The goose that lays golden eggs has been considered a most valuable possession. But even more profitable is the privilege of taking the golden eggs laid by somebody else’s goose.
— Louis Brandeis
The New Republic, June 14, 1975
NOT LONG AGO a West Coast bank president mentioned to me that a piece of land he had purchased near San Francisco, situated alongside a new state highway, had doubled in value in a few years. Several miles away was a low-income Chicano neighborhood, and naturally the new highway cut right through it, forcing residents to give up their homes and seek, probably without much success, equivalent low-cost housing elsewhere in the area. The bank president noted a certain irony in the fact that the same public investment could cause hardship to low-income families and simultaneously bestow a windfall upon someone who scarcely needed it. But, he added, he would keep the money.
The bank president’s windfall is an example of what John Stuart Mill called the “unearned increment” — the increase in land value brought about by general progress. The increment is unearned because the beneficiary has done nothing — other than buy land and wait that might entitle him to be rewarded.
The question of what is earned and unearned becomes more complex when one considers ownership of capital rather than land. If a man invests his savings in, let us say, a new brick factory, he is surely entitled to a return on his investment. Society needs bricks; anyone who builds a brick factory is performing a socially useful task and should be rewarded. But the potential for unearned gain is present. If the brick factory happens to be located in a community that, for one reason or another, begins to thrive and grow, the factory appreciates in value. Some of the increased value will be attributable to the factory owner, and some to the efforts of others, but the factory owner will reap it all.
Suppose that the factory owner gradually buys out all other brick manufacturers in the area. Now he will be in a position to reap even more spectacular gains. The value of all of his factories will go up, as will his operating profits. That portion of his newly acquired wealth which is attributable to monopoly is clearly unearned. The factory owner, as monopolist, adds nothing to the general wellbeing. He is not producing more bricks than the individual factories, separately owned, once produced. He is probably producing fewer bricks and charging higher prices for each.
Observe another change that has occurred. The factory owner is no longer an original investor; he has become what might be called a second-generation appropriator. Whereas original investors are often risk-takers and innovators who contribute to the advancement of society, second-generation appropriators tend to accumulate wealth largely at the expense of others. Consider the sturdy New York apartment building I once lived in, which was constructed around the turn of the century and had paid for itself many times over before I moved in. The rents, far from decreasing after the building was paid for, were climbing all the time. Property taxes and maintenance costs, of course, were rising, but these should have been more than offset by the disappearance of financing costs. The problem was that financing costs did not disappear, but, in fact, grew, because the apartment house was sold and resold every few years, and each new landlord had to collect a return on his investment. None of the resales added anything to the joys of living in New York City; they merely saddled the tenants with somebody else’s financing charges and profit margins.
These examples barely touch upon the possibilities for garnering unearned income in America. Bookstores abound with titles such as How To Get Rich While You Sleep—Let Real Estate Do Your Work. Magazines bring us wondrous tales of fortunes made through the use of leverage (i. e. , other people’s money), of conglomerates whose paper values far exceed the sum of their parts, of tax-sheltered investments that effortlessly increase the wealth of the already wealthy.
There are, at least in my mind, two prime criteria for judging whether a person’s income, or gain in wealth, is earned or unearned: (1) Does the activity which generates the income add to the supply of goods and services available to society? (2) Is the income a result of its recipient’s efforts, or is he merely reaping the benefits of others’ exertions? By these criteria, all income from productive labor, except for inordinately high executive salaries or professional fees, is earned. Income from the ownership of wealth is not, ipso facto, unearned, but is likely to contain a large unearned element. The precise categorization of income from wealth is somewhat complicated by the separation, in practice, between the earning agent and the beneficiary. A rise in GM stock may, from GM’s standpoint, be partially earned; but from the standpoint of the absentee stockholder, who does nothing but open his mail, the increment might be considered unearned. Government handouts and subsidies should undoubtedly be considered unearned.
How large, in a given year, is the unearned segment of national income? Assuming that unearned income is operationally defined as all income other than that earned through labor, before-tax unearned income in 1970 was roughly $200 billion (national income, $800 billion, minus reported wages and salaries, $600 billion). This includes poor people’s welfare, and, if we might call it that, rich people’s welfare. A comparison between these two components is interesting. The total amount paid out by federal, state and local governments for aid to dependent children, general relief and other noncontributory welfare programs for the poor, disabled and aging was $16 billion. By contrast, the unearned income going to wealth-owners included $34 billion in interest ($19 billion on the national debt alone), $25 billion in dividends and $23 billion in rent. And let’s not forget unrealized capital gains and appreciations in land value, which are omitted from reported income. These aren’t trifling amounts: the National Commission on Urban Problems, chaired by former Senator Paul Douglas, estimated that land values rose an average of $25 billion per year during the 1960s, while a study by James D. Smith of Pennsylvania State University found that, in 1958, top wealth- holders enjoyed a net capital gain of $57 billion.
