Why it’s hard for politicians to stop coddling Wall Street

by Russ Roberts on November 11, 2013

in Financial Markets, Taxes

Noam Schreiber at the New Republic has an interesting piece on the division in the Democratic Party over how to treat the rich, particularly the rich members of the financial sector who benefit from government coddling:

On one side is a majority of Democratic voters, who are angrier, more disaffected, and altogether more populist than they’ve been in years. They are more attuned to income inequality than before the Obama presidency and more supportive of Social Security and Medicare.1 They’ve grown fonder of regulation and more skeptical of big business.2 A recent Pew poll showed that voters under 30—who skew overwhelmingly Democratic—view socialism more favorably than capitalism. Above all, Democrats are increasingly hostile to Wall Street and believe the government should rein it in.

On the other side is a group of Democratic elites associated with the Clinton era who, though they may have moved somewhat leftward in response to the recession—happily supporting economic stimulus and generous unemployment benefits—still fundamentally believe the economy functions best with a large, powerful, highly complex financial sector. Many members of this group have either made or raised enormous amounts of cash on Wall Street. They were deeply influential in limiting the reach of Dodd-Frank, the financial reform measure Obama signed in July of 2010.

Schreiber’s point is that Elizabeth Warren may be a very popular alternative to Hillary Clinton in 2016 among Democrats.

Matt  Yglesias has an even more interesting response. He notes that the populist Democrats who want to take it to Wall St have a problem. I have called it the Willie Sutton theory of politics–Wall Street is where the money is, so it’s hard to be hard on Wall St. Yglesias points out that there’s a fundamental tension between populism about the financial sector and a big-government philosophy (at least the way the current tax system is structured):

Suppose that President Warren rides to town with a raft of new legislation and tough regulators and a set of U.S. Attorneys firmly dedicated to prosecuting financial wrongdoing with the utmost rigor. Well if it works, the pre-tax income of Wall Street types is going to plummet. And while that might well be good for the country and the middle class broadly, it would cause the tax base in New York and California and other politically blue high-inequality jurisdictions to fall. Rather than hiking rates on the rich to pay for new programs and more generous wages, these places would find themselves either needing to tax the middle class (a much tougher sell politically) or else shift into a neoliberal efficiency-seeking mode. By contrast the Tim Geithner philosophy—regulate Wall Street but don’t seek to transform it or displace the sector from its leading role in America’s political economy—is a great match for the politics of progressive taxation to finance public sector social democracy.

Which is to say that the alliance between labor unions and bank bashing is a very effective and powerful one as long as it doesn’t actually win. A big city mayor doesn’t have the authority to crack down on Wall Street, so he or she is ideally positioned to tap the rhetoric of bank bashing in service of an agenda of progressive taxes and high spending. But a president really could take on the fat cats—not just taxing them but making their underlying businesses less lucrative, leaving less in the way of tax revenue to scoop up.

It would be nice to think that this leaves an opening for Republicans. But Republicans have struggled to support smaller government. They like to talk about it and they have stopped some of the increases. But Republicans like tax revenue, too.

Back in 2011, when Elizabeth Warren was arguing that the rich didn’t pay their fair share, I wrote this in the WSJ:

When the super-rich pay such a large share of the tax burden, the interests of the political class and of the wealthiest Americans coincide in a particularly creepy way. The politicians want the rich to thrive—they’re the cash cow they milk via taxes. When the top 1% is the source of almost 30% of all your revenue, you have an incentive to take really good care of those people. That helps politicians of both parties convince themselves that coddling Wall Street is good for Main Street.

The symbiotic relationship between politicians and the super-rich is destructive of democracy and our economy. Let’s not make it worse. To close our deficit, let’s spend less rather than tax anyone more.

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