A couple days ago, we covered the 1929 stock market crash in our New Deal series, and I had mentioned that cheap credit and monetary expansion helped inflate this bubble. What we didn’t yet discuss is the way governments can direct capital in a society.
A few of us who spend time discussing these things have affectionately dubbed the international banking system of today, social monetarism. Where profits are privatized and losses are socialized. Winners and losers are chosen by government bailout programs and credit expansion. But there is more to government intervention in economic action than just this.
The other ways governments affect economic activity are with spending, tax breaks, and legal monopoly status. We will cover each of these, but today I want to focus on corporate tax breaks in the vein of the 1929 stock market bubble.
In 1921, as an effort to stem off wartime taxes from the Great War, Treasury Secretary Mellon pushed for the Revenue Act of 1921. His argument was that economic growth would require significant tax reduction, which of course we know is true.
With the Revenue act, Mellon repealed the “Excess Profits Tax” (a hilarious concept in and of itself) and also introduced exemptions for employee contributions to pension plans from federal corporate income tax.
Now here marks an interesting shift in corporate tax incentives. Pensions were not yet widespread in the US at this time. In fact it wasn’t until the 1940s that labor unions became interested in pension plans and pushed to increase the benefits offered. By 1950, nearly 10 million Americans, or about 25% of the private sector workforce, had a pension. Ten years later, about half of the private sector workforce had one.
Recall that saving for the future takes a much different form under a less expansionary monetary system. With the creation of the Fed in 1913, and the subsequent expansion of the money supply, these incentives for corporations to direct capital towards pension plans (which in turn directed capital towards equity speculation) may have been a very important factor is helping create the stock market bubble of 1929.
Capital which ordinarily may not have gone into the equity or debt markets, was softly directed by corporations wishing to shield themselves from some of the burden of corporate income tax.
More capital, than perhaps otherwise would, going into the markets means asset inflation, which creates a feedback loop of speculative participation. Which then creates bubbles. Which then creates crashes.
Following this logic out from the start of corporate tax incentives through pensions in the 1920s, and the growth of pensions in the 40s and 50s, into the highly financialized system we have today… it’s not hard to see how government policies (in tandem with monetary policy) have created the current financial paradigm.
Futures get planned around retirement funds. A huge percentage of allocated capital makes its way back into existing businesses. The search for yield becomes endless.
Yes, more capital than would otherwise normally be available makes its way into equity, but remember opportunity cost. Entire industries crop around servicing financialization of the economy, and before long you end up with a system where growth at all costs becomes the norm.
Book of the Month:
“Competition in coinage is no panacea. Abuses are always possible and in many cases they cannot easily be repaired. The virtue of competition is that it offers the prospect of minimizing the scope of possible abuses”
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