Rich people’s welfare, besides being more plentiful than the poor’s, is concentrated among fewer people. According to IRS figures for 1966, fewer than two percent of all taxpayers received 74 percent of all dividends and 76 percent of all capital gains. A large number of wealthy welfare recipients have done nothing more to qualify for their unearned income than to have the right parents. According to a study by the Federal Reserve Board, inherited wealth accounted for a “substantial portion” of total assets of 57 percent of those with income of $100,000 or more.
Rich people’s welfare has many advantages over the poor’s. There’s no legal ceiling, no humiliating means test, no prying by social workers, no questions about men in the house, no public opprobrium, no danger of cutoff. You can hire accountants, lawyers and lobbyists to do your chiseling, and best of all, you don’t lose a penny if you get a job.
If you happen to be one of those less fortunate millions who do have jobs, you will notice that rich people’s welfare beats working, too. There’s no boss to contend with, no unsafe working conditions and no need to be competent at anything. You can sleep late in the morning and not worry about rush-hour traffic. You needn’t fear illness, sexual discrimination or getting fired. And to top it off, you’re eligible for a dazzling array of tax breaks and subsidies.
That many forms of unearned income should be more lightly taxed than earned income may appear incongruous in a country that, according to Mr. Nixon, sanctifies the work ethic, but the explanation is not hard to fathom: wealth-owners have more political power in America than non-owners of wealth. The list of tax privileges that wealth-owners enjoy runs the gamut from the petty to the grandiose. The initial advantage is that taxes on unearned income are not withheld automatically, as are taxes on wages and salaries. Unearned income is also exempt from social security and other payroll taxes, which are the fastest growing federal taxes. In 1963, payroll taxes raised only 42 percent as much as personal income taxes; in 1973, the proportion will be 68 percent.
Another tax break for wealth-owners is the deductibility of depreciation from taxable income, often at accelerated rates. This amounts to a hefty federal reimbursement for wear-and-tear, general obsolescence and decreasing earning power of wealth-owners’ assets. There is no comparable compensation for the declining earning power of workers’ bodies and minds; there is, in fact, a regressive labor depreciation tax (i.e., Social Security). Some wealth-owners are particularly favored by the depreciation rules. Real estate wheelers-and-dealers, for example, are permitted high depreciation rates during the early years of owning a building; when deductions for depreciation start diminishing on one building, they can sell and start deducting on another. Owners of timber, oil, coal and other mineral properties receive a special allowance called percentage depletion. This enables them to deduct from taxable income not the actual decline in value of their assets, but an arbitrary percentage of gross revenues. What they save on income taxes can be many times what they pay for their properties.
y far the largest loophole for wealth-owners is the preferential treatment for capital gains, (i.e., increases in the value of property). First, unrealized capital gains are not taxed at all. This allows wealth-owners to accumulate wealth without interruption or diminution; if they don’t cash in their holdings before death, their heirs escape taxation on the long-term capital gain. Second, only half of realized capital gains need be counted as taxable income, or, if all is counted, the tax rate is approximately half the tax rate of income from labor, up to a maximum rate of 35 percent.
The epitome of unearned income is that which derives from inherited wealth. Theoretically, self-perpetuating fortunes could be whittled down by estate, gift and inheritance taxes, and there exists a federal estate tax with a nominal maximum rate of 77 percent on taxable estates over $10 million. But the tax has become increasingly porous since the 1940s. Through marital and other deductions, gifts and placement of estates in tax-exempt foundations and trusts, most large fortunes can be passed on virtually intact.
One could go on to discuss tax-exempt state and local government bonds, the tax advantages of stock options and various tax-sheltered investment schemes, but the point is clear. Except for dividends on stock and interest on savings deposits — the.two types of unearned income most frequently collected by persons of moderate means — unearned income is treated by the Treasury with far greater respect than earned income. In other words, wealth-owners not only reap from the labors of others, they pay lower taxes.
