The other day I met a friend who is a large stockholder in General Motors, and he told me a story. A few weeks before, his son had used somewhat excessive strength on the mixing valve in his bathroom and broke the handle off. The local plumber couldn’t repair it, so he ordered and installed a new valve. The valve turned out to cost $22.50. The installation, at $4 an hour, brought the total up to $100.
That sounded steep enough; but it was not until my friend had made some mental calculations that he realized how steep it really was. His income falls into the 90 percent tax bracket. So he figured that in order to acquire the $100 with which to pay this plumber’s bill, he had to receive $1,000 in dividends from General Motors. (For the benefit of the non-mathematical, $1,000 in dividends minus $900 in taxes on them leaves $100 to pay a plumber’s bill.)
But this is only the beginning. In order to pay $1,000 in dividends, General Motors has to earn more than $4,000 before taxes. (General Motors earned $1,502,000,000 before payment of taxes in 1952. It had to pay $943,000,000 in taxes, leaving it $559,000,000 in net income, out of which it paid $362,000,000 in dividends. So for every $1,000 it paid out in dividends, it had to earn $4,149 before taxes.)
But in order to earn $4,149 before taxes, General Motors had to sell $21,570 worth of cars—say eighteen Chevrolets—to its dealers. (GM total sales and income in 1952 amounted to $7,645,000,000.) To sum up, because of cost and tax erosion, in order for my stock-holding friend to replace a bathroom valve, General Motors had to make and sell eighteen Chevrolets.
“So what?” some reader may ask. “If this fellow pays a 90 percent income tax, he must be rolling in it. Don’t expect me to weep.”
The point of the story is not that anyone should stop to weep, but that a few of us should stop to think. The question is not what our incredible burden of taxation is doing to this rich individual or that, but what effect is going to have in the long run on our whole economy—on productivity, wages, and employment.
Obviously a continuation of this rate and kind of taxation must undermine incentives, discourage new business ventures, and even prevent the formation of new capital for such ventures. For every dollar that General Motors paid to stockholders last year, it had to pay $3 to the government (not counting what it collected and paid in excise and sales taxes). The case of General Motors, in this respect, is not exceptional. The Department of Commerce estimates that corporate profits before taxes in 1952 were $39,700,000,000; that out of this the corporations had to pay $22,600,000,000 in taxes, and that they paid out $9,100,000,000 in dividends. In other words, the government took an average of 57 percent of all the earnings of the corporations. And for every dollar that the corporate stockholders got in dividends, the government got $2.48.
Even this does not tell us what the stockholders were able to keep in dividends after paying personal income taxes. A stockholder whose income gets into the top tax bracket of 92 percent can keep only 8 cents out of each dollar of dividends. The government gets the other 92 cents. Adding this to the $2.48 that it has already taken from the corporation gives the government $3.40. In other words, the government gets 42 times as much out of the average corporation as the investor in the top income-tax bracket is allowed to get and keep.
This may seem like a wonderful racket for the government while it lasts. But Congress should not be entirely astonished if it wakes up one day to discover—we hope not too late—that this division of the profits does not furnish the highest incentives for private investment in new enterprises; and that new venture capital has been drying up, with unpleasant effects on wages, employment, and production, and even on government revenues themselves. If we do not want to repeat the present predicament of England, we should not imitate the policies that brought her to it.
[Originally printed in Newsweek on March 30, 1953. Available in Business Tides: The Newsweek Era of Henry Hazlitt.]
It never ends. We are besieged by articles on today’s increasing economic inequality. These articles have three things in common:
1. Each one has a favorite explanation/boogeyman.
2. Each one calls for political reforms to make things more equal.
3. Each one fails to mention Pareto’s 20/80 law.
Here is the main problem with these articles: economic inequality has not increased since at least 1897 — the year that Vilfredo Pareto published his discovery: about 20% of the people in every European nation he studied owned about 80% of the wealth.
