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Friday, March 11, 2011
 What people say about Social Security...

Topic: Commentary

In the grand scheme of things Social Security isn't one of the most important issues at the moment in terms of budgetary concern. The program is relatively secure, well funded, and well liked, however the way in which people talk about Social Security is an extremely important indicator of their overall approach to dealing with America's fiscal issues, their understanding of America's budget problems, and the ways in which they are likely to address other budgetary and fiscal issues.

How people address Social Security is such a important indicator of their overall knowledge and approach to budgetary and fiscal issues because the finances of Social Security are so simple and straight forward. It is an easy system to understand, with well defined inflows and outflows, and no complex budgeting.

Before we go any further we have to keep in mind that Social Security is funded by the FICA tax (which also includes the 2.9% tax for Medicare as well), and the Social Security portion of the FICA tax has always only been applied to payroll income up to a certain limit. That limit changes over time and is currently $106,800, which means that the 12.4% FICA tax rate is only applied to income from wages and salaries, not capital gains, etc., and it only applies to income below $106,800. Thus, the FICA tax is the most regressive tax in the country, and right now the total revenue raised from the FICA tax is roughly equal to the total revenue raised from the income tax. This means that the taxes raised from payrolls under $106,800 is virtually the same as the taxes raised on all other income. Over the past 30 years this has not generally been due to increasing levels of Social Security taxation, but falling levels of taxation on individual income and corporations. During this time, excess revenue from Social Security has served as a major source of revenue for the federal government, essentially offsetting tax cuts on higher incomes and corporations. It has essentially been a highly regressive stealth income tax.


source: http://motherjones.com/politics/2011/02/income-inequality-in-america-chart-graph

We often hear people claim that addressing America's long-term deficits will require "reforming entitlement programs", including Social Security and Medicare. While future Medicare spending is projected to grow significantly, which will likely lead to future budget problems, Social Security does not currently, and never will, contribute to America's deficit. In fact, Social Security is forbidden by law from ever running a deficit. Social Security cannot legally ever go into debt or add to the deficit, and so, regardless of anything else, Social Security is not now, and will never be, a contributor to the federal deficit. If Social Security revenues are insufficient to pay promised benefits, the system is required by law to pay lower benefits, not to borrow to pay promised benefits.

There are in fact two completely different issues that have to be considered when talking about Social Security finances, paying back the "Trust Fund" and long-term budget shortfall forecasts. First lets address the Social Security "Trust Fund" issue.

When many people talk about Social Security adding to the deficit, what they are talking about is the "repaying" of the Trust Fund. What "repaying" the Trust Fund actually involves is "selling" the securities held by the Trust Fund. How this is exactly done can make a big difference. Over the past 30 years $2.5 trillion in excess Social Security taxes have been collected and "put into the Trust Fund", which essentially means that they have been buy long-term government bonds, thus that $2.5 trillion served to finance the national debt. It is a debt owed to American workers and retirees who paid excess taxes for the past 30 years in order to establish a "savings" for payment of Social Security benefits to the baby boomer generation.

What is important to keep in mind is that the Social Security system is not the cause of the debt, the Social Security system was used to finance debt that was already being incurred. If either the Social Security Trust Fund didn't exist or the money for the Trust Fund was put into something else, like for example invested in the stock market, either that debt would still have been incurred or income taxes would had to have been raised in order to avoid the debt, which means that total tax rates would had to have been higher for the past 30 years had the Trust Fund not existed in its current form.

To say that any strains placed on the budget due to the redeeming of securities in the Trust Fund are "caused" by Social Security would be like saying that the Chinese are a cause of our deficits due to the fact that we have to pay them back for the money we borrowed from them. Or, as a more individual example, it would be like borrowing money from your 401K (which you are legally required to pay back), and then when you have to pay the money back, stating that your 401K is the cause of you not having enough money.

The fact is that Social Security taxes have been financing the deficit for the past 30 years. Over the next 30 years there won't be a Social Security surplus to continue financing the deficit, and on top of that, either money will have to be raised from general revenue to pay for the securities that are redeemed from the Trust Fund each year to pay for Social Security benefits, which would reduce the national debt, or those securities will have to be sold to other debt holders, thus doing nothing to reduce the debt, just transferring it from the Trust Fund to private debt holders.

Any attempt to "reduce the deficit" by making changes to Social Security necessarily means defaulting on the debt, or at the very least extending the terms of the loan agreement in such as way as to defraud those who paid in the extra taxes in the first place. Social Security itself will never ever add to the deficit, it legally can't. The only thing that can happen is that it can have insufficient funds to pay the scheduled benefits, but it can't run a deficit.

Any talk of raising the retirement age or reducing benefits in order to "reduce the deficit" really equates to defaulting on the securities held by the Trust Fund, not paying back money that is owed the Social Security system, ultimately the American retirees who paid into it. But those who claim that reductions in benefits are needed to "reduce the deficit" don't put it that way. What they are really saying, however is, "our plan to reduce the deficit is to not pay back our creditors," and in this case, "our creditors" are us. Framing the issue as deficit reduction is just a way of tricking the public into agreeing to being defaulted on by the federal government.

The federal government currently has a debt of over $14 trillion, of which $2.5 trillion is held by the Social Security system. Of that $14 trillion in debt, the $2.5 trillion held by Social Security is the money we should be most obligated to pay back in a timely way. The other $11.5 trillion is owed disproportionately to wealthy individuals, institutions, and foreign governments, those who least need it. The $2.5 trillion owed to Social Security is owed  disproportionately to America's least advantaged, the disabled and elderly, and mostly to those in the poor and middle class. Make no mistake, what those advocating "reducing the deficit through adjustments to Social Security" are talking about is writing off a portion of that $2.5 trillion which is owed to America's poor and middle class retirees, in order to make it easier to pay back the $11.5 trillion owed to wealthy bond holders and foreign governments.

The simplest way to think about it is that the Social Security Trust Fund, for the past 30 years has forced America's poor and middle-class to become one of the largest financiers of the national debt. Of all of the national debt, the debt financed by the Social Security Trust Fund is the portion of the national debt most heavily paid for by poor and middle-class Americans.

Claiming that paying back the money owed to Social Security will "add to the deficit" is no different than saying that paying back any of the debt we owe will "add to the deficit". The lenders aren't the cause of the deficits, the borrowing is the cause. The Social Security system (financed by taxes levied entirely on low and middle incomes) has been one of the major lenders to the federal government for 30 years, now the bill is due.

Now let's move on to issue number two, the long term funding of Social Security.

The Social Security system is currently on track to exhaust the money allocated to the Trust Fund and be unable to meet the currently projected benefit obligations in about 30 to 50 years. That's a pretty long way off. At that time the Social Security system, according to current projections, would not have enough money coming in to pay out the promised benefits. At that time it is estimated that if nothing at all is done, Social Security would be able to pay out approximately 75% of the currently scheduled benefits indefinitely, meaning that if no changes are made, in about 40 years the benefits would be about 75% lower than what the currently promised benefits for those retirees are. However, also keep in mind that the way that benefits are calculated also means that in about 40 years the currently promised benefits would be higher, even after adjusting for inflation, than what current recipients receive. This is because benefits grow faster than the rate of inflation (which is a potential problem with the benefit calculation), so the fact that we wouldn't be able to pay the fully promised benefits in 40 years doesn't even mean that people in 40 years would be getting less than people now, it means they would probably be getting the same amount as people now, because the promised benefits for people retiring in 40 years are higher, even after adjusting for inflation, than what people get today (according to projections, which are so far off they could be largely meaningless).

So even doing nothing at all is no tragedy. But the real question is, why do we have this projected shortfall in the first place, since back in 1983 the National Commission on Social Security Reform, appointed by Ronald Reagan and headed by Alan Greenspan supposedly "fixed" Social Security for good by significantly raising the FICA tax (from 6% to 12.4%) and eliminating various exemptions, etc.?

The biggest factor in the projected shortfall of Social Security has been increasing income inequality. When the calculations were made for funding Social Security they were made based on the assumption that both the ratio of payroll income to capital gains would stay the same and the distribution of payroll income would stay the same. After all, these ratios were relatively stable for the 30 years that preceded the action of the Social Security Commission (which began meeting in 1982). The data that they had to look at showed stable income distributions for 30 to 40 years. However, beginning in the 1980s income distributions began shifting dramatically, both the portion of Gross National Income going to payrolls and the distribution of income within payrolls.

What has happened over the last 30 years is that the portion of national income subject to the FICA tax  has steadily decreased. It is sometimes noted that back in 1983, then the revisions to Social Security were made, that 90% of payrolls were subject to the FICA tax, and today that has dropped to around 84%, but what most people fail to also point out is that payrolls themselves, as a percentage of national income, have been falling as well.

In 1983 close to 60% of Gross National Income was subject to the FICA tax, whereas today that has dropped to around 53%.


source: http://www.stateofworkingamerica.org/charts/view/160


Comparing the percentage of national income subject to Social Security taxation prior to 1983 is largely meaningless since the rates were much different, the caps were different, and there were many different exemptions from the program, etc., so it's simply not comparable.

This is the the fundamental root cause of the long-term funding issues with Social Security. Anyone who attributes the long-term funding issues with Social Security to any other cause, such as declining number of workers to retiree, people living longer, etc., etc., is either lying or doesn't know what they are talking about, period, it really is that simple.

The number of workers per retiree has been stable at around 3 workers per retiree for 40 years, and is projected to fall to 2 workers per retiree by 2030. While this is a decrease in the number of workers per retiree, productivity per worker has also increased dramatically over this time as well and can be expected to continue in the future. The problem is simply that over the past 30 years 98% of that economic increase has been captured by the highest 10% of income recipients, and thus virtually all of the increased productivity over the past 30 years has been untaxed by FICA, and without any changes will continue to be untaxed by FICA in the future. We could easily support an increasing number of workers per retiree if all, or at least more, economic growth were taxed by the Social Security system. The way the system currently works it is as if we are trying to support an increasing number of workers per retiree in an economy with zero economic growth. That, of course, wont work. The taxes being paid into the Social Security system over the past 30 years have been capped in such a way as to not capture any economic growth, only population growth, it is as if Social Security in 2011 is still being funded by the economy of 1970.

