How big is the risk of another Black Monday equities crash?

Thirty years on, the market is different but has similar characteristics, from high valuations to trading strategies that could accelerate a sell-off

by Nicole Bullock, Robin Wigglesworth and John Authers In New York and Christian Pfrang in Hong Kong



Art Cashin recalls the heady atmosphere that dominated the New York Stock Exchange for much of 1987. After five or six straight days of the market rallying, senior partners at brokerage trading desks would instruct the junior partners [traders] to “lighten up a little bit”, Mr Cashin says. “When they did, the market just went higher.”“

The market in 1987 was relentless,” says Mr Cashin, director of floor operations for UBS Financial Services at NYSE, who began working on “the floor” as an assistant clerk in 1959, straight out of high school. “Unfortunately there are some similarities [to today]. It reminds me a bit of what we have seen this year.”

Market veterans like Mr Cashin have no shortage of Wall Street war stories, but little compares to the events of October 19 1987, when US stocks fell more than 20 per cent — their biggest-ever one-day crash — giving birth to an event known as “Black Monday”.

Yet with the 30th anniversary on Thursday, the comparisons with today’s market are more than just a curiosity. With US equities on an almost uninterrupted bull run for more than eight years, boosted by a flood of cheap money, the prospect of another nasty surprise lingers over the market.


Black Monday chart


“People just keep buying the dips and following the money up. When you have been doing this for over 50 years, when you see those similarities, you say the last time it got like this it didn’t end well,” says Mr Cashin.

No two market eras are alike, yet the “buy the dips” mentality — something that has been stronger than ever on Wall Street this year — is only one of a number of striking parallels with 1987. After hitting a succession of fresh all-time records, valuations are stretched. Now, as then, the US is engaged in sabre-rattling with foreign foes, including Iran. Trading strategies designed to protect investors could end up exacerbating any correction, just as in 1987, while regulators could be as ill-placed to monitor risks as they were back then.“

There are similarities, and lots of them,” says Rob Arnott of Research Affiliates and the global equity strategist at Salomon Brothers in 1987, although he does not expect severe market turbulence in the near future.

The biggest red flag is the most obvious: US stocks look historically expensive. The cyclically adjusted price-to-earnings ratio kept by Yale economics professor Robert Shiller is at levels topped only by the peaks before the dotcom bubble burst in 2000 and the Great Crash in 1929.

“That is disturbing company for us to be keeping,” Mr Arnott says.


London traders scramble to sell and avoid losses during Black Monday © FT


Black Monday was not just about valuations. It did not even start a bear market: unlike the 1929 or 2000 crashes, stocks had recovered in little over a year.

Instead, many observers saw it as an extreme technical accident. The most popular explanation hinges on “portfolio insurance”, which used sales of futures in an attempt to limit damage to investor portfolios in a sell-off.

The strategy used protean computer programmes that would automatically sell index futures when markets fell, in theory protecting a fund’s downside in return for a modest premium. When markets plummeted on October 19, the selling of more and more index futures turned a rout into carnage.

While the scale of Black Monday’s slide might never be replicated — controls are now in place to halt trading in times of sharp declines and official intervention is expected — some people have warned about the dangers lurking in modern hedging strategies.



Black Monday chart


Although advances in computing power provide the opportunity to back-test strategies, it remains hard to know whether hedges could contribute to a broader unwinding of trades.

For example, an increasingly popular risk management tool called “volatility control” could in theory mimic the feedback loop that portfolio insurance caused. “Strategies that buy as the market goes up and sell as the market goes down are similar in nature,” says Hayne Leland, a finance professor and a pioneer of portfolio insurance in the 1980s.

These funds target a specific level of volatility to maintain a constant level of risk — which is usually shorthand for how much they gyrate. If markets are rocky, they systematically sell down to slip below their target. The Vix volatility index, the CBOE’s measurement of short-term volatility implied by S&P 500 option prices, has been hovering around all-time lows in recent years.