Every year, when about 1,500 of the richest people in the world meet at Davos, Switzerland to attend the World Economic Forum, a Left-wing group called Oxfam issues a report. The group rewrites the annual report and the accompanying press release, but it is always conveys the same message: about 1% of the rich own 50% of the world’s wealth. I wrote a response to Oxfam and its report in 2014: “Envy Never Sleeps: Attacking the Rich.” I did this again in 2015: “Pareto Statistic: The Wealthiest 1% Will Soon Own 50% of the World’s Wealth.”
The Right also indulges in similar expressions of outrage. Here is an example.
A PARETO PYRAMID
This was offered by Charles Hugh Smith. I like it because it includes a pair of graphics. Both of them are tied to the underlying image of a pyramid: straight sides, with the same angle all the way up, from base to capstone. The image is pure Pareto.
I am not.
The Pareto law is a power law. The same 20/80 rule applies all the way up. This is why it is a pyramid.
1. 20% of the population owns 80% of the wealth.
2. 4% (.2 x 20%) of the population owns 64% (.8 x 80%) of the wealth.
3. 0.8% (.2 x 4%) of the population owns 51% (.8 x 64%) of the wealth.
Smith’s pyramid shows that 0.7% of the population owns 45% of the wealth.
This sounds about right. As we say, it’s close enough for government work.
Smith blames this pyramid on the Federal Reserve System.
His explanation makes sense to all of us anti-central bank fanatics with respect to which groups are at the top. It makes no sense with respect to the existence of the pyramid. That’s because nothing makes sense with respect to the existence of the pyramid.
We do not know what causes it. We only know that it is as close to universal as any outcome in history.
Taking Smith at his word, the Federal Reserve is the cause of this pyramid. But it isn’t. It is merely the cause of who gets into the top of the pyramid — maybe.
To understand who gets in and who is shoved out, and why, we first need to know the law governing the structure of the pyramid. Sadly, no one has proposed a plausible explanation.
Smith resurrects his graphics in an April 6, 2016 article.
Smith is a well-meaning author. He just doesn’t understand the presence of Pareto’s law. He never mentions it.
Because critics of this or that institution of modern capitalism want to pillory this institution for inequality, they resurrect this pyramid of ownership. They cry out: “Shame! Shame!” Then they cry out: “Reform! Reform!”
The favorite boogeyman may well be the cause of which group gets into the top. But readers should never forget this rule of analysis: this does not explain the perpetual nature of the 20/80 pattern.
Here is the problem: the pattern will persist in the post-reform period. Then new groups can bring their accusations of unfair political system-rigging against whichever group is now in the top 1% (actually 0.8%).
There will be debate about how people get into the top group. There will be debate about exactly who has squeezed his way in. But of this we can be sure: the pyramid will be there, just as Cheops’ pyramid is. All the other seven wonders of the ancient world have disappeared, but this one remains, oblivious to change. No one knows how the Egyptians built it, just as no one knows why Pareto’s pyramid persists.
The reformers just do not get it: the Pareto pyramid is found everywhere, no matter which reform group won the most recent reform.
This does not just apply to wealth. It applies across the board in institution after institution. No one knows why, but it does.
Richard Koch has created a personal publishing cottage industry by writing books on Pareto in business. They are good books. I assign two of them to my Business I students in the Ron Paul Curriculum.
The Pareto curve is a huge grab bag of instant outrage for authors who need something to write about, either for or against a particular reform.
It really is a shame that no one can explain it.
The Pareto law is not only widespread, it is convenient for all economic reformers. All they need to do is this, when writing their justifications for reform:
1. Plug in the latest statistics on wealth distribution.
2. Create a pyramid graphic.
3. Offer an explanation as to how a group has politically rigged the economy to favor itself.
4. Call for reform.
All this requires the following:
5. A refusal to mention that the latest distribution deviates only slightly from a universal pattern.
הרב אמנון יצחק נשאל שאילות חדות כתער, למחפשי האמת בלבד
ראה עלון נר לשלחן שבת, עמוד 2: