Senator Phil Gramm - The Myth of American Inequality

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0:20Welcome to a Book of the Legs podcast. I'm Cole Smead. I'm the CEO and a portfolio manager here at Smead Capital Management. At our firm, we are readers and book junkies. It can be said that leaders are readers and we believe books provide us a great source of information for filtering what is and isn't important for us as investors. Investing is the last great liberal art and the best way to spend a lifetime of learning. This podcast is for readers, thinkers, business-minded people, and investors who want to grow their knowledge from great authors and their writing. Charlie Munger often talks about using multiple mental models and analysis.

0:53Our aim for this podcast is to help listeners test Munger's theory in business, markets, and people. Thank you for joining us for this episode of the podcast. we are going to talk about the importance of work, incentive structures as we think about the United States of America, and we will all understand, despite our shortcomings, why this is the greatest country in the world to be poor, middle class, or rich. Phil Graham is joining us to talk about the book he co-authored with Robert Eklund and John Early, titled The Myth of American Inequality, How Government Biases Policy Debate. Senator Graham served six years in the U.S.

1:28House of Representatives and 18 years in the U.S. Senate, where he was chairman of the Banking Committee. Mr. Graham is a visiting scholar at the American Enterprise Institute. He was vice chairman of UBS Investment Bank and is now vice chairman of Lone Star Funds. He taught economics at Texas A &M University and has published numerous articles and books. Senator Graham lives in Helotus, Texas. Senator Graham, thank you for joining me today. Thank you, Cole. So I can make some assumptions. And just so you know, I love this book. I think your information, it's probably the most data-related book that we've done on the podcast ever.

2:02So I love the data. But what inspired you and Robert and John to build this story together? Well, it really started when I was chairman of Commerce State Justice Appropriation. And I was working on Graham Rudman and the Reagan budget. and in my capacity as a subcommittee chairman, I oversaw a bunch of agencies, including the census. And it struck me that the numbers I was dealing with in the budget seemed very different than the numbers the Census Bureau was putting out in terms of household income. Household income is a building block of all of our statistical measures of well-being, from poverty to income inequality.

2:54And so I started looking at it, and then a seat opened on the finance committee, and I took off and left to go to the finance committee. But I came back to it in 2017, when I happened to look at the Census Bureau puts out once a year what household income is, and they break it out into five different quintiles, the bottom 20 % up to the top 20%. And also at roughly the same time, the Bureau of Labor Statistics puts out consumption by quintiles. And in 2017, the income level, average income level, the bottom 20 % of earners was$13 ,000, and they were consuming$26 ,000 worth of goods and services.

3:50And the second quintile was consuming 11 % more than its income, and the top quintile was consuming only about half of its income, even though there was no evidence that such thrift levels exist anywhere. aware. So that's when I started working with Eakland to figure out what in the hell is going on here. And in that process, we discovered John Early. Eakland was a prominent scholar who stayed in academics when I left to go to government. John Early is a mathematical statistician who was twice assistant commissioner of the Bureau of Labor Statistics. So in any case, we went back and figured out that in 1947, when the census set up its procedure to estimate household income, that almost all payments were made in cash or cash equivalent.

4:54And so for simplicity purposes, they just counted cash payments. And that produced about a 95 percent accurate picture. But in 1967, when the war on poverty ramped up, almost all of those benefits were paid in kind. You got a debit card that was charged with food stamps. You ran up Medicaid bills the government paid them. You got housing subsidies the government paid, over 100 federal programs. That's when the census made an extraordinary set of decisions in deciding not to count the very payments that we had put in place to deal with poverty, including food stamps. And remember that we define poverty in America as a multiple of the amount that it costs for a nutritionally balanced diet.

5:57So a poverty number based on consumption of food didn't count food stamps as being a benefit in dealing with poverty. So anyway, and also we found the census does not take into account taxes, which means it doesn't count refundable tax credits when you get a check from the Treasury. In total, the census doesn't count two thirds of all transfer payments as income. It doesn't take taxes into account. So about 40 % of the economy of the United States is not counted in the measure of household income. So the census tells you the top 20 % makes 16.7 times as much as the bottom 20%. But we show using government data that if you count all transfer payments as income gained and all taxes paid as income lost, The ratio of the top 20 % at the bottom is not 16.7 to 1, but 4 to 1.

