Michael Hudson: History of US shows economy grows when top tier tax rates and workers wages are high
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in New York City. Joining us now is Michael Hudson. He’s a distinguished research professor at the University of Missouri – Kansas City. He’s the author of Super Imperialism: The Economic Strategy of American Empire and the book Trade, Development and Foreign Debt. Thanks for joining us.
MICHAEL HUDSON, RESEARCH PROFESSOR, UMKC: Thank you.
JAY: So we’ve been having conversations. And let’s pick up on the issue of taxes. Now, during the Eisenhower years, the marginal tax rate at the highest level was 90 percent. Give us a little bit of the history, because that seems an astounding number compared to the debate that’s going on today. How did we get to that 90 percent? And then what happened?
HUDSON: But you got to that 90 percent right with the first income tax law that was passed in 1913. Under the original income tax law, only 1 percent of Americans had to file income tax returns, and you had to make the equivalent of about $120,000 in today’s dollars even to be liable to file. The idea of the income tax was to get what the classical economists called unearned income. Most people who made over $100,000 at that time got it from rent or interest, or the financial sector or the real estate sector.
JAY: What was the politics of the time that allowed such a thing to be passed?
HUDSON: It was called the progressive era. And you had–at that time the Republicans were still relatively progressive. You had the business schools believing in the economy of high wages doctrine and–that underlay American progress after the Civil War. The idea was that American labor could undersell foreign labor by being highly paid, because highly paid labor was well-clothed, well-educated, healthier labor. So the idea was to raise wages and the economy hand-in-hand, and it would be a feedback where there would be positive growth. And the essence of free market economics at that time, which is what the Republicans believed, and many Democrats, was that a market was free of interest and rent charges. The idea of free market from Adam Smith, John Stuart Mill, Henry George, and the American progressives was how do you free market from income and prices that are not necessary. And what is unnecessary in prices? Well, you need to pay wages, you need to pay the cost of living, but you don’t need to pay rent and interest. And the idea was that the government was initially to collect all of the higher rental income of land, that that was basically–land rent was created by public prosperity, it belonged to the public.
JAY: Now, this is a fairly radical departure, even from British capitalism, where all this emerged.
HUDSON: Not really.
JAY: I mean, rent’s a bit–was not a–the rentiers were a big stratum of the capitalist class [inaudible]
HUDSON: Yes, they were. But the ideal of–what had put all of this idea politically in was a right-winger, Henry George. Henry George was the antithesis of socialism, because he said, you don’t have to nationalize the land to take it over. All you need to do is to tax the land rent, and you can leave housing, commercial property in private hands, you can leave utilities in private hands. So whereas the European countries would take over electric power utilities as a nationalistic–nationalized public enterprises, in America we left the electric utilities, the gas utilities, most of the public infrastructure in private hands, but we taxed away the surplus and we regulated the prices, so that the idea was to keep prices in line with cost value. Now, this was what classical economics is all about. You have not only the labor theory of value, which was of necessary cost, but you had the price theory of economic rent, rent being the excess of price over and above the necessary cost of production. And so the income tax law said: how do we make the American economy more productive, so we can become the most productive economy and outcompete foreign economies? And the answer was: so that we can keep our prices in line with costs; and the costs will go up, our labor costs are going to go up, but our productivity is going to rise even more. So you had Democratic as well as Republican administrations doing wage productivity studies from the 1890s on that showed that highly paid American labor could undersell what was called proper labor. So you had America get rich by following the exact opposite of what Paul Samuelson says, the exact opposite of what is taught in international trade theory today, the exact opposite of what Nobel prizes are given for, that if you increase living standards, you make labor more productive. This is why Asia today is becoming more productive than the United States.
JAY: Okay. Let’s back up. So income tax is introduced in 1913. It’s at 90 percent at that time?
HUDSON: Ninety percent, yes. The–and right after the income tax was passed, you had World War I. So you had–90 percent, basically, is the–
JAY: Top marginal rate,–
HUDSON: –top margin. You can look it up on Wikipedia.
JAY: –on, you’re saying, 1 percent–.
HUDSON: Only 1 percent of the American population even had to pay a tax return. And that 1 percent that had to file tax returns paid up to a 90 percent marginal rate. Wikipedia gives a whole history of the American tax rate. This became normal during World War II. You had high tax rates in the–up to 90 percent not only here but in England, in Europe. You had, all over the world, very high marginal tax rates, because the theory was that over a given amount of income, you just didn’t need any more income, and that if you made more than, let’s say, 30 or 40 times what a normal worker made, it was probably unnecessary income, and it was income that was created by public spending and by public subsidy and public infrastructure. There was a whole different view of how the economy worked than what you have today.
JAY: But massive fortunes were accumulated during this period.
HUDSON: Yes, they were, even at 90 percent. You’re quite right. Massive fortunes were accumulated. And they were accumulated because even with paying high tax rates, you had the greatest prosperity of all. You could say that GDP, national income, and prosperity and wealth grows fastest when income tax rates are highest, and wealth slows in–the economy slows when taxes are cut. That’s counterintuitive, but if you look at any chart comparing tax rates and economic growth rates, that’s what you find. The 19th century knew it. The 18th century knew it. But today you have a kind of counterrevolution of junk economics that is basically anti-labor economics.