There are three ways to address this problem. The first is to get income distributions back to the way they were in 1980 and keep them there forever. The second is to change the formula for calculating the FICA tax cap so that it is pegged to the percentage of payroll income needed to fund Social Security instead of to a wage index (meaning that if we need to tax 90% of payrolls to fund the program, then set the cap to whatever will capture 90% of payrolls each year). The third would be to fully eliminate the cap on the FICA tax and apply the FICA tax to capital income as well as payroll income.

The first option is obviously the least likely to ever happen. That's pretty much a non-starter, even if you are in favor of lower income inequality. We can't rely on lowering income inequality to fix the system. That option is out.

The second option is workable, and unfortunately is probably along the lines of what would most likely be done. It still isn't perfect and will still have problems dealing with a changing ratio of capital and fringe benefit income to payroll incomes. If the portion of national income going to capital gains continues to increase, even this fix will eventually run into the same problem that we are currently facing. In addition, this would also mean preserving the currently exorbitantly high FICA tax rate of 12.4% on all payrolls below the cap.

The third option is to remove the FICA taxation cap entirely, and apply the tax to capital income in addition to payrolls. This also necessarily implies keeping the benefits the same as what they are now, even though people with high incomes would be contributing much more into the system. However, by doing this it would effectively solve the problem of income distribution leading to shortfalls, and it would allow for a significant reduction of the FICA tax. The current FICA tax of 12.4% could be cut roughly in half to around 6% and still bring in more money than currently, if the cap were removed and it were applied to capital income as well.

This means that someone with an average income of $5 million a year for 30 years would pay $9 million in FICA taxes, but still only receive roughly $2,000 a month in retirement benefits.

The third option, or at least the option of removing the taxation cap, is also by far the most popular option among America. Every poll for the past 5 years that asks about ways to fix Social Security funding and gives the option of "remove the taxation cap" has shown that removing the taxation cap is favored overwhelmingly by roughly 70% of Americans and is always the number one option selected as the best way to fix Social Security finances. See as one example: Poll: Fix Social Security by Taxing Wealthy

When the Social Security Commission met they combined the OASI (Old Age and Survivorship Insurance) and DI (Disability Insurance) programs into OASDI. The 12.4% FICA tax now goes toward OASDI combined. Of that 12.4% tax, however, 1.8% of it goes to the DI program. Even president Obama's conservative deficit commission has listed eliminating the cap on the DI portion. So, if nothing else at least that should be done, and be done quickly. By eliminating the cap on the DI portion the DI tax rate could probably be reduced to 1.4% (cutting the total FICA tax to 12.0%) and still bring in more revenue.

As it stands right now, we have a situation where essentially the entire burden of paying for the disabled falls entirely on the poor and middle class, while those with high income pay virtually nothing toward the care of the disabled. This, of course, is completely ludicrous.

To sum things up here, the fact is that the finances of the Social Security system are not a pressing issue, but nevertheless what people say about the finances of the Social Security system can tell you a lot about both their understanding of the federal budget and their ideological biases.

Anyone who claims that "fixing Social Security" is a component of reducing the deficit is either lying or uninformed, period. The Social Security system never has and never will add one dime to the deficit. The Social Security system, through taxes levied entirely on middle to low wages, has been one of the biggest financiers of the national debt for 30 years. The root cause of all of the fiscal problems with Social Security is income inequality and a system of taxation and benefit adjustment that doesn't take changing levels of income inequality into account. The system was designed under the assumption of static levels of income inequality and a static level of gross national income going to payrolls. As both the portion of national income going to capital income has increased and income inequality has increased both the revenue and expenditure have failed to account for these conditions and thus revenues are falling behind and expenditures are increasing too much.

The way to fix the system then, is not to do something like raise the retirement age, which is just a completely unrelated action that just works around the underlying problem, but rather it is to fix the formulas or take income inequality completely out of the equation by eliminating the taxation caps and applying the tax to all forms of income. The first solution, fixing the formula, would result in a balanced Social Security budget and the ability to keep the benefits essentially unchanged while raising the FICA taxation cap and keeping the tax rate the same, while the second solution would allow us to cut the FICA tax roughly in half while still maintaining benefits. In addition, taking either one of these actions, by bringing in more revenue immediately, would allow for a slower draw down of the Trust Fund, thus reducing the rate at which that debt would have to be paid back, while neither decreasing benefits nor raising taxes on the poor or middle class, who have already been overpaying for the past 30 years.

See also:

The Truth About Social Security

The real deal with Social Security

REPORT OF THE NATIONAL COMMISSION ON SOCIAL SECURITY REFORM JANUARY 1983


Posted by rationalrevolution.net at 10:44 AM EST | Post Comment | View Comments (33) | Permalink
Updated: Wednesday, March 16, 2011 7:41 AM EDT
Monday, March 7, 2011
 Clarifying Wisconsin Pensions

I had been trying to write a post about the Wisconsin pension system for about a week, but was unable to confidently do so due to lack of clear and reliable information. I have finally been able to get enough solid information to make some reasonable statements about the system, in large part thanks to a March 3rd posting on the Wisconsin Employee Trust Fund website.

The main reasons to even focus on this issue are the way in which it has been reported in the corporate media, and even by outlets such as NPR, as well as the many misconceptions that people have about public retirement benefits in general.

See the following for some examples: Really Bad Reporting in Wisconsin: Who Contributed to Public Worker's Pensions? (Note that even this article I believe gets a few things wrong, or at least not clear)

First let's just get all of the basic facts on the table:

  • This entire discussion about governor Scott Walker's actions in relation to public workers' benefits and collective bargaining rights in Wisconsin is in relation to Wisconsin State Senate Bill 11.
  • The Wisconsin public employees pension system is 99.8% fully funded, and stands as among the most financially secure state pension systems in the nation.
  • Virtually all of those participating in the state pension system are exempt from Social Security, they pay no Social Security taxes and accrue no Social Security benefits while participating in the pension system.
  • The total percent of payroll contributed to the pension system varies each year and by classification of the employee, but is generally around 11.2%, less than the percentage of payroll taxed by Social Security.
  • The bill proposed by governor Scott Walker would not reduce the retirement benefits for anyone currently participating in the pension system, either as current recipients or future recipients.

Those are the basics, from there it gets a little more complicated.

First, the state pension system in Wisconsin does not have financial problems. It is not under-funded, and the immediate effects of Senate Bill 11 would not do anything to change the total amount of money going into the state pension system, nor would it do anything to reduce the retirement benefits of those in the state pension system. As such, the effects of this bill have nothing (directly) to do with long-term fiscal issues relating to the retirement system. (There are some provisions I'll get to later that could have a big long-term impact though)

Thus, any claim that this legislation is needed to address long-term pension obligations or anything like that are completely unfounded, because the legislation does not directly have any impact on the long-term benefit obligations of the pension system.

Secondly, and this is important because it is one of the major areas of confusion, what this bill states (which I have not been able to independently verify) is that under current law it is possible for the employer to pay the "employee's" pension contribution portion, and what this bill would do is eliminate that provision.

This is the meat of the issue. Currently the pension agreement for general state employees (this 90% of state employees and is the main focus of the legislation), states that 6.2% of the pension contribution (for 2009 for example) is to come from the employee, while 5% is to come from the employer. See: Wisconsin Retirement System Fact sheet

To think of this in the way that Social Security works, for anyone who is a full-time or part-time  employee, they have 6.2% of their income (up to a limit, currently around $106,00) taxed from their paycheck by FICA, the Social Security tax. Their employer contributes another 6.2%, for a total of 12.4%. If you are self-employed, etc. then you pay the entire 12.4% yourself.

What this legislation states is that while there is a similar agreement in place for public employees, what is happening is that some public employers are "paying the employee's share on their behalf".

What this means is that if an employee has an annual salary of $50,000, under the agreement they should be paying $3,100 into the pension system each year from that $50,000, and the state should be contributing an additional $2,500 on top of the $50,000. Apparently, however that isn't happening, apparently some departments are paying the "employee share", so that with $50,000 in annual salary, little or nothing is coming out of the $50,000, while almost the entire $5,600 is being paid by the state on top of the $50,000. This is, in effect, a backdoor raise.

Now I don't pretend to know how this situation came about or why it exists, but I would agree that this sounds like bad practice, for multiple reasons from the purely bookkeeping to the political reasons on display now.

However, for anyone who came into the system with such an agreement in place what simply changing this practice means is that forcing the employee portion to come out of the employee's paycheck will act as a pay cut. If someone agreed to a job based on the provision that their retirement contributions wouldn't come out of their paycheck, then of course this will result in a loss of agreed upon benefits, their pay will go down.

So the real effect of the legislation is to reduce current state payrolls, not to do anything about long-term benefit obligations. Under the proposed change the long-term obligations will stay exactly the same. Personally, I'm opposed to the whole notion of hidden "employer paid" fees for anything, be it Social Security, pensions, health care befits, whatever, and think that all of these things should visibly come out of the employee's paycheck, BUT, I think that the portion of all of those things currently being paid by employers should be paid to the employee, not that they should be paid by the employee without any changes to employee pay. But of course, doing that would never be in the cards in this case because the whole point of the legislation is to reduce spending, whereas what I'm talking about would be completely spending neutral.

To claim, however, that the state employees were somehow getting a "free ride" is nonsense as well, because ultimately all compensation agreements are in respect to the entire compensation package. If private employees participating in Social Security were told, "Employers will no longer have to contribute to Social Security, but you still have to pay 12.4% so the full 12.4% will now come out of employee paychecks," this would essentially be no different than what is taking place in Wisconsin. It's just a matter of accounting in the first place. If a teacher takes a job at $40,000, with $5,000 in benefits paid by the employer, then that's no different than $45,000 with $5,000 taken out each year for benefit contributions. What this legislation does is take people who agreed to the first scenario and then shove them into the second, but without adding $5,000 to their paychecks. It is a permanent, long-term, salary reduction.

So that much is clear, but what about the claim that the public pension systems are costing tax payers more, due to their "generous benefits"? Actually, at least in Wisconsin, this is not true, and in fact under the legislation I believe the total benefit contribution will go up, from 11.2% to 11.8%, so the benefit  itself will actually cost tax payers a little more, though this will be more than paid for by the effective salary reductions on public employees.

But the point is that if these employees weren't exempt from Social Security (something I'll cover in a later post) they would be costing tax payers more, because then they would have to pay 12.4% of payroll to Social Security as opposed to the 11.2%-11.8% of payroll that the pension currently cost.