7:06We also show that the poverty rate is not 12.4%, but about 2.5%. And then some other blockbusters are, you know, The Economist magazine has said income inequality is high in the West and rising. Senator Sanders has told us that it's obscene, un-American, and unsustainable. Well, in fact, we show that when you count all transfer payments and taxes, that income inequality is actually a little less today than it was in 1947. Now, we show a lot of other things in the book as well, but that's the core of the findings of the book. So one of the parallels for historical eras you draw early in the book is you talk about Victorian England, which was obviously the explosion of the Industrial Revolution and really kind of what I consider modern business.

8:08To quote Dickens, he said it was the best of times. It was the worst of times. How are the circumstances of then a lot like today where you see a lot of wealth, and at the same time we know that there are people that aren't as good off, but the question is, is this a good thing? Well, first of all, what Dickens thought he saw was not true. Okay. You've got to realize that poor people in rural England were across the creek, off the main road, away from the city, and even a mud hut where you're sharing it with your farm animals from the veranda of a manor house that's across the creek from you looks quaint.

8:59Rich people had never seen poor people up close and personal, except when they were cleaned up to come to work. When the Industrial Revolution came, people chose to move to the cities because they sought a better life. And they were all too visible then. And you've got to realize that the established parliament and the landowners were losers from the Industrial Revolution because it pulled labor into the cities. and the bottom line was even though Dickens could not understand why Scrooge, for example, in the Christmas Carol, how his wealth did any good given he didn't spend it, well that wealth was going to fund the Industrial Revolution in Great Britain so the bottom line is that But in the Victorian era, from 1830 to 1900, the economy grew faster, wages grew faster, the lifespan grew faster, literacy grew faster than at any other time in the history of the world.

10:24and in America, despite all of it, you pick up any textbook in America and it tells you that in our gilded age, the rich got richer, the poor got poorer. Well, the reality is everybody got richer. Now, there were 4 ,500 millionaires in 1890, but 66 million people had the fastest growth in their living standard that any people on the face of the earth had ever achieved. And the writers of the era were so preoccupied by the 4 ,500 millionaires that they totally turned a blind eye toward the 66 million workers. So the truth is, the rich got richer, the poor got richer, and everybody got richer. To go back to the Industrial Revolution, you mentioned, though, that because a lot of what your book's trying to address is how do we set up a great environment and the right incentives for people to succeed in their own choices, right?

11:33What they want to do in their life, right? In other words, we can't force them to do anything. And we don't want to set up a structure that requires them to do anything. We want to give them the situation for them to succeed. So in the case of Victorian England, there was a major change in terms of the regulation around businesses. Can you explain how royal charters worked and when they went away, what that allowed for? Well, royal charters basically were a system whereby the crown made money by granting charters to people who wanted to engage in business activity. That corrupt system was discredited by the South Sea bubble, where investors just lost huge amounts of money.

12:21And the parliament set up a system that over 150 years evolved into anybody could get a corporate charter that could put up the money. There were two major changes that made all this possible. The enlightenment, which basically established the principles you had the right to worship God your own way. You had the right to your own opinion. And you own your labor and the fruits of your thrift. You got to remember in the Middle Ages, you owed theity to the crown, the church, the guild, the community. And these had become leeching powers that leached away people's incentive to work and save. But with the Enlightenment, people came to own their own labor and own capital, and it changed everything.

13:24And then the Industrial Revolution, that unleashing of effort and capital and entrepreneurship and energy created the Industrial Revolution, which changed the world, and those changes have never stopped. Correct. So one other thing you mentioned during that time was you talked about how the Black Death reduced the labor supply at the same time, which obviously produced higher incomes from less available labor. I think a lot about the post-pandemic world that we sit in, where people have left the labor force. You talk a lot about some of the incentives that caused them to do that. But also it's been noted that, for example, baby boomers pretty much retired during the pandemic at some point.

