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The high nominal wealth levels shown in publications like the Sunday Times Rich List are only sustainable because of market valuation. Were all those in such a list to put 2% of their holdings on the market at the same time, the multiples would tumble and with it their wealth. Perhaps institutional purchasers could absorb some of it and head off a major crash but were 2% of all residential property holdings put up for sale at the same time there would be insufficient buyers and you would get large problems of falling valuations for everybody as in Spain and Ireland.
This is why property taxation has to be handled with great care. Paying for it comes out of income and most do not have much to spare.
TWO CONCEPTS OF CAPITALISM
Reviewed by ANDRE BEAUMONT
Of one thing one can be certain in relation to Warren Buffett's investments: the corporations he invests in have a great deal of market pricing power.
His August 2011 pronouncement that the 'mega-rich' should pay more tax, however, avoids a growing contemporary problem for the health of capitalism: monopoly pricing power.
To only tax the 'mega-rich' an extra amount without addressing monopoly is like allowing motorists to drive at over the legal speed limit provided they pay a special toll for early arrival at their destinations.
Exceptional inequality has more to do with monopoly than tax rates.
This is demonstrated by a simplified look at the mechanism of valuation.
A corporation with average to good market pricing power might be valued by the financial markets at 15 times profits. One with monopoly pricing power might be valued at 30 times. The multiples will, of course, vary with the type of company and the state of the markets.
It is one thing to permit corporations to pursue globalisation in the way they choose, another to allow them monopoly rights in territories in which one has jurisdiction. One should not allow a company to have a quasi-monopoly position at home in order to strengthen its hand abroad.
Be vigilant about monopoly at home and many more companies will flourish, especially if they are in the clusters that stimulate innovation, whilst inequalities will be diminished without going near the word tax.
From the European side of the Atlantic his statement that 'people invest to make money, and potential taxes have never scared them off' seems plain wrong.
A statement such as 'corporations invest to make money, and potential taxes have never scared off those larger than a certain size' might just have held water (if you have pricing power, you can simply raise prices to compensate for a higher corporate tax rate if it bothers you but small companies cannot do this) but with European rates of personal direct taxation being what they are, people - individuals - are very much scared off from risk taking.
If one were being rhetorical one might say the main problem in Europe is not jobs but the lack of opportunity.
This is highlighted by the travails of Greece, Portugal and Spain.
We used to relocate manufacture of products like cars from higher cost places like Britain and Germany to Spain.
Now few global corporations are going to send manufacturing to those three countries. They do have lower cost bases than some of their neighbours but, for now, Asia is going to be the manufacturing location of choice.
People, though, are not inclined to sit around doing nothing. Free them from the constraints of too much predatory monopoly, red tape and taxes and they will begin to trade, perhaps unknowingly following John Cowperthwaite's best precepts that continue to make Hong Kong one of the most prosperous enclaves in the world.
Go onto the eBay auction website to buy new goods containing electronics and you will find it awash with Hong Kong businesses, trading as very small corporations, unincorporated businesses and individuals, selling everything.
A flourishing emerging economy (Hong Kong has long since emerged) does not just have some, or even many, large players but also allows individuals free range to trade rather than being cooped reluctantly within the batteries of employee status (as was especially the case in collectivist societies), with frequently poor employee rights.
For maturer economies with paltry inward investment the correct policy choice is increasingly clear - make it cheaper for people to trade as individuals or micro-businesses than it would be for medium-sized or large corporations to do the same trades and they will solve the growth problem for you.
Indeed, for the global economy to right itself or enter a new phase of improved capitalism some element of rebalancing away from monopoly is essential.
By 2005, in Britain, a small minority in the business community were beginning to pull in their horns. Something of a boom had been running since 2001 and Britain's post-war economic history suggested that a downturn after every 3-5 years of expansion was necessary to keep the economy healthy. Nothing much was to be feared from having a boom, nor from a cyclical downturn, but quite a lot from a continuing boom. The bust would be all the more sharp and catch people of a sudden.
The necessary discipline of a cyclical downturn on those who had expanded capacity too fast or who had geared too much would be absent.
However, the boom continued in other countries, too, allaying some fears.
