The Blue Lagoon Has a Return on Equity of 18 Percent

The United States government should create a national social wealth fund along the same lines as the Alaska Permanent Fund (apf). For the purposes of this paper, I will call this proposed fund the American Solidarity Fund (asf).

The American Solidarity Fund will operate the same way that any other social wealth fund operates. Money and assets will be placed into the fund; a public entity will manage those assets in a way that generates investment returns; then those investment returns will be used to fund social spending, in this case a universal basic dividend for the citizens of the country.

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The remainder of this section provides details for the various aspects of the asf. Not every detail is essential and there are multiple ways to do most things. Where multiple options exist, I try to detail all of the options and provide my recommendation.

Generally speaking, there are five ways to bring assets into a social wealth fund: voluntary contributions, ring-fencing existing state assets, levies, leveraged purchases, and monetary seigniorage. I recommend all of the above, but think only the latter three are likely to provide substantial ongoing inflows of assets.

Voluntary Contributions

Adding assets to the asf through voluntary contributions is pretty simple. The administrators of the asf will create a way for people to donate money or other kinds of assets to the fund and the government will encourage people to contribute.

Lynn Stout and Sergio Gramitto favor this approach in their social wealth fund proposal.⁵⁵ In their paper, they argue that "ultra-high-net worth individuals are a significant potential source of [social wealth fund] donations" in part because "this cohort already frequently participates in philanthropy" and because, for the ultra-wealthy, "philanthropy is the only real place money can go." They also note that "if the top decile of equity holders contribute half their holdings to [the social wealth fund], while living or upon death, the fund would within a few decades come to hold forty percent of all corporate equities."

Stout and Gramitto argue that corporations might "also have reason to donate their own shares." Contributions to the fund would be good public relations and could be used by companies to counterbalance "the influence of short-term shareholders, especially activist hedge funds."

I am skeptical that the level of voluntary contributions would be high enough to create an adequately-sized social wealth fund. But certainly nothing is lost by allowing such contributions to be made.

Ring-Fencing Existing Assets

Another way to grow the fund would be to transfer existing state assets into it. Dag Detter and Stefan Fölster are the most prominent advocates of this approach.⁵⁶

The United States government owns a large amount of physical assets. Those assets include over 450 million acres of land valued at $1.8 trillion,⁵⁷ over 900,000 buildings worth hundreds of billions of dollars,⁵⁸ thousands of miles of intercoastal waterway, and countless infrastructure projects. The government also owns the electromagnetic spectrum, which it currently auctions off to telecommunications companies.

After depositing these and other existing assets into the asf, the fund could generate investment income from them by renting them out or, where appropriate, selling them and using the revenues from the sales to buy other more promising assets, such as stocks and bonds. Some of the land and building assets are already being used by the federal government for other purposes. After making the asf the owner of the land and buildings, the other governmental agencies could be made to pay rent to the asf for their use.

Insofar as handling physical assets is labor intensive, this particular source of assets will probably be the most difficult to manage.

Levies

The government could also bring assets into the fund through levies, i.e. taxes and fees.

Any type of levy could conceivably serve this purpose. For instance, Peter Barnes proposed, among other things, a value-added tax on the telecommunications sector, which is a type of consumption tax.⁵⁹ During its 1971 Congress, Denmark's trade unions proposed building a social wealth fund using a payroll tax, which is a type of labor tax.⁶⁰

Although levies on consumption and labor can work, levies on capital seem to be a more natural way to go. After all, the purpose of a social wealth fund is to transfer wealth into a collective pool. Applying new levies directly on wealth seems to serve that purpose the best. Thus, what follows are a variety of capital taxes and fees that I think would be ideal mechanisms for bringing assets into the asf.

One-time market capitalization tax.

To jump start the fund, the government could impose a one-time tax on the market capitalization of public (and possibly non-public) companies. Companies would have the option of paying this tax in cash or through scrip, i.e. by issuing new shares to the asf. The sec already imposes a 0.01245 percent market capitalization tax on newly-issued securities, which it calls a "filing fee."⁶¹ At the end of 2017, the market capitalization of listed domestic companies was $32.1 trillion.⁶² A one-off 3 percent market capitalization tax would thus bring in around $1 trillion of assets. And this would amount to only a few months of the total return provided by the stock of these companies.

Ongoing market capitalization tax.

To continue bringing money into the fund, the government could impose ongoing market capitalization taxes. This would be done at a lower rate, e.g. 0.5 percent per year. As with the one-time tax, the sec could administer this ongoing tax since it already imposes such a tax on newly-issued securities.

IPO tax.

