It was no surprise that a House committee
extended the federal ban on Internet taxes last week, ahead
of schedule and with little debate. By concentrating wealth
in the hands of the richest, most heavily taxed Americans, the
new economy is pouring money into federal and state coffers
as never before. As a result, a new social contract has been
struck, harmonizing the interests of a cash-rich bureaucracy,
a burgeoning, stock-centered economic elite and middle and working
classes who get big government without paying full freight.
This strange turn of events emerged in the mid-1990s when huge
sums of foreign capital, drawn to the safety of the world's
last superpower, and tax-favored retirement funds flooded into
U.S. stocks. Blessed with limitless, relatively unsophisticated
money and backed by a fawning media, Wall Street sold the new
economy as fast as it could invent it. A torrent of initial
public offerings, huge fund-management fees and stock options
spectacularly enriched a select group of corporate executives,
stockbrokers and investment bankers.
Richer people pay taxes at far higher rates than everyone else.
The base federal tax for a family of four with an income of
$1 million is a whopping $361,000. The same wealth held by 20
families with incomes of $50,000 generates 75% less federal
revenue; Washington takes a paltry $13,000 from $1 million spread
among 50 families. A dollar in the hands of the richest Americans
is worth far more to the government than one held by working-
or middle-class taxpayers.
Driven by stock-market capital gains, which more than tripled,
and record corporate bonus and executive stock-option grants,
upper-income wealth and tax revenues skyrocketed in the 1990s.
Since 1993, the taxable income of the wealthiest 1.5% of all
Americans grew by an astounding $600 billion, half the country's
total increase in disposable income. As the super-rich pocketed
more and more money, the Congressional Budget Office estimated
that their share of all federal income-tax revenues climbed
to more than 40%, from 29.8% just five years earlier. Nearly
60% of Washington's total tax windfall in the 1990s was drawn
from less than 2% of the U.S. population.
These trends are also evident in new-economy hotbeds like California,
where Department of Finance data shows that the richest 7.5%
of all taxpayers gobbled up more than 40% of the state's income
and paid 66% of state income taxes. Californians with taxable
incomes of $20,000 or less comprised more than 40% of the state's
taxpayers but contributed less than 1% of total income-tax revenues.
Giddy state officials recently attributed all of California's
$9-billion tax windfall in 1999--a 15% surplus above projected
revenues--to capital-gains and stock-option income realized
by the state's dot-com millionaires.
It was inevitable that relations among the government, the
nation's stock-rich elite and the middle and working classes
would be dramatically revised. Where state and federal bureaucracies
were once skeptical of wealthy interests, in the 1990s they
eagerly embraced the jackpot capitalism and trickle-down economics
that so quickly rescued their budgets. Tax subsidies, trade
policies and local land-use decisions skewed in favor of anything
that created super-rich taxpayers.
Government, in fact, took an increasingly direct stake in its
Wall Street benefactor. According to Federal Reserve Board statistics,
since the mid-1990s, state and local government pension funds
alone boosted their equity investments from $790 billion to
more than $2 trillion. Even excluding federal-employee investments,
such funds now own more than 10% of the entire U.S. stock market.
Nearly 65% of the total retirement assets managed on behalf
of state and local public employees depends completely on stocks.
For their part, the new rich have willingly shouldered their
vastly disproportionate, growing share of the nation's tax burden
as long as their incomes continued to rise faster than everyone
else's. The government's take of the nation's gross domestic
product could quietly be pushed to postwar highs even as tax
rates for all but the wealthiest citizens dramatically fell.
This bargain between government and America's wealthiest helps
explain some of the new economy's most perplexing politics.
For example, because public-sector unions now dominate working-class
activism, the fact that working wages and benefits are stagnating
relative to stock and corporate profits provokes surprisingly
little unrest. Government budgets and public-sector jobs are
among the biggest beneficiaries of the nation's wealth disparities.
Despite its apparent logic, tying public-sector finances so
closely with stock-market windfalls is not without risk. Everything
works fine as long as wealthy incomes and tax revenues rise
rapidly and the rest of economy enjoys at least moderate health.
Difficult conflicts emerge when the balance is upset.
As share prices rose beyond all rational calculation, Wall
Street developed an insatiable need for capital. The supply
of stocks so outstripped demand by late 1999, for instance,
that many believe only the brokerages' extension of more than
$250 billion in margin credit, the most ever, to stimulate buying
avoided a painful crash. In a hair-trigger market, anything
that shifts money from stocks--the merest threat of rising interest
rates, wages or energy costs, for example--can cause a panic.
Government, of course, is supposed to impartially administer
the nation's laws. But if public fiscal solvency, and the very
health of government-employee pensions, are overwhelmingly dependent
on stock wealth, can the state reasonably be expected to dispassionately
regulate the economy against what may be its own self-interest?
What happens, for example, when more of the working class tires
of slow wage growth during times of plenty and begins demanding
a greater share of the new wealth, as Los Angeles janitors did?
A reinvigorated private-sector labor movement would redistribute
capital from wealthier, high-taxpaying individuals to those
with far smaller incomes in much lower tax brackets. Should
government encourage such trends and promote social equity even
if public budgets and pension funds would be adversely affected?
Suppose environmental or foreign instability drives up energy
costs, which fortuitously remained stable, or even fell, throughout
the stock-market boom. Should the U.S. abandon its ecological
agenda to limit diversions of capital to buy energy and protect
public finances? Would the risk of oil or other energy-supply
disruptions, a development that would likely wreak stock-market
havoc and severely reduce windfall-tax revenues, justify a Desert
Storm-like military deployment?
Global economics pose even tougher questions. The United States
has been blessed with a mammoth stock-market run-up and low
inflation despite a record trade deficit, in no small measure
because import prices fell while foreigners exported their capital
back to America. In effect, we could buy more things with other
people's money at much lower than normal prices, a trade and
investment pattern without a historical parallel.
If import prices suddenly rise or overseas investors repatriate
capital to home markets, U.S. inflation would likely spike,
stock prices plummet and public finances bleed red. Is preserving
today's odd global status quo therefore critical to U.S. national
security? Must the U.S. limit overseas expansion and consumption
of capital, perhaps by encouraging the sort of deflationary
financial attacks that so recently crippled the once highflying
The five interest-rate hikes so far by the Federal Reserve
Board make clear just how precarious new-economy public policy
can be. To curb inflation, the Fed has repeatedly acted to restrain
wages and prices by boosting the cost of money and trying to
throttle expansion. Stock markets typically like such policies
because corporate revenues rise when labor and supply costs
fall. But rising interest rates also lure fund managers away
from equities into safer investments like higher-yielding CDs.
If the Fed's anti-inflationary stance too abruptly upsets the
balance between stock-investment flows and slow wage and price
growth, it could push the economy into recession.
The United States is woefully unprepared for such possibilities.
It has bet the house on information-age business and finance,
to the exclusion of almost everything else. This strategy served
well over the last few years, but should its profound public-
and private-sector conflicts once again become overt, it may
yet prove a costly bargain indeed.