Men watch the display screens at the New York offices of a mutual fund group on Black Monday, October 19 1987 © AP


If there is enough money in “vol-control” funds — ranging from variable annuity accounts at insurers and trend-following hedge funds — then their automated selling can pour fuel on an already combustible situation.

“I don’t think it’s an accident waiting to happen, but it’s something to watch,” says Dean Curnutt, chief executive of Macro Risk Advisors. “It will take a significant shock to sentiment for it to start to matter, but then these things potentially feed on each other.”

Exact numbers are hard to come by, but according to Deutsche Bank and JPMorgan, there is close to $1tn of funds that have embedded some sort of “vol-control” mechanism.

A related but separate concern is the swelling interest in “selling volatility” or betting that volatility will remain somnolent — something that has proved phenomenally profitable since the global financial crisis, prompting money to flow into popular exchange traded funds that offer retail investors a clean way to bet on tranquility.

Yet like portfolio insurance and volatility-control funds, selling volatility can exacerbate a market rout. Investors caught the wrong way if volatility spikes would have to hedge themselves by selling index futures, worsening the correction and driving volatility higher again.

Black Monday chart


“Whenever you see strategies deployed that automatically sell in a down market, it is reminiscent of portfolio insurance,” says David Harding, the head of Winton Capital Management, a big quantitative hedge fund. Few people in today’s market remember the lessons of 1987. “People are long on self-belief and short on experience,” he says.

These days, Prof Leland worries that portfolio insurance “has gone underground”. Banks and hedge funds have stepped in to sell portfolio protection products to the market. “The real worry is that these banks in concert are all going to hedge in the same direction,” he says, adding that statistics about aggregate hedging should be made public. “Regulators are focused on whether individual banks are OK, rather than their collective impact on the market.”

The other risk factor concerns the structure of the market. Today’s market may be more sophisticated and automated, but like three decades ago key elements are largely untested. New categories of securities, particularly ETFs that now control more than $4tn of assets, play an increasingly large role in trading but are yet to go through a crisis.



'Rout on Wall Street': How the October 20 edition of the FT reported Black Monday


There is a perennial worry that a bout of fierce selling, particularly in ETFs indexed to less liquid securities, could exacerbate market losses. The ETF industry argues that these instruments merely reflect rises or falls in the market, rather than prompting them.

Today’s market is also much more fragmented. The monopoly that Mr Cashin and other traders at the NYSE once enjoyed has been smashed, with most share trading carried out electronically, often with minimal human intervention. The market is now operated by about a dozen registered national exchanges, 40 broker/dealer-operated trading venues and other trading systems.

“My greatest concern is the lack of a central marketplace,” says Laszlo Birinyi, the founder of Birinyi Associates, who saw Black Monday unravel from the trading room at Salomon Brothers.“

Back then it was gut-wrenching, but we could see what was happening. What concerns me today is that a lot of the time we can’t see what’s happening. There are so many venues and the reporting is so much more difficult. We don’t know what’s going on in dark pools or in internal trading desks.”


Black Monday chart


Yet there are also big differences between the situation today and 1987, which may provide insulation against another accident. Among the starkest contrasts is the low level of interest rates. Two weeks before the 1987 crash, Jeremy Grantham, founder of Boston fund management group GMO, was quoted on the cover of a newsletter saying: “Buying bonds at 10.3 per cent and selling stocks is almost a free lunch.”

The situation now with bonds is “cosmically different”, he says. “What competition do we have now [for equities]? You are lucky if you get any real return in a long bond.”

Unlike three decades ago, US investors today are unlikely to feel blindsided by events on the other side of the world. The US market moved lower that Monday in 1987 after aggressive selling in Asia and then Europe, perhaps marking one of the first global sell-offs. In London, where share prices tumbled before Wall Street had even opened, many thought the freak hurricane that hit south-east England the previous Friday had triggered the selling.


