How Capitalism Will Save Us (30 page)

Hedge funds were also mistakenly blamed for helping to propel the steep rise in the price of oil—another example of shooting the messenger. Hedge funds alone couldn’t set the value of a commodity traded worldwide in so many markets. They went along for the ride. Their speculation was prompted by the Federal Reserve Bank’s easy-money policy, which sent the prices of all commodities rocketing upward. When the Fed tightened up that policy in the summer of 2008 by not printing excess dollars, commodities, including oil, crashed—and hedge funds were powerless to prevent it.

Given the current economic disaster, there will certainly be new rules and regulations for equity and hedge funds. Whether they will be constructive or destructive remains to be seen. Suffice it to say that big collapses of “underregulated” hedge and equity funds have been far fewer than those of highly regulated banks and insurance companies.

H
arvard Law School professor Elizabeth Warren and her daughter Amelia Tyagi did a study comparing an average middle-class family who lived on one income in the 1970s with the two-income family of today. They claimed that even though today’s two-income family brings in 75 percent more income than yesterday’s one-income wage-earning family, they actually have less disposable income. Why?

According to Warren and Tyagi, five budget items—housing, health insurance, cars, taxes, and child care—now eat up three-quarters of the income of today’s two-income families. A generation ago, they assert, these expenses consumed only half the income of a single-earner family.

Critics of capitalism also blame tax cuts and free trade for squeezing the middle class. It may be tempting to believe such gloom-saying during the current, especially sharp, recession. But it is not borne out by long-term statistics. In the 1980s, the net worth of U.S. households increased 110 percent; in the 1990s, it rose 108 percent. And until the financial crisis of 2007 it increased another 50 percent. In the current downturn, household net worth took a real hit because of the sharp slump in both the housing and equity markets. But this is not a permanent state of affairs. We’ve had periods in the past of decline followed by rebounds that exceeded the previous highs. The only exception, of course, was the 1930s, when, as we’ve seen, government policies hurt recovery.

Before the financial crisis and recession the nation was, in the view of
some, nearly at full employment, with unemployment rates lower than they had been throughout most of the past thirty years.

Critics of capitalism have long insisted that Census Bureau numbers reflecting a smaller percentage of middle-income earners since 1980 suggest the decline of the middle class.
Forbes
columnist and author Bruce Bartlett, a former Treasury official, dismisses “the clear implication that the percentage of those defined as the ‘middle class’ has fallen because many of those who used to be considered middle class have become poor.” That idea, he claims, is essentially hogwash. “In fact, the ranks of the poor have fallen along with those of the middle class” over the past three decades.
³⁸

The reason, he says, is that more of them are richer. Multiple studies confirm this trend, including the 2007 U.S. Treasury Department study mentioned earlier in this chapter. It reported that “roughly half of taxpayers who began in the bottom income quintile in 1996 moved up to a higher income group by 2005.”
³⁹

Bartlett asks, “How can it not be a good thing for society that fewer people are now making low incomes and more are making high incomes?”

But what about those people left in the middle? Aren’t they being squeezed by higher health-care, education, and insurance costs? Yes, those things are more expensive. But it’s taxes that are causing the problem.

Writing in the
Wall Street Journal
, George Mason University professor and bankruptcy expert Todd Zywicki shows how Warren and Tyagi’s study downplays the tax issue. “When a spouse enters the workforce, he or she is immediately taxed at a higher marginal rate than one worker would be alone.”
⁴⁰
Not only that, he says, family budgets are stretched still further by rising state and local taxes, especially property taxes.

Mortgage payments, health insurance, and car payments have increased since the seventies. However, “the increase in tax obligations is over three times as large as the increase in the mortgage payments and almost double the increase in the mortgage and automobile payments combined. Even the new expenditure on child care is about a quarter less than the increase in taxes.”
⁴¹

Zywicki takes a closer look at the numbers in Warren and Tyagi’s comparison. He finds that the tax bill for their present-day middle-class family had increased by $13,086—an incredible 140 percent. Meanwhile,
“the percentage of family income dedicated to health insurance, mortgage and automobiles actually declined between the two periods.” In other words, he says, today’s middle class families are not in a “two-income trap” but in a “two-income-tax trap.”
⁴²

“The typical family in the 2000s,” he says, “pays substantially more in taxes than the combined expenses of their mortgage, automobile and health insurance.” Some may wonder how this can be the case in light of the tax cuts that have taken place since the 1970s. It’s because until the 1970s, most income earners were not in high tax brackets, especially after President Kennedy cut taxes in the 1960s. Then, too, Social Security and Medicare taxes were very low. In 1970 the payroll tax for FICA ate up a maximum of 6.9 percent of your income; by 1980 it was 8.1 percent; in 2009 it was 15.3 percent.

Moreover, the real value of standard exemptions (deductions for kids and spouse) was higher in real terms in the 1950s and 1960s than afterward. When you have two income earners, especially among professionals, you fall into a very high tax bracket. People didn’t hit those brackets as often in those early days, and exemptions were richer. Add increased payroll taxes, zooming property taxes, and burgeoning state income and sales taxes, and you have yourself a heavy burden indeed. For example, New Jersey had no sales tax until the mid-1960s. Today it is 7 percent. The Garden State had no income tax until the mid-1970s, and then the maximum rate was 2.5 percent. In 2009 the highest rate was almost 11 percent.

As for rising health and education costs, they are anything but the result of too much capitalism. As we shall see in
chapter 7
, health-care costs are the result of layers of laws and regulations distorting markets for medical care. And isn’t government responsible for those substandard schools that families are economically stretching themselves to escape?

Today’s middle-class squeeze is partly the result of another development that the gloom sayers don’t necessarily like to acknowledge: today’s higher level of material affluence and opportunity that has raised consumer expectations and standards. Yesterday’s innovations and luxuries have become today’s necessities. As personal-finance writer Laura Rowley puts it, it’s harder to live on one income today because there is “so much more stuff to say ‘no’ to.”
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Take higher education. Spiraling college costs were not an issue
decades ago when the majority of people did not go to college. But now many more do.

Another modern convenience that was not part of life back in the 1950s: credit cards. Few people realize that they became a major factor only in the 1960s. Before, people often used personal-loan companies to borrow money for household purchases. Their rates made credit cards look like bargains. “Plastic” lowered the cost and availability of credit. You didn’t have to run to the bank to get cash. It made buying things a whole lot easier. But the downside was that you could misuse these powerful tools and incur too much consumer debt.

The truth is that there
are
middle-income families that are living on one income. How do they do it? Through prudent budgeting and consumption. Living like a one-income family in the 1970s can sometimes mean scaling back consumption to something resembling 1970s standards. This sounds harsh. But those who have managed to do it insist that it isn’t. One typical post on Wise Bread, a blog for people “living large on a small budget”:

Carl, a single-income earner, opines that, in the end, family life on a single income ends up being cheaper because there aren’t the costs associated with a second job—like child care and transportation.

Writes Paul, a stay-at-home dad, living on his wife’s income “allows me to garden, take care of the chickens, take care of the bees, plan and cook good meals, write poetry, walk with the kids, etc.”