommended by the gentleman from General Motors. This is not rocket science, it is basic personal finance in conjunction with the will to delay gratification. Financial comfort is available to most of the population today, if they live a personally responsible lifestyle and systematically apply some basic principles from personal finance. Believing in the a "victim-oppressor" model of the economy and taking on the personna of a victim is a non-starter in a capitalist country. Financial success is available to all with ability and desire. Go for it.

Thomas W Hagedorn - 2/3/2004

Your lack of knowledge of capitalism and economics allows me and mine to prosper. And the more students you infect with your misinformation, the greater opportunities there are for us capitalists.

Why, Mr. Rees, do you suppose that people from around the globe would love to come live here in the U.S.? And why, are not people streaming out of the United States to go elsewhere to countries with more socialism and more "equity"? Canada, for example, is quite close to the U.S. and offers European-style socialism.

Ken Melvin - 2/2/2004

Convenient dates, methinks. What was the rate of return from 1929 to 1939, kind sir?

John H. Lederer - 2/2/2004

I find it interesting that the cited references show this as the greatest inequality since ...1929.

What did 1929 and 2000-2001 have in common?

Austin K. Williams - 2/2/2004

One thing Professor Rees overlooks is the relationship between the various forms of corporations and the taxation that is applies to them.

C-type corporations are first taxed on net income at a statutory rate of 35%. Prior to the recent reduction in dividend taxation, dividends were then forced out of the corporation via the excess accumulated earnings provision and taxed at the top marginal rate of the shareholder(s) receiving them. At a 39.6% rate (top marginal equal to the excess earnings penalty), each dollar of net income to the corporation could be taxed as high as 60% (nice work if you can get it). These figures are exclusive of state and local taxation. Today, the top rate for C-corporations is on the order of 45% exclusive of state and local taxes. It should also be noted that the dividends that "escape" immediate taxation at the shareholder level due to deferral in 401ks, IRAs, etc. will be subject to tax at the individual's top marginal rate upon withdrawal.

The other, more interesting corporate entity is the pass-through (subchapter S, LLC, partnership, etc) for which net income is "passed through" to the owners and taxed at their top marginal rates. Where the top individual rate used to be 39.6% compared to the corporate one at 35%, the pass-through owner was at a slight disadvantage. From the government's perspective, however, pass-throughs are a huge loser (60% vs. 39.6% then and 45% vs. 35% now). The obvious solution is to employ a mechanism that acts to convert pass-through entities to C-type corporations. That mechanism is the gift/estate tax regime.

Closely-held pass-throughs (the vast majority of the genre), are generally highly illiquid. Should the majority owner wish to transfer ownership of the business to his/her offspring, the gift tax presents an immediate financial burden to the owner that can only be borne by putting the entity deeply into debt. Obviously, this "solution" operates to the detriment of the entity as it must now struggle to meet both its new debt service and its business objectives. Futhermore, the entity's ability to take on additional debt to finance expansion or to upgrade its capital equipment is severely impaired. At some point, usually sooner rather than later, the business will fail and will be purchased by, yes, a C-corporation.

The same scenario plays out in the estate tax game. The heirs face a huge tax bill based on the value of the entity. The only ready source of cash to pay the bill comes from the entity itself (see nightmare scenario above) or from the open market via sale of the entity to, yes, a C-corporation.

The transfer tax regime thus acts very effectively to move the net income of successful companies from low-taxed pass-throughs to highly-taxed C-corporations within a generation or two.

Note also that changes in the transfer tax regime (including the upcoming elimination of the estate tax) will maintain this pass-through to C-corporation conversion mechanism as the gift tax regime is fully retained. The only option for tax-free pass-through succession is to keep the octogenarian owner in control of the business until the date of his/her death. Not a great business plan.

Austin K. Williams

John H. Lederer - 2/2/2004

Money invested in the Dow in 1929 and hel until 1949 would have had an inflation adjusted annual return of 4.54%. Not great, but not bad, and...much better than Social security.