When the Ruling Classes Can No Longer Buy Off the Mob

“I think Marx was basically right. History is largely a class struggle,” said another friend last night.

“Back in the 18th century, people wondered how society could function without divinely-appointed kings to hold things together. But then came the American Revolution and the French Revolution…and then they booted out Napoleon…and turned kings and queens into celebrities. The ruling classes realized they had to find a way to keep a lid on the public.

“Bismarck created the welfare state. He figured he could buy off the public. As long as they were getting money from the state, people wouldn’t revolt.

“There was a long boom in the 19th century. Everything seemed to be going along smoothly. But then came WWI and the Bolshevik uprising; the rich saw that socialism was real…and dangerous. They knew they needed to come to terms with it…to protect themselves – or they’d be ruined.

“Essentially, the deal that Bismarck struck was the one that caught on and endured. The rich agreed to pay a lot in taxes so that the poor would stay in their places. Then, every time this new order was threatened – in England after WWI, in France before and after WWII, in America in the 1960s – governments just gave out more money. They spent money on guns AND butter…military and social welfare programs.

“In France after WWII a quarter of the population voted with the communist party. And the communists were armed. But the government bought them off with more social spending.

“Then they started to run out of money. They tried taxing the wealthy classes even up to 100% of their income. In Britain and Scandinavia, the marginal rate went up above 100%. But that just depressed the state’s revenue. Kennedy proved that you could lower tax rates and still squeeze more money from the wealthy. Reagan tried that too, but the results were less positive. Art Laffer showed that you had to find the optimal tax rate…and once you had it, you could raise it or lower it, it didn’t matter. Either way, you got less revenue.

“But the ruling elites just kept making more and more promises. That was how they were able to hold onto power. And now they can’t make more promises. The welfare state has reached the end of the road.”

If our friend is right, we are facing more than just a sovereign debt crisis. We are facing a crisis in democracy. The ruling classes can no longer buy off the mob.

In a sense, democracy was always based on a fraud. Imagine that you are the government. You go to the taxpayer and you say: “Give me your money. I’ll take 10% or 30% or 50% off the top and then give the rest back to you in services.”

Not a good deal for the taxpayer, right?

So, instead the implied deal is this: “Give me your money. I’ll give you MORE in services than you gave me.”

That is the deal that makes sense to the voter. Trouble is, if you’re the state, you can’t really do it. Overall, taxpayers get back in “services” what they paid in taxes minus overhead, waste, corruption and so forth. You can rob the rich on behalf of poorer voters, but after you’ve already pumped the rich at the optimal rate, what do you do? You then have to turn on future generations. You take one generation’s pension contributions and spend them in the present. Then you use the next generation’s pension contributions to pay off the first generation… It all works until 1) you’ve promised too much and 2) the next generation is smaller or poorer than the one that preceded it and 3) a credit contraction makes further borrowing impossible.

Then, the mob feels betrayed. It looks for a leader to give voice to its disappointments…and make new promises… and start new wars.

Oh! Bama! Wherefore art thou?

Bill Bonner
for The Daily Reckoning

The Daily Reckoning