When a company goes public through an initial public offering (ipo), its stock becomes much easier to trade. This "liquidity" is highly valued by investors and so they are willing to pay more money for publicly-traded stock than they are for private equity. This "liquidity premium" is estimated to increase the value of publicly-traded stock by around 20 to 30 percent.⁶³ Since it is the government that creates the uniform and tightly-regulated securities markets that make this liquidity premium possible, it stands to reason that it should share in the value it creates. The 0.01245 percent market capitalization "filing fee" currently charged by the sec is too low. It should be raised to, for example, 5 percent (payable in scrip or cash). For consistency purposes, the ipo tax should also be assessed when public companies acquire private companies.

Mergers and acquisitions tax.

The government could impose a tax (payable in scrip or cash) on companies that merge with or acquire other companies. The ftc already imposes such a tax in the form of the fees it collects during premerger reporting under the Hart-Scott-Rodino (hsr) Antitrust Improvements Act of 1976.⁶⁴ The current hsr fees range from $45,000 to $280,000 depending on the value of the transaction in question. The new tax should be much higher, e.g. 3 percent of the value of the transaction with some minimum threshold so as to exclude very small businesses. The ftc can collect the tax just as it already collects the hsr fees. To avoid duplication, this tax would only be assessed where the ipo tax discussed above is not assessed.

Financial transactions tax.

The government could levy modest taxes on the volume of financial transactions. Dean Baker estimated in 2016 that a 0.2 percent tax on stock trades, a 0.1 percent tax on bond trades, and a 0.002 percent tax on derivative trades would bring in around $120 billion, or 0.6 percent of gdp.⁶⁵ It is worth noting that the sec already has a very modest financial transactions tax. It is set at 0.00231 percent of the value of securities transactions.⁶⁶ Finra also charges a Trading Activity Fee (taf) for certain securities transactions, which is similar to a financial transactions tax.⁶⁷

Securities custodian tax.

Most securities are held by a custodian company such as the Depository Trust Company (dtc). When securities are traded, they do not change hands, but rather book-entry changes are made by the custodian indicating the new owner. The dtc boasts that it is the custodian of "more than 1.3 million active securities issues valued at us$54.2 trillion as of 7/31/2017."⁶⁸ An annual tax on securities custodians of 0.1 percent could pull in $54 billion from the dtc alone. Presumably the dtc would pass that along to the companies issuing the securities.

Fund management tax.

Many investors own shares of funds that themselves own large baskets of various securities. These funds make money by charging fees equal to a percentage of the assets in the funds. Typical management fees are between 0.51 percent of assets and 0.74 percent of assets depending on the fund type.⁶⁹ Some go as low as 0.03 percent.⁷⁰ The federal government could impose its own assets under management (aum) tax for these kinds of funds, e.g. 0.05 percent. Fund managers would pass this through as slightly higher management fees for their overwhelmingly affluent investors.

Inheritance and gift tax.

The US only has a tiny tax on very large estates despite the fact that around 60 percent of US wealth has been inherited.⁷¹ Inheritance and gift taxes should be massively increased with their revenues going into the asf as a collective inheritance for everyone, not just the children of the affluent.

Elimination of certain tax expenditures.

The US currently has a variety of tax breaks oriented towards promoting individual asset-building. These tax breaks are give- aways to the rich and do not even appear to achieve their stated purpose of incentivizing saving.⁷² These tax expenditures should be eliminated and the revenue redirected to the asf, which will directly increase the wealth of everyone in the country by an equal amount. The Joint Committee on Taxation recently estimated that, in 2018, the mortgage interest tax deduction and the exclusion of capital gains on sales of principal residences cost $105 billion; the reduced tax rates on dividends and long-term capital gains cost $135 billion; the exclusion of capital gains at death cost $35 billion; and tax exclusions for pension and ira contributions cost $240 billion.⁷³ All together, that's $515 billion per year.

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These are not the only possible levies, but they are particularly promising levies that directly embody the idea of shifting assets away from the wealthy and into a collective fund.

Leveraged Purchases

The government could also borrow money at low interest rates to invest in financial assets with high rates of return. Between 1990 and 2017, the average interest rate for a 1-year treasury bond purchased on the first day of the year was 3.17 percent.⁷⁴ During the same time, the average total return of the s&p 500 was 11.3 percent.⁷⁵ The difference between them, 8.13 percent, is the approximate rate of return that could be accomplished by an asf that issued government debt in order to buy stock equity.

For example, if the asf had existed between 1990 and 2017 and borrowed $1 trillion per year at the prevailing 1-year treasury bond rate and invested that $1 trillion into the s&p 500, it would have generated a cumulative return over the period of $2.275 trillion (nominal dollars). That return could have been directly parceled out at as dividends or been deposited towards the principal of the asf.

