The Bear’s Lair: The decay of property rights

New York Mayor Bill de Blasio claimed last week that there was plenty of money for his pet projects, but it was “in the wrong hands.” In response, the Wall Street Journal, supposedly the voice of capitalism, gave a turgid list of rich New Yorkers’ charitable donations while blasting the inefficiencies of de Blasio’s administration. Both sides are wrong; in a well-run system, property rights should be inviolable regardless of what owners do with their property. That’s tough to defend when funny money has unfairly rewarded speculators – yet another reason to return to sound policies.

Politically, de Blasio doubtless feels he is on the winning side of the argument. A majority of Millennials claim to favor Socialism, though a high percentage of that majority are unable to define it correctly. That combination is a staggering indictment of U.S. public schools and colleges, but we knew that. Rich New Yorkers tend to have an exceptional penchant for displays of vulgar, tasteless excess – even by the standards of those who, like myself, find President Trump’s gold leaf rather attractive. Most important, since New York is the United States’ financial center, much of the New York wealth has been gained by exploiting the artificially low interest rates and overblown asset prices of the last 24 years – so can it really be said to be legitimate?

Certainly, the Wall Street Journal’s defense of New York’s capitalists is feeble indeed. You can bet your bottom dollar that every $50 million extension to the Metropolitan Museum has given its donor an equivalent tax deduction. That means roughly $20 million or even $25 million, given state and city taxes, of that $50 million extension has come from the pockets of you and me, and represents extra taxes we must pay to fund public services. Looked at that way, de Blasio would seem to have a point – if he simply seized the $50 million and funded public services directly with it, you and I would be $20-25 million better off. The charitable tax deduction is a universally corrupting influence and needs to be abolished. Certainly, completely contrary to the Wall Street Journal’s view, the fact that rich people get to deduct their charitable donations is the best possible argument for their expropriation.

That counter-intuitive argument, that de Blasio is right and we should wish the very rich to be expropriated, is an indication that the current U.S. economy has moved a long way from a healthy free market. Accumulation of wealth by rich speculators is subsidized by interest rates that have been for two decades far below their free-market levels. It is also subsidized by a charitable tax deduction that blesses the ultra-rich far more than it does other taxpayers, producing the nauseating result that by making flashy well-publicized charitable donations they save taxes and at the same time get held up as models of virtue by the Wall Street Journal. It is perfectly possible for the very rich to be models of virtue, but the most virtuous ones are those whose wealth accumulation does the most for their fellow men, not those prone to splashy tax-deductible charitable donations that burden the rest of us with the taxes they have avoided.

The problem with just shrugging our shoulders and accepting the morality of de Blasio and the current tax system and Fed policy is that such an economic system does not work too well. In this system, it is much easier to get rich from borrowing excessively and doing something not very clever than from true entrepreneurship. Eddie Lampert’s destructive 14-year ownership of Sears is a prime example of this.

In a system in which cheap money is the most reliable source of wealth, access to cheap money becomes the deciding factor in who gets wealthy, so mediocre projects with quick paybacks get financed in vast numbers and the long-term and difficult projects don’t happen at all. The result is an economy in which innovation and productivity improvement slow to a crawl or cease altogether, as was the case in the United States in 2008-16 and is still the case in Britain and the Eurozone.

To see how the economy ought to work, we must go back to the dawn of the Industrial age, when low tax, sound money and well-aligned incentives made productivity growth in the British and later world economies accelerate rather than decelerate. From 1819, Britain was on the Gold Standard, so there was no question of spuriously cheap borrowing making people rich. At that period, if you became rich, you had done it either by successful trade or by getting your hands dirty in some way in industry. On the other side, there was no Income Tax and all taxes were on some element of consumption, so the very rich who engaged in vulgar displays of ostentation were financially penalized by paying taxes on the cost of their ostentation. As for charity, there was no charitable tax deduction (because no Income Tax to deduct it from) so charitable donations were made only by the truly charitable, for genuinely beneficial purposes – and they cost non-donors nothing.

In the early industrial system, statesmen on both sides of the political divide held property rights as sacrosanct. “Property is theft” was the sort of thing only a Frenchman (Pierre-Joseph Proudhon, 1840) could say, resulting from that society’s impoverishment and tendency to violent revolutions – with such attitudes it was no wonder that country never made any material progress! With property rights sacrosanct, entrepreneurs and inventors could be sure that, if they devised a new product or way of doing business that was genuinely superior, they would be able to keep most of the proceeds of doing so.

For the early 19th Century, there was also an important moral component to this. John Locke, a hundred years earlier, had defined the purpose of government as to secure people’s life, liberty and property. Security of property from arbitrary raids, either by powerful barons or the government, was a vitally important principle over which the English Civil War had been fought, and which was incorporated into British constitutional practice by the great Earl of Clarendon after the Restoration. Britain’s better economic performance after 1660, and the growth of a huge capital market that could finance government’s needs, were important advantages the country enjoyed over rivals such as France that did not have such security. The United States, where Thomas Jefferson perverted Locke’s trilogy to replace property with French rubbish about the pursuit of happiness, suffered thereby in having a distinctly gamey business climate.

For statesmen of the early Industrial Revolution, the idea of “redistributing” people’s property to remedy imagined injustices would have been a laughable negation of what government was about. It was not possible for “the wrong people” to be rich, because there was no mechanism to make them so; the law existed to prevent fraud, and with a Gold Standard monetary system there was no great advantage to having better access to financing sources. Since property had been acquired legitimately its possessor had an absolute moral right to it – the miser just as much as the philanthropist.

The lesson is clear. Capitalism is a moral economic system and works well if allowed to do so. It however requires certain rules in order to function, notably the security of private property. If private property is insecure, to be looted by every passing populist, then the universally enriching features of capitalism do not work. Capitalists, instead of competing properly in the market, spend their resources on shielding their wealth from populists, thereby preventing it from doing any good.

If the economic system is distorted by government meddling, however, the moral equation that is central to capitalism falls apart. If interest rates are artificially distorted by government over a prolonged period, then not only does the capitalist system itself work badly, but it unfairly rewards some participants, producing property to which there is no intrinsic moral right. Equally, if government provides egregious tax breaks to the very rich for their “charitable” activities” then not only do corrupt excrescences like the Clinton Foundation spring up, but government gains the moral right to divert property into its own uses, rather than just rewarding property owners for deploying their property in one manner rather than another.

De Blasio is wrong, politically, morally and economically. But we must eliminate grossly distorting government policies such as “funny money” interest rates and the charitable tax deduction before we truly have the right to rule him out of the discussion.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)