4.2.1 The Higher Return on Capital

Even so, even if we set aside the Cold War debates, some might argue that the return on capital invested in the stock market has always exceeded the return on obligations—and would likely exceed the return on coöperative membership. As a result, capital wealth would just flee the coöperationist jurisdictions and find other countries in which to invest. There would be a flight of capital and no way to funnel that capital into coöperative enterprises. The economy, in effect, would collapse.

It is of course true that capital investment has historically outperformed investment in Treasury, state, municipal, or corporate bonds. We tend to explain that based on the risk-reward equation: the return on U.S. Treasuries, for instance, has historically been much lower than the return on stocks because there is practically no or little or less risk. The spread between the (long-term) return on Treasury bonds and stock markets supposedly reflects this natural risk-reward equation. To be sure, right now, in September 2020, it is a particularly strange time to compare Treasuries and the stock market because the United States is devouring debt, which is pushing government fixed-income returns to nothing—in fact, even negative returns for a split moment—and inflating the S&P 500. But the historical data is consistent. For $100 invested at the start of 1928, you would have had in 2019:

• $502,417.21 if you had placed it in S&P 500;

• $ 48,668.87 if you had placed it in BAA Corporate Bonds;

• $ 8,012.89 if you had placed it in US Treasury bonds; and only

• $ 2,079.94 if you had placed it in 3-month Treasury bills.²⁶⁷

There is, of course, greater risk if one speculates on individual stocks and does not maintain a diversified portfolio. But if you kept the money in a market index and did not speculate further—if, for instance, you just had an S&P 500 Index over the long-term—here is what the returns for the four asset classes would have been over the past two decades:²⁶⁸

The fact is, historically, over the period 1928-2018, the average returns have been sharply different: “On an annual basis over this period, the return on the S&P 500 averaged 9.5% per year, T-bonds 4.8% and T-bills 3.4%.”²⁶⁹ From a financial perspective, the compounded difference in interest of about 5% over 90 years results in a huge difference in wealth. In the short term, people may prefer to avoid the risk, but over the long term, the differential is staggering.

Though hard to believe, this is actually right—mathematically. If you use for instance the compound interest calculator on the website of the U.S. government,²⁷⁰ and you compare 4.8 and 9.5% compounded annually, you get a striking difference:

Now, part of this differential is reduced as a result of existing tax rates. Most of us are familiar with the basic tax rules:

1. Dividends from stock holdings (which are paid with after-tax corporate dollars), are taxable at the federal, state, and local level, but at a lower rate equal to a maximum rate of 20% at the federal level for qualified dividends;

2. Returns on capital (capital gains) will depend on whether they are short or long term;

3. Long-term capital gains are taxed at a lower rate (20% federal maximum about, depending on tax bracket);

4. Interest income is fully taxable at ordinary income tax rates, which can easily reach almost 50% in high tax brackets when federal, state, and municipal taxes are included;

5. Interest on U.S. Treasuries will be taxed at the federal income tax rate, but exempt from state and local taxes;

6. Interest on municipal bonds is triple-tax free.

So, in effect, and these are back of the envelope calculations, it is fair to say that the difference in the net return on the different investment portfolios would be less sharp than in the above scenario. In simple terms, we might expect the following:

1. On a Treasury bond annual return of 4.8%, there should be about a 35% tax rate for the highest federal tax bracket, and no other state and local taxes, so that return would reduce to about 3.12%.

2. On the equity return of 9.5%, there should be about 20% federal tax rate at the highest tax bracket, plus another 8.82% for, say, New York State, plus NYC taxes of about 3.8%, for a total of about 32.62% tax rate, which would lower the net return to about 6.4%.

That means, in effect, a slightly smaller net disparity. Before, the differential was 4.7%. With the tax load, it would be 3.28%. There is still a difference if you compound annually. Actually, this is how 3.12% versus 6.4% compounded annually looks like, this time, to make it simple, over 100 years:

The differential has shrunk considerably but remains important. And of course, tax shelters and tax planning could help increase the net differential.

This is precisely what makes the proponents of capital investment so sure of themselves and of their argument that everyone should prefer investing in the stock markets—or even, that the federal government should replace Social Security with individual stock market accounts. This is the strongest argument against coöperatives and for capital investment: the long-term returns over the twentieth century demonstrate that capital investment is the best thing to do with your savings. In all likelihood, returns on mutual and coöperative equity will look more like returns on bond obligations; therefore, coöperation is a non-starter.