Black Monday chart


Markets may be even more linked now, but the flow of information is far faster. Kenny Polcari, director at O’Neil Securities but a 26-year-old rookie on the NYSE floor back in 1987, says he was unaware of the market bloodletting around the world until a friend phoned him on the exchange floor at 7am that morning.

“I picked up the paper that morning and [it] was telling me what happened on Friday. Meanwhile there was devastation on Monday in Asia.” Now there are any number of news sites, emails, texts, alerts or tweets to let investors and traders know what is happening, often in real time.

Even leading market sceptics, many of whom believe stock prices could start to drop, doubt that another extreme sell-off in equities might be imminent. Partly this view comes from a belief that over-confidence is currently absent. “I don’t think the market carries the typical traits of a bubble, which is euphoria,” says Mr Grantham. “It is a very strange comparison to old-fashioned euphoria, where they buy houses because houses always go up, or tech stocks in 2000. None of those features exist.”

One reason may be that humans may have learnt something from the recent past. Most traders today are aware of Black Monday, and many got their fingers burnt in the financial crisis from 2008. Although the market continues to rally, it has routinely been called the most hated bull market of all time.

According to Tobias Levkovich, chief US equity strategist at Citi Research and another Black Monday veteran: “There isn’t this enthused bunch of people who feel the world is their oyster,” he says. “The majority of investors are still reluctant and cautious about where the next bogeyman is coming from.”


Regulators play catch-up with complex markets


Regulators have studied closely the crash of 1987, but some doubt whether they are equipped to deal with the highly fragmented markets of 2017.

The “flash crash” of May 2010, when the Dow Jones Industrial Average dropped nearly 1,000 points, or about 9 per cent, within minutes before recovering, was blamed in part on the decentralised nature of modern markets and the rise of high-frequency trading, where moves occur faster than the blink of an eye.

Regulators and the equity industry have instituted measures to protect investors in times of stress, which gives some comfort. But here too the record is far from perfect.

In a 2015 event simply referred to by market participants as “August 24”, selling in Asia on another Monday morning spilled over into a big drop at the opening of the New York markets, resulting in chaos as the S&P 500 lost more than 5 per cent. Some 1,278 securities, mostly exchange traded funds marketed in part for their ease of trading, were halted due to sharp movements. Trading in others was delayed and electronic market-makers backed away from the market.


A trader watches a monitor showing a two-minute "flash crash" in the pound on Asian markets in September 2016, which analysts said was exacerbated by computer-initiated sell orders © Bloomberg


The industry has since tinkered with the mechanisms around trading halts and other rules, but the experience indicated that such safeguards are still being stress-tested. And the essential regulatory system that failed in 1987 and even more spectacularly during the 2008 financial crisis remains intact in its key areas — trading in stocks and trading in derivatives based on them have different regulators, while the Federal Reserve, charged with maintaining financial stability, has direct control over neither.

The highly computerised nature of modern trading has meant an increasing number of technical glitches that perennially impede trading.

Regulators also have to prepare for the risk of a cyber attack on the trading system, which could create a dramatic interruption.


Behold the New Emperor of China

Xi Jinping is the most powerful leader since Mao, and he is set to hold power for as long as he wants.

By Graham T. Allison

A photo of Chinese President Xi Jinping at an exhibition for China's outstanding achievements in Beijing, Sept. 28. Photo: wu hong/epa-efe/rex/shutterstock/EPA/Shutterstock


The Chinese Communist Party’s 19th Party Congress will convene Wednesday to select leaders for the next generation. Few events will have greater impact on the shape of world politics.

The script for the Party Congress hasn’t been revealed, but I am betting that Xi Jinping will not only be “re-elected” to a second five-year term as the party’s general secretary and China’s president, but also that he will effectively be crowned China’s 21st-century emperor.

