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Like it or not, the 1 percenters who’ve been getting so much attention keep this city afloat
Photograph courtesy Jessica Craig-Martin/Trunk Archive
Here’s a piece of hopeful news about the economy: Porsche sales are back up. Through the first ten months of last year, 2,284 of them were newly registered in the L.A. area, an increase of 21 percent over the same period in 2010 and 55 percent over 2009, when the recession was coming to an end. “People held onto their money for a while, but at a certain point they figure they need to live their lives,” says Victor Ghassemi, senior sales manager at Porsche of Downtown L.A. “They still want the car.”
This might seem inconsequential to the rest of us who can’t afford a $205,000 Porsche 911, but it’s really not. When someone cuts a check for one of these cars, the economy is strengthened in several ways. Most directly the dealership is enriched, which means that the sales staff can keep working, which means that the
nearby sandwich shop can stay in business, which means that dozens of distributors and wholesalers won’t be losing a customer. The purchase of a six-figure automobile signals something else: that the wealthy are starting to spend money again. Not nearly as much as they were spending before the downturn—Porsche sales in L.A. remain 30 percent below 2006—but enough to be noticed.
For months rich people have been demonized by Occupy L.A. protesters and other Occupy movements around the country. At the risk of oversimplifying, U.S. households that have incomes of $350,000 to $400,000 a year—the minimum requirement for entry into the infamous 1 percent club—are being blamed for the financial miseries of the other 99 percent. The problem with such sniping is that, first of all, it’s ridiculous (Bill Gates and Warren Buffett are hardly cut from the same cloth as Bernard Madoff and Frank McCourt), and more important, it ignores how reliant—for better or worse—the 99 percent is on the 1 percent. California households making more than $200,000 a year contributed almost two-thirds of the state’s total tax bill in 2008 (the last year data is available). Without those dollars, state government would be effectively wiped out. There is no other place to find that kind of money.
The arrangement, though, has become complicated. The highest rung of the income ladder is a rickety place, with investors bringing in huge amounts when times are good and then losing substantial amounts when times are bad. As of 2009, according to the Internal Revenue Service, U.S. households making more than $500,000 a year accounted for 14 percent of the nation’s income, which is half the level of 2007. One reason for the disproportionate drop is that most of us 99 percenters didn’t have the opportunity to pursue the kind of high-risk investments that went kablooie in 2008 (hedge funds that year tumbled almost 20 percent). Everybody lost money—California’s median family income fell 5 percent between 2007 and 2009—but what’s been left out of the narrative is that the gap between the rich and the nonrich, while still massive, has actually narrowed a bit since before the meltdown.
L.A., of course, is among the nation’s most affluent locales. Roughly 41,000 households in the county reported more than $400,000 in adjusted gross income in 2009, according to the Franchise Tax Board. Perhaps more astounding is that postrecession, 20,000 households have a net worth of at least $10 million. This represents the 1 percent—serious money, Beverly Hills-Brentwood-Malibu kind of money. Yet it’s considerably less money than before. Financial managers and others I spoke to say that as a rule, portfolios at the highest end shrank anywhere from 10 percent to 20 percent. Ballparking, that translates into losses of $40 billion to $80 billion (though some of that money has been made back). “This was a very personal loss,” says Tim Lappen, a partner at the Los Angeles law firm of Jeffer Mangels Butler & Mitchell, who has years of experience working with wealthy families. “Personal net worth is personal self-worth, especially when they’ve dedicated their lives to building an empire. Then suddenly there’s a train wreck.”
The bad times weren’t so bad for Los Angeles-based multimillionaire Mark Kress, who sold jewelry in partnership with Joan Rivers on QVC and started a company that manufactures hair care products to cover bald spots. Nevertheless, Kress, whose net worth is somewhere in the eight figures, says he’s pared down debts and isn’t as status conscious as he used to be. “I’ve become aware of how hazardous life can be, money can be—how easy it is to lose a business,” he says. Since nobody outside his income bracket is likely to feel much sympathy, Kress commiserates with other rich people through the Los Angeles chapter of an organization called Tiger 21. “When the economy is going crazy, you get swept up in it,” he says, describing the days preceding the downturn. “There was a great deal of recklessness and assumptions that prices are only going one way. Everyone thinks they’re a genius.” What about now? “It’s changed their assumptions about life and their future.”
The economist John Kenneth Galbraith had it right when he said, “Of all the classes, the wealthy are the most noticed and the least studied.” What’s worth remembering about the upper crust is that it used to be a small and stable group, with most of its money coming from oil and family trusts (inherited wealth composed a large portion of that). As noted by Wall Street Journal reporter Robert Frank in his book, The High-Beta Rich, only 276 people in the United States made more than $1 million in 1955. We’re talking about a genteel, class-conscious sort of wealth (depicted in movies like Sabrina and The Palm Beach Story). Federal taxes at the high end were astronomical—around 90 percent between the 1940s and early ’60s—and powerful labor unions, along with a growing entrepreneurial class, created the post-World War II economy that became dominated by the middle class, not the well-to-do. And it stayed that way for the next 30 years.
