This speech by David Morris was originally presented at a conference entitled “Growing Equity: Assets and Opportunities for Communities Left Behind,” hosted by the Corporation for Enterprise Development in Washington, D.C., on December 4, 1997.
Money sets the world in motion,” noted the Roman statesman Publius Syrus. The motion of money can be either beneficial or harmful. According to observers as varied as George Soros and Ralph Nader, the movement of money today is having an increasingly pernicious impact on our economies and communities.
The financial sector is one of the fastest growing parts of our economy. According to Deputy Treasury Secretary Lawrence Summers, “The output of U.S. securities firms…has grown four times faster than our economy as a whole since 1977, and financial services now account for some 7 percent of our GNP.”
We trade more than $100 worth of stock and bonds for every dollar raised for investment in new plant and equipment, a ratio almost four times greater than 30 years ago. In 1992 almost $56 trillion of U.S. stocks, bonds and government securities were traded, an amount ten times greater than the U.S. economy’s total output of goods and services.
In1970, more than 95 percent of currency trades were for activities linked to what many call the “real economy” – investment, tourism, foreign aid, trade. Today only two percent are. The volume of currency trading is now some 50 times greater than the volume of trade in goods and services.
This increased speculation has been accompanied by the physical delinking of our financial institutions from our communities. The number of independent banks is lower than at any time since 1934 and the tidal wave of mergers and acquisitions continues to shrink that number. Depository institutions are closing branches while the fastest growth in the financial sector is in non-depository institutions like mutual funds and pensions that have never had a physical presence in communities.
This delinking of money from place and productive investment is not the inevitable result of technological advances or economic evolution. Money is a human invention and the rules that control its dynamic are also a human invention. The rules we have fashioned favor mobility over community, speculation over productive investment and volatility over permanence.
The challenge before us is to develop new rules. We need policies that once again link capital and community, with a special emphasis on those parts of the community that traditionally have been left behind. The title of this conference expresses our goal: “Growing Equity” in both meanings of that term -wealth and fairness.
In keeping with this goal, let me offer three rules that will grow equity while nurturing strong communities.
Rule 1: Introduce a Modest Financial Transactions Tax and Use the Revenues to Finance Individual Development Accounts
A financial transactions tax is not a new idea. John Maynard Keynes proposed one back in 1930. In 1978, Nobel Prize winning economist James Tobin proposed a tax on international financial transactions. Speaker of the House Jim Wright proposed such a tax on domestic transactions in 1987. Larry and Victoria Summers proposed such a tax in 1989.
The justification for such a tax is straightforward and was laid out in 1995 in a well-researched report by Dean Baker of the Economic Policy Institute and Robert Pollin and Marc Schaberg of the University of California-Riverside. Excessive speculation wastes resources, increases volatility, hikes risk, destabilizes economies and siphons money and intellectual resources from productive investments.
A modest tax on financial transactions could dampen volatility and encourage longer-term investment; that is, patient capital. For example, most financial transactions now consist of churning money: holding assets only for a few hours. The trader is happy with a very small return on each investment because these returns translate into astonishingly high profits on an annual basis.
A 1 percent profit for churners is quite satisfactory. A .5 percent financial tax would represent a heavy burden on churners, enough we would hope to curb their pernicious behavior. But for those who hold assets for several years and earn 15-30 percent or more on their investments, such a tax would constitute a minor inconvenience and would have little if any influence on investment decisions.
Baker,Pollin and Schaberg suggest a .5 percent tax on equity sales and a smaller tax on corporate bonds, government securities and on derivatives and options. They estimate that in 1992 such a tax would have raised $40-60 billion in revenue. These figures would be substantially higher in 1997.
Baker and company refrain from imposing a tax on currency trading. I assume this is because they believe this must be done on an international level. Certainly the recent collapse of Asian economies (due in part to currency speculation) would argue for such a tax. James Tobin estimated back in 1978 that a .05 percent tax would generate $150 billion. Today the revenue generated by such a tiny tax would be several times greater.
A flat financial transaction tax is inherently progressive. The wealthiest 1 percent of the population own more than 50 percent of all stock and over 75 percent of all bonds owned by households. The richest 1 percent would pay more than 50 percent of the tax. The poorest 10 percent would pay little if any tax.
Financial transactions taxes are in place in more than 15 countries. The highest rate is Finland’s 1.6 percent. Denmark has a 1 percent tax. The United States had a financial transactions tax from 1914 to 1966, but then reduced it to a trivial .004 percent tax only on stock transfers. The revenue supports the operations of the Securities and Exchange Commission. ?
What is to be done with the revenue generated by a financial transactions tax? We could add it to the government coffers, but the federal budget is so nearly in balance there is little reason to do this from a deficit reduction perspective. And most of us have little faith that the federal government would spend increased revenue in a way that builds community and grows equity.
