Republicans celebrate Ronald Reagan for winning the Cold War, reviving the economy, and restoring American confidence. Yet this is actually to understate his contribution to his party. A technical decision of his administration in 1981 lit the fuse for an explosion of stock ownership that is transforming American politics.
Prior to that time, the dominant form of employee pension was the “defined benefit” plan. Labor unions negotiated cash benefits for each employee, calculated on the basis of years of service and a percentage of annual pay. Management, not workers, assumed fiduciary responsibility for plan investments. Government provided tax breaks to encourage this.
But the country’s industrial malaise in the 1970s put many of these plans at risk. Companies went bankrupt holding millions of dollars in pension liabilities. Troubled firms with solvent plans became takeover targets for investment bankers, who questioned the rationality of freezing pension capital within companies that needed to retool. The Democratic Congress responded to worker anxiety by tightening fiduciary regulations on management and by mandating a business-funded bailout program-shackling responsible managers to the bad ones. Corporate enthusiasm for defined-benefit programs predictably waned.
All along, however, a small but influential group of companies, such as Eastman Kodak, Fisher-Price, and Procter & Gamble, had based at least some retirement benefitson profit-sharing-giving employees cash or stock based on the company’s performance-rather than on defined benefits. Until 1978 the tax code continued to favor defined-benefit plans. But that year, the profit-sharing companies succeeded in securing a tax law that allowed both employers and employees voluntarily to defer “compensation” into a tax-advantaged pension plan.
What, exactly, was “compensation”? The defined-contribution revolution was itself deferred three more years while the IRS decided. The Reagan administration’s 1981 ruling held that the “compensation” eligible for tax advantages included not just profit-sharing distributions and bonuses, but wages as well. The employee’s contribution to his retirement plan would get the same tax break as his employer’s.
The 401(k) was born. Several large profit-sharing corporations immediately filed under the new ruling, and the tax breaks soon lured other companies. By 1984, 7.5 million employees owned $92 billion in 401(k)s. Assets in such programs tripled to $277 billion in 1989, tripled again to $860 billion in 1995, and then almost doubled over the next three years, to $1.54 trillion in assets in 1998. That year, 39 million Americans participated in 401(k) programs, while other defined-contribution plans enrolled 16 million more. A trickle of stock ownership had become a flood.
This resulted in the greatest dispersion of capital ownership in human history. By 1999, 76 million Americans, 43 percent of our households, held shares in corporations or equity mutual funds.
During these same years, the country’s political balance was also shifting in favor of the Republicans. This was not a coincidence. Most political analysts missed the impact of expanded stock ownership because they assumed that portfolios were an accoutrement of wealthy white households; if stock owners were more Republican than others, this was simply a function of their race, sex, income, etc.
But the rapid growth of shareholding among groups that had not been in capital markets called this assumption into question. From 1989 to 1995, stock ownership increased 46 percent among households earning $25,000 to $49,999, and 78 percent among households earning $10,000 to $24,999. Indeed, by 1995, half of American shareholders had annual incomes below $50,000. Investment in equities also increased substantially among young adults and seniors in the first decade of their retirement.
According to a January 1999 survey by Rasmussen Research for the Cato Institute, the democratization of the stock market is having large political effects. The 6,400 respondents to the survey were divided by the usual demographic markers such as race and sex, but also, for the first time, by whether they owned more than $5,000 in stocks, bonds, or mutual funds. The results: Investors, even among groups such as unmarried women and blacks, identified themselves as Republicans in substantially higher percentages than non-investors.
The GOP has been slow to recognize the ramifications of Reagan’s gift. True, Republicans are for medical savings accounts, Social Security privatization, universal IRAs, and other policies that promote investment. But they have offered these programs with a bad conscience. All too often, they have denigrated investment-based tax cuts as social engineering or, worse, elitism. Some, adopting the language of their ideological foes, disparage savings incentives as “tax expenditures.”
They are wrong to do so. An investment-side politics can promote supply-side economics, making taxes both flatter and lower. Flat-tax advocates implicitly assume that the current tax code is skewed to favor consumption today over long- term wealth seeking. That’s why an important feature of the leading flat-tax proposals is the mitigation of the double taxation of savings. An investment- based approach to tax cutting makes this assumption explicit. And the problem of “social engineering”-that it’s wrong for the tax code to promote individual saving for, say, health care over other personal goals-is self- correcting because of the normal processes of politics. Government programs tend to grow by showering more and more benefits on more and more voters. That’s why most “targeted” programs are reduced to idiocy over time (federal aid for the education of the disadvantaged, for instance, goes to almost every school district in the country).
But the same process will make an investment-side policy better. Each time the benefit is increased, more income is exempted from double taxation. Each time the constituency is enlarged, the demand for lighter taxation grows. Each time the approved purposes for tax-exempt saving are expanded, social engineering gives way to individual freedom. Tax cuts for investment will affect the circuitry of government as a virus affects a computer, growing at its expense.
Investment-side politics builds on the Reagan administration’s neglected legacy: the creation of history’s first mass class of worker shareholders. If Republicans help
make that class an actual majority, our political debates in the future will center not on whether to side with capital or labor but on which party can best represent
worker capitalists. This is one other thing that Ronald Reagan wrought.