Our Land of Opportunity Needs Reform and Revival

Economists often point out that the most important decision you make in your life is your choice of parents. You want to choose rich, well-educated parents. Unfortunately this seemingly humorous commentary is based on some not-so-humorous empirical evidence from studies about a poor person’s chance of rising out of poverty and a rich person’s likelihood of falling into poverty. More specifically this is based on the income and wealth of your parents in comparison with your own income and wealth. It is asking whether your cross-generational socio-economic status has increased, decreased, or remained unchanged.

In the late 1800s and early 1900s the transition from an agricultural society to an industrial society greatly enhanced the socio-economic status of many people from relatively poor families. However, in recent decades socio-economic status in the United States has become more or less frozen. The land of opportunity has become a land more or less permanently divided between the haves and the have-nots. Celebrated cases to the contrary are merely exceptions to this well-established fact.

What makes this fact especially painful is that the United States is among a handful of countries where this is true, including China and a number of Latin American countries. At the other end of the spectrum are Scandinavian countries including Denmark, Norway, Finland and Sweden, along with Canada where upward mobility is more the rule than the exception.

In the United States the underlying cause of this problem is the extreme differences in political and economic power between the wealthy and those not so fortunate. Given the political power of the wealthy, it should be no surprise that income generated from wealth (realized investment income) is taxed at a much lower rate than income from work (earnings). You pay a higher tax rate so that the wealthy can pay a lower tax rate.

Moreover, the tax loopholes have been designed to substantially reduce the taxable income of the wealthy. For example, Internal Revenue Service (IRS) code IRC-469 allows a substantial deduction in taxable income through write-offs for property “depreciation” for property owners who spent at least 750 hours or more during the tax year on property management (or paid someone who spent 750 hours or more). Ironically, if a property has substantially appreciated in value prior to purchase, the amount claimed for “depreciation” is greatly increased. Only the wealthiest Americans and corporations own enough property to require at least 750 hours of property management each year.

Blackstone and other Wall Street firms have been buying up homes throughout the United States to turn them into rental properties to take advantage of IRC-469. Turning owner-occupied homes into rental properties denigrates our neighborhoods because renters and Wall Street property companies have much less incentive to keep those properties looking good. Perhaps you have received a call or a mailing from one of these Wall Street firms offering to buy your home.

The Supreme Court’s Citizens United decision that declared corporations to be “people” under our constitution fundamentally changed our political system from a one-person-one-vote system to a one-dollar-one-vote system. It gave corporations a lot more influence over our politicians to reduce corporate taxes and adjust regulations to do a better job of suppressing rivals, reducing competition, and blocking entry. In general the enhanced political power of wealthy corporations have enabled them to greatly lower their tax liabilities and increase their market power. Someone has to pay for the aircraft carrier. If the rich pay less, everyone else has to pay more.

The resulting monopolies, duopolies, and oligopolies reduce overall economic efficiency and productivity to reduce costs while increasing prices and lowering both quantity and quality to increase their profits. All this undermines the primary goal of economics which is to bring about the most efficient allocation of resources. This reverses Adam Smith’s invisible hand of competition that improves quality and lowers prices for everyone.

Hard work pays off. But not for the person doing the hard work. The employee’s hard work pays off for the shareholder under the maximization of shareholder value mantra. Companies focus on maximizing short-term share price through increased dividends and share buybacks instead of rewarding employees for their hard work and dedication, or investing those funds in customer satisfaction through better quality at lower prices, product development and improvements in productivity.

The fundamental problem is the composition of corporate boards. Many corporate boards essentially consist of the CEOs golf buddies. They only know what the CEO tells them and read the reports the CEO provides about how great a job the CEO is doing. Steven Clifford who has served on a number of corporate boards has written the book: The CEO Pay Machine, which explains the very non-free-market way that a CEO’s compensation is determined. Often it boils down to “I’m on your board and you’re on my board so I maximize your compensation so that you will maximize my compensation.” Satisfying customers and rewarding employees is not of much concern. The focus is on short-term share price and offering big bonuses to the corporate leadership when share price increases significantly in response to paying for expensive share buybacks and dividends that diverts the money from more important and productive uses.

Before 1982 share buybacks were considered insider trading and illegal under Security and Exchange Commission (SEC) regulations. However, politicians under the influence of wealthy corporate donors pressured the SEC to drop the restriction on share buybacks so that after 1982 corporations were free to jack up their stock price by buying back lots of their company’s stock instead of using that money to create new products or reward hard-working and industrious employees.

Creative entrepreneurs like Steve Jobs worked hard to create new, exciting, and amazing products for Apple, Inc. customers. Then John Sculley came along and said: “You know Steve, you really need to increase Apple’s profit margins and increase Apple’s share price.” The Apple corporate board set Steve Jobs aside and turned over Apple, Inc. to John Sculley. Under Sculley, Apple focused on Apple’s share price and pretty much ignored product development. Microsoft and other computer companies began to move ahead of Apple, Inc. in product development and consumer satisfaction. Eventually as demand for Apple products slumped, Apple’s corporate board caught on and removed John Sculley and brought back Steve Jobs.

Germany has recognized and addressed this problem of CEOs and their golf buddies diverting money from product development and employee compensation and requires employee representation on all corporate boards. German companies now stay focused on product development and consumer satisfaction along with incentives for employees to work hard for the corporation. The United States should follow Germany’s example and require that a significant part of corporate boards be elected by the company’s employees to represent product development, production, marketing, sales, and distribution.

Burns and McDonnell started out as a small construction company in Kansas City. It developed into a nation-wide engineering company and in recent years into a world-wide engineering company. Former Burns and McDonnell CEO Greg Graves has recently written a book about the success of Burns and McDonnell called: Create Amazing. Graves explains that Burns and McDonnell is entirely owned by its employees. Any employee that retires or leaves for any reason must sell his or her shares in the company back to the company and receive money for those shares. Company ownership by employees creates strong incentives for employees to work hard and also to make sure that their fellow employees are working hard as well. It creates a team spirit. We are all in this together. Together we can create tremendous consumer satisfaction and make big profits for our company and for ourselves. Employees that don’t share this commitment don’t last long in the company.

Essentially Burns and McDonnell and other such employee owned companies have re-established John Locke’s link between capital and labor. Employee owned companies reward an employee’s sweat equity with capital ownership. Locke (1632-1704) established the principle of capital ownership through sweat equity which created the frontier spirit in America where pioneers established land ownership through working the land. This contrasted sharply with Argentina which was at the same stage of development and economic wealth in the 1800s as the United States but allocated the land to wealthy nobility and never developed as extensively or grew its gross domestic product (GDP) as quickly as the United States.

Rewarding people for their hard work pays off both in individual enterprises and for our nation as a whole. We need more employee representation on corporate boards and more employee owned companies if we are to compete successfully on into the future and give people a chance to improve their socio-economic status so that we can again call our country the land of opportunity.

Feel free to leave your comments, suggestions and ideas in the Comment box below.

You can sign up for this monthly Money Flow Newsletter here: Sign up now