By 2007, an uncritical approach to the business culture had to be abandoned. Micro-businesses were not failing to do as well as expected because they were not good at marketing, or missing the mindset of growth businesses, or not trying hard enough to win public sector contracts.
Public authorities, certainly, by then, had no intention of letting contracts directly to micro-businesses.
Small companies trying to be growth businesses were having a hard time in an economy favouring monopoly and finance.
For instance, despite the high quality of British research why had no biotech company in Britain made the grade to anything near the big time after ten years of New Labour governance?
A crack in the markets also signalled a wider malaise with the global economy.
You can read Sir Isaiah Berlin's Two Concepts of Liberty and only with some difficulty prefer one concept to the other, or agree with both concepts, so interwined are the two.
So it is with two strands of capitalism. They are intertwined and practitioners use both.
The first is rent seeking capitalism.
The second is capital based capitalism.
In periods when one is too dominant over the other, capitalism can seem to be heading for a crisis.
The rent seeking form of capitalism is exemplified by the stage globalisation is currently at.
With rent seeking capitalism capital flows to where it will produce the greatest return in terms of income, yield, coupon or rent. The presence of one of these always needs to be demonstrated.
The cost of capital in relation to the rent is seen as very important. In times of crisis, eminent financiers of the rent seeking persuasion appear in the media to tallk in anguished tones about the cost of capital for a bailout. They resist scrapping the coupon on a security in exchange for getting the full capital back at a future date. The coupon, because it pays current outgoings like pensions, seems inviolable to them. (In practice, payment of the coupon also sustains the current value of the security).
The idea of good years and lean years is anathema to rent seeking capitalism. A corporation with overtly falling profits one year risks being hammered by the markets or taken out as prey.
It is a form of capitalism that tends to favour debt capital and gearing over equity capital.
It prioritises return on capital and so is more open to the idea of paying bonuses or cutting the workforce if it raises the rate of return.
The rent seeking capitalist may calculate the rate of return on capital spend on education.
He may even take offence if the beneficiary of education ceases to be an employee and engages in a capital based form of capitalism like trading vintage cars.
He may then be quick to reclassify any profit made as being income, so that he can continue to make return on capital calculations for the education, quietly ignoring that you can make a loss on trading cars, being a risk taker, while you would be hard pushed to make a loss on an employment contract. Should the rate of return go negative has the education totally spoilt the person?
He may inadvertently offend you on seeing a spare room in your house and advising you to rent it out.
His views, though, may make society and him a lot more money in the long run.
The capital based capitalist can also be caricatured, perhaps as the speculator in luxury yachts. He orders a bespoke yacht with all the cutting edge features and design well before others twig they can have them and he sells it on, usually at a profit, just before taking delivery or when trading on seems advantageous.
He does not trouble too much about the cost of crewing, the berth or the annualised cost of purchase finance. He simply tots up all the costs and deducts them from what he gets from the sale.
For good measure he woos a princess whilst he has the yacht and she eventually bankrupts him.
Capital based capitalism is mainly about buying an asset, preferably at a discount to its true worth in the eyes of the purchaser, improving the asset to add value and letting some time pass to also add value.
Capital based capitalism also uses assets as collateral.
It is a form of capitalism that is often more willing to recognize losses quickly and is often of the view that distressed assets are better off in the hands of someone new.
It is a form of capitalism that is currently much less exploitative of other human beings than rent based capitalism.
Homes bought to live in rather than to rent out fall within the parameters of this capitalism.
Capital based capitalism probably produces less wealth for society as it is willing to let capital lie fallow more often.
Two conclusions can be drawn from a report that the poorer half of Americans (50%) own 8% of the wealth but when their real estate holdings are taken out they only own 1%.
Firstly, that the real concentrations of personal wealth are not to be found in residential real estate but in the ownership of corporations and securities. Impose a mansion tax, an idea floated in Britain, and Mr Buffett would not qualify to pay it, even were his house in Britain.
Secondly, only the ownership of homes, if not by them then by some member of their family, prevents a new kind of serfdom for many of the poor.
