Schemes of the Rich and Greedy

by Michael Hudson

Tax-Avoidance – The Worst is Yet to Come

“Let me tell you about the very rich. They are different from you and me.”
“The Rich Boy,” by F. Scott Fitzgerald

The 30-year campaign of the wealthy to rig our economic system – especially the tax component – for their own benefit will accelerate with the GOP capture of the House of Representatives and the likely capture of the presidency and Senate in two years. For a foreshadowing of what is to come, a dress rehearsal has been conducted in Latvia, Iceland, Ireland and other financially strapped countries. Latvia has been burdened with the world’s most regressive tax system, while Iceland and Ireland have become record setters in tapping taxpayers to bail out financial crime syndicates, a.k.a. banks.

The Irish bailout will encumber its people with perhaps as much debt as a $9 trillion bailout would be here in the United States. The Irish also are expected to also gut unemployment insurance, their minimum wage and similar social safety nets while boosting interest rates and home property taxes to pay tribute to the European creditor agencies that have “rescued” them. They will relinquish ownership of much of Ireland to their creditors, capped by ownership of government policy-making. The new banks will be owned by foreigners, who will put Ireland on a debt treadmill to transfer its taxable surplus to mainland Europe and Britain.

Just as the U.S. taxpayer saved Goldman Sachs and the other high rollers from taking a loss, the Irish are being forced to “socialize” (that is, oligarchize) the losses of the banks. Think of how the Federal Reserve gave the banks 100 cents on the dollar for the some $2 trillion of toxic assets they took off the books of the banks and you get a sense of how the Irish bailout money will be used. It will keep the banks and creditors whole.

Bad banking is going unpunished.  Shareholders, bondholders, large depositors and bank executives are not facing constraints on moral hazard. The European Central Bank (ECB) has cleaned up their mess, enabling their wealth to grow on its trajectory as before – at the price of impoverishing the non-financial parts of society. Every effort will be made to re-inflate the property bubble putting off the day of reckoning. Taxes – like accountability – are for what Leona Helmsley referred to as the “little people” (not referring to Irish leprechauns).

The key to the success of the wealthy is their ability to hold the economy hostage (dependent of course on the government’s willingness to be unnecessarily held hostage). This dictates the fiscal and financial strategy of the super-rich: to create a crisis and then present their demands. Inasmuch as I expect the U.S. Congress to be plunged into this situation next spring, it is worth quoting Luke Johnson’s observation in Wednesday’s Financial Times: “The probable cost to the Irish taxpayer” of its government’s announcement on September 30, 2008, that it would fully back Ireland’s insolvent banks – a cost “running in the tens of billions of euros – helped the banks but left the country in need of a bail-out. A measured restructuring would have been far better, with domestic depositors kept whole, but all levels of bondholders forced to share plenty of pain. In a panic, the bureaucrats and lawmakers who preserved the banks in their entirety struck an ill-judged, carte-blanche deal that will haunt Ireland’s taxpayers for years.”[1]

The key phrase above is, “In a panic …” The actions of European Central Bank and IMF (imposing domestic austerity to make sure that Casino Capitalists do not have to take a “haircut”) provide a set of experiments replete with rhetorical patter talk that Republican and Democratic plutocratic protectors are watching as an object lesson for how to maneuver this spring by creating a financial emergency – a grab-bag 9/11 for the bankers – to trot out their Financial Invasion plans into the domestic U.S. economy. Lacking a Democratic party committed to reverse the recent redistribution of wealth up the economic pyramid, we may expect Congress to shed crocodile tears as they complete the tax shift off the oligarchy onto the middle class – the constituency they are in a position to sell out.

First, consider the GOP cover-up lie: “We are tax cutters, because we want you to keep more of your money.” A more verifiable, restatement of the impact of their actions would be: “Our designated task is to legislate tax shifters to shift the tax burden onto middle-class voters so as to shift more of the wealth of this nation upward to our core campaign contributors.”

In their ability to buy this political support, the super-rich are indeed different from you and me. Freed from the normal societal constraints on greed and selfishness, they are able to buy whole armies of propagandists and politicians. What is noteworthy is that such prominent members of the super-rich as Bill Gates Sr. and Warren Buffett exercise a form of responsible wealth rather than letting themselves be pulled towards the dark side. As the ancients well described, wealth is addictive. The enlightened attitude of the would-be “responsible rich” is more than offset by the rapacious greed of others at the top of economic pyramid.