In the above example, the asf issues debt and buys stock regardless of the relative price of each security. In a more realistic scenario, the asf would be able to make better decisions about when such a move is the most likely to generate an investment return. So, it would not borrow money to invest when treasury rates or price-to-earnings ratios are especially high.

In general, because the return on us government debt is lower than the return on other kinds of marketable securities, the us government should be able to take advantage of that spread to generate investment returns.

Monetary Seigniorage

The Federal Reserve makes adjustments to the money supply by purchasing securities through open market operations. The way this works is that the Federal Reserve creates new money and then buys assets with it. Right now, the Federal Reserve almost always chooses to buy Treasury bonds. But the government could require that the Federal Reserve inject money into the system by buying more lucrative securities such as publicly-traded equities.

This is what the Bank of Japan (boj) has been doing for the last few years. In January of 2008, the boj owned just 1.5 trillion yen of stocks, shares of exchange-traded funds, and shares of real estate investment trusts.⁷⁶ In May of this year, the same figure was 21.1 trillion yen, which is equal to $193 billion.⁷⁷

During the same period, the Federal Reserve also expanded its balance sheet considerably by buying Treasury bonds. In January of 2008, the Federal Reserve owned $740 billion of Treasury bonds. In May of this year, it was a little under $2.4 trillion.⁷⁸ Had the Federal Reserve instead chosen to buy up total stock market exchange-traded funds, like the Bank of Japan did, it could have profited handsomely off of the massive stock market rise over that period. And if those assets were connected to the asf, the profits could have been paid out to everyone in the country through the corresponding universal basic dividend program.

In addition to directing the Federal Reserve to buy other kinds of securities, the government could also adopt a higher inflation target (e.g. 4 percent rather than the current 2 percent), an idea that already has significant support on the merits.⁷⁹ A higher inflation target would permit larger expansions of the money supply and therefore enable more purchases of return-generating assets.

Managing The Fund

After assets are brought into the asf, they have to be managed in some way. The management of asf presents three main questions: 1 what entity will manage it, 2 what assets will it hold, and 3 how will it exercise its ownership rights over its assets? These questions are answered in order below.

1 The Managing Entity

The cleanest way to manage the asf is by creating a new state-owned enterprise (soe) that is fully owned by the Treasury Department and then "hiring" that soe to be the fund manager. This is the model used by the Alaska Permanent Fund and gpf-Norway. In Alaska, the soe is called the Alaska Permanent Fund Corporation and in Norway it is called the Folketrygdfondet.⁸⁰

Folketrygdfondet Management Team

The way this would work in practice is that, pursuant to an act of Congress, the Treasury Department would create a new corporation. Let's call it the American Solidarity Fund Corporation (asfc). The Treasury would formulate articles of incorporation for the asfc and appoint its board members, board chairs, and auditor. From there, the asfc's board would be responsible for the management of the asfc, including the election of the asfc's ceo.

Once the responsibility for managing the asf is handed over to the asfc, the Treasury would not be involved in the day-to-day operations of the fund. But it would be able to create rules, mandates, directives, and other sorts of guidance that the asfc would have to follow. This kind of separation will reduce the administrative burden that the Treasury has to take on itself and provide a certain level of operational independence for the fund managers.

As with the Alaska Permanent Fund Corporation, we should expect the asfc to start out as a fledgling organization and evolve over time into a mature and professionalized operation. This evolution would also likely mean that the asfc would initially rely on some level of outsourcing to carry out its business, but, in the medium and long term, would seek to do all of its fund management with its own staff.

2 Asset Allocation

What assets the asf will hold is ultimately a political question that will, in practice, be answered by the us Congress or by Treasury mandates that the asfc has to follow. swfs across the world have taken all sorts of approaches to asset allocation and so it is difficult to say there is any settled approach.

One possible approach to asset allocation would be to initially invest in easy-to-manage listed securities like domestic and international equities and bonds. As the fund gets bigger and the asfc becomes a more mature organization, it may make sense to broaden the asf portfolio to include unlisted assets like private equity and real estate.

When thinking about asset allocation, it will be important for decision-makers to consider how best to leverage the unique attributes of the asf: its size, long-term horizon, and low need for liquidity.

In addition to making general asset allocation decisions, the asf could also make narrow allocation decisions that pertain to specific companies. For instance, the Treasury or us Congress could create a process for excluding companies from the fund if those companies are found to violate established guidelines, such as engaging in human rights violations or environmental destruction. Norway's gpf-Global maintains an exclusion list along these lines.⁸¹

3 Ownership Rights

Since the asf will own shares of companies, it will have the ability to exercise the ownership rights that those shares confer, i.e. vote on shareholder matters like the election of the board and shareholder resolutions. There are three basic approaches to exercising ownership rights:

1. No Voting. The first approach is to abstain from voting, i.e. to opt out of exercising ownership rights. This is the approach favored by Dean Baker.⁸² In this scenario, only the remaining private shareholders would vote on board members and shareholder resolutions.