It is worth noting that the tax system was not always so one-sided. The property tax was, in its historical antecedents, a genuine tax on wealth; only in relatively recent times has it become primarily a tax on the average man’s residence (i.e., property on which banks make income, but workers pay taxes). The federal income tax was intended to be a levy upon income “from whatever source derived,” as the 16th Amendment put it, and not primarily a tax upon the wages of labor. There was once, in fact, a special deduction from federal income taxes for income earned from labor, but it was abolished during World War II for the sake of “simplification of the tax code.” Nowadays the maximum tax rate on earned income is 50 percent, as opposed to 70 percent for unearned income, but this is a distinction that benefits salary-earners only at the very top, rather than the bottom, of the wage scale.
Things would be sufficiently out of kilter if government favoritism for wealthowners stopped with the tax code, but the state’s generosity goes further. In addition to the relatively small sums that the government dispenses to those who are too old, young or sick to earn income from labor, the government ex-pends billions of dollars annually that add to the unearned wealth and income of the propertied. Sometimes the subsidy to wealth-ownership is indirect, as when a government-built highway, irrigation project, airport or other public facility augments the value of nearby land (and, to a degree, capital). In such cases, workers benefit in that they may use the new facility, or be employed by it, but they enjoy no gain in net worth, and indeed may have to pay user fees (e.g., tolls), higher rents and property taxes.
Often and quite consciously, the subsidy to wealth- owners is direct. The Joint Economic Committee last January published a rather astonishing study in which it is estimated that federal subsidies to private citizens or businesses, intended to alter their economic behavior, totaled more than $24 billion in 1970. These handouts were of two basic types: subsidies to consumers and subsidies to producers. The former included food stamps, grants to students and job trainees and a few other items; the latter encompassed everything from indemnities to beekeepers to cash payments to regional airlines.
The justification for subsidizing producers rather than consumers, and among producers, wealth-owners rather than workers, is the old trickle-down thesis: if enough benefits are handed out to wealth-owners, somethingwill seep through to workers. Some consequences of this approach can be seen in two major federal subsidy programs — the section 235 and 236 housing assistance programs of the Department of Housing and Urban Development, and the farm subsidy program. HUD’s section 235 and 236 programs were intended to stimulate the construction and rehabilitation of inner city homes and apartments. The idea was that if HUD subsidized lenders and developers by paying most of the interest cost on housing loans, more units for low-income families would be built. More units were built, but so many were overpriced and shoddy, and so many inexperienced buyers were cheated by subsidy-seeking speculators, that HUD has been racked by scandal and saddled with thousands of repossessions. Sadder, wiser and billions of tax dollars later, HUD Secretary George Romney now admits it would make a lot more sense to give money directly to poor families to buy or rent shelter in the regular market.
The farm subsidy program, when it began during the New Deal, was intended to keep impoverished small farmers and sharecroppers on the land. Since the 1930s, the program has been transformed into a windfall for the biggest owners of wealth. Payments are made to landowners to take acreage out of production, not to workers to work, or even not to work. In 1969, the wealthiest seven percent of farm owners received 40 percent of the benefits, while the poorest 50 percent got nine percent, and millions of landless farm workers received nothing. In fact, by paying land‑owners to withdraw land from production, the program causes a hardship to many farm workers, depriving them of the opportunity to earn income from labor. They then must apply for poor people’s welfare, for which they are roundly excoriated by subsidized landowners.
The convoluted ethical posturing that surrounds the receipt of unearned income is one of the most curious aspects of this entire subject. Hard work, goes the litany, builds strong moral fiber. The distributive corollary is that no one is entitled to income unless he gets off his butt and toils for it. In point of fact, the notion that income ought to be related to labor is not without merit, but the righteous indignation that usually accompanies its assertion is pointed in the wrong direction. Certainly there are able-bodied persons whose characters are presumably being weakened by receipt of unearned income. But the more these recipients get, the more likely they are to think of themselves as deserving, upstanding leaders of the community. One thinks, for example, of Richard Nixon, a strong believer in “workfare, not welfare,” and a man who has used the nation’s highest office to extol the character-building virtues of mopping floors. What, one wonders, might have been the debilitating psychological effects of Nixon’s bounteous legal fees at Mudge, Rose, Guthrie and Alexander, where he labored to preserve and expand the unearned income of wealth-owners? And what grievous spiritual toll must he have suffered from the unearned increment he made in Florida real estate? The point is not that Richard Nixon is a parasite, but that the question of how our system rewards labor and non-labor needs to be demystified and sensibly debated.