A Citizen's 2% Solution

How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget

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Sausage Politics & Salacious Journalism Undermine Tax Policy Debate

Two weeks ago it looked as though the tax revelations about Donald Trump published by the NY Times might actually stimulate a meaningful discussion of why America needs radical structural tax reform. But the opportunity was buried amidst the firestorm over his misogyny. Before the moment entirely passes it is worth some examination.

Donald’s defenses have been, as always, so convoluted as to be blackly comical. He defends his use of the tax code as “brilliant,” proof of his business acumen. Simultaneously, he decries the tax code as grossly unfair, blames it on Hillary personally and politicians in general, and insists that “only he can fix it.” Hardly anyone comments on the fact he has set forth no policy proposals suggesting any intent to fix it. Indeed, his published policy proposals promise to make it massively worse.

For her part, Mrs. Clinton offers little better. She maligns Donald for paying no federal tax, but offers no policy discussion about the NOL Carryforward (or other tax preferences offered to real estate investors) which resulted in that outcome. Remember, as far as we know, Trump did not in fact engage in any illegal actions. He didn’t need to; the most egregious inequities in our tax code are designed features, quietly supported by both parties. They disagree about top marginal rates; but they jointly support structural preferences that facilitate suppression of taxable income.

Thus, Trump’s offensive ten-year-old braggadocio provided cover for both sides of the aisle; diverting attention from the substantial policy issues that ought to be driving voter decisions: taxes, health care, foreign policy, and the ingrained cronyism of our political class. While Defenders of the status quo salaciously revel in examination of Trump’s appalling personal morals they turn a blind eye to the political norms which make some 40% of the population want to storm Washington, pitchforks carried high. When Wikileaks posted Hillary Clinton expressly acknowledging she had “both a public position and a private position” the establishment shrugged and said, “so what” – which explains in a nutshell why a narcissistic bigot has gotten so close to occupying the oval office.

A large portion of mainstream Americans are longing for principled leaders. We know that the sausage makers in Washington have rigged the game. We know that well-heeled campaign contributors receive preferential policies in return for their financial support. We know that the massive rise in inequality is inextricably linked to the backroom trades of money and influence – conducted with a wink and a nod from politicians in both parties. We know that money buys access and access is power.

Unfortunately, neither Clinton nor Trump come close to offering the principled leadership we crave and desire. Thus, those most angered by the status quo seem prepared to forgive Trump’s glaring flaws; and those most frightened by Trump’s erratic, abusive and unprincipled behavior seem resigned to accept the dismal status quo.

At the last debate we heard Clinton and Trump agree on one thing: the fact Trump escapes federal tax liability, while middle and low-income wage earners do not, is evidence of indefensibly inequitable treatment under our tax code. So why have neither offered proposals to solve that inequity? Because the political process we rely upon is so deeply broken that the electorate is faced with the choice between a man who thinks with his sausage and a woman who believes duplicity is the grease that shapes public policy.

For those keeping score – America is the clear loser in this presidential race.

The Blind Spot of Modern Economic Policy

When did modern economists (and politicians) abandon the teachings of Adam Smith?  When did we lose faith in his famous Invisible Hand and decide that the most privileged and wealthy among us deserve preferential tax treatment?

Until America stops subsidizing unproductive capital with structural tax preferences and inflating asset bubbles with monetary policy – we will not stimulate robust job creation.   

But if we remove the misguided preferences that currently distort investment incentives – we could unleash a $2 Trillion stimulus program funded entirely with private capital.  

  

A Policy White Paper

by

Douglas Hopkins

President – Kestrel Consulting, LLC

 

 

Executive Summary:

Structural tax preferences aimed at wealth have been inadvertently diverting capital away from productive deployment and encouraging speculation in serial asset valuation bubbles.  Attempts to stimulate the economy by inflating asset valuations and encouraging debt are not only inefficient and economically unsustainable, they are contrary to key principles of democracy and capitalism and one of the proximate causes of our increasing income and wealth inequality.  Structural reform, replacing investment income taxes with an annual wealth tax, could equalize effective tax rates between labor and capital while simultaneously stimulating more productive investments – and thereby job creation.

 

Structural Tax Reform Offers a Path to Growth and Equity

It has become popular since our Great Recession to blame the anemic recovery upon our banks’ reluctance to lend.  Similarly, it has been popular for a couple decades now to assert that the path to stimulating growth is simply a matter of reducing our tax burden.  Conservative dogma, attractive in its simplicity, insists that leaving more money in the hands of our citizenry, particularly our investment class, is all we need do to fuel economic growth and prosperity.  Yet four years and counting after the crisis our recovery remains stalled.  Our investment class has done quite well, with stock indexes recently reaching new all-time highs and corporations and high-worth individuals sitting on mountains of cash.  But the percentage of our population actively participating in the workplace remains at historic lows – and working class wages have been stagnant for decades.

Our political class (pundits included) remain stubbornly locked in a battle of bad ideas:

  • Should we bribe businesses to create jobs by increasing government subsidies in public/private partnerships?
  • Can we keep interest rates near zero forever?  And if we do, will that force productive investments and increase employment?
  • Should we double down on the strategy of reduced tax revenues and preferential treatment of investment income?
  • Or do we increase taxes, perpetuate deficit spending, and embark on a government jobs program?

I suggest that these competing options are not only politically deadlocked, they are each substantively flawed.  If helping the rich get richer was the simple path to growth we wouldn’t be struggling with our current malaise.  The massive increase of income and wealth concentration of the last three decades, to levels not seen since the Gilded Age, has not been accompanied by sustainable growth or broad-spread prosperity.  But while flooding the market with low interest funds may be a great way to inflate asset valuation bubbles, it is an exceptionally inefficient way to stimulate productive enterprise and job creation.  Despite persistent and prolonged support among conservative economists and politicians, preferential tax treatment of investment income has resulted in benefits at the top of our economic pyramid while undermining its foundations.  Unfortunately, the simple converse approach, raising tax rates on high earnings is more likely to stimulate aggressive tax avoidance and income sheltering activities than economic growth – unless we incorporate fundamental changes in our tax structure.