14:13Many left the workforce for, I'll call it finality, that they're not coming back. Do you see any of those similar labor supply reductions being a symptom that we're seeing right now, even outside of what we'll debate in the policy side, tied to what's happened post-pandemic? Well, what I was saying about the Black Death was that for the thousand years prior to the Industrial Revolution, that there was no significant economic growth and that wages pretty much were flat. In fact, there have been a lot of studies of this and that they would spike occasionally because of a reduction in supply like the Black Death.

14:59But then population grew and wages fell. The beginning of the rise in real earning power for ordinary people occurred in the Industrial Revolution in Great Britain and then spilled into the United States and now has gone all over the world. The important point about labor force participation rate in America today is that in 1967, when the war on poverty ramped up, the average family in the bottom 20 percent of income earners was receiving$9 ,700 worth of payments from the government. By 2017, 50 years later, they were receiving$45 ,400. And labor force participation rate for the bottom 20 % of earners had fallen from 67 % to 36%.

16:08Sure. And the reason it fell is the rewards for working, given that you could get as much from government by not working as you got from working, were so small that the amazing thing is that 36 % still work. And during the pandemic, remember that these benefits were being paid to people that were making as much as$150 ,000 a year. And so many of them just decided, well, I won't go back to work. Now, it's beginning to change somewhat as those programs expire. But clearly, we have had a dramatic decline in labor force participation rate as the amount of subsidies the government provides through transfer payments have grown.

17:08if you pay people not to work you can't be shocked that they don't agree and and i think a lot anecdotally when you drive around you know places like texas places like arizona any any you know business that needs low skilled wages or unskilled wages uh you know working there you see now hiring signs everywhere i mean it's hard to find a business that's not hiring, to be downright honest. And yet they go unmet or someone's there for a while and then doesn't stay because either they find a better job or to your point, they recognize that, you know, this isn't as good. And so, you know, I want a question I want to ask you kind of from a bigger picture perspective, because you mentioned Senator Sanders earlier.

17:56Why? You know, I think a lot of the framing to think about, you know, what incentives do we want? I think a lot of the framing comes down to really two views. Some people in American society look at the prosperity available to all as a zero-sum game. In other words, if I succeed, Senator Graham, if I succeed, you lose. Versus I look at capitalism and economics and to your point, what we've benefited from the Enlightenment and our ability to use our human creativity, it's more like a game a golf it's me versus me that's what decides whether i succeed or not it's me and that's it i would maybe throw in god's provision and blessing as the only thing that really helps me ultimately but i pointed out because your success has really nothing to do with mine it is that that that is that really where the debate is let's go let me just give you a very brief history.

18:57Plato, huge wealth and income is zero-sum game because you had a city state. Wealth was almost totally based on land ownership, and it was a relative zero-sum game. All collectivists since the time of Plato implicitly assume that the world was zero-sum game. you take Thomas Piketty in his book Capital in the 21st Century he never uses the term earns or creates to talk about the income that high income people get he talks about them taking income demanding income seizing income but never earning income Well, look, I don't own an electric car. I don't expect I ever will. But Elon Musk has never taken anything from anybody.

20:05He's rich as he can be, but he created every penny of it. And I'm no poorer because of it. How does Bill Gates being rich make me poorer? I'm richer. I use his products. my pension fund owns part of his company. He owns only 7 % of Microsoft. Pension funds, 401ks, ours, annuities, only about 70 % of Microsoft. He didn't get to the top of the mountain alone. He took the rest of us with him. So if you want to be envious, you can always find a reason But please understand this. When people, and let me say, I admire Senator Sanders because he believes what he says. Sure. He's wrong. The facts don't bear him out.

20:59But he's a sincere member. And I've always admired that about him. But the bottom line basically is that when you're talking about billionaires, and if billionaires paid more, we could have all these things. If you took every penny of income from every bill, every person in America who is in the Forbes 400 that the government doesn't already take, we couldn't have funded a week of federal, state and local spending in 2020. OK, the problem with rich people is that too few of them. So this idea that, A, they don't pay their fair share of taxes, which is preposterous and verifiably false, and B, that we could somehow have all this stuff if they only gave us their money is just totally false and made up.