This means that societies polarize if they don’t maintain vigilant protection against wealth addiction, above all in the financial sphere. If regressive taxation and an oligarchic (anti-socialist) state is not resisted, the economy will shrink. And as it shrinks, the wealthy will gain even more relative power, and make the tax system even more regressive – locking in a dynamic of economic and financial decline.

“Rapacious” and similar words are necessary to describe how the super-rich wish to “free” themselves from taxes, above all on financial wealth or property. They want whatever funds that government does have to be used for their benefit – to bail out financial losers (such as A.I.G. or Bear Stearns in 2008) so that winners such as Goldman Sachs can collect on bets that otherwise would be owed by deadbeats. The wealthy want subsidies and guarantees for their deposits, and to be “made whole” on whatever gains they are threatened with losing, regardless of how fictitious these gains may be, as in the case of junk mortgages. The aim is simply – crudely, often covertly, with bribery and junk economics as its rationale – to increase their share of wealth and income and to make their takings tax-free.

Everyone would like to be free of taxes. But only the rich have sufficient wealth to “buy up Congress” to give themselves enough tax breaks to shift the cost of running government off their shoulders onto the rest of society – and while they’re at it, to make sure that the government uses its resources to make the rich even wealthier, again at the cost of stifling the economy below them.

This is the situation into which American society is now falling. And at the end of this road is a flat-tax dystopia. It not only ends progressive taxation, it frees from taxes altogether the kinds of income that the wealthy take – returns to financial wealth and property.

The danger the United States faces today is that the government debt crisis scheduled to hit Congress next spring (when Republicans are threatening to vote against raising the federal debt limit as the government deficit soars) will provide an opportunity for the wealthy to give a coup de grace on what is left of progressive taxation in this country. A flat tax on wage income and consumer sales would “free” the rentiers from taxes on their property – just the opposite of Keynes’s hoped-for “euthanasia of the rentier.”

Obviously, all governments have to levy taxes – that is, they have to tax somebody. But the super-rich would like this tax to be shifted off their shoulders onto those who have to work for a living. In diametric opposition to Adam Smith and other putative “founding fathers” of “free market” neoliberalism, the super-rich want to shift taxes off “free lunch” economic rent – off interest, dividends, rents and capital gains – onto wage-earners.

This tax shift already has been underway for the past thirty years. It has doubled the proportion of the returns to wealth (interest, dividends, rents and capital gains) enjoyed by the wealthiest 1%, from a reported one-third in 1979 to an estimated two-thirds of the U.S. total today.

This regressive tax shift off wealth onto wage earners has occurred in three ways. The largest and most egregious was the Greenspan Commission’s ploy of moving the cost of Social Security and Medicare out of the general budget (where it would have to be financed by taxpayers in the higher brackets) onto the bottom of the scale in 1982. Instead of being treated as “entitlements” paid by the highest tax brackets, it is treated as “user fees” by employees with a cut-off (currently about $102,000) for higher-income earners. The pre-saved “Social Security fund” was invested in Treasury bills and then lent to the government – enabling it to cut taxes on the higher brackets. “Social Security and Medicare” became a euphemism for giving the government enough “forced saving” of labor so that the Treasury could cut taxes on the higher income and wealth brackets.

This First Great Republican Tax increase was folded into a reduction in tax rates across the board – above all on the highest tax brackets. This has been ongoing since 1981. The 1981 tax “reform” also gave an accelerated depreciation allowance to absentee property owners, permitting them to pretend that their real estate was losing value even as it was soaring in market price. The effect of this “fictitious property accounting” was to free the real estate industry as a whole from having to pay income tax. (The loophole was not available to homeowners!) The rental income thus “freed” was available to be paid to banks as interest.

Meanwhile, at the state and local level, governments have scaled back property taxes and replaced them with income taxes and sales taxes. These taxes fall mainly on wages and on consumer goods, not financial and property income.
The trick has been for Republicans (and “Blue Dog” Democrats) to pose as “tax cutters” rather than tax shifters. Many wage earners now pay more in FICA paycheck withholding and other taxes cited above than they do in income tax. These changes over the past thirty years have reversed the 20th century’s tendency toward progressive taxation with a regressive tax system.