JAY: Now, in terms of attack on workers’ wages in the United States, one of the big attacks takes place right after World War II in 1946. There’s 5 million workers on strike. It’s followed by the Taft-Hartley Act, which goes after union rights. So talk about this period, ’cause it’s kind of a mixed bag here. While wages compared to now were relatively higher, it was still the beginning of a real onslaught against workers’ ability to organize.
HUDSON: That’s right. The–things changed after World War II, and you begin emerging from the war with an economy pretty much free of debt. There wasn’t much for consumers to buy during the war. Companies didn’t borrow. There were a lot of savings. Not only in America but in Third World countries and other countries you had pretty much a debt-free economy. So there was a lot of room. The economy had a heavy government debt, but there was very little–
JAY: You mean private debt.
HUDSON: –very little private debt after the war, hardly any consumer debt, very little corporate debt. There were heavy savings that were the counterpart to the debt. So debt wasn’t a problem after war. Every recovery since World War II has taken place with a larger and larger proportion of debt to income. So it’s as if you’ve been trying to drive a car with the break pedal pressed further and further, tighter to the floor, and now the debt is so high that you have debt slowing things down. So that’s changed a lot.
JAY: Okay. Let’s back up to taxes. So after the war you’ve got–still you’re up at a 90 percent marginal tax rate for the top–what? One, two percentile?
JAY: And then what? How do we get from there to here?
HUDSON: Well, steadily you’ve had two things happen after World War I, when it all began. Number one, you have a redefinition of income. So you give small-print tax loopholes to wealth so that wealth is not taxed. In the original income tax, capital gains were taxed the same rate as earned income, on the theory that if you have a capital gain and build up your savings that way, it’s just as if you’d earned the income to save it. There was a whole body of tax literature on this. Eighty percent of the capital gains in the economy are not capital gains; they’re land value gains. Real estate is the largest asset in every economy. And people think of America being an industrial economy and Europe being an industrial economy. All economies are still basically real-estate economies. The largest sector’s real estate. And within larger real estate, half the value is the land’s site value. So when you have a capital gain on a house, what you’re really selling is the value of that house. Well, once you had the capital gains tax cut to half the normal income tax rate, all of a sudden you made it possible for–.
JAY: When was that?
HUDSON: That was, I think, in the 1930s and ’40s. Today the capital gains rate is only 15 percent. That’s less than the 15.3 percent FICA withholding tax that workers have to pay in their Social Security and Medicare. So now you have, all of a sudden, the economy encouraging speculation in real estate, in stocks and bonds, instead of direct investment. So the result of lowering the taxes, of steadily lowering the taxes on the rich, has been to encourage money to be made in the way that the rich make their money, which isn’t on building factories. It’s not on employing labor. It’s on speculating on real estate, stocks, and bonds. And every day in the American economy, an entire year’s national income passes through the New York Clearing House every day and the Chicago Mercantile Exchange. The money is spent mainly on assets, on stocks and bonds.
JAY: When you say speculating in stocks, I mean, in theory that’s the way companies raise money to go, in theory, to do something productive, by selling stocks.
HUDSON: Take any stock in the United States. The average time in which you hold a stock is–it’s gone up from 20 seconds to 22 seconds in the last year. Most trades are computerized. Most trades are short-term. The average foreign currency investment lasts–it’s up now to 30 seconds, up from 28 seconds last month. So we’re talking about really short-term. The financial sector is short-term. They talk as if they’re long-term, because you have–essentially, economic discussion in this country is like a Chinese menu. You have what really happens in column A, and you have column B, what people would like. You take what really happens and you think, what word for what they’d like would be an appropriate label for this? So you can say–ripping off corporations and embezzlement, you can call that–Alan Greenspan would call that wealth creation. You have an appropriate euphemism for every kind of reality. But there’s a disconnect between the language that you use and what’s actually happening financially. And if you’re making money as sort of a–suppose you’re an ATM robber and you hold up somebody and you say, “Your money or your life.” The National Income Accounts would call that providing a service: you’re giving them the life, and you’re taking a payment for the service. Well, you don’t really do that, because you’re small scale. But when a pirate was taken before Alexander the Great, Alexander the Great said, what do you have to say for yourself? And the pirate says, well, I’m a little pirate. When I rob ships, you call me a pirate. But when you, the king, rob an empire, you’re called a great king. Well, that’s how the National Income Accounts do. When a bank tells a homeowner, your house or we’re going to foreclose, that’s not treated like an ATM. The interest in the fees that a bank get is part of a service economy. So when we have a service economy, this is what the 19th century called a free lunch economy, unproductive income–or unearned increment is what John Stuart Mill called it. You’ve all of a sudden replaced the classical economic vocabulary with a kind of euphemism, and then you pretend that Adam Smith and John Stuart Mill were your grandfathers and your patron saints, when actually Adam Smith and John Stuart Mill and the classical economists denounced almost everything that the Chicago boys and the junk economists that are appointed by presidential commissions are saying today is their received wisdom.
JAY: Thanks for joining us.
HUDSON: Thank you.
JAY: Thank you for joining us on The Real News Network.