In our current hyper-partisan environment, where politics is a competitive team sport and politicians are publicly pilloried for deviating from approved party talking points, it is difficult to introduce fresh perspectives and innovative ideas.  But I propose we need to do exactly that.  We need to reexamine the real drivers of sustainable prosperity and challenge the flawed structure of current investment income tax policies.  The issues and answers are not all intuitively obvious.  But it’s not rocket science either.  If one applies discipline in evaluating the facts, and sets aside the flawed dogma of wishful thinking and political intransigence, I believe the causes of our current malaise come pretty quickly into focus.

I offer four core observations:

  1. Demand is the primary driver of economic activity.
  2. The Productive Deployment of Capital is an important secondary driver.
  3. Structural tax preferences aimed at wealth have been inadvertently diverting capital away from productive deployment and encouraging speculation in serial asset valuation bubbles.
  4. The artificial demand created by building asset bubbles is unsustainable and destabilizing in its effect.

Tax and monetary policies that attempt to stimulate the economy by inflating asset valuations and encouraging debt are not only unsustainable, they are one of the proximate causes of our increasing income and wealth inequality.  Our struggling middle class uses private savings and debt to chase the bubble to the top, and when it bursts they bear the brunt of the pain.

Examine the recent mortgage debacle.  Mortgage brokers, lenders and government policies encouraged people to treat home ownership as a leveraged investment opportunity:

“Borrow as much as you can and invest in a housing market that will only go up.  Don’t worry if you are over-extending yourself and relying upon artificially low teaser rates – you can ultimately rely upon the asset appreciation to refinance again next year.  You can’t afford not to own your own home.”

Likewise, during the prior decade, though many including Alan Greenspan clearly foresaw the “irrational exuberance” of an over-heated market in which valuations became disconnected from operational earnings, economists and politicians alike touted a new paradigm, a market that would only go up.  They disavowed regulatory controls and hyped retail investment products which promised to give the middle classes access to the same opportunities and advantages as high-net-worth individuals and institutional investors.

In too eager pursuit of the so-called wealth effect, America’s middle class was encouraged to borrow against their appreciating homes and stock holdings, both of which were being inflated by easy money interest rate policies, in order to fuel a consumer driven economic boom.  While private equity funds and sophisticated investors fanned the speculative fires with complex structured investment products, and hedged with derivatives, the financial media cheered markets ever upward.   When the collapses came, it was the homeowners and unhedged retail investors that bore the brunt of the decline.  Heaping injury on top of injury, following the mortgage collapse the government stepped in and propped up the lending institutions while leaving homeowners on the hook for the full principal amount of their borrowings.  Unlike business bankruptcies, where borrowers are provided opportunities to restructure obligations at fair market value and “work their way out,” home mortgage borrowers were in many cases expressly prohibited by the government from bidding at auction to repurchase/refinance their own homes at fair market value.

The game is structurally unsound and stacked against our once-rising middle class.  By sheltering unrealized gains, leveraged investments and illiquid holdings from taxation, while over-burdening earned income and profitable enterprise, our policies distort investment incentives, encouraging speculation and stimulating recurring asset bubbles.  Retail investors are encouraged to over-pay during the booms, while secured lenders and more sophisticated investors receive tax advantaged returns during the run-ups, followed by post-collapse bailouts during the inevitable busts.  Chasing bubble valuations is rather like playing musical chairs; as the game progresses more and more players are sent permanently to the sidelines.

The lesson here, which should be obvious to all careful observers, is that building valuation bubbles does not create sustainable economic growth.  Where does sustainable growth come from?  It comes from productive enterprise.  It comes from expanding the workforce, not culling it.  Demand is the primary driver of economic activity.  But the artificial, temporary demand that is stimulated by low interest rates and easy monetary policy is not sustainable.  Loaning money to consumers so they can fuel the economy only works if those consumers are simultaneously provided with adequate and stable incomes.

At its best, business enterprise creates a virtuous cycle:  in order to produce goods and services businesses hire people; the wages those employees earn fuel increased demand for goods and services.  Henry Ford famously observed that the key to building a thriving economy was a productive workforce with both adequate pay and sufficient leisure time to create demand for the products they made.  It is the underlying justification for the modern consumer society and was the primary engine of growth for the bulk of the twentieth century.

America’s challenge today is that we need to examine, challenge and correct the policy flaws that obstruct that virtuous cycle.  We need to stop stimulating and subsidizing the creation of valuation bubbles and implement reforms that will encourage productive domestic enterprise to rebuild the stable working middle class which is the only truly sustainable source of economic growth and prosperity.

Efficient and productive allocation of capital both a) facilitates production of goods and services to fulfill demand and b) generates jobs and increases disposable incomes that fuel demand.  But policies that subsidize the unproductive allocation of capital encourage speculation and undermine our productive economy.  Over the past several decades we have had a shrinking workforce with stagnant incomes.  Productive jobs have been steadily moving offshore while a financial services industry that primarily manipulates the value of paper has grown by leaps and bounds.  An economy in which a progressively smaller portion of the population is actively engaged in the workforce will eventually implode.

Recently George Mason University economist Tyler Cowen wrote that the new battleground of politics and policy is going to be Wealth Taxes – claiming that “that is where the money is”.  He points to the right idea, but cites the wrong reason.  Comprehensive structural tax reform, incorporating an annual