The 2000 Republican presidential primaries saw Steve Forbes run on a plank that would be the capstone of this tax shift off wealth: a “flat tax,” one that would do away with taxing the wealthy more than blue-collar labor. Mr. Forbes was laughed out of the presidential primaries for proposing this flat tax. It was promoted as being “tax simplification.” The problem was that it is so “simple” that it falls only on employees and their employers as a wage tax.

The details are much more regressive than seem at first glance. The flat tax actually would tax wage earners much more steeply than the wealthy, whose income it would largely exempt! The flat tax is supposed to fall on employment, not returns to wealth. Employees and their employers would pay the tax, as they pay today’s 12.4% FICA paycheck withholding, but the flat tax would not be levied on financial and property income.

The flat tax is supposed to be accompanied by a European-style regressive value-added tax (VAT). By taxing “value,” it essentially falls on labor – as in “the labor theory of value.” The tax does not fall on “empty” pricing in excess of value – what the classical economists termed “economic rent,” that element of price (and income) that has no counterpart in actual cost of production (ultimately reducible to labor) but is a pure free lunch: land rent, monopoly rent, interest and other financial fees, and insurance premiums. This economic rent is the major return to wealth. It is grounded in the finance, insurance and real estate (FIRE) sector.

The effect of untaxing the FIRE sector is twofold. First, it increases the power of wealth, privilege, monopoly rights and property over living labor – including the power of hereditary wealth over the living. Second, it helps “post-industrialize” the economy, creating a “service” economy. A service economy is mainly a FIRE-sector economy. Does any of this sound familiar?

I think that matters are going to get much, much worse for U.S. taxpayers. In fact, we have a dress rehearsal of what is likely to occur already before our eyes. Un-remarked by the press, the flat-tax has been applied with increasing disaster abroad. One might think of this as a cruel psychological economic experiment to see just how far a national economy can be pushed in terms of income and wealth inequality causing poverty at the bottom of the economic pyramid.

Tigers in debt
The cruelest economic experiment has been in the post-Soviet economies. The “Baltic Tiger” Latvia has become a testing ground for how far living standards can be depressed, how steeply an economy can be taxed while removing public social support in the face of a wealthy kleptocratic class at the top.

Latvia’s GDP has plunged by over 22% during 2008-09, unemployment is rising, and the government has cut back spending on hospitals and health care, schools and other basic social integument. But what has most intrigued Europe’s ruling class is its tax favoritism that has created a Bubble Economy (euphemized as a Tiger Economy to make a debt-leveraged real estate bubble appear as if it were a road to wealth rather than to debt peonage). Latvia siphons off more than 51% of wage income in a flat tax – with only a 1% tax on property. This regressive tax system has been largely responsible for its property bubble.

When the Soviet Union broke up, neoliberal advisors were given a free hand in designing their ideal “free market” system. The result became hell for 99% of the population, but heaven for the top 1% who were given public property, enterprises, land, buildings, utilities and other property as part of their “wealth creation” windfall neoliberal style. This gave new meaning to “free” market.

Industrial production and agriculture have been scrapped, forcing the economy into chronic trade deficit – which was financed by an inflow of foreign mortgage loans (mainly from Swedish banks) to bid up housing prices for the Latvians. Without work, a rising proportion of young Latvians have had to emigrate – primarily to Ireland, only to experience the bursting of its own bank bubble this year. So without further ability of housing and property prices to rise – and hence, to pledge as collateral for bank loans – Latvia has had to borrow from the European Union (EU) and IMF.

This borrowing has involved the kind of “conditionalities” imposed only on prostrate Third World countries in times past. Last year the government cut back spending and raised taxes. But it is not enough.

My colleague Jeffery Sommers and I have written numerous articles on Latvia, and the story just gets worse and worse. The pretense is that EU and IMF lending is designed to “rescue” Latvia, to “help it get back on its feet.” The reality is that it is killing the economy – and the population, literally. I would not recount it here except to show the kind of disaster that is being celebrated as a success by the EU and IMF – and is being looked at as an object lesson by flat-tax advocates in the United States.