22:02Well, so let's go to – you talk about the U.S. Census Bureau, to your point, and how they laid out what they did in 1947 to use cash payments. OK, well, you know, you started that kind of begets in your writing about the federal transfers and why we really look at the bottom income quintile or the bottom two income quintiles poorly based on that. But I thought a lot about, you know, on the other side of that chart that you show where, you know, federal tax is being taken away. I, as an American citizen, am legally obligated to pay my federal, state and local tax. I cannot get around those. And to your point, there's nothing discretionary about that.

22:43I can't say, well, you know what? I'm not going to pay you this year like I didn't want to buy a car this year. So therefore, I have no say over the money. I am liable. It is held as a liability until tax day arrives, ultimately. And so I was kind of shocked that people don't look at income that already has a call on it. They're treating it as though the rich have that money to play around with and the poor don't. Is that another way of looking at that? Yeah, well, and look, people that are making over a million dollars a year are paying about 41 % of their total income in taxes. Okay.

23:26The, the, the, the tax system is, is we have the most progressive tax system in the world. on four more progressive than Germany, France, or Sweden. And tax rates rise up until the income level of about$30 million. And then for a very small number of people who give away vast amounts of money and who earn mostly through capital gains, it dips into the high 30s. But this idea that rich people don't pay their fair share taxes is false. And if you look closely at, for example, ProPublica, that's had that stolen tax data and put out the thing about how Warren Buffett didn't pay much taxes. if you look at what they write, it's clear that it, or at least it looks as if they took what Warren Buffett actually paid in taxes, but they didn't take his taxable income.

24:43They made up an income based on what that income would be if he sold every asset he owned every year and paid taxes on the game. Sure, sure. And the same thing is true of Saves, who've done all this work with Piketty. If you look at their tax data, what they do is they don't, when you look at high income people, they're not talking about taxes on their income. They're talking about what their taxes would be if they sold all their assets every year. Well, nobody taxes on that basis. What even people, you know, ordinary people would have massive taxes if they sold their house, cashed out of their retirement, sold all the assets they own and paid the taxes on it.

25:40And in one given year, they would pay extraordinary taxes. But no country in the world taxes that way. When I thought a really wonderful point, a wonderful point in your book, Senator Graham, is you talked a lot about who sits in those income quintiles across the five. And it's actually a fairly mean reverting system. For example, can you teach our listeners how, let's use me. I, in my lifetime, am likely to be in the lowest income quintile at some point. And by God's grace, I could end up in the highest quintile at some point. Can you explain how these quintiles don't really tell us much about what's going on in America?

26:26Well, they tell us what's going on at the instant the photograph is taken. Sure. But, you know, you could be in the bottom quintile while you're getting an MBA at Columbia in finance. Sure. And you could be in the top quintile by the time that you have started your own hedge fund. And you're the same person, of course. and look the level of mobility in America is very large a Pew study looked at what percentage of children that were born and grew up in the bottom quintile ended up making more money than their parents in real living standards 93 % 64 % make so much more that they move up into a higher quintile, including a not insignificant number that go all the way to the top.

27:39So look, there's no denying it. If you can be born rich, brilliant, and beautiful, do it. I mean, there are big advantages to all three of them, But the point is, you can be none of them and still succeed in America. And people do every day. But the welfare system, as it is now structured, has basically delinked the bottom part of the income distribution from the economy. And the economy is where most people find success. so they don't ever get on the escalator that takes them up and then they can rise faster if they're climbing and that's the downside we never debated poverty in my 25 years in government that I didn't start to debate by saying the great tragedy of our welfare system is that we've never found a way to help people help themselves and in trying to help them, we have destroyed their incentive to help themselves.

29:00Yeah, let me, because I think you comment in the book, if I remember from memory, that a middle class income in America would be a household with about$50 ,000 to$90 ,000 of income. That would be considered middle class. and to your point when you adjust for federal transfer payments the lowest income quintile makes almost a middle income when you count all the benefits and government largesse they receive so i guess my question is do we really have a low income quintile in america yeah it's about 2.5 percent of the population and there are people that because of middle or physical disability or because of drug addiction can't take care of themselves and the people they're supposed to take care of and that basically have fallen through the cracks in system.