Afar better idea would be to return the money to households on an equal per capita basis in the form of contributions to Individual Development Accounts (IDA). IDAs were first proposed by Michael Sherraden, director of the Center for Social Development at Washington University in St. Louis. In his 1991 book, Assets and Equity, Sherraden observed, “Incomemay feed people’s stomachs, but assets change their heads.” IDAs operate like IRAs except that their funds can be withdrawn only for the purpose of increasing equity – for education, a home purchase, or investing in one’s own business.
It’s hard to believe that even after Sherraden wrote his book, most states made the poor ineligible for welfare if they managed to amass $1,000 in assets. That rule has now changed and a major effort is underway to spread the creation of IDAs for low-income households. I applaud this conference’s host, the Corporation for Enterprise Development (CfED), for leading that effort.
The tens of billions of dollars in revenue generated from a financial transactions tax, if directed toward IDAs not only for low-income households but for all households, would move the concept from the margins of public policy to its center. Not only would it grow equity for the low and moderate income sectors; it could constitute a source of “patient” capital for those communities. A community of 10,000, for example, would see their collective IDAs grow by more than $3 million a year: money that could, for example, be used to finance community-development efforts.
Rule 2: Extend the Community Reinvestment Act to Non-depository Institutions and Establish a National Reinvestment Fund
The Community Reinvestment Act (CRA) is one of the great success stories of grassroots organizing. People in neighborhoods came together in the 1970s, first to painstakingly gather the data necessary to analyze the lending patterns of their local financial institutions, then to just as painstakingly organize politically to persuade Congress to require banks and savings and loan associations to compile and make public this data, and finally, to convince federal regulatory agencies to consider the level of local lending by financial institutions when reviewing their applications for operational changes.
In 1987, Congress held hearings on the tenth anniversary of the CRA. Much of the testimony focused on its failures. In 1989 several useful reforms were introduced, including more public disclosure. And in the 1990s a combination of more vigorous enforcement, coupled with the increased desire by banks to seek federal approval for mergers, transformed the CRA into a powerful and effective tool for growing equity.
Comptroller Eugene Ludwig estimates that since 1977, $215 billion in loan commitments to low and moderate income housing have been made: $175 billion of this has occurred since 1994! Since 1993 home mortage loans in low and moderate income census tracts has risen by 22 percent.
The CRA enables home ownership by those who have traditionally been shunned by the mortgage financing institutions. Home ownership has a profoundly beneficial impact on both community and individuals. Home ownership is one of the most important stabilizing influences on local economies and neighborhoods. And the equity in the home constitutes about 80 percent of the life savings of the poor and working class.
Banks were fearful that the CRA would force them to make bad loans. The evidence leads to the opposite conclusion. A survey of 600 lending institutions by the Federal Reserve Bank of Kansas City found that 98 percent found CRA lending to be profitable. Indeed, the nation’s leading credit scoring company, Fair Isac and Company, studied the default performance of a spectrum of incomes and concluded that income is negatively correlated with loan repayment behavior. That is, the higher the income, the higher the probability of default.
The CRA has been a very effective tool, but the financial system is changing. Banks are merging and closing branches, especially in low income communities. And more and more of the money we save is not going to banks, but to mutual funds, pension plans, insurance companies and non-bank lenders. As the financial system restructures, the CRA applies to a rapidly shrinking portion of its assets.
From1983 to 1993 the percent of the domestic credit market debt owned by depository institutions dropped from 40 percent to 27 percent, according to Tom Schlesinger of the Financial Markets Center. The portion owned by private non-bank financial firms rose from 26 percent to 37 percent. As Schlesinger points out, “The fastest growing outlets for household savings have no direct lending capacity and generally bypass large areas of the entrepreneurial economy. Non-bank financial firms, who use those savings, conduct very little flexible, patient portfolio lending. As a result, business and household borrowers who depend on community-based capital markets frequently find themselves stranded in an ocean of global finance.”
Last year Congress nearly passed legislation that would have ended the CRA. Next year it will again debate a law that would severely cripple the CRA. The National Community Reinvestment Coalition has led the fight not only to defend the CRA, but to level the playing field by extending it to non-depository institutions. That is fair and appropriate. However, simply extending the CRA to institutions without a presence in communities may not be enough to accomplish our objectives. Instead, we should seriously pursue a bold idea proposed by Schlesinger to create a National Reinvestment Fund (NRF).
The NRF would be financed by a .03 percent premium on all assets or pretax earnings of non-depository institutions, an amount Schlesinger estimates is the cost of complying with CRA by depository institutions.