But, the benefits are better right, so it must cost more somehow? Not so. Yes, the benefits have historically been a little better, namely that you can retire earlier (as early as 57 for general employees), but this doesn't cost tax payers anything, this is a product of the fact that the pension system generally is able to generate more benefits from less contributions, because pensions are investment systems (similar to what a "privatized" Social Security system might look like). The state pension requires that workers contribute for a minimum of 30 years, and after 30 years of contribution there is a minimum retirement of 57, so after age 57, once you have contributed for 30 years you can draw benefits, with a maximum retirement age of 65, meaning that anyone can draw benefits by age 65, no matter how long they have contributed.

So, at least in regard to the pensions, while the benefits are a little better, they aren't "costing taxpayers more". I'll save the discussion of pensions vs Social Security for a later post as well.

However, after having gone through all of that, the most interesting part of the whole bill in relation to pensions is the following provision on page 124:

(3)  MODIFICATIONS TO WISCONSIN RETIREMENT SYSTEM.
(a)  The secretary of administration, the director of the office of state
employment relations, and the secretary of employee trust funds shall study the
structure of the Wisconsin Retirement System and benefits provided under the
Wisconsin Retirement System.  The study shall specifically address the following
issues:
1.  Establishing a defined contribution plan as an option for participating
employees, as defined in section 40.02 (46) of the statutes.
2.  Establishing a vesting period of 1, 5, or 10 years for employer contributions
under section 40.05 (2) of the statutes and for eligibility for retirement benefits.
3.  Modifying the supplemental health insurance premium credit program
under subchapter IX of chapter 40 of the statutes.
4.  Permitting employees to not make employee required contributions under
section 40.05 (1) (a) of the statutes and limiting retirement benefits for employees
who do not make employee required contributions to a money purchase annuity
calculated under section 40.23 (3) of the statutes.
(b)  No later than June 30, 2012, the secretary of administration, the director
of the office of state employment relations, and the secretary of employee trust funds
shall report their findings and recommendations to the governor

Basically, this says that the governor is interested in replacing the entire pension system with a 401K style system, which means defined contributions but no defined benefits. This talks about making it optional, but it appears that the intention is to start trying to transition public employees out of the pension system altogether. Permitting employees to not make contributions and also not receive benefits would be an obvious tactic for trying to just drive employees out of retirement benefits altogether, if they aren't paid enough to make ends meat now, they'll elect to opt out, then once they get old, they are just screwed.

At any rate, after about a week of looking into this subject, this is what I've come up with. My conclusion is that overall the reporting on this subject has been both hugely lazy and irresponsible. Most articles, even from major outlets  like the New York Times, NPR, and USA Today, etc. haven't relied on solid sources, they have mostly just used the press releases and talking points from the governor as their source, and they have allowed the governor's spin to color their own descriptions of the situation. Even those "on the other side" haven't really gotten it right either.

The ultimate point is that the pension system in Wisconsin is financially sound and the legislation supported by the governor doesn't reduce future pension obligations. Some public employees currently do apparently (and I haven't even been able to fully verify this myself) have a portion of their pension contribution which is designated as the "employee portion" paid by their employer (the state) which means that they are able to take home a larger portion of their gross income. The legislation in question seeks to eliminate this practice, without providing additional compensation to the employees from which to pay that portion. This would result in an effective pay cut for the employee, while do nothing to change the total amount going to the pension system (although there is an additional provision to increase the amount a small bit as well). The overall cost of the pension contributions of public employees has been and will remain lower than Social Security, thus the pension system is actually a less expensive benefit for public employees than Social Security would be. And furthermore, the public employees have already agreed to the proposed changes regarding the employee portion of the pension contribution anyway.

This post isn't actually what I was planning on writing about initially, but I figured just getting the facts straight was important in the first place.  I'll write another post about pensions vs Social Security (my initial intention) at a later date.


Posted by rationalrevolution.net at 11:22 AM EST | Post Comment | View Comments (6) | Permalink
Updated: Tuesday, March 8, 2011 7:22 AM EST
Tuesday, February 22, 2011
 Redistribution vs. Redistribution

Topic: Commentary

One of the major claims/beliefs of conservatives, including genuine middle-class "Tea Party" type conservatives who are genuinely concerned about the state of the American economy, is that "redistribution of income" from income earners to welfare recipients is one of the major causes of stress on the American middle-class.

According to the Heritage Foundation (a major conservative think tank), welfare spending has increased from 0.5% of GDP in 1962 to 4.4% of GDP in 2010. The welfare programs cited by the Heritage Foundation are all clearly redistributive programs. These are food stamp, housing assistance, Medicaid, and income assistance programs.

The Heritage Foundation puts total welfare spending in 2010 at $648 billion.

It is absolutely true that there has been an increase in spending on anti-poverty programs over the past 50 years, and that spending on welfare programs is higher today than it has ever been, and it is absolutely true that these programs constitute "redistribution of income" from income earners to those with less or no incomes, however, this isn't the whole picture of redistribution in America.

If we grant that this $648 billion roughly represents the "forced" redistribution from the haves to the have-nots in America today (surely there is some charity in addition to this spending, plus there are other less direct programs that benefit the poor such as public schools, etc), the next question is, what about redistribution from the have-somes to the have-mores?

The middle-class is definitely getting squeezed in America, but who is doing the most squeezing?

Capital income is also a form of redistribution, which is why it is classified by the IRS as "unearned income". Income from capital constitutes income from dividends, interest, rents, and gains from the sale of capital, i.e. selling a stock for more than what you paid for it.

Ultimately all capital income is a tax on wages. Capital income comes from owning property, not from doing work. The value used to pay capital income has to be produced by work. Without work being done there can be no capital income.

Using a similar time-frame as that of the Heritage Foundation, what we find is that from 1960 to 2010 the portion of national income going to capital has increased from roughly 14% to 24%. The portion of national income going to wages has dropped from 67% in 1960 to 55% in 2010. If we look at the portion of wages going to the bottom 95% of the population what we find is that this has dropped from roughly 62% in 1960 to 44% in 2010. Sounds unbelievable I know, but that's the case. Only about 44% of gross national income in 2010 went to the wages of the bottom 95% of income earners. Even when we add in proprietor's income (income of small business owners) for the bottom 95% that still only adds up to around 52% of gross national income.


source: http://www.stateofworkingamerica.org/charts/view/138

Now even if we ignore the wage issue and just focus on capital income alone, what we find is that in 1960 roughly 1.5% of gross national income went to the capital income of the top 5%, however as of 2010 roughly 12% of gross national income went to the capital income of the top 5% of income recipients.

So let's consider this. In 1960 roughly 0.5% of gross national income went to welfare programs for the poor and roughly 1.5% went to the capital income of the rich. Both of these are forms of redistribution from workers.

As of 2010 roughly 4.5% of gross national income went to welfare programs for the poor and roughly 12% went to the capital gains of the rich, and again, both of these are forms of redistribution.

This doesn't even take into consideration disproportionate income gains in the areas of wages and benefits, which I would argue have also been redistributive in relation to executives and other ultra-high income individuals, however there is a problem here of double counting, because a portion of that 4.5% going to welfare programs is actually paid by the rich, and so it isn't actually a direct drag on the middle-class. It is, in effect, a tax on the income that is redistributed from the working-poor and middle-class to the rich, and then redistributed back to the poor. But since welfare programs at the federal level are funded primarily from more progressive income tax, and the top 5% currently pay roughly 60% of federal income taxes, let's attribute 60% of that 4.5% of GNI to the rich, which leaves only 1.8% of middle-class income going to support the poor through federal taxation.

Let's also consider that some portion of the increased capital income of the top 5% in America is a product of redistribution from foreign workers, and thus not directly redistribution from American workers. Let's assume that one third of the capital income of the top 5% of Americans comes from foreign workers, that still puts the redistribution from American workers to rich capital owners at around 8% of gross national income.

So we conclude that somewhere around 1.8% of all income below the 95th percentile is being redistributed toward federal anti-poverty programs, and somewhere between 8% and 12% of income below the 95th percentile is being redistributed in the form of capital income to the top 5% of income receivers. (Note that this likely grossly underestimates the full level of redistribution from the middle-class to the rich since it doesn't take into account inflated fringe benefits and wages that are also partly paid for by underpaying middle-class workers.)

Whether or not you support the concept of capital income or believe in the merits of capital income as a driver of investment in productivity, etc. the fact is that the pie has to be split between wages and capital income, and the fact is that over the past 40 years that pie has been increasingly split in favor of capital, not wages.

We can clearly see the effects of this on compensation in relation to productivity. As productivity has soared, wages for the middle-class have stagnated. This is because the increases in productivity have gone increasingly to capital, executive bonuses, and ultra-high wage receivers, again like executives.


source: http://www.stateofworkingamerica.org/charts/view/145

The fact that the income pie is going increasingly to capital isn't a problem in and of itself, in fact this is in many ways a good thing, the problem, however is that virtually all of the capital is owned by the wealthiest 5% of the population, and this is why the net effect is hugely redistributive. If capital ownership were broadly shared, then this effect wouldn't be considered redistributive, but under the current condition of high capital ownership concentration it is.

So if we consider the middle-class worker, the redistributive burden on them to support the poor is a small fraction of the redistributive burden on them to support the rich. In other words, the tax on labor to support the rich is at least 5 or 6 times higher than the tax on labor to support the poor, and this doesn't even take into consideration the burden of side-effects of wealth concentration, like the ways in which the wealthy are able to use their power to undermine the voting interests of the middle-class, etc.


Posted by rationalrevolution.net at 9:29 AM EST | Post Comment | View Comments (85) | Permalink
Updated: Tuesday, February 22, 2011 9:50 AM EST
Friday, January 21, 2011
 Stop Calling it a Moral Issue

Topic: Commentary
Paul Krugman recently "penned" an op-ed called A Tale of Two Moralities in the New York Times that was intended to address the ideological divide between so-called "liberals" and "conservatives" on the issue of economic "fairness". What Mr. Krugman did, however, was he perpetuated the single most harmful meme in American economic thought. He framed the debate, as the majority of liberals wrongly do, as a moral conflict between the notion that "it's not right for rich people to be so rich while poor people are so poor" and the notion that "people deserve to keep the money they have earned, no matter how rich they are."
"One side of American politics considers the modern welfare state — a private-enterprise economy, but one in which society’s winners are taxed to pay for a social safety net — morally superior to the capitalism red in tooth and claw we had before the New Deal. It’s only right, this side believes, for the affluent to help the less fortunate.

