Finance Is Ruining America

 Alana Semuels 

BRIDGEPORT, Conn.—Few places in the country illustrate the divide between the haves and the have-nots more than the county of Fairfield, Connecticut. Drive around the city of Bridgeport and, amid the tracts of middle-class homes, you’ll see burned-out houses, empty factories, and abandoned buildings that line the main street. Nearby, in the wealthier part of the county, there are towns of mansions with leafy grounds, swimming pools, and big iron gates.

Bridgeport, an old manufacturing town all but abandoned by industry, and Greenwich, a headquarters to hedge funds and billionaires, may be in the same county, and a few exits apart from each other on I-95, but their residents live in different worlds. The average income of the top 1 percent of people in the Bridgeport-Stamford-Norwalk metropolitan area, which consists of all of Fairfield County plus a few towns in neighboring New Haven County, is $6 million dollars—73 times the average of the bottom 99 percent—according to a report released by the Economic Policy Institute (EPI) in June. This makes the area one of the most unequal in the country; nationally, the top 1 percent makes 25 times more than the average of the bottom 99 percent.

In some ways, this is a mathematical artifact: Any place where rich people live will have greater inequality, since incomes can go up practically infinitely but they can only fall so low. Yet what’s troubling is that the well-off’s rise seems to be providing no upward pull for those at the bottom. From 2009 to 2013, the incomes of the top 1 percent in Connecticut grew 17.2 percent, while the incomes of everyone else dropped 1.6 percent. As wealth grows in Connecticut, the state’s biggest city, Bridgeport, is left behind. The poverty rate in Bridgeport has increased from 18 percent to 20 percent from 2007 to 2015, according to a report from the nonprofit Connecticut Voices for Children.    

That leads to a crucial question: Why? Why are the sky-high incomes at the top not pulling up those at the bottom? And is it possible that the struggles faced by those in Bridgeport are somewhat caused by the good fortunes of those who live in Greenwich?

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On the surface, the reasons behind Bridgeport’s poverty and Greenwich’s wealth do not seem related. Bridgeport is struggling because it is a one-time manufacturing hub whose jobs went overseas as factories moved away in the late 20th century. Greenwich became a home for New York City financiers who wanted to live somewhere a little more bucolic than New York, and later hedge-fund managers decided they could work closer to home and set up their companies there, too.

These two towns have different fates in part because of two distinct dynamics in the American economy. Yet there are economists who believe that there is a link between the improving prosperity of the wealthy and the eroding bank accounts of everyone else. The reason? It’s two-fold: First, there is the rise of the financial industry, which has fueled extraordinary wealth for a very few without creating good jobs down the line, and, second, a tax policy that not only fails to mitigate these effects, but actually incentivizes them in the first place. It’s probably not surprising, then, that the 10 states with the biggest jumps in the top 1 percent share from 1979 to 2007 were the states with the largest financial service sectors, according to the Economic Policy Institute analysis.

Indeed, the growing wealth of Connecticut can be tied to the rising fortunes of the financial industry. The three richest towns in Fairfield County—New Canaan, Darien, and Greenwich—are home to hedge-fund managers, chief executives, lawyers, and accountants. Around 200 hedge funds call Connecticut home; the state is second to only New York in terms of the amount of funds under management, with $300 billion, according to Bruce McGuire, founder of the Connecticut Hedge Fund Association.

Hedge-fund managers are among the wealthiest people out there. They manage huge amounts of money and try to increase the value of that money through high-risk methods. Hedge-fund managers earn a lot just by showing up to work, and when their bets do well, they can earn even more. According to a study done by the market intelligence group Greenwich Associates, based in Stamford, Connecticut, in Fairfield County, and the compensation consulting firm Johnson Associates, the people who work at these firms made $760,000, on average. Equity portfolio managers made $850,000, on average. Greenwich resident Ray Dalio, who, according to Institutional Investor magazine, was the third-highest-earning hedge-fund manager in the world, is worth an estimated $15.6 billion.

Hedge funds aren’t the only well-paying business in Fairfield County. There are also a few industries whose work goes hand in hand with those funds, McGuire says: lawyers and accountants, who are also highly compensated. Many finance firms and banks are also located in Fairfield County: GE Capital, which was one of the biggest lending institutions in the country at the time of the financial crisis, was based in Norwalk, which is also in Fairfield County. UBS Financial Services and the Royal Bank of Scotland had giant trading floors in Stamford, also in Fairfield County, and still have offices there.