The$3.5 billion or so the fund would raise each year would capitalize community-development finance institutions (CDFIs) and provide credit enhancements, financial guarantees and policy coordination for federal loan-guarantee programs.
Schlesinger further proposes that the NRF be administered by the regional Federal Reserve Banks. This would be in keeping with the spirit of the Congressional legislation that launched the Fed. The final report of the House Banking and Currency Committee on the Glass Federal Reserve Bill, issued in September 1913, insisted that the Reserve Banks “would be in effect cooperative institutions, carried on for the benefit of the community…” And what was Congress’ vision? “Local control of banking, local application of resources to necessities, combined with Federal supervision and limited by Federal Authority.”
Schlesinger’s idea, if adopted, would re-energize the Fed’s original mission of regional economic development, while providing billions of dollars of capital to community based and community oriented financial institutions.
Rule 3: Create a Canadian-style Venture Capital System
In the late 1980s, to provide venture capital for small and medium-sized Canadian firms, Canada’s federal and provincial governments offered matching tax credits to those who invested in labor-union-managed venture capital funds. The 30 percent tax credit (15 percent from the federal government, 15 percent from the provincial government) is available for investments up to $3500. Those who take advantage of the tax credit must hold their shares for at least 8 years.
About25 of these labor-sponsored funds now exist, 20 having been created since 1990. More than 400,000 Canadians are shareholders. The funds attract an additional $500-700 million a year.
Venture capital investments by Canadian firms have soared from $300 million in 1982 to $1.3 billion in 1997 and much of this increase is due to the labor-sponsored funds. Today these funds provide about 50 percent of all Canadian venture capital.
Each province has its own fund requirements. Manitoba’s may be the most pertinent to the objective of rooting capital. Manitoba requires such funds to have as their primary goal the fostering of worker ownership or local ownership. That is, Manitoba wants to channel a portion of the household savings of the whole community to create a dynamic yet rooted economy. Manitoba’s six-year-old Crocus Investment Fund currently manages $80 million in pursuit of that goal.
Nova Scotia recently established another type of equity fund with a different yet compatible community focus. That province extends a tax credit for equity investors in community development projects. Cooperatives are a major beneficiary.
Canada’s labor-sponsored funds are still evolving. Their returns have been lower than those of mutual funds, but that is to be expected since they are a hybrid creature – part mutual fund, part venture capital fund. Labor fund managers believe their returns will be competitive when they begin to sell their investments. Crocus’ exit strategy is to sell to the employees of the firms in which it has invested.
In this country, only about 1 percent of pension fund assets are in venture capital. Although workers contributed about $600 billion of the$6 trillion currently in pension assets, not counting the $1.7 trillion in public pension funds, they control only a small fraction of this total. The Canadian experiment, at a minimum, will provide valuable lessons about how a country’s small and medium-sized businesses benefit when their venture capital primarily comes from union-controlled funds. And at a maximum, the Canadian experiment will teach Americans how to tap into household assets to build equity investments that marry social and economic ends.
Canada’s labor-sponsored funds are backed by significant government incentives. Yet several studies have shown that the lost tax revenue to governments is made up in two to three years by increased revenues from corporate income and payroll taxes and from decreased expenditures on unemployment insurance and the like.
We should propose a Canadian-style venture capital system to Congress, but we should not ignore the possibilities of instituting it on the state or even city level. Wherever governments offer tax credits for job creation, a Canadian-style venture capital program may be an attractive alternative. Instead of giving a tax credit to the employer, why not give the tax credit to the household that invests in a venture capital fund whose objective is to build strong and rooted local economies?
These, then, are my three proposals:
- Institute a financial transactions tax that can generate $50-100 billion for Individual Development Accounts which can grow equity at the household and community level.
- Extend the Community Reinvestment Act to non-depository institutions through the imposition of a small premium on the assets or pretax earnings of these institutions. The revenue would fund a National Reinvestment Fund administered by the regional Federal Reserve Banks. The premiums of $3.5 billion annually would capitalize Community Development Finance Institutions and provide credit enhancement and guarantees.
- Create Canadian-style venture capital funds that combine social, economic and fiduciary objectives. In Canada such funds generate $500-700 million a year, equivalent on a per capita basis to $5-7 billion in the much larger United States.
We have made the rules that have uncoupled capital from community. If we understand money as a means, then it is our choice and social obligation to channel it toward its most productive end. To do this we need new rules. These three proposals represent such rules. Adopting them would move us much closer to our ultimate goal: growing equity and nurturing strong communities.
This speech was originally presented at a conference entitled Growing Equity: Assets and Opportunities for Communities Left Behind, hosted by the Corporation for Enterprise Development in Washington, D.C., on December 4, 1997.