The other side believes that people have a right to keep what they earn, and that taxing them to support others, no matter how needy, amounts to theft. That’s what lies behind the modern right’s fondness for violent rhetoric: many activists on the right really do see taxes and regulation as tyrannical impositions on their liberty."

Framing the debate in this way and seeing the issues in this way, again, as American "liberals" commonly do, is completely wrong and fundamentally fails to recognize what is really going on in the American economy. Framing the debate in this way is the single biggest reason why, as Mr. Krugman points out, both sides end up talking past each other and the discussion goes nowhere.

What Mr. Krugman has done here, and what most liberals do when they talking about economic inequality in moralistic terms, is grant a starting assumption that the underlying economic system is fair in the first place, starting from the basis that the incomes of the super-rich are in fact "earned". Instead of challenging the fundamental validity of incomes in America, they grant the presumption that incomes are fundamentally valid, and then go on to claim that people who "earn" huge incomes should "be nice" and "give" some of their "earnings" to "less fortunate" people.

But all of this is complete nonsense.

The fundamental reality is that #1) the incomes of the super-rich are not earned and #2) there is a direct relationship between one's income and the benefits that one receives from society, such that the higher one's income the greater the benefits that one receives from society. Thus, there is an obligation to pay an increasing amount of one's income toward the funding of public goods the higher one's income is, and when one doesn't, they are in fact freeloading.

Let's start by simply addressing the income issue. The way that Mr. Krugman and most other liberals frame the issue is as follows:

Paul goes out into the woods with his ax and he chops down 2 trees a day, and after he chops down 2 trees he calls it a day and goes home to relax and drink beer. Every week Paul brings his 10 trees to market to sell them.

Peter goes out into the woods with his ax and he chops down 10 trees a day, staying out into the evening to finish his work. Every week Peter brings his 50 trees to market to sell them.

Peter has a much higher income than Paul.

But says Mr. Krugman, it's "not fair" for Peter to have so much more than Paul, so Peter should give Paul some of the money he has earned so that Paul won't be so poor, and if Peter won't give it to him, then we should "rob Peter to pay Paul".

Now you see, the problem we have in American economic discussion is that both the conservatives and most liberals are basing their arguments around this exact scenario. When economic conservatives talk about fairness and about redistribution, what they do is they frame the economic discussion around the scenario that I just provided. They frame the issue as two people who have equal types of incomes and equal opportunities, where one is just a harder worker and thus has a higher income purely because of their harder work, and thus it wouldn't be fair to take from Peter to give to Paul.

If you start with those assumptions, then the conservatives are exactly right. In the scenario that I just provided it would be unfair to take from Peter to give to Paul, in fact even Karl Marx would agree that it would be unfair to take from Peter to give to Paul.

In the scenario that I just provided, the income inequality is a product of fairness, and making the incomes more equal would require "redistribution". This is exactly what conservatives go on and on about.

The problem is that the economic framing of the debate by conservatives, which most liberals, including Mr. Krugman, just blindly go along with, is complete nonsense. That's not how our economy works and that's not the root cause of the vast income inequality that we see in America.

In our economy the major causes of economic inequality are not simply the differences in productivity of individuals. It's not that someone with  an income of $40 million a year works 1,000 times harder or is 1,000 times more productive than someone with an income of $40,000 a year.

To claim that is to claim that a single movie star or CEO or hedge fund manager creates as much value as 1,000 school teachers or construction workers or nurses etc. Certainly we can easily agree that there is no person on earth who can work thousands of times harder than an average full-time working person, that simply is impossible, so differences certainly can't be chalked up to a matter of effort.

If we agree that a doctor with an income of $400,000 creates about 10 times more value than a plumber or a school teacher with an income of $40,000, and we agree that doctors are among the hardest working and most highly trained professionals in our society, it is hard to conceive how a doctor, whose income is only 10 times higher than a plumber (which perhaps seems about right), still has an income tens of thousands of times lower than those with the highest incomes in America. There are individuals in America with single yearly incomes in the $4 billion range (hedge fund managers). That would be to say that someone with an income of $4 billion in a single year contributed as much value to our society as 10,000 above average doctors. Is that believable to you? It certainly isn't to me.

What would benefit America more, 1 more super hedge fund manager, or 10,000 more doctors? What do you think?

Once you realize that incomes in America are not fundamentally tied to actual value creation, and that  incomes, especially of the super-rich, are often grossly disproportionate to actual contributions, this means that there is a tremendous amount of "redistribution" taking place within the compensation system in the economy in the first place and the overwhelming majority of that redistribution is a redistribution from the working poor and middle-class to the super-rich.

The question then becomes: how does this happen and what are the mechanisms?

The answer to this question will explored in depth in my upcoming article on American capitalism, but the basic answer is fourfold: through the inherent mechanisms of capital ownership that capitalism is founded on, through market distortions in the economy via mechanisms such as monopolistic power, asymmetric information, etc., through outright manipulation and favoritism via things like government contracts, tax loopholes and tax evasion, government subsidies, collusion, cronyism, etc., and lastly through differences in social starting points of individuals, i.e. through the advantages that some people and groups start out with vs others, such as whites having generations of accumulated wealth and positions of social power over groups like blacks, where most individuals are born into families of lesser means, who have been families of lesser means for generations going back to slavery, etc.

And so the picture of the economy that we arrive at is not one in which those that are exponentially  more wealthy than the majority are people like Peter, who have exponentially more wealth simply because they have worked exponentially harder than the average person, and created exponentially more value than the average person, but rather the super-rich are orders of magnitude richer than the average person due to redistribution in the first place. Value created by the average person is being redistributed to the super-rich to start with, and the super-rich are super-rich not just because they "worked harder", but also, and in some cases only, because we have an economic system that funnels value created by the many to the few, with various levels of distortion and redistribution, such that super-rich individuals have received varying levels of "unearned" wealth through the system.

It is important to note here that we do have a "semi-meritocratic aristocracy", which is to say that the aristocrats are not all completely undeserving of their wealth (some of them are), most of them have made real contributions and have earned a meaningful portion of their wealth, it's just that the rewards are amplified beyond even their actual contributions. In the best of cases in America the incomes of the super-rich are amplified only by the mechanisms of capital ownership and nothing else, but even this alone is very significant. It means that while the difference in contribution between the richest 0.1% and those at the 98th percentile is actually more like 5 times or 10 times, the difference in reward between the richest 0.1% and the 98th percentile is more like 100,000 times.

It's as if someone who comes in first place in a competition for cutting logs cuts 10 logs in an hour, and the one in second place cuts 9 logs in an hour, and the value of each log is $100, but the first place competitor receives a reward not of $1,000, but rather a reward of $100,000, while the second place person gets a reward of $900, and the person in 3rd place gets $500 for their 7 logs, and everyone that came in under 3rd place gets something between $10 and $50, but the value of their logs is what's used to pay the first place winner. Yes, the first place winner did do the best job, but nevertheless his reward is actually grossly disproportionate to the actual difference between his performance and everyone else, and that disproportionate reward is enabled by taking the value created by the majority of the people and redistributing it to the first place winner. And again, this is assuming the best case scenario, where there are no market manipulations, there is no collusion, no tax evasion, no government favoritism, and the winner wasn't born on 3rd base to start with, etc.

So now that we've covered the inherent biases in the American income system in the first place, let's move on to issue #2, which is who benefits the most from society and thus has the greatest the obligation to pay for public goods.

What many conservatives would have us believe is that the poor receive the most benefits from society and from the existence of government and public institutions, and that the wealthy are victims of society, whose individually created wealth, which they would have even independent of society, is taken from them to subsidize the lives of those with lesser means.

This Ayn Randian view is completely upside down, and it is quite easy to demonstrate how this is so, even if we disregard what has just been said about incomes and we assume that all incomes are fully earned. The measure of the benefit that one receives from society is the difference between one's condition within that society and what one's condition would be if they lived alone in isolation, as if on an island.

From this perspective, clearly the condition of the homeless is hardly different within society than if they lived alone, indeed in some cases the homeless would be better off without society. In other cases they may be dead without society (as would many people), but regardless, the level of their wealth would be little changed in any event. In other words, the homeless have essentially nothing to lose from the dissolution of society and receive very few benefits from its existence.

As we go on up the ladder it is apparent that the more wealth one has, of course the more one has to lose from the  dissolution of society. Those that would be hurt the most from a total collapse of government would be the wealthy, those that would be hurt the least would be the poor. If America defaulted on its debt, if our money became worthless, if the rule of law were to become null and void, it's not the poor who would suffer most, it is the wealthy, whose property rights would then be meaningless and whose property would become prey to the force of the masses.

But even more than that, there is a direct relationship between the benefits that one receives from society and one's income. Generally, the higher one's income the more that income is dependent upon a larger array of economic transactions and public goods.

Let's take Bill gates for example. Bill Gates' income is, and was, hugely reliant on American public education. The products of his company (Microsoft), are only valuable to a literate and educated society. Given that roughly 85% of Americas are educated in public schools, the literary and general education of those Americans is a product of public resources. Given that Bill Gates arguably benefits more from the institution of public education than any single individual in America, since without it the products produced by Microsoft would be largely worthless, Bill Gates has an obligation to pay a larger portion of his income to support public schools than those with lesser incomes. (Even Bill Gates himself acknowledges this)

And this gets to a key point: Many people think, "Well if I don't have kids in public schools then I shouldn't have to pay taxes to support them." Wrong, because everyone benefits from public schools, whether you have children in them or not, and again, those with higher incomes are receiving the highest benefits. This goes for all public goods, not just education. Public infrastructure, law enforcement and emergency services, military power, regulations, etc.

Even when we look at a small business, the dependence on public goods is apparent. Let's take a local clothing sore for example. The existence of public schools means that the business owner is able to hire employees that already have some basic level of skills, such as being able to read and do at least basic math, etc. Public education also raises the productivity of others in society, thus raising their incomes, thus giving them resources to spend on the goods that the store owner sells. The existence of roads and rail lines all around the country are needed in order to ensure that the goods for the store can be shipped there. The existence of local roads allows employees and customers to come to the store. The existence of banking regulations ensure that the financial transactions and holdings of the company are reliable and insured. The existence of other regulations ensures that the store owner can have some confidence that problems with products will be minimal and that certain types of problems can be legally taken up with the suppliers with an expectation of resolution. The legal system again insures that transactions and ownership of goods can be enforced by the state. Police and emergency services provide a secure environment that reduces the risk of theft and assault, etc.