Every member of the seven-man Politburo Standing Committee will be a reliable Xi loyalist. Among them will be Mr. Xi’s closest associate, Wang Qishan, who spearheaded Mr. Xi’s anticorruption inquisition. That campaign rewrote the rules for doing business in China and restored a sense of fear (of jail) among party cadres and the moneyed class.

Custom requires Chinese leaders to retire by 68, so the 69-year-old Mr. Wang’s continued place on the committee—along with the conspicuous lack of any visible successor to Mr. Xi—will set the stage for Mr. Xi to remain China’s leader for as long as he chooses. As this new reality sinks in, Americans will ask: Who is Xi Jinping? For a start, let me offer five tweet-sized points.

First, he will increasingly be recognized as the most powerful leader of China since Mao Zedong. Mr. Xi is overshadowing even Deng Xiaoping, who buried Soviet-style economics and replaced it with the party-led market capitalism that has produced three decades of double-digit economic growth.

Second, Mr. Xi is the most ambitious leader on the international stage today. Long before Donald Trump pledged to “make America great again,” Mr. Xi declared his intention to do the same for China. His 2012 banner stated his vision for the “Chinese Dream”: “the great rejuvenation of the Chinese nation.” To that end, he’s undertaken four revolutions: turning China’s export-led economy into a world leader in innovation and high-value manufacturing, fueled by the world’s largest consumer middle class, while maintaining economic growth above 6.5%; reorganizing and rebuilding China’s military so that it can, as Mr. Xi says, “fight and win” against a modern adversary (such as the U.S.); reviving nationalism and pride in the restoration of a Great China; and, most critically, revitalizing the party and re-establishing its authority. Any one of these initiatives would overwhelm most heads of state. Mr. Xi is managing all four at once.

Third, he is the most surprising leader on the international stage today. In a field that includes Vladimir Putin, Kim Jong Un and Donald Trump, this claim may seem exaggerated. But recall the conditions in 2012, when Mr. Xi was appointed to succeed Hu Jintao. Like Mr. Hu, Mr. Xi was expected to be a bland figurehead and technocratic spokesman of a nine-man collective leadership. The skill, speed and determination with which he has effected a regime transformation to charismatic one-man rule is stunning. Never before has a nation risen so far, so fast, on so many dimensions as China has over the past generation. The same could be said of Mr. Xi, who went from a politically exiled peasant living in a cave to “Chairman of Everything.”

Moreover, his choice to upend Deng’s policy—“hide China’s capabilities and bide our time”—has blindsided the international community. From China’s new Asian Infrastructure Investment Bank, which has overshadowed the World Bank, to his massive geoeconomic master plan known as “One Belt, One Road” financing 900 infrastructure and business projects at a cost exceeding $1.4 trillion (the equivalent of 12 Marshall Plans), he is nothing if not audacious. As the U.S. has retreated from its traditional role on the world stage, Mr. Xi has moved swiftly to fill the void, shocking the Davos elite in 2017 when he proclaimed himself,―to little dissent,―champion of the new global liberal economic order.

Fourth, Mr. Xi is the most effective global leader today. Assess China’s performance over his first five years: revitalizing a party that many Western analysts believed would soon fall to the “inevitable” march of democracy, maintaining robust economic growth when so many expected crisis and collapse, and asserting China’s power abroad against all competitors, getting his way from the South China Sea to the Himalayas.

Finally, of all the leaders on the international stage, Mr. Xi will be the most consequential. This is not simply because he rules a nation of 1.4 billion people and an economy that overtook the U.S. in 2014 to become the largest in the world (measured by purchasing power parity, which both the International Monetary Fund and CIA regard as the single best yardstick). By the end of his second term, China’s economy is on pace to be 40% larger than America’s.

At that point he will have firmly established Beijing as the capital―and Xi Jinping as the man―to which a world looking for growth and stability turns first. China will have been restored to its position as the “sun” around which the nations of Asia orbit—as they did in earlier millennia. And Mr. Xi will have become the modern emperor of China.