30:00We show in the book that the distribution of income in America really flattens out at the bottom and that 60 % of Americans basically have very similar incomes. And if you adjust for the number of people in households, it gets even flatter where you've got people that live in the same neighborhood that have basically the same or similar resources and you got one household where both adults are working and another household where nobody's breaking a sweat and needless to say there's resentment about it and it's justifiable resentment well so beyond beyond the federal transfer payments that you you comment and write a lot about in the book like You know, just to name a couple, just so our audience has a feel for what we mean by federal transfer payments, food stamps would fall into that category, Medicare, Medicaid, HUD, the housing and urban development programs, the earned income tax credits, which are effectively negative tax liabilities.

31:10So another part, there's also private assistance with their charitable endeavors all across this country seeking to improve and benefit the lives of their communities. You point out that Americans donated 1.44 % of the GDP in aggregate to charity. I was kind of appalled at this number, to be honest, Senator Graham, because where I come from, 10 % is the floor. That's the kind of legacy that I live in, right? So I say that because I was shocked. I mean, I was utterly astonished to find out that that is the highest giving of any country in the world, according to your deal. Oh, exactly. By far. By far.

31:52America far outships any other country in the world in charitable giving. And this— And most of that giving helped poor people. Yeah, so I thought, you know, to your point, I mean, the really, I think it's incredible because you point out the imbalances. There are imbalances. Those are creating perverse problems. But, I mean, the other thing that your data does a great job of telling is what an incredible country this is. And just to put some, you put some numbers on this. I mean, you point out that these charity transfers are obviously not counted in the federal transfer payment number to adjust for incomes, but they represent another$3 ,313 per household.

32:42You know, I would say we're throwing more resources at poverty than any nation in the world. Is that a fair way of looking at it? Other than France, we're second. in terms of the percentage of our GDP that is redistributed. Now, poor people in America are much better off than poor people in France because our whole society is richer. The Pew Foundation did a study where they defined low income or poverty as two-thirds of the median income. And by that definition, since the median income in America is so much higher than in France and Germany, when you apply our standards, a huge percentage of their population, a larger percentage, is poor than in our country.

33:43so if you don't want to be poor anywhere but if you want to be poor anywhere you want to be poor in america now again there are people living on the streets in austin and in san francisco and the left loves these little examples there's somebody living on the street in san francisco And Warren Buffett is rich. But the reality is that our welfare system is not reaching that person street in San Francisco because no matter how much we spend on food stamps or refundable tax credit, it's not getting to them. What we need to be doing instead of spending$45 ,400 to every household in the bottom 20 % on average, is we need to go out and ask that lady or that person sleeping on the street in San Francisco, what is their problem, and try to help them solve it.

34:53I agree. Simply throwing more money at it doesn't do it. And look, my hostility is toward the system, not toward the people. Sure. There are poor people every day who succeed in America, and God bless them. So you're touching at something. Just so you know, Senator Graham, we moved our company from Seattle, Washington, back in the middle of 2020. we had worked on the work to do that prior to the pandemic, you know, coming about and we continue with our plan. And I look at my own hometown, Seattle, Washington, downtown Seattle has been completely ruined by the phenomena you just mentioned. And, and it's a really interesting, like to your point, how do we want to help our fellow man and woman in those cities, you know, using Austin, like you use the example, they'll say, well, this is a, this is a housing issue.

35:50and the irony is no, because you get into some really interesting data from studies that have been done. I think you referenced, and I was trying to pull this out of my notes as we talk about it, but you referenced studies done on, say, food stamps, for example, right, where people had, you know, I think it was the US DA had gone in and done studies looking over a decade where they asked people that were on food stamps how they felt about their food situation. And I think you talked about how the food stamps didn't change their feelings. Yeah, the point I made was we see these things in the paper and people get very upset about them.

36:35And if they were true, they'd be reasonably upset. 40 million people in America are hungry. During the pandemic, when we just had an explosion in food stamps, you had advocacy groups putting that out. Well, where did it come from? Well, where it came from was the U.S. Department of Agriculture does a survey that asks, in any one day in the year, did you ever have a concern that you might not have enough money to eat? And if somebody says yes to that questionnaire, everybody in their household is defined as having food insecurity. And then these advocacy groups take that and say that many people were hungry.