Capital gains, mob psychology

Much of the political discourse on the recent capital gains tax reduction focused on the distribution of the benefits. The tax cut’s few opponents emphasized the gift to the wealthy in a society already characterized by unprecedented levels of inequality. But equally problematic is the ability of this tax change to deliver its supply-side promise.

It is unlikely to stimulate more investment or to assure that such investment goes to its most socially productive outlets. This tax cut will likely be paid for by reductions in other federal income support and educational programs long vital to states that, like Maine, are relatively poor and depend on cyclical industries.

Business interests maintain that lower capital-gains taxes will encourage citizens to save more of their income and invest it in the stock market, thereby fueling more corporate growth. Yet Warren Buffett, the legendary Berkshire Hathaway investor, commented some months ago that even with the old rate few people were foregoing investment out of concern about taxes. Market participation had already reached record levels. The nearly 30-percent reduction in the capital-gains tax rate thus represents an enormous windfall that will generate little new investment.

Won’t this lower rate at least encourage investors to sell shares in unproductive firms and move their money to more efficient and innovative managers? The problem with this line of thought is that most businesses generate funds for growth internally from profits rather than from the market. Most market activity involves resales of already outstanding shares of stock.

In any case, speculation on market winners and losers is often shortsighted and can have a destructive effect on economic productivity. Studies of the market show that both prices of individual shares and the market as whole fluctuate more wildly than underlying corporate trends would merit. Much stock market investment isn’t based on so-called fundamentals. Those who prosper in the market are making bets about how others will perceive a situation, and a mob psychology easily emerges.

Though stock price fluctuation doesn’t directly affect real investment in plant and equipment, it does often lead to adverse changes in corporate structure. Doug Henwood remarks in his new book, Wall Street: “The stock market isn’t just about prices, it’s about the control of whole corporations, which are bought and sold, combined and liquidated, often on purely financial considerations through the mechanism of the stock exchange. So the judgments of an ignorant, greedy, and excitable mob do have considerable real world effects.” Cutting capital gains taxes is only going to add to this volatility.

Those managements that don’t deliver steadily increasing quarterly profits are subject to hostile takeovers, leveraged buyouts, and other forms of reorganization orchestrated by pension funds, other managers, or activist shareholders.

Henwood remarks: “Big corporations, with easy access to the public (non bank) credit markets, have more money than they know what to do with.” Between 1981 and 1995, these corporations spent $1.9 trillion buying each other out, about a third of what they spent on productive investment. High levels of debt were incurred, making firms very vulnerable to subsequent downturns.

The academic literature suggests that most of this process of merger and acquisition did not foster long term economic efficiency or even steady increases in profits. Both to avoid hostile takeovers or as a result of those, downsizing — even of mid level management — became the order of the day. Cuts in forms of research and development that couldn’t be justified in immediate terms were also mandated. Henwood writes: “Throughout the late 1980’s and early 1990’s the stock market rewarded firms announcing write-offs and mass firings — a bulimic strategy of management — since the cost cutting was seen as contributing rather quickly to profits. Firms and economies can’t get richer by starving themselves, but stock market investors can get richer when the companies they own go hungry — at least in the short term. As for the long term, well that’s some else’s problem for the week after next.”

Part of getting the economy back on track requires curbing the casino economy. Rather than rewarding and encouraging market manias, we ought to be considering a tax on speculative security and currency transactions. And in an economy where corporate profits and the investments of the wealthy are so often misdirected, a modest wealth tax like Switzerland’s would also be entirely appropriate. A wealth tax could fund public investment in education, transportation, and basic research, the capital formation that most effectively promotes modern economic development.

In the long run, sluggish wage growth and inequality characterizing this society are unlikely to abate until workers and communities gain a greater say in how corporate profits are reinvested. Continuing attacks on the most minimal worker rights, as exemplified in the recent UPS dispute, provide a sad reminder of how far we are from such a politics. Nonetheless, more complete understanding of markets and their excesses is a necessary first step in our political reconstruction.

John Buell is a political economist who lives in Southwest Harbor.