Mr. Allison, a professor of government at Harvard, is author of “Destined for War: Can America and China Escape Thucydides’s Trap?” ( Houghton Mifflin Harcourt , 2017).


How Pay Inequality Affects the Bottom Line
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Taxes

 
Most private firms have strict policies about salaries: Workers aren’t allowed to know how much money they make compared to their peers. But that’s an unrealistic and outdated notion, especially with so much information available online. Pay inequality is a persistent problem that is getting more exposure than ever before. In her latest research, Wharton management professor Claudine Gartenberg examines how inequality affects individual workers and entire companies.

Her findings are outlined in three papers: “Pay Inequality and Reductions in Corporate Scope,” co-authored with Wharton management professor Emilie Feldman and Julie Wulf of the National Bureau of Economic Research; “Islands of Equality: Competition and Pay Inequality within and across Firm Boundaries,” co-authored with Wulf, and “Pay Harmony? Social Comparison and Performance Compensation in Multibusiness Firms,” co-authored with Wulf.

She spoke to Knowledge@Wharton about why top-tier managers need to pay more attention to this issue.
 
An edited transcript of the conversation follows.


Knowledge@Wharton: You have three recent papers that look at the issue of pay inequality. Could you tell us about each one of those?

Claudine Gartenberg: These are a series of joint studies with Julie Wulf, at the National Bureau of Economic Research, and Emilie Feldman, management professor here at Wharton, which focus on this question of pay inequality among workers, primarily within companies but also the implications at a societal level. This question of how much pay inequality to tolerate inside of your company is actually a tricky one for managers. It’s one that every manager faces, and it has big consequences not just for HR but also for the company’s strategic position and ability to compete.

In these papers, we have three big findings. The first is that it appears that your pay co-moves more with your colleagues than it would just be predicted for your job itself. Pay moves in lockstep, goes up, goes down, you get some rare bonuses. We attribute that to people comparing pay inside firms more with their colleagues and their co-workers than with just people who work in other companies.

The second thing we find is that it also appears to tie managers’ hands a bit in terms of how firms can respond to competition. We look at a trade shock — this is a free-trade agreement with Canada — and what you would want to do is pay workers more or differently based off how well they’re able to compete and respond to this trade shock. We find that firms respond in lockstep with employees, so they either all give them raises, or they all respond very similarly and not in line with how productive workers are.  
Lastly, we find that pay inequality predicts divestitures. If you have firms with very high levels of inequality, it is predictive that they will shed a business unit that is contributing to that. So, it has major strategic consequences; it is not just an HR issue.

Knowledge@Wharton: We like to think that our pay is based on what we do and how well we do it. The first two papers seem to show that it’s also about how much our co-workers are making or what’s going on in the larger context of the world.

Gartenberg: Oh, completely. We are social beings. We evaluate our self-worth by how we stack up relative to each other. It’s just in human nature. We’ve seen that behavior in monkeys as well. Once you join a firm, you evaluate yourself against workers inside those firms. That is an inevitable consequence. The thing that is interesting about it is that there’s really two sides of performance pay.

On the one hand, performance pay is a fantastic thing. It’s why it’s been adopted increasingly over the last three decades. You want to give people bonuses for how well they are doing, you want to reward your top workers, you want to make sure people feel valued. On the other hand, performance pay creates pay differences inside firms, and if people perceive those are unfair or unjust, it can create real problems inside firms. In fact, Uber is dealing with this right now. Uber’s cultural issues have received all of the attention in the news, but arguably among the employees themselves the bigger issue is compensation differences. It’s a very real issue that affects companies across the board.

Knowledge@Wharton: There’s been a lot of talk lately about NAFTA and whether it has been good or bad for American business. A part of it that we haven’t heard much about is that NAFTA did affect salaries.

Gartenberg: This is an interesting question. It’s not one that we can get directly at with the data that we have for our research, because we have compensation data for division managers of top companies — real “one-percenters.” These are not your model American workers.