But the fact that finance is making a few people very rich is not particularly revealing. More critical is what finance is doing to everyone else—or, more to the point, what it isn’t doing: providing good middle-class jobs. As Time’s assistant managing editor Rana Foroohar describes in her book Makers and Takers: The Rise of Finance and the Fall of American Business, financiers in recent decades have made their money by focusing more on wealth creation through manipulating and timing markets rather than by lending and creating. Investors, asset managers, traders, and others have figured out how to craft financial products that can make money but that do not result in jobs or businesses, she argues.

“The business of America isn’t business anymore, it’s finance,” Foroohar writes.

This means that as the financial professionals of Fairfield County saw their compensation rise, there was little spillover benefit for anyone else. According to the economist Thomas Philippon, total compensation of financial professionals, including profits, wages, salaries, and bonuses, is around 9 percent of U.S. GDP—about $1.4 trillion dollars. That’s up from below 3 percent of GDP in 1951. As compensation in the financial sector grows, though, there’s no sign that more finance is bolstering economic activity, Philippon finds.

According to a study from the Roosevelt Institute, every dollar of earnings or borrowing used to be associated with a 40-cent increase in investment. Since the 1980s, though, less than 10 cents of each earned or borrowed dollar is invested. This means fewer jobs created and more money winding up as shareholders’ profits.  

Part of the problem is that trying to achieve incredible returns for those at the top can motivate companies to make changes in the way they run their business, such that they employ fewer people. This happened in Fairfield County, at a company that has, for decades, been a household name: General Electric. As Foroohar explains in her book, in the 1980s, as Wall Street demanded big returns from General Electric, then-CEO Jack Welch focused on expanding GE Capital, a division of the company that sold financial products—a bit of a departure from the company’s original mission of making things. GE Capital became the largest issuer of commercial paper in the world and borrowed billions of dollars to make even more money. GE Capital made up 60 percent of GE’s earnings growth between 1990 and 2005, according to the company’s 2015 annual report.“Under Welch, GE came to rely on financial wizardry rather than new technological breakthroughs to satisfy investors,” Foroohar writes. Between 1996 and 2015, CEO Jeff Immelt’s pay jumped 433 percent, to $32 million from $6 million, according to the company’s annual reports. (Immelt recently listed his New Canaan home in Fairfield County for $5.5 million.)

But as GE Capital was making money, GE was laying off staff, outsourcing jobs, and shifting more costs onto employees. Welch laid off 100,000 in five years and cut research-and-development spending as a percentage of sales by half, according to Foroohar. GE closed an Indiana refrigerator plant and relocated some of the production of models to Mexico. It cut 2,500 jobs in a turbine division to save $1 billion. In 2007, it shuttered a 1.4 million-square-foot plant in Bridgeport that had once, in the heyday of American manufacturing, made clocks, fans, radios, washing machines, and vacuums, and employed thousands of people. In short, investors were getting wealthy, but working class-people weren’t sharing the rewards. Instead, they were losing their jobs.

“The stereotype of what finance is supposed to do is take the income of savers and channel that to productive investments,” Marshall Steinbaum, an economist at the Roosevelt Institute, told me. “That’s not what finance does now. A lot of finance goes in the opposite direction, where essentially they are taking money out of productive corporations and sending it back to investors.”

Bridgeport knows the consequences of this all too well. For much of the 19th and 20th centuries, the city was a hub of industry. There were, in the period before World War II, 500 factories in Bridgeport, according to Eric Lehman, a professor at the University of Bridgeport and the author of Bridgeport: Tales from the Park City. The workers from those factories and the people who owned them crossed paths on an everyday basis. The huge brick building that housed Remington Products, which manufactured razors and other personal-care products, sits near a giant mansion built by relatives of P.T. Barnum, the 19th-century entertainment showman.

There is little of that industry left today, nor are there many signs of wealth. Between 1990 and today, the number of manufacturing jobs in the Bridgeport-Stamford-Norwalk area dropped by 60 percent.

Now, people who once worked in manufacturing are finding jobs in the service sector, or turning to temp industries. I talked to Yolanda Navarro, 34, who lives in one of the public housing complexes in Bridgeport; she sat on the front stoop of her brick building as young men on motorcycles and four-wheelers raced up and down the street, creating a deafening noise. She told me all the jobs she can find are temporary. She doesn’t have a college degree. She’s worked at Burger King and CVS, but none of the jobs lasted long. This month, her mother lent her $127 to cover her utilities.