So there are all kinds of benefits from public goods, just for the proprietor of a local clothing store. The variety of public goods and the extent of their benefit generally scales up exponentially with income. The extent to which a corporation like Wal-Mart, and thus Sam Walton and his heirs, and Wal-Mart executives, etc. benefits from public goods is tremendous, far more than say, a local plumber. Wal-Mart is hugely dependent upon the national infrastructure for shipping, the vast majority of their employees have a public school education, regulation of food and product manufacturers reduces the liability for goods that they sell, like all businesses they are huge beneficiaries of a regulated and relatively secure financial system, they are beneficiaries of law enforcement systems, etc.

Yes, virtually all of us benefit from these things, but the degree to which one benefits from them generally increases as one's income increases. There are essentially no examples today where an individual produces increasing amounts of wealth independent of society and independent of interaction with all of the public goods provided by government.

When a higher portion of one's income is not paid toward the funding of public goods as one's income increases, this is in fact freeloading. Since the benefits an individual receives from public goods increases with income, if higher portions of income aren't paid to fund those public goods then individuals are receiving benefits that they aren't paying for. In fact, this is also a significant reason for growing income inequality in America today. Not only are the super-rich receiving undue income via redistribution from the working class, but they also aren't paying enough taxes to pay for the benefits they receive from public goods, so they are getting too much income and paying too little in taxes to support the public institutions that they benefit from. Thus 99% of the population is heavily subsidizing the super-rich on both ends of the ledger.

The income of every single super-rich individual in America today is or was a product of collectively created value. Throughout all of human history, vast wealth has always been the product of collective labor, and those who owned vast wealth were always recipients of the products of collective labor. This was true of the Egyptian pharaohs, the Roman emperors, and the medieval Kings and Barons. No individual can create vast wealth, it requires a society and hundreds, thousands, or millions of people working together to do it. Any time that an individual possesses vast wealth, whether thousands of years ago or today, it is through a system of redistribution, where wealth created by thousands or millions of people is transferred to a few.

What has been true in every human era is that some small number of individuals, by one means or another, has found a way to confiscate value created by the majority and transfer it to a ruling minority, and nothing has changed today.

"Liberals", "progressives", "leftists", whatever, have to stop treating the issue of economic inequality as a "moral issue", and start treating it as an issue of justice. Yes, justice and morality are highly related, but it has to be made clear that the issue is not that it's immoral for some people to be rich while others are poor, the issue is that the wealth of the wealthy is unearned in the first place, and the wealth of the super-rich is a product of redistribution from the working poor and middle-class to begin with.

What we have to be clear on is that we are not saying that we should rob Peter to pay Paul, what we are saying is that Peter is currently stealing from Paul to begin with, that's why Peter is so rich. We demand putting a stop to the robbing of Paul to pay Peter! (Actually in the example scenario with Peter and Paul no one is robbing from anyone, but in this context I'm equating Peter to the American super-wealthy)

The problem we face is that any time this argument in made in America the discussion killing reply is simply that anyone making such an argument, "is a Marxist," end of discussion. When such an argument is made the reply is: CLASS WARFARE! MARXIST! MARXIST!

But the reality is that it doesn't matter. These are the facts and you can't allow the the debate to be framed on a false premise that completely obfuscates the economic realities and the fundamental basis of economic inequality just to avoid being called names, but yet, that is exactly what "mainstream liberals" have done in America over the past  30 years, and it's one of the major reasons why the case against growing economic inequality in America has had such little traction with the American public.

The majority of the America public still sees arguments against the current level of economic inequality in America the way that Mr. Krugman portrayed it: As arguments that it is simply "not fair" for some people to be so rich while others have less, thus we should "rob from the rich to give to the poor."

As long as that is how the case against economic inequality is perceived, there will never be actionable support for addressing the fundamental injustices in the American economic system and for taking action to substantially reduce economic inequality.

Stop calling economic inequality a moral issue. Stop saying we should take from the rich to give to the poor, and make it clear that it is the super-rich who are stealing from 99% of the population right now. What we demand is not to redistribute the wealth from rich value creators to poor leaches, but to stop the on-going redistribution of wealth from the working-class value creators to the wealthy leaches.


Posted by rationalrevolution.net at 2:39 PM EST | Post Comment | View Comments (8) | Permalink
Updated: Friday, January 21, 2011 4:00 PM EST
Monday, January 17, 2011
 Dr. King : Great American Thinker

Topic: Commentary

There are plenty of articles about Dr. Martin Luther King Jr. so I'll keep it short here on this Martin Luther King Day. Dr. King is often accused by his detractors of being an anti-American, a communist, a Marxist, etc.

This isn't true, but what is true is that Dr. King was a "communist sympathizer", which is different from being a communist. Dr. King studied Marxism and he attended meeting of the Communist Party in America. He spoke out in favor of the Communist side in the Vietnam War.

What Dr. King understood, during the height of America's anti-Communist fervor, was that communist revolutions happened because people were disenfranchised and that opponents of communism had nothing to offer if they did not offer alternatives to ending the disenfranchisement of the masses around the world.

Communism, at the time especially, was of course heavily associated with the Soviet system, and King was by no means any supporter of the Soviets or the Chinese Maoists, but he understood that those revolutions happened, and communist revolutions around the world were happening, because majorities of people in populations around the world were disenfranchised and living in poverty. Dr. King understood that the way to "defeat communism" was to end disenfranchisement, to put an end to mass poverty, and to put and end to economic exploitation, not simply to build more atomic weapons and drop bombs on people.

Dr. King was a great American thinker, he studied Marxism and many systems of thought on revolution, justice and economics, from the secular to the theological, and he developed a truly American perspective that took the good from each of these ideas and left aside those things which didn't fit his American sense of how the world should work.

Yes, of course Dr. King's insights on racism and his actions in the Civil Rights movement are of huge importance, but his real genius is in how he understood and was able to communicate the fundamental roots of injustice that went beyond race, creed, or nation.

Sadly, while aspects of Dr. King's dream for racial harmony in America have come to pass, economic injustice, both as it relates directly in blacks in America, and for the population as a whole, has only gotten worse since the time of Dr. King's passing. American militarism has, at the very least, not been diminished since the days of Dr. King.

Dr. King in his own words from Beyond Vietnam - 1967:

Beyond Vietnam - Time to Break the Silence - 1967 (with audio)

Commentary from Democracy Now (2005) including excerpts from Beyond Vietnam

"It is with such activity in mind that the words of the late John F. Kennedy come back to haunt us. Five years ago he said, "Those who make peaceful revolution impossible will make violent revolution inevitable." Increasingly, by choice or by accident, this is the role our nation has taken, the role of those who make peaceful revolution impossible by refusing to give up the privileges and the pleasures that come from the immense profits of overseas investments. I am convinced that if we are to get on the right side of the world revolution, we as a nation must undergo a radical revolution of values. We must rapidly begin...we must rapidly begin the shift from a thing-oriented society to a person-oriented society. When machines and computers, profit motives and property rights, are considered more important than people, the giant triplets of racism, extreme materialism, and militarism are incapable of being conquered.

A true revolution of values will soon cause us to question the fairness and justice of many of our past and present policies. On the one hand, we are called to play the Good Samaritan on life's roadside, but that will be only an initial act. One day we must come to see that the whole Jericho Road must be transformed so that men and women will not be constantly beaten and robbed as they make their journey on life's highway. True compassion is more than flinging a coin to a beggar. It comes to see that an edifice which produces beggars needs restructuring.

A true revolution of values will soon look uneasily on the glaring contrast of poverty and wealth. With righteous indignation, it will look across the seas and see individual capitalists of the West investing huge sums of money in Asia, Africa, and South America, only to take the profits out with no concern for the social betterment of the countries, and say, "This is not just." It will look at our alliance with the landed gentry of South America and say, "This is not just." The Western arrogance of feeling that it has everything to teach others and nothing to learn from them is not just.

A true revolution of values will lay hand on the world order and say of war, "This way of settling differences is not just." This business of burning human beings with napalm, of filling our nation's homes with orphans and widows, of injecting poisonous drugs of hate into the veins of peoples normally humane, of sending men home from dark and bloody battlefields physically handicapped and psychologically deranged, cannot be reconciled with wisdom, justice, and love. A nation that continues year after year to spend more money on military defense than on programs of social uplift is approaching spiritual death.

America, the richest and most powerful nation in the world, can well lead the way in this revolution of values. There is nothing except a tragic death wish to prevent us from reordering our priorities so that the pursuit of peace will take precedence over the pursuit of war."


Posted by rationalrevolution.net at 10:48 AM EST | Post Comment | View Comments (4) | Permalink
Updated: Tuesday, January 18, 2011 9:37 PM EST
Wednesday, January 12, 2011
 What the 2nd Amendment really means

Topic: Commentary
Given the the discussion around run rights and gun regulation that has sprung up due to the recent shooting in Arizona, I guess I'll chime in on the issue as well.

My view on guns is basically that the public should generally be allowed to own and use guns, but there does need to be significant regulation of the types of guns that people are allowed to buy, and who can buy them, and how they can buy them.

First lets deal with the 2nd amendment. Here is what the 2nd amendment says:
"A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed."
The Supreme Court recently ruled that the 2nd amendment grants "an individual right to bear arms". I completely disagree with this and consider this ruling to be an "activist" position. In fact, the very people who ruled that the 2nd amendment grants an individual right to bear arms are the same people who call themselves "originalists", in other words the so-called "conservatives".

It is clear from the 2nd amendment that the concern of the amendment is not personal use or protection, but rather the objective of the 2nd amendment is protection of "the State". Let's make this clear, the objective of the 2nd amendment is to ensure protection of the government by the people.

Now, one can argue as to whether this was protection of the local state government from the federal government, or whether this was protection of all forms of government from foreign powers, but what is clear is that the purpose of the 2nd amendment is to ensure security of "the State", because the founders were also opposed to standing armies, and thus if the country didn't have a standing army then in needed a "well regulated militia" for national defense.