The interesting thing that we find that I think ought to inform this debate is that the Canada Free Trade Agreement predated NAFTA by five years, but had a very similar impact. It had a very large impact on American companies. The effect of the Canadian Free Trade Agreement was to raise the one-percenters’ salaries. Even though we don’t have the information to prove this, generally people have found that trade agreements lower unskilled worker salaries across the board. If you put those two facts together, these trade agreements should probably widen the gap between the top one-percenters and the 99%. It really does affect pay inequality in a distributional way that is getting a lot of attention and should get more attention going forward.

Knowledge@Wharton: Looking more closely at the third paper, you find companies are more likely to divest divisions where there is more pay inequality. Is there action that can be taken as a result of knowing that?

Gartenberg: This is a really interesting question about corporate strategy that I think has not gotten enough attention out there, which is that companies want to extend into different types of businesses that might be complementary, or they want to acquire companies. A major factor appears to be compensation policies across those business units and how those affect the workers, how those affect post-merger integration, how those affect worker morale, productivity, etc. I think it is something that managers ought to pay attention to.

To give examples from my own experience when I consulted to the energy industry — there was a period of time when energy companies were trying to heavily get into trading operations, sort of Wall Street energy derivative trading operations. To do that well, you need to pay these guys Wall Street salaries. On the one hand, you’ve got a business unit that is paying Wall Street-level salaries. On the other hand, you’ve got your asset side of your business, which is the people operating the pipes in the facilities and moving the product back and forth, and they’re getting paid hugely different amounts. I saw the amount of tension that provoked. These pay differences and the differences of these workers, the way they were treated between these units, it was very, very hard to manage that. That is definitely something that managers should pay attention to when they’re deciding what businesses to operate in.

Knowledge@Wharton: What your research shows is that pay inequality really impacts everything. But companies often believe salaries are a secret, so it doesn’t impact anybody.

Gartenberg: If there’s one takeaway we want from this research, it’s for people to recognize that these pay policies are not an HR policy. It’s really a strategic decision that firms need to make. As much as firms want to keep their pay under wraps, in today’s day and age, that’s increasingly unrealistic. It was unrealistic 10, 20, 30 years ago as well. And it does have major consequences for what firms can do and how they can compete. That is very important to account for.

Knowledge@Wharton: What will you study next?

Gartenberg: The real holy grail behind this research is looking at societal-level inequalities, which are at unheard levels within the U.S. and also other countries around the world, and putting firms and firm strategy into the center of that research. What are the choices the companies are making today in terms of their HR policies and outsourcing? How are those choices influencing inequality? How is societal inequality affecting what managers can do and what type of compensation they can offer their employees? That is a big question, it’s extremely important, and it’s one that we’re just starting to get our heads around.


Déjà Voodoo

Joseph E. Stiglitz



NEW YORK – Having failed to “repeal and replace” the 2010 Affordable Care Act (“Obamacare”), US President Donald Trump’s administration and the Republican congressional majority have now moved on to tax reform. Eight months after assuming office, the administration has been able to offer only an outline of what it has in mind. But what we know is enough to feel a deep sense of alarm.                            

Tax policy should reflect a country’s values and address its problems. And today, the United States – and much of the world – confronts four central problems: widening income inequality, growing job insecurity, climate change, and anemic productivity growth. America faces, in addition, the need to rebuild its decaying infrastructure and strengthen its underperforming primary and secondary education system.
 
But what Trump and the Republicans are offering in response to these challenges is a tax plan that provides the overwhelming share of benefits not to the middle class – a large proportion of which may actually pay more taxes – but to America’s millionaires and billionaires. If inequality was a problem before, enacting the Republicans’ proposed tax reform will make it much worse.
 
Corporations and businesses will be among the big beneficiaries, a bias justified on the grounds that this will stimulate the economy. But Republicans, of all people, should understand that incentives matter: it would be far better to reduce taxes for those companies that invest in America and create jobs, and increase taxes for those that don’t.
 