Eastern Europe suffered harshly under feudalism and again under collectivist regimes. Now the housing stock of almost entire towns there is said to be, or to have been, in the hands of private equity.
When British social democrats call for less ownership of rental property by small-time landlords and more by institutions, they need to have cognizance of the reality that the only institutions that unquestionably have the resources to buy rental property, or care homes for the elderly for that matter, on a large scale, are private equity houses.
Much as the latter have the potential to achieve good things for the future, one would not necessarily want to find oneself in a place where the available local accommodation was in the hands of a single owner and where many of the businesses appeared to be monopolistic.
A route for advanced economies to put recession behind them could well be to turn themselves into ever more capital rich economies, both in terms of infrastructure capital and private capital.
Add to the capacity of the London Underground, as is happening under the current mayor, and there will always be purchasers of tickets to travel.
Build a million more homes in Britain and there will always be buyers or tenants to live in them.
Capital based capitalists might see Walter Bagehot as being right in a wider sense (though in Lombard Street he meant it in relation to the actions of a central bank towards other banks in a liquidity crisis): lend to anyone who brings good security.
People do not necessarily need to have paid off their debts by retirement and then feel a need to govern the rest of their lives by estate planning requirements. (Estate duties start at around $0.5m on this side of the Atlantic rather than $3m).
Instead of seeing Britons pay the duties at 40% perhaps banks should be lending retired people up to 40% of their assets, rolling up the interest and waiting to get the money back from the estate. The money could be used to set up businesses and pay for care and other needs.
Capital based capitalism needs to be made to function well as a counterweight to rent seeking capitalism.
The tax collected would be less but so it should be in such cases of self-reliance.
Indeed, inheritance tax could be replaced by a gifts receipt tax which the recipient pays, freeing the donor to continue in business and to stop worrying about estate planning.
It should not be forgotten that the period 1979-1997 was one of reduction of monopoly in Britain that helped John Major leave a golden economic legacy to his successors.
British Steel, British Shipbuilders, British Telecom, British Airways, British Gas, the Central Electricity Generating Board, British Rail, National Bus Company, British Leyland, the National Health Service and the National Coal Board were all monopoly legacies of the nationalisations of the 1950s to 1970s.
The reduction of the monopoly position of many of these contributed much to reviving the economy.
It did not matter that as the Central Electricity Generating Board in England was split into various entities - National Power, Powergen and the National Grid being the most memorable - that privatisation of the parts was not immediate. Already the situation was better when National Power competed with Powergen. An organisation with competitive pressures upon it, especially from customers, is likely to be better irrespective of ownership.
Now a new era of reduction of monopoly is called for with the monopolies being found within the ranks of global corporations.
The best candidates to undertake such reduction of monopoly are the investment banks and private equity houses. They are the break up specialists.
It may never happen but should it do so then major changes to customary ways of undertaking economic activity will be under way.
One problem future generations should lose some, but not too much, sleep over is the debt burden. It will have been partly inflated away within a generation wherever quantitative easing has taken place. Quantitative easing was followed by a 25% depreciation in the value of sterling. In foreign currency terms, at least, all the outstanding British government debt instruments issued before are now worth less. We have, of course, seen devaluation before and if there is competitive devaluation we may find ourselves back, in foreign currency terms, to where we were before - but the inflation will persist.
A back of the envelope calculation suggests that British QE was worth $20,000 per adult.
Though pumping the money through the banking system was the classic prescription or, as it proved, experiment, why not, if the unwelcome next time comes about, try something different?
Imagine that each adult were to be given the $20,000 on condition that it went to pay off existing personal debt, into a pension fund or to buy an annuity, or into a combination of these.
No actual cash would be in anyone's hands with the exception of the sums representing a few first annuity payments made to those old enough to receive them. Most people's steps, though, would be lighter and they would face the future with greater confidence. There's nothing like natural persons rather than non-natural persons hitting the jackpot.
(Of course, the state would have to give the central bank an asset of equivalent value for creating the money - perhaps its rights in perpetuity to license the continental shelf).
With such a massive injection of actual cash into banks, insurance companies and pension funds and with the implicit deleveraging of the former, any bank that still remained insolvent would deserve to go under.