Redistribution Even a Conservative Could Love

President Obama has made it clear in his campaign promises and his policy proposals that flattening economic inequality is an expressed goal of his administration. He has promised tax reductions for the bottom 50% of the population to be paid for by closing tax loopholes and raising taxes on the wealthy. The recent Chrysler workout seems to favor the UAW over shareholders and senior creditors. And in his pronouncements on Supreme Court appointments Obama stated he is looking for “pragmatic” candidates who will make judgments based on “empathy,” presumably for the have-nots or weaker members of society. One can only wonder how far these subjective, “political” judgments will go.

While noble in its oblige, Obama’s ideological stance has raised a vocal opposition to failed tax and redistribution schemes of the past and accusations of a socialist mentality. While “socialist” may be hyperbole, past failures of liberal tax and redistribution schemes are real. One can argue that robbing Peter to pay Paul will change Peter’s productive behavior, making them both poorer. Certainly this is what we observed with the command and control economies, as well as with the welfare states of Europe. So, how do we flatten inequality in a free market society without throwing the baby out with the bathwater?

The solution lies in recognizing the basic law of capitalist finance that risk and reward are positively correlated. More risk leads to higher expected returns or potential losses. This is a natural law of human behavior that we break at grave risk of unwelcome consequences – as we have experienced with the current credit crisis. It is the moral foundation of our contract law – responsibility is meted out so that the innocent should not pay for the mistakes of the guilty. It’s why we are so offended by bankers playing “heads we win, tails you lose” with other peoples’ money.

If risk and reward are positively correlated and we want to distribute the rewards more broadly, it stands to reason that the risks of capitalism must be spread more broadly as well. This doesn’t mean widows and orphans should be trading derivatives on Wall Street, but it does mean that the equity risks in a capitalist society must be spread in order to close the inequality gap. To do this by expropriation of the haves to give to the have-nots is a gross and unjust violation of the law stated above.

The best and most just way to redistribute wealth is to empower capital accumulation and diversification—in other words, encourage the have-nots to buy equity from the haves at the market price. No one can object to this voluntary transaction and we would be surprised how easy it could be accomplished by removing some of the tax disincentives to both parties (Zero capital taxes on the poor? Lower labor taxes, higher consumption taxes?). It is also concomitant that the law vigorously defend the rights of ownership, so those with power and influence cannot abuse shareholders’ interests. The regulatory authorities have failed in this capacity too often for us to take it for granted.

The left in the capitalist societies have too often associated shareholding with rich capitalists, but the public corporation spreads equity ownership to the masses – workers hold it now in their pensions and retirement funds. As workers they already carry the risks of the capitalist enterprise with unemployment, risks they rarely get paid for. In any event, labor is a cost on the wrong side of the profit equation. Thus, wage earners are constantly fighting international wage levels in a world of capital mobility. It’s time for the left to realize how the have-nots can buy membership into the capitalist club, rather than trying to storm the barricades or sneak through the backdoor.