So as far as I'm concerned, invoking the 2nd amendment to protect an individual's "right" to "bear arms" for personal protection and enjoyment is a completely fallacy and a complete misinterpretation of the 2nd amendment. It requires, in fact, not looking at the original intent of the drafters and signers of the Bill of Rights. The original intent of the 2nd amendment is protection of the State, given that there would be no standing army. That's it.

That doesn't mean that I'm against gun ownership, I own guns myself and have used guns since childhood, but I do not believe that private gun ownership for personal use is a right enunciated in the American Constitution. It's also clear that the right to an abortion is not enunciated in the Constitution, but I'm pro-choice, and I don't think that "health care" should be considered a right either, but I do think that it is in our best interest as a nation of means to provide universal healthcare and ensure that everyone has access to at least basic health care. Just because something isn't a "right" doesn't mean that we shouldn't have laws that allow people to do it, but I view gun ownership more like driving privileges. It should be considered a privilege, but one that is broadly allowed. In fact we already do treat it more like a privilege than a right anyway, since even the most conservative judges agree that we should be able to restrict the right of certain people from owning guns, like certain types of felons and those with mental health problems, so we already treat it like a privilege anyway.

But lets get back to the 2nd amendment and gun ownership. Many supporters of interpreting the 2nd amendment as a personal right to bear arms argue that the intent of the 2nd amendment is to grant citizens the right to "bear arms" in order for the citizenry to protect itself from the government.

Perhaps, but even if that were true, all it would mean is that the 2nd amendment is now obsolete. Firstly, the 2nd amendment grants the right to "bear arms", not the right to "own guns". "Arms" is anything from clubs and knives to air craft carriers and nuclear weapons. How is it that we've settled on equating "arms" to "guns"?

If the real purpose of the 2nd amendment is to have an armed citizenry that can challenge the power of the American government through use of para-military force, then the citizenry needs a lot more than the types of arms that we are currently legally allowed to own anyway. In order to challenge the power of the government we need fully automatic assault rifles, rocket launchers, mines, various explosives, body armor, etc. as just the starting point, if not also control of fighter jets, tanks, and military sea vessels. Given that all of this is illegal for citizens to own right now, we are already in full violation of the 2nd amendment right now under the the interpretation that the 2nd amendment is about arming the citizenry against the government.

And furthermore, if one supports the "original intent" of the founders, and thus the 2nd amendment, then one has to be against standing armies, in which case all backers of the "original intent" of the 2nd amendment should be calling for a complete disbanding of the US military, which I don't see any folks at the NRA, nor other conservatives save a very few guys like Ron Paul, doing.

The reality is that the local police department is already far more well armed than pretty much any citizen could ever be. The difference between personally own-able arms and arms owned by the state is many times greater today than it was 200+ years ago, back when muskets and cannons represented the pinnacles of advanced weaponry.

I don't believe that guns make the citizenry any more capable of taking on the government in America than not having them. After all, look at Europe, where there are far less gun rights and far fewer people own guns, and yet the citizens challenge the government a lot more than we do here in America. In fact in many ways having so many guns reduces our propensity to engage in protests and mass movements for the same reason that the nuclear arms race deterred war during the Cold War. People don't want to take to the streets in America because there is a greater threat of violence due to all the guns, so instead we protest less (among many other reasons). Having guns just invites more use of force by the government, and a greater threat of force by citizen opponents, so in fact the real effect of all these guns isn't to empower people, its just the opposite.

If we are going to address the gun issue we have to be realistic. Fantasies about armed citizen revolts against the government are just that, fantasies, and in many ways those fantasies only serve to weaken our real resolve to petition the government and bring about change through political power. We need to stop thwarting needed gun regulations out of the fantasy that by allowing people to have a few extra rounds in their clips or that by allowing people to have some assault weapons we are actually protecting democracy, we aren't, we are just pretending.


Posted by rationalrevolution.net at 7:39 AM EST | Post Comment | View Comments (11) | Permalink
Tuesday, January 11, 2011
 Collecting Coconuts

Topic: Semi-random Thoughts

Jane, Jim, Suzy, Bill and Bob live on an island. They need to collect coconuts for food. In order to spur competition they decide that at the end of the day, whoever collects the most coconuts will get half of all the coconuts collected.

Jane collects 4 coconuts
Jim collects 6 coconuts
Suzy collects 8 coconuts
Bill collects 10 coconuts
Bob collects 12 coconuts

At the end of the day, Bob has collected 3 times more coconuts than Jane, and 1.5 times as many as the median (8).

Everyone puts half of their coconuts into the pool and keeps the other half. This puts 20 coconuts into the pool and leaves Jane with 2 coconuts, Jim with 3, etc. Since Bob gets the half that went into the pool, Bob ends up with 26 coconuts to Bill's 5. Bob now has 6.4 times the median (4).

Jane has 2 coconuts
Jim has 3 coconuts
Suzy has 4 coconuts
Bill has 5 coconuts
Bob has 26 coconuts

The competition did encourage people to try harder, thus resulting in more net coconut collection than if there had been no competition, however, it's likely that everyone except Bob ended up with fewer total coconuts at the end of the day.

Bob likes the competition and chides the others for being such inferior coconut collectors. Bob touts his superiority by noting that he has "earned" more coconuts than all of the rest of them combined. Bill notes that if everyone would try harder, they could all be like Bob.


Posted by rationalrevolution.net at 10:51 AM EST | Post Comment | View Comments (6) | Permalink
Updated: Wednesday, October 26, 2011 7:29 AM EDT
Monday, January 10, 2011
 Why there won't be an economic recovery

Topic: Commentary

There are plenty of people predicting an upturn for the US economy in 2011, and the basis for most of these predictions has largely been growing retail sales and modest increases in hiring. I've learned my lesson on trying to be too precise with timing, I thought that we were going to have a major economic recession around 2006-2007, but that didn't happen, despite the fundamentals showing that it should have happened, because of a massive credit bubble which I had underestimated.

However what I do know is this, whether there is some modest "improvement" in 2011 or not (what exactly defines improvement?), nothing in current economic policy or conditions is paving the way for long-term economic recovery, in fact just the opposite.

People keep talking about how it could take a decade to "recover" the jobs lost during the 2008-2009 recession, but to be honest that assumes that there is any recovery at all, and I see no reason at this point to believe that there will be any such recovery at all. At the rate we are going I would predict higher unemployment rates 5 years from now than we have today and major economic collapse. That may not happen, but it won't be because of anything that's happening right now. If that doesn't happen it will be because of a change of course in American economic policy. Without a major change of course there isn't going to be any recovery. The whole reason that many people saw the election of Barack Obama as a major relief and believed for about 6 months that his election would improve the state of the American economy was the belief held by many people that Obama was going to bring about the needed change in course in American economic policy, but it now becomes more evident every day that Barack Obama is not going to bring about such a change in course, and that in fact he is doubling-down on all of the failed economic policies of the past.

What makes Barack Obama even more dangerous to America than a president like George W. Bush is that Obama is able to push through much more devastating policies with less opposition, or at least with less properly directed opposition. The loudest opposition to Obama's policies is largely misdirected opposition from the so-called "right" which is easily debunked, even if it is politically powerful, but meaningful opposition from Democratic voters is muted at best.

Had George W. Bush pushed the same exact health care "reforms" that Obama signed into law Democratic voters would have been outraged, and would have been outraged with coherent arguments against the "reforms", namely that the healthcare changes do little to actually reduce costs but largely shift the burden of costs from the government to individuals (that's how it reduces the deficit) and that it further intrenches the role of private-for-profit insurance in the system instead of reducing it, etc., etc. But Barack Obama was able to get away with this, and this anti-progressive "reform package" is largely defended by Democratic voters and talking-heads.

As Obama continues to put the heads of Wall Street in charge of American agencies and pushes through tax cuts that that heavily benefit the wealthy, as his "stimulus" efforts continue to rely on tax cuts and "trickle-down" economics, as unions and public employees come under increasing attacks, there is very little resistance from Democratic voters, far less resistance than if these exact same policies were being enacted by a Republican president. Obama not only enables greater attacks on the working class than what a Republican would be able to mount without resistance, but he's also setting up a situation where in the future where Republicans will be able to make the same types of attacks and more since the precedents will have already been set, both in the legal sense and in the voting public's mind.

And so the country is now being set on the path of major economic downfall. It is very difficult to understand how and why this is being allowed to happen, but the best I can figure is that it's a mix of pursuit of the short-term economic interests of the politically and socially powerful super-wealthy, especially those in the financial sector , in addition to a mix of truly misguided beliefs in how to improve the economy.

But the plain facts are these: The American economy has been in decline for 30 years, having largely been masked over that period by public and private debt. The Clinton years, which so many Democrats like to tout, were themselves largely driven by debt, speculation, and off-shoring (loss of American capital). Housing prices are still way over inflated. They have been over inflated for 15 years, it was only from 2003-2008 that the most dramatic bubble occurred, but the whole last 15 years has been a housing bubble, and prices will continue to fall in many areas for years to come. It is reasonable to expect that commodity prices will continue to rise for the indefinite future based on global demand and growing scarcity of some commodities, leading to real inflation (not inflation caused by monetary policy). And most important, average wages are continuing to decline.

There can be no economic recovery in America until real incomes for average workers in America rise, and rise significantly faster than inflation. This will not happen until the forces driving income inequality are reversed, and there is nothing in any foreseeable economic policies over at least the next 2 years, and possibly not even over the next 8 years, that will bring about that change.

The most likely scenario at this point, based on what's coming out of Washington and the corporate media, is that there will be a loss of living standards for 90% of the American population for the next 10 years at least, while income inequality increases and the incomes of America's super-rich become increasingly less dependent on America as they become increasingly tied to the global economy.

The retirement of the baby boom generation is actually one of the few possible things that could bring about some economic improvements on its own, if enough of them leave the workforce to help drive down unemployment rates, but there is essentially nothing in any of the economic polices in place at the moment to actually drive down unemployment, and the message from Washington is essentially that "it's not the governments job to fix unemployment". Every time I hear anyone from the Obama administration talk about unemployment, there message is that "it will take a very long time for this to work itself out". Well, that would be true if the same approach had been taken 15 or 20 years ago, but today it's simply never going to work itself out, it's not going to happen, and it doesn't have to take a long time anyway. We could cut unemployment down to 6% or 7% if we wanted to with the proper policies, but they aren't going to do it, and it becomes more and more clear every day that there is no force in the American public sector that can stand up to the interests of the super-rich and that no policies will be pursued to improve the American economy if those policies require any sacrifice on the part of the super-rich, who have not only stolen trillions of dollars from the working class over the past 30 years, but who are still stealing from the working class today. We haven't turned any corners over the past 2 years, in fact all we have done is strengthen the hand of the very forces that are destroying the American economy and further entrenched the country on the path that has brought about our current conditions.