After all, it is not as if America’s large corporations were starved for cash; they are sitting on a couple of trillion dollars. And the lack of investment is not because profits, either before or after tax, are too low; after-tax corporate profits as a share of GDP have almost tripled in the last 30 years.
 
Indeed, with incremental investment largely financed by debt, and interest payments being tax-deductible, the corporate tax lowers the cost of capital and the returns to investment commensurately. Thus, neither theory nor evidence suggests that the Republicans’ proposed corporate tax giveaway will increase investment or employment.
               
The Republicans also dream of a territorial tax system, whereby American corporations are taxed only on the income they generate in the US. But this would only reduce revenue and further encourage American companies to shift production to low-tax jurisdictions. A race to the bottom on corporate taxation can be prevented only by imposing a minimum rate on any corporation that engages in business in the US.
 
America’s states and municipalities are responsible for education and large parts of the country’s health and welfare system. And state income taxes are the best way to introduce a modicum of progressivity at the subnational level: states without an income tax typically rely on regressive sales taxes, which impose a heavy burden on the poor and working people. It is thus perhaps no surprise that the Trump administration, staffed by plutocrats who are indifferent to inequality, should want to eliminate the deductibility of state income taxes from federal taxation, encouraging states to shift toward sales taxes.
 
Addressing the panoply of other problems confronting the US will require more federal revenues, not less. Increases in standards of living, for example, are the result of technological innovation, which in turn depends on basic research. But federal government support of research as a percentage of GDP is now at a level comparable to what it was 60 years ago.
 
While Trump the candidate criticized the growth of US national debt, he now proposes tax cuts that would add trillions to the debt in just the next ten years – not the “only” $1.5 trillion that Republicans claim would be added, thanks to some growth miracle that leads to more tax revenues. Yet the key lesson of Ronald Reagan’s “voodoo” supply-side economics has not changed: tax cuts like these do not lead to faster growth, but only to lower revenues.
 
This is especially so now, when the unemployment rate is just over 4%. Any significant increase to aggregate demand would be met by a corresponding increase in interest rates. The “economic mix” of the economy would thus shift away from investment; and growth, already anemic, would slow.
 
An alternative framework would increase revenues and boost growth. It would include real corporate-tax reform, eliminating the tricks that allow some of the world’s largest companies to pay miniscule taxes, in some cases far less than 5% of their profits, giving them an unfair advantage over small local businesses. It would establish a minimum tax and eliminate the special treatment of capital gains and dividends, compelling the very rich to pay at least the same percentage of their income in taxes as other citizens. And it would introduce a carbon tax, to help accelerate the transition to a green economy.
 
Tax policy can also be used to shape the economy. In addition to offering benefits to those who invest, carry out research, and create jobs, higher taxes on land and real-estate speculation would redirect capital toward productivity-enhancing spending – the key to long-term improvement in living standards.
 
An administration of plutocrats – most of whom gained their wealth from rent-seeking activities, rather than from productive entrepreneurship – could be expected to reward themselves. But the Republicans’ proposed tax reform is a bigger gift to corporations and the ultra-rich than most had anticipated. It avoids necessary reforms and would leave the country with a mountain of debt; the consequences – low investment, stalled productivity growth, and yawning inequality – would take decades to undo.
 
Trump assumed office promising to “drain the swamp” in Washington, DC. Instead, the swamp has grown wider and deeper. With the Republicans’ proposed tax reform, it threatens to engulf the US economy.


Joseph E. Stiglitz, recipient of the Nobel Memorial Prize in Economic Sciences in 2001 and the John Bates Clark Medal in 1979, is University Professor at Columbia University, Co-Chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and Chief Economist of the Roosevelt Institute. A former senior vice president and chief economist of the World Bank and chair of the US president’s Council of Economic Advisers under Bill Clinton, in 2000 he founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. His most recent book is The Euro: How a Common Currency Threatens the Future of Europe.