By the time Ronald Reagan came into office, several important developments had taken place. The top marginal tax rates were lowered from 70 percent to 50 percent, and in 1982, Congress passed legislation that deregulated the savings and loan industry. Further regulatory loosening over the next several years allowed banks, insurance companies, and brokerage houses to consolidate their operations into massive financial companies. The result was an explosion of investment possibilities, allowing the financial services industry to profit handsomely in what’s become known as the “financialization of wealth.”
Customers gradually moved from the usual collection of stocks, mutual funds, real estate, and commodities into more exotic bets, such as mortgage-backed securities, credit default swaps, and collateralized debt obligations. “Pre-2008, wealthy investors were fine to say to us, ‘Here’s a pool of money. I’ll sign a mandate, and you can manage it as you see fit,’ ” says Michael Walsh, managing director of the L.A. offices of J.P. Morgan’s Private Bank. In 2008, 10 million U.S. households were in the millionaire bracket, double the figure for 1990.
Los Angeles became one of the country’s two or three biggest financial centers, and by the 1990s, state officials began noticing a jump in the amount of personal income taxes being paid by the richest households. The money came from Silicon Valley entrepreneurs, Hollywood producers, newly arrived immigrants, and aging business owners who were selling their companies for vast amounts and then retiring, often to Southern California. In essence, they supplemented state sales tax revenue, which had been the dominant source of government funding but could not keep up with California’s spending needs. Then, as today, California income tax rates are more progressive than federal rates—that is, the wealthy shell out a disproportionate share. The upshot is that a large percentage of low- and middle-income households pay little or no state income tax.
While there’s nothing wrong with soaking the rich, lawmakers sidestepped an obvious flaw in the system: When the economy goes south, such as during a recession, high-end personal income taxes plummet as well. Revenue from Californians in the $200,000-plus category totaled $25.1 billion in 2000—right before the dot-com downturn—and then fell to $13.8 billion in 2002. By 2007, at the height of the economic bubble, it soared to $33 billion. The next year it collapsed. The state could have controlled such unpredictability by putting aside enough money during the flush years to cover expenditures during the lean ones—commonly referred to as a “rainy day fund.” Former governor Arnold Schwarzenegger tried to expand the fund as the economy grew worse, but he had only limited success. The budget deficit, in turn, got bigger and bigger, and state officials were stuck having to make drastic cuts. The long-term solution, overhauling the tax system so that most everyone has a little skin in the game, is impossible because of the fractured political system. For the moment Governor Jerry Brown is focusing on interim steps, such as a November ballot measure that would raise the state sales tax by half a percentage point, to 7.75 percent, and boost the income taxes of wealthy households over the next five years. In other words, Brown wants to bankroll the economy by depending largely on the 1 percent—the very system that helped get us into this mess.
To some extent the 1 percent is cooperating, like when Neiman Marcus was able to unload ten pewter-colored Ferraris, at $395,000 each, only 50 minutes after they went on sale last fall. But spending patterns are not what they used to be. An L.A. money manager says that one of his clients decided last year to buy a used Ferrari because he would be saving $50,000 (he wound up paying more than $250,000 anyway). Transactions in L.A.’s ultra-high-end housing market—typically $10 million and up—have been stubbornly down because property owners are not motivated to sell (“I can’t tell you the number of wealthy clients who have said, ‘I just want to pay off the mortgages,’ ” says Brett Bartman, senior vice president/financial adviser at RBC Wealth Management in Beverly Hills). Such hesitancy to spend is likely to be around for a while—at least two or three years would be my guess.
More worrisome over the long term is a hesitancy to invest. A business owner told me that after losing millions of dollars in retirement savings, she now keeps everything in a savings account earning nearly zero interest. J.P. Morgan’s Walsh mentioned clients who were buying bars of gold and having them stored under the Thames River in London (they periodically fly there to check the serial numbers). The conservative reflex is understandable, and yet the key to earning money on your money is taking risks—the greater the risk, the higher the return. Before the economic meltdown, losses were seldom a concern because everyone was doing so well. Today it’s about being risk averse—and yet if the wealthy don’t grow their assets in significant amounts, they won’t generate the income to pay the capital gains taxes needed to fund the schools. They also won’t be buying the stuff that keeps so many folks employed. Like it or not, this is the connective reality of our economic system, and no amount of protesting is going to change it.