It appears thus far that the voting public is sufficiently confused, misled, and demoralized to prevent any major change of course in economic policy being pushed forward by a popular majority. Since it's clear that economic policy in America is dictated by the interests of the super-rich, what I think will most likely happen is that over the next several years conflicts of interests among the super-rich will lead to a push for nominally beneficial changes for the working poor and middle-class. The super-rich are not a monolithic group by any means, either in terms of pure economic interest or in terms of ideology. Right now there are already rifts, with some of the super-wealthy calling for increasing progressive taxation while others lobby against it. Some of the super-wealthy are more dependent upon the American economy for their wealth than others, and some of the super-wealthy, regardless of economic interest, genuinely support a more fair economic system and understand that the burden of paying for public goods should fall more heavily on the wealthy, who benefit the most from those public goods.

But economically progressive changes brought about through the leadership of the wealthy will likely be incremental at best, and will mostly just soften the blow dealt to the working-class, the changes won't upset the order of things. It's quite possible that there will be no efforts for serious economic reform until America's economic decline hits the super-wealthy, and there is a chance that, with sufficient globalization, a significant portion of the super-wealthy could avoid economic decline indefinitely. By the time the will to take action to truly improve the US economy exists, it may be too late to do so.

While I certainly think we should be working for major changes to America's economic system, and support efforts for a progressive/populist mass movement, I am not optimistic about the prospects of such a movement forming and being successful over the next decade, and think that it's far more likely that the next decade will be a very painful one for the American working-class, with little or no improvements in economic conditions for the vast majority of the American population.

Until capital ownership becomes less concentrated and the share of national income going to bottom 80% of the population increases, there will be no meaningful economic recovery. I don't foresee these things happening for a long time, if ever...


Posted by rationalrevolution.net at 11:27 AM EST | Post Comment | View Comments (2) | Permalink
Updated: Monday, January 10, 2011 11:38 AM EST
Wednesday, December 22, 2010
 Obama the bipartisan negotiator...

Topic: Semi-random Thoughts

Republicans: "We want to launch all nuclear weapons and blow up the world! We demand that our goals be met!"

Obama: "In the interest of bipartisanship, I have agreed to reach across the isle to put together a centrist bill with our Republican friends and colleagues. In order to sustain school funding at 2008 levels through the end of 2014, I have agreed to a compromise with the Republicans in which we will blow up the world. The bill isn't perfect, and we didn't get everything we wanted, but in the real world you have to engage in a give and take, so I feel that this is the best bill we could get at this time.

Though our schools will be woefully underfunded and will be atomized by nuclear bombs, we are happy to announce that schools will remain funded due to these negotiations and my willingness to reach across the isle and compromise with our Republican friends."

CNN: "Looks like another big win for Barack Obama. Despite grumbling from radicals on the left within his own party, Obama shows a real determination to get things done."

@SarahPalinUSA: "Obamas failure 2 privatize schools shows once again hes a extreme Marxismist"

FOX News: "Once again Barack Obama is showing his extreme Marxist bent, and shows that the Democrats are willing to stop at nothing and won't compromise with the Republicans. He has now forced the Republicans' hand in taking America down the path of Socialism by continuing funding for the public school system.

In other news, the world will be destroyed in 3 days, thanks to Mitch McConnell's successful efforts to bring Jesus back to earth on his birthday!"

"Liberal" Blogger: "Barack Obama's deal with the Republicans to blow up the world in exchange for reducing public school funding is insane! Obviously we should not agree to this absurd demand by the Republicans, can't you see that blowing up the world will kill everyone? The Republican position is extremist and crazy. The president should be speaking out forcefully against the Republican agenda and demanding increased funding for public schools; after all, most Americans don't want us to blow up the world and they do want increased funding for public schools!" 

Robert Gibbs: "President Obama has to do this. If he doesn't nuke the world the schools will not be funded, and the poor and middle class WILL benefit from nuclear exposure.  The radical leftist naysayers will never be satisfied, they are living in a fantasy world."

Random Democrat: "Barack Obama is doing his best. We all need to rally behind keeping public school funding at 2008 levels indefinitely, this is much better than the alternatives. Do you want to let the Republicans win?"

ABC News/USA Today Poll Results: "The bipartisan agreement between Obama and the Republicans is a popular one. 78% of respondents had a favorable view of the agreement, across all party lines*.

*Poll questions:

1) Q: Do you support president Obama's centrist bipartisan agreement with the Republicans to continue funding for all American public schools? Results: 78% Yes; 15% No; 7% Unsure

2) Q: Do you you think we should launch all nuclear weapons to destroy the world? Results: 93% No; 3% Yes; 4% Unsure

3) Q: Do you think that American public schools should receive A) More funding B) Less funding C) Funding should remain at 2008 levels? Results: 86% A; 8% B; 6% C"


Posted by rationalrevolution.net at 7:00 AM EST | Post Comment | View Comments (8) | Permalink
Updated: Wednesday, December 22, 2010 2:12 PM EST
Friday, December 17, 2010
 How the Financial Industry Get's So Much Money

Topic: Commentary

There has been some buzz around a recent article by Tyler Cowen, The Inequality that Matters.  It is a decent article and makes some good points, but ultimately it misses the mark in my opinion.

The most obvious error made is a semantic one, one of my pet peeves, in which Cowen continues to use the term "top earners" and to talk about the super-rich "making" their money, even though the point of the article is that the super-rich aren't actually earning their incomes, or at least this is one "possibility" that Cowen "considers".

Cowen rightly points out that the highest income receivers in America disproportionately come from the financial sector.

"In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning more than $100 million a year was nine times higher than the public company executives earning that amount."

But when he tries to provide explanations for their over sized  incomes he comes up extremely short. Firstly, Cowen focuses on the financial sector in relation to other high income receivers implying that the incomes of other high receivers are themselves justified, which they are not. The incomes of corporate executives and celebrities are not justifiable either, as I discussed in the article How Reagan Sowed the Seeds of America's Demise.

But when Cowen tries to explain how those in the financial industry get such huge incomes he falls flat. Cowen's big answers are that investors "go short on volatility" and they use other people's money to gamble. These things are true, but hardly revelations and they don't get to the heart of the issue.

First, when it comes to "going short on volatility", Cowen compares betting against the housing market (which is what many of the biggest hedge fund managers did in 2007 and 2008) to betting that a bad sports team would win a championship, it's not the conventional wisdom so it pays off big etc.

But this really isn't a good analogy. Cowen implies that betting against the housing market was some kind of huge risk or that it took genius to do it or that or that the big payoffs outweigh the losses, etc. This is all nonsense. First of all, it didn't take a genius to figure out that the housing market was going to crash, this was obvious, the only challenge there was having a sense of the timing. But having a sense of the timing isn't so difficult if you are a financial insider who sees the books of banks and knows what deals are being made and is managing the money of the biggest financial institutions. After all lets not forget that John Paulson, one of the biggest profiteers of the housing market crash, is acknowledged to have been involved in picking the the assets going into investment pools setup by other firms, which he was then betting against.

Even though neither Paulson nor the firms that created the toxic Abacus CDO were ever charged with anything, it points to the level of involvement and knowledge that these financial insiders have. They can much more easily time the market than your average guy because they have a far different level of information and are much more closely monitoring the situation, and that's being generous and assuming no funny businesses.

But even that isn't the point and totally fails to get to the root of the matter. The real question is this, why is it that firms like Goldman Sachs are able to reap such huge profits and to pay their employees so highly? In a competitive market profits should be driven down, yet profits for "Wall Street" have been going up dramatically over the past 30 years, most dramatically over the past 10 years. Well, what that tells us right off the top is that we aren't dealing with a competitive market.

What does Goldman Sachs do? Goldman Sachs is an investment bank; their primary function is ostensibly to help clients bring companies public, i.e. to manage IPOs, and to manage mergers and acquisitions, etc. Now, they also do a lot of stuff on the side, like trading and investment banking, etc. The function of the stock markets is supposed to be to help companies raise money via IPOs. That, really, is the sole "economic good" provided by stock markets, the "sharing of capital". However, that isn't where most of the money is made in the stock market, most of the money is made simply trading stocks around, which doesn't generate any real revenue and provides no direct benefit to the corporations whose stocks are being traded.

Now, when it comes to a company like Goldman Sachs, their revenue comes from two main sources: fees paid by clients and profits from trading. The first issue to address is the "fees paid by clients". Based on the level of the profits, the question is, why do clients agree to pay these fees, since clearly Goldman Sachs is skimming a lot off the top? In a competitive market we would predict that competition would come in a drive down prices, but this doesn't happen on Wall Street, the big players are the big players, they have been the big players for a long time and they remain the big players today, and there is very little real competition. Why? I suppose that there are multiple reasons, some of which are based on economic principles and some of which I suspect have to do with the laws on the books, collusion, backroom dealing and personal relationships, etc. I can't speculate on the latter issues, so I'll just stick to the issue of economic principles.

What exactly are stock exchanges? Well actually stock exchanges are the original "social networks". The stock exchanges are essentially the first major predecessors to the internet, and specifically they are the predecessors to social networking sites like Facebook. The value of all social networks and social networking platforms is predominately a product of membership in the network. The networks become more valuable and more attractive the more people join them.

In fact, social networks tend to create natural monopolies, however, our legal system doesn't recognize dominant social networks as monopolies. As discussed in this article Zuckerberg: Non-Evil Non-Genius, sites like Facebook benefit hugely from being the first in the market and then once a slight dominance is established in terms of membership, the membership itself become the most valuable aspect of the platform. People don't join Facebook because Facebook has better features than other alternatives, in fact Facebook sucks in terms of its implementation and user interface and user friendliness. As an application Facebook is horrible, it's horribly designed and it's record on user privacy is deplorable, but people use it and flock to it because that's where everyone else is. The membership is the primary draw, and thus Facebook is a type of natural monopoly, just like Microsoft Windows was a type of natural monopoly by attracting enough users to become a standard. Many people adopted Microsoft not because they loved Windows, but because they wanted to share documents with other people who only had Microsoft compatable documents and they wanted to use programs that only ran on Windows, because that's what was being used at work, etc.

