Alan Blinder and Ben Stein don't often agree on economic issues, but this week in their respective columns in the New York Times, they joined in an attack on Wall Street's welfare queens, equity fund managers who make 100 of millions, but pay a lower percentage in taxes then their secretaries. Prof. Blinder is a former deputy chairman of the Federal Reserve Bank and a frequent adviser to Democrats; Mr. Stein is a Conservative economist, actor, and investor. They are united, however, on the issue of tax fairness. Prof. Blinder takes on the hedge fund managers who “earn” excessive salaries, but pay little tax. They are normally compensated on a “2 and 20” scheme: they get 2% of the total funds under management and 20% of the profits. So, for example, a manager of a fund with $2 billion in assets that makes 15% return gets a $40 million management fee plus 20% of the $300 million profit, or another $60 million, for a total income of $100 million. The $60 million is not taxed as ordinary income, but as capital gains which means it is taxed at a rate of 15% for a tax bill of $9 million. But if it were taxed as ordinary income, at 35% plus 2.9% for payroll taxes, the bill would be $22.7 million, or a savings of $13.7 million. Note also that the total $100 million compensation means investors are paying one-third of the profits to a manager. Why would investors accept such an arrangement?
The reason for taxing capital gains at a lower rate is that it is supposed to encourage investment. But as Prof. Blinder points out, it really favors one kind of investment over other kinds. Indeed, the Tax Reform Act of 1986 taxed capital gains at the same rate as income without affecting investment at all. Indeed, the problem in the economy right now is not too little capital, but too much, capital that has difficulty finding profitable investment opportunities; that is why investors are willing to accept such law returns and high fees. Instead of real investment, that is, giving funds to entrepreneurs to expand production, the money goes to stock-market speculation (which provides almost no new funds to business) or to consumer credit (usury).
Ben Stein takes on the private equity funds that rip, strip, and flip companies. Using just a small sliver of their own capital, the managers buy up companies, tear them apart, lay-off workers or outsource them, and sell off the pieces at a profit, profit that is taxed at the capital gains rate. As Ben Stein points out: We are in a war. We are apparently not winning the war. The military is desperately shy of funds, to the point where our fighting men and women are being shortchanged in training and equipment. We also need more money for our soldier's pay, so their families do not live like church mice while their spouses are deployed in Iraq or Afghanistan. In these circumstances, it is fitting and morally right for the richest of the rich to be paying either very low taxes or no taxes at all?...Or, put it like this: do we dare send our men and women to fight for an America in which the very rich are so favored by the government that it amounts almost to an aristocracy?
It is this last point, the rise of an aristocracy, that is most telling. American government (Democratic or Republican) now serves the rich more and more to the detriment of the common good. That is to say, our government long ago ceased to be a real democracy, and has become an oligarchy in which government serves only those with money. And oligarchy, as G. K. Chesterton points out, is not really rule, but a riot—a riot of the rich. But riot is the very definition of disorder. As Ben Stein puts it, Long ago, I had a European history teacher [who said] that one of the causes the French Revolution was the sad truth that the aristocracy was not taxed at all, while the workers and burghers were taxed highly. Is this our future?
When even Ben sounds like a Bolshevik, you know there is a serious problem.