2. Representative Voting (recommended). The second approach is to make voting decisions through the country's government. What this means in practice is that the Treasury would issue voting guidelines that the asfc would have to implement on a vote-by-vote basis. For instance, the Treasury could create ceo pay guidelines that the asfc must follow when casting shareholder votes for or against ceo pay packages.

3. Direct or Proxy Voting. The last approach is to allow the citizen-owners to directly vote on shareholder matters through a website maintained by the asfc. This is the method favored by Lynn Stout and Sergio Gramitto.⁸³ Under this approach, citizen-owners would be allowed to either vote directly on shareholder questions or give away their voting rights to a proxy organization that they trust to exercise them in their interest. Proxy organizations would register with the asfc so that they could be selected on the website and citizen-owners would be permitted to change their preferred proxy organization at any time. For instance, a citizen-owner who was interested in labor rights might give their votes to the afl-cio while a citizen-owner who was interested in the environment might give their votes to the Sierra Club.

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In my view, the no-voting option is a serious mistake. If the government does not vote its shares, then it is ceding total control of corporations to the most affluent people in society. It is fair to worry that the government might make bad shareholder votes from time to time, but not reasonable to think that very affluent people will on average make better shareholder votes than a democratically-elected government.

Between the other two options, I have a slight preference for representative voting, at least initially. In the early years, the asf and asfc will need to focus its organizational time on more important implementation challenges and will not own enough assets for their shareholder votes to make much of a difference anyways. Over time, it could make sense to add a direct or proxy voting system.

The final aspect of the asf is the easiest one: paying out the universal basic dividend (ubd) from the return on the fund. Alaska already provides a concrete model for how to do this, but I would recommend some cosmetic and substantive modifications to the Alaskan approach.

ASF Ownership Shares

Every qualifying citizen should be given one nontransferable share of ownership in the asf, which is what entitles them to receipt of the ubd. The Alaska Permanent Fund does not provide any kind of formal ownership shares, but the residents of the state nonetheless conceptualize themselves as joint owners of the fund. The idea of providing a quasi-formal ownership share was supported by the 1971 Danish trade union proposal, which would have provided each owner "an annual certificate setting out their entitlement in the fund" that "could not be sold for at least seven years" and even then could only be sold "back to the fund itself."⁸⁴ Unlike the Danish proposal, I am recommending that the citizen-owners never be permitted to sell their ownership share and that the share remit back to the asf upon its owner's death.

As part of this ownership arrangement, the asfc should have a website that looks like the sites run by Vanguard or Fidelity where citizen-owners can log on and see their single share of ownership, track its value over time, and so on. This is also where they would input their banking information and address to receive their dividend checks. The purpose of the website and the ownership share generally is to impress upon people that this is their collective wealth fund. This is partially a communications gimmick, but no more so than many of the hyper-abstracted ownership gimmicks that already exist in the country's capital markets.

Dividend Amount

The dividend amount should be set equal to a five-year moving average of a percentage of the asf's market value. The percentage would be set legislatively or by the Treasury and would aim to, on average, withdraw an amount equal to the inflation-adjusted return of the fund. This is a hybrid of the way Norway's gpf-Global and the Alaska Permanent Fund currently manages fund withdrawals.

So, for example, the rule could be that 4 percent of the five-year moving average of the asf's market value will be withdrawn each year and used for the ubd. If the asf's value over the last five years was $8 trillion, $9 trillion, $10 trillion, $11 trillion, and $12 trillion, then the dividend withdrawal would be 4 percent of $10 trillion, or $400 billion.

Using a specific percentage of market value makes withdrawals administratively easy and using a five-year moving average of market values smooths out market volatility in asset prices, ensuring that the dividend amounts do not swing wildly year to year.

Dividend Eligibility

Alaska provides its dividend to every citizen of the state, including children. I would recommend excluding children from the asf dividend. Under this proposal, every citizen over the age of 17 would receive an ownership share and thus a dividend. Families with children should receive child allowances for each of the children they are caring for, but that should be done through a different program.

In an ideal construction, retired people would also be ineligible for a dividend. As with children, retired people are owed a cash income, but they already receive such an income through Social Security's old-age pension. Excluding children and the retired from ownership and dividends would allow the dividends to be higher by reducing the number of beneficiaries.

In practice, excluding the retired seems like it would be difficult to do. The retired are a large voting bloc and many of them are dependent on private capital ownership for their retirement income. Since the asf proposal intends to shift some of that capital ownership into a collective fund, they will need to be included in the asf's ownership as well.

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Source: https://www.peoplespolicyproject.org/projects/social-wealth-fund/