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One of the most convincing explanations for why those in finance are so focused on earning more money has to do with relatively low tax rates for those who make the most. The top tax rates fell in the U.S. from 90 percent in the 1970s to 50 percent in the 1980s to 28 percent, while they remained relatively high in countries such as Germany and France. The economists Thomas Piketty of the Paris School of Economics, Emmanuel Saez of the University of California, Berkeley, and Stefanie Stantcheva of Harvard argue that as tax rates fell, those at the top had more motivation to bargain for higher salaries and partake in behavior that increases their income, since they can keep more of it. If 90 cents out of every dollar is going to taxes, after all, there’s little incentive to earn more dollars; if only 28 cents are going to taxes, there’s more incentive to earn more.

Lower taxes for those at the top have lead to higher rates for those in the middle and at the bottom. After all, the less the government collects from the rich, the more it needs from everyone else. “When rich people pay less in taxes, if you want to finance public goods, like schools, hospitals, and infrastructure, you need to generate revenue elsewhere,” the economist Gabriel Zucman told me. “Revenue has been generated by increasing taxes on the middle class, in particular, through payroll taxes.”

Christopher Matthews, a resident of Norwalk, in Fairfield County, feels it. He’s a 63-year-old chef who has worked for assorted catering companies. Despite his 40 years of experience, he can only find jobs these days that pay $14 an hour. But a lot of that pay disappears out of his paycheck, he told me. “Connecticut is one of the highest-tax states. On the wages we make, we’re lucky if we can spare $700 for a room to rent,” he told me. “We’re chefs, we can’t afford to buy food.”

Indeed, a Bridgeport family making $50,000 a year has the second-highest tax burden of any similarly-earning family in the largest city in each state, at 13.5 percent, according to a report from the Office of Revenue Analysis. A Bridgeport family making $75,000 a year faces the highest tax burden nationwide, at 15.8 percent.

“This state has a really unbalanced revenue structure in which the wealthiest families in the state are paying a much lower effective tax rate than the poorer families,” Ellen Shemitz, the executive director of the nonprofit Connecticut Voices for Children, told me.

There are other rules in the tax system that favor the wealthy over the poor, too. Capital is taxed at a lower rate than wages, so earning money from investments or stock options is a better bet for accruing wealth than getting a high salary. The capital-gains rate, at 23.8 percent, is much lower than the 39.6 percent that those in the top bracket pay on their income. Wealthy people tend to save their money in tax-free or otherwise tax-advantaged accounts, such as Roth IRAs or 401(k)s. Many put their savings into offshore accounts and avoid paying taxes on them that way.

The share of U.S. stock held in taxable accounts has declined to 24.2 percent in 2014, from 83.6 percent in 1965, as people moved their money to retirement accounts and other tax-free holdings, according to a study done by Steven Rosenthal and Lydia Austin of the Urban-Brookings Tax Policy Center. That means that there is much less wealth that the U.S. government can collect on taxes from those at the top, which causes it to raise taxes on the middle class. “My basic view on how the tax code fits in income inequality is that the tax code exacerbates it,” Rosenthal told me.

Other factors may also be exacerbating Connecticut’s income inequality: For instance, Connecticut does not have any county-level government, and so towns operate independently and don’t share resources. That means wealthy towns make money from property-tax revenues while cities like Bridgeport can’t; its property values are low and it houses many institutions like hospitals and universities whose land isn’t taxed.

While income inequality may be particularly apparent in Connecticut, the things that are fueling it—financialization and the tax code—are causing problems across the country. It will be national policy—such as increasing taxes on top earners—that could lead to less of the financial wizardry that benefits so few people. Yet policies to address income inequality nationally often focus on helping those at the bottom make more; groups such as the Center for American Progress propose raising the minimum wage, increasing access to preschool, and expanding apprenticeships to help low-skilled workers get into higher-paying jobs. But as the example of Fairfield County shows, the struggles of those at the bottom are at least in part a consequence of the rise of extreme wealth. Without changes to the incentives people have to make and keep tons of money, help for the poor and middle-class won’t likely make much of a difference.  

Raising tax rates on the rich might not seem particularly feasible right now. But it has happened before: In 1916, top tax rates jumped to 15 percent from 7 percent; the next year, they jumped to 67 percent. Those tax rates changed in part because of war, but remained high throughout the 20th century as  Americans decided that excessive wealth wasn’t good for society.

Some politicians, including Bernie Sanders and Hillary Clinton have proposed increasing taxes for the very wealthy, signaling a return to a time when extreme wealth was not accepted in American society. Such policy isn’t just a way of getting more revenue to the government; it could help alleviate poverty in America, too.  /atlantic