But Microsoft won the court case that attempted to define Windows as a natural monopoly, preventing the operating system from being labeled as such, and thus avoiding the regulation that comes along with the designation. The reality, however, is that virtually all of the super-rich are types of natural monopolists. Celebrities are a type of monopolist. Everyone can't be a celebrity for the same reason that when you go to watch a play you have hundreds of people watching a dozen people perform on a stage. Even if everyone in the audience was as good a performer as those on stage, it wouldn't work if everyone started performing in order to compete for attention, it only works when a few people have the attention and the majority observe.

If incomes and profits get very high for auto-mechanics then more people will become mechanics, increasing competition and driving down profits and incomes. Celebrities have huge incomes, so why don't market forces result in more people becoming celebrities, thus driving down the profits of celebrity? Because celebrity is a form of natural monopoly, and so is social networking, and and stock exchanges are a type of social network and so are investment banks.

Goldman Sachs reaps huge profits, so why don't market forces result in there being more investment banks who compete against Goldman Sachs and drive down prices, thus reducing profits, which, as Adam Smith outlined so long ago, is the whole point of markets in the first place, to drive down profits and thus increase the social good?

Because a part of investment banking is social networking and once dominant social networks are established their momentum can be  nearly unstoppable and the barriers to entry for competition are nearly insurmountable. The problem is that these types of businesses aren't widely acknowledged as natural monopolies, but they are. Most acknowledged natural monopolies today are things like utility companies and toll roads.

But that isn't the whole story. In terms of revenue from clients companies like Goldman Sachs have an advantage because they are natural monopolies, or natural oligopolies, and are thus able to extract rents for their services due to the power of the social network that they are able to tie clients into. However they also receive a large portion of their revenue from trading. People greatly misunderstand the revenue generated from trading by large institutional traders and investment banks.

The biggest misconception is the fact that most people don't understand just how unlevel the playing field is between professional traders and the average guy. This isn't like the difference between professional athletes and the average guy, the biggest advantages of the professional trader, especially today, have nothing to do with the natural abilities of traders and have everything to do with the information and tools at their disposal.

First lets take the example of the old school floor trader for the New York Stock Exchange. Floor traders are able to trade on their own accounts, and before various rule changes, including the adoption of decimal pricing instead of fractional pricing, floor traders were able to essentially make no lose deals. Floor traders were, and are in the NYSE, responsible for making the transactions when someone wants to buy or sell a stock (or whatever instrument these days). Let's say that you put in an order to sell your stock at $23.25, and the floor trader got this order, and they saw someone who wanted to buy that stock for $23.75. The floor trader could use his own account to buy your stock from you at $23.25, and then turn around and sell it to the other guy for $23.75, pocketing 50 cents a share on top of his commissions in the process.

Doing this wasn't a matter of being any kind of market genius, it was simply a matter of being able to see all the cards on the table, and it was an easy way to make money. Technically they aren't supposed to do that type of stuff anymore, but we are in a new era of sophistication now. Even without engaging in those types of obvious abuses, traders have a level of understanding of the market activity that the average person doesn't.

But, that was the New York Stock Exchange, which famously had/has all of those traders down there on the floor yelling and making deals. Then came the NASDAQ, and what sets the NASDAQ apart from other exchanges is that the NASDAQ is an all electronic exchange. There are no floor traders, all of the trades are executed electronically, which eliminates middle-men and thereby reduces the overhead cost of executing trades, and it also was supposed to address issues like traders gaming the system.

Ahh, but it hasn't. Now we have something called high-frequency trading, which effectively does the same thing as what the guys on the NYSE used to do, but now it is in fact much much worse, for now it's automated and essentially constant and automatic and all of the investment banks do it.

When you submit an order to buy or sell a stock on the NASDAQ your buy or sell price is supposed to be hidden information that the other party cannot know. If you submit an order to buy 100 shares at $23.75 for example, and there is also an order out there to sell 500 at $23.25, then the way it is supposed to work is that you buy 100 of those shares at $23.25, you get the best price available. The "person" selling at $23.25 doesn't know your price and thus doesn't know that they could have changed you more, etc.

This is where high-frequency trading comes in. Investment banks have computers that do nothing but sit there all day submitting bogus transaction requests. They submit orders to buy and sell stock every fraction of a second basically probing the asking prices in the market, which they aren't supposed to be able to know, but what they do is they submit fractionally higher and lower bids very quickly and then when one is accepted they cancel the transaction, this lets them know the asking prices of the bids in the market. Then once they have determined the spread on selling and buying prices of different bids, they step in and buy a block of shares at one price then sell it immediately to the other person at the other price. So, in the case of someone wanting to sell for $23.25 and someone wanting to buy for $23.75, computers would submit transactions to find those limits, then buy at $23.25 exactly and sell at $23.75 exactly, keeping the 50 cent spread themselves. It's a no lose transaction, there is no speculation taking place, there is no risk, and there is no real allocation of resources. The investment bank just steps in and extracts a fee for doing nothing and its stepping in benefited neither side of the deal, it's purely parasitic. And these large institutions have these programs running all the time, they are unmanned, there is no real strategy or anything it's just a pure profit machine that provides no benefit to anyone other than those running the programs and it serves as an added tax on the investors making the trade.

And this is just one aspect of how these banks are now using computers to engage in trading systems that are effectively just gaming the whole system. And make no mistake, the recently passed financial reform legislation that was passed by the Democrats does nothing to address these issues and doesn't tackle high-frequency trading at all.

But what really makes all of this work and makes the profits for those in finance so high, is the giant pool of money that they operate on. That giant pool of money is what has been created by the rest of society, including Americans and foreigners. Those in the financial institutions are getting hugely wealthy because the giant pool of money produced by the rest of society has grown rapidly and those in the financial institutions are getting a cut out of it, largely by using "heads we win, tails you lose" techniques both in terms of high-tech trading systems and of course in terms of government backed subsidies, in addition to the natural monopolies enjoyed among the various components of the financial system, from the stock exchanges to the highly connected investment banks. It is the collective production of society that has produced the wealth, not these bankers, hedge fund managers and traders, and yet they are the ones reaping the rewards by extracting massive rents on the system.

There are theoretical ways that the entire financial system could be radically changed however, in ways that would effectively eliminate the rent seekers. First is the stock exchanges themselves. As I said, stock exchanges were really the first major social networks, the first major predecessor to the internet, but guess what, now we have the internet, we don't actually need stock exchanges anymore. The whole point of a stock exchange is to serve basically as a giant chat room that allows all of the buyers and sellers of stocks to transact in a single market. Technically when you buy stock you have a certificate. You could go out on the street and sell that certificate if you wanted to, but we don't do that because out on the street you have no idea what other people would be willing to pay for it and you may not find anyone that wants to buy it, so we have exchanges, where everyone who wants to buy or sell "chats" in the same room. The exchange model is over a hundred years old, it made sense when we didn't have the ability to individually connect the way we do now. Now it is a fact that stock exchanges are functionality obsolete, they are totally unnecessary, but they still exist out of moment and regulation. Also note that stocks and other assets only trade on specific exchanges. Companies pay to get listed on a given exchange, and their stock only trades on that exchange. That could all be eliminated with open standards and the development of full market internet based direct trading where buyers and sellers interact directly with each other without middle-men. It's technically possible now, but clearly there are powerful interests, indeed some of the most powerful and wealthy people in the world, who would not let that actually happen. In this case, protecting the interest of the financial industry and the stock exchanges requires preventing the rise of a freer market system. A freer market without exchanges would benefit stock owners at the expense of the middle-men currently in place who graft off the top of every transaction.

As noted by Lord Adair Turner in What Good is Wall Street, investment bankers and traders are really just glorified utility operators. The objective of financial institutions is to channel capital from individuals and institutions to the places where it can, theoretically, do the most good. You put money into the pot and in theory the activity of those on Wall Street is to allocate your money to the businesses that can make the most use of it, allowing them to produce a return on that capital. That's the theory, and that's describing the activities of Wall Street in the best possible light. In reality most of the activity on Wall Street is just outright gambling with no real economic benefit.

But granting the utility of Wall Street activity, it is effectively equivalent to an operator at an energy company who has to rout electricity and turn on and turn off various power plants in order to optimize electricity usage throughout the day, to rout the electricity to where it is most needed. But do we pay such operators by the amount of electricity that flows through the system each day, are they paid by the kilowatt? No, they aren't, they are paid a wage like any normal worker. Do we pay operators at facilities for large cities exponentially more than operators for smaller areas that use less electricity? No, we don't. Operators for larger regions may get slightly higher pay, but its double or triple the pay of smaller operators at most, we don't pay operators 10,000 times more who work for New York city power companies than ones who work in Arkansas, but when it comes to finances it's a different story.

The scale of the income in the financial industry is directly related to the scale of the economic activity, even though we don't pay power grid operators or water management operators in direct proportion to the scale of the flow through the networks they manage. Given that the financial industry is really a glorified utility, and that they benefit from monopolistic characteristics, the industry should bemuch more heavily regulated, including the use of price controls and major compensation restrictions.

There really is no question that the financial industry is extracting massive rents for, at best, providing no real value, and at worst the financial industry is in fact profiting from causing real economic damage. To argue that the events of the last 5 years, with the near collapse of the financial system and the housing bubble isn't an example of profiting from real and massive damage is to just plain ignore reality.

The massive profits in the financial industry are certainly only made possible by the large amount of real value created by the rest of society, which creates the massive pool of money that the financial industry extracts profits from, but the real question of why it is that competition doesn't drive profits down is the more complicated one. The only answers appear to be that players in the financial industry benefit from forms of natural monopoly, while not being regulated as monopolists, that there is indeed nefarious activity taking place both technically illegal insider trading as well as technically legal forms of insider trading, and the rise of computer driven trading schemes has created true virtual money machines that produce essentially risk free profits throughout computerized trading, which is a complete corruption of the markets. All of this in association with the virtual guarantee from governments that major losses will be propped up by tax payers has resulted in a no lose environment where the big players are able to extract massive rents unchallenged by either competition or the law.

See also: Wall Street by Doug Henwood


Posted by rationalrevolution.net at 7:43 AM EST | Post Comment | View Comments (2) | Permalink
Updated: Friday, December 17, 2010 10:21 AM EST

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