The New Entitlement

The United States is approaching the millennium with a lotus-eating culture and e.commerce that some insist have banished the bad old business downturn. But what if we are actually living in America’s first major example of an aging economic cycle on the financial steroids of a “wealth effect?”

Then today’s tax-cut drum beaters would be wrong about a new plateau of prosperity. The next business cycle and politics could easily bring the reverse of today’s giddiness: an “unwealth effect” in which consumer spending contracts as paper affluence shrinks.

Politics, in turn, has become a twin of this new economic culture. Money is king more than at any time in memory. Texas Gov. George W. Bush has been all but anointed as the Republican presidential nominee for 2000, because he is so far ahead. Not in delegates, not in talents (few are sure of those), but in funds raised. He has a record bank account.

The GOP-controlled House of Representatives, for its part, has just passed a 10-year, $792-billion tax cut, in which its worship of Baal has become public. Tax breaks for corporate America are as numerous as semicolons in the pages of its fiscal legalese. As for household impact, Treasury Department calculations reveal that the wealthiest 1% of Americans--1 million families--would receive 33% of the dollar benefits. The poorest 60% of the population would get only roughly 7% of the benefits.

It would be better by far to combine the proposals of President Bill Clinton and the Republican Senate. The former would use most of the apparent budget surplus--10-year projections are more astrology than science--to support and protect Social Security and Medicare. The Senate GOP focuses its tax cuts on trimming the 15% income-tax rate now paid by a majority of Americans down to 14%, and reducing the marriage penalty. With the economic future so unclear, caution is reason.

But House GOP architects insist on huge tax cuts to give the money back to those who made it. Bush also seems amenable to this. Still, courtship of wealth is bipartisan. The No. 2 Democratic contender, former Sen. Bill Bradley, known as “Dollar Bill” in his high-earning sports days, also has drawn a good share of financial-sector contributions.

The underlying premise is nurturing of wealth. The longest peacetime business cycle of the 20th century, abetted over two decades by five or six Washington bank and investor bailouts, has created a stock-market boom that dwarfs the ballyhoo years of the 1920s. Rich in the United States now means mega-rich, though the nation also has the industrial world’s largest gap between rich and ordinary citizens. The House, meanwhile, is so sure the market bubble can’t be popped that its focus is on predistributing the expected fruits of the next 10 years of prosperity.

The orgy, however, is also an unveiling. The tax-cut debate about giving money back to high earners is helping to sketch in important details of the wealth effect: Who, where and how much?

The benefits in the House package that the Treasury Department says would concentrate on the richest 1% come from many provisions, including the 10% across-the-board reductions in federal income-tax rates. Two of the sweetest are immediate reduction of the current top tax rate on capital gains from 20% to 15%; and the phased-in elimination of federal gift and inheritance taxes by 2009.

Greed is a better explanation for these changes than economic-stimulus anxiety. The richest 1% of Americans enjoy about 13% of U.S. household income under the official definition, which excludes capital gains. This is up from 8% or so 25 years ago. But if capital gains are included, as they should be, those at the top have 20%-25% of U.S. income. Marie Antoinette and the French nobility (also a wealthy 1%) had a comparable share in 1789.

As for the political favoritism involved, official 1993 data show that U.S. taxpayers with incomes of more than $200,000--then roughly the wealthiest 1%--reported about 60% of the dollar value of taxable capital gains. Reducing the current top capital-gains-tax rate from 20% to 15% would bring toasts in champagne glasses, not beer mugs.

Precedent is as lacking as justification. All the U.S. bull markets of the last 50 years occurred with a 20%-28% top capital-gains rate. What is more, capital-gains revenues have been rising in recent years, and a 15% rate would undermine the emerging budget surplus.

Then there’s the House provision to phase out estate and gift taxes. Demographers predict that with the deaths expected over the coming decade, the next 10 years will set a record wave of estates, perhaps totaling $6 trillion-$8 trillion, passing through the inheritance processes. The richest families have the great dollar bulk of what are now taxable estates, and if they pass untouched or lightly taxed, wealth and position in the United States will emerge as ever more inherited, not earned.

It’s not altogether a grab, however. There is a genuine belief, especially among conservatives, yet also among rich liberals, that we’re in a new economy, one that’s moving beyond recessions and stock-market collapses. Part of what’s occurring is a wealth effect that trickles down from stock-market gains to high-end consumer spending and surging employment for security providers, nannies, bankers, landscapers and travel agents to the rich and prosperous. Tax relief for those at the top, by this argument, has economic as well as political merit.

This prosperity helps explain the increasing tolerance for the corruption of U.S. politics by “big money,” where contributions are especially likely to come from multimillionaires and the corporate and financial sectors. Nonetheless, Bush’s recent decision to reject federal matching funds and spending limits to raise and use unlimited funds in next year’s GOP primaries has crystallized discussion.

The issue divides both parties. If Bush likes the current system, one of his GOP rivals, Sen. John S. McCain (R-Ariz.), indicts today’s election finance system as “an elaborate influence-peddling scheme in which both parties conspire to stay in office by selling the country to the highest bidder.” McCain also ties together the obvious: selling tax and other federal legislative favors goes hand in hand with the access bought by campaign contributions. We can even wonder what percentage of the income and wealth of a few Americans comes not from sweat or innovation but from the influence that political contributions have bought in Washington.

Too much. History repeatedly confirms the overlap between the go-go eras of speculative capitalism, trickle-down theology and the corruption of politics by money. The last 15 years clearly resemble the Roaring ‘20s and the late-19th-century Robber Baron era. Yet, the same history cautions against expecting reform before the financial bubble pops.

Which brings us back to the unprecedented wealth effect of the 1990s and what it may mean. Other discussions of the imminent end of a business cycle--well-publicized in the late 1920s and late 1960s--coincided with periods in which stocks boomed and the business cycle stretched out nearly a decade. Wealth effects probably played a role in each longevity. But they did not end cycliality.

The weightier wealth effect of the 1990s could, in turn, lead into a new form of “unwealth effect.” Last winter, this current U.S. business expansion became the century’s longest in peacetime. The record of the 1960s recovery, which straddled the Vietnam War, won’t be equaled until this coming winter. But many experts assume the expansion will last.

The nature of what’s happening, though, is more important than the precise timing. These tax-cut debates in Washington have spotlighted both unprecedented riches and lawmaking for hire. If we have entered a “Palm Beach Triangle” of sharpening concern with the fortunes and tax breaks, growing attention to money as a political corrupter and caution about a business cycle strung out on an unprecedented wealth effect, the descent could be rocky.

For now, Clinton says he will veto the GOP tax package, which, in its House version, may be the most outrageous in 50 years. You have to go back to 1948, when the Republican 80th Congress passed a far-reaching tax cut, which President Harry S. Truman vetoed, to find a similar case. That confrontation helped the Democrats recapture Congress as well as reelect a president. A Clinton veto could be a significant barometer.

So, too, for the possibility that Congress will reluctantly enact a serious overhaul of campaign finance, although few would bet on it. If upper-bracket confidence in the power of the business cycle and the reliability of political favoritism starts to ebb, the stock-market averages may not be able to sustain the current sky-high valuations, which are partly based on both assumptions. Unwealth-effect psychologies could begin to bite.

It’s hard to say which would be rockier, the politics or the economics.*