On November 22, Latvia’s Dienas Bizness newspaper reported how the new plan. It is to reduce the flat tax on income from 26 to “just” 25% (and as a sop to the poor, to raise the untaxable minimum from 35 lats to 45 lats a month (less than $90). The even more onerous “Social Security tax” (i.e., tax on wage-earners to free the wealthy from taxation) is to be raised to over 35%. (Employers are to contribute 24.09%, as before, while wage withholding on employees is raised from 9% to 11%.) The tiny 1% property tax will be roughly doubled and made slightly progressive.

The result is that employment taxes total 60% (25% + 35%). And it gets worse. The VAT on sales is 22%. Assuming that Latvians spend the entire remaining 40% of their wages on sales, this would amount to 8%. All totaled, this would raise the overall tax burden faced by wage earners to 68%.

However, this calculation does not take account of what Latvians have to pay for debt service on their mortgage loans, car loans and other bank debts, and on housing. If these costs amounted to just 25 or 30% of their income (much lower proportions than for the United States), this would absorb over 90% of their income before they have any month to spend consumer goods.

“Great,” say EU economic planners. Latvia has finally balanced its trade! Nobody can afford to import much. So the EU has held out Latvia as a model for Greece and Ireland to follow. In the Greek crisis, one read repeated articles urging it to “stand up and take it” like Latvians.

Here’s how Latvians are getting by – in much the same way that families in Ecuador and other Central American countries have done. The tax system is so regressive, so burdensome on industrial employment, that more than 12% of Latvia’s population is now reported to be working abroad. This leaves the elderly and the young at home, while working-age Latvians try their luck in the shrinking Irish and European economies. Their families are trying to live on what their working-age relatives can send back to the country!

The press has made much of the fact that Latvians have just voted back into office the same neoliberal coalition that has saddled them with the flat tax and VAT. What actually happened last month, however, was that the election was fought mainly over ethnic issues. The would-be progressive reformers of the neoliberal right-wing “reforms” consisted largely of Russian-speaking parties in the Harmony Center coalition. The neoliberals managed to steer voters along ethnic divisions rather than fighting the election over economic policy. So as so often happens in the United States itself, voters let themselves be distracted away from economic issues.
Yet another object lesson for “how to do it” in the United States …

Can a regressive flat-tax be pushed through U.S. Congress?
Returning to the U.S. economy, the wealthy want just what bankers want: the entire economic surplus (followed by a foreclosure on property). They want all the disposable income over and above basic subsistence – and then, when this shrinks the economy, they want the government to sell off the public domain in “privatization” giveaways, and they want people to turn over their houses and any other property they have to the creditors. “Your money or your life” is not only what bank robbers demand. It is what banks themselves demand, and the wealthy 10% of the population that owns most of the bank stock.

And of course, the wealthy classes want to free themselves from the share of taxes that they have not already shed. The flat-tax ploy is their godsend.

Here’s how I think the plan is intended to work. Given the fact that voters have already rejected the flat tax in principle, it can only be introduced by fiat under crisis conditions. Alan Simpson, President Obama’s designated co-chairman of the “Deficit Reduction Commission” (the euphemistic title he has given to his “Shift Taxes Off Wealth Onto Labor” commission, STOWOL) already has suggested that Republicans close down the government by refusing to increase the federal debt limit this spring. This would create a fiscal crisis and threat of government shutdown. It would be a fiscal 9/11, for the Republicans to trot out their “rescue plan” for the emergency breakdown of government.

The result would cap the tax shift off finance and wealth onto wage earners. Supported by Blue Dog Democrats, President Obama would shed crocodile tears and sign off on the most right-wing, oligarchic, anti-labor, anti-black and anti-minority, anti-industrial tax that anyone has yet been able to think up. The notorious Flat Tax which would fall only on wage income (paid by employees and employers alike) and on consumer goods (the value-added tax, VAT), while exempting returns that accrue to the wealthy in the form of interest and dividend income, rent and capital gains.

If you think I’m too cynical, just watch …

Footnotes

[1] Luke Johnson, “The rights and wrongs of going bankrupt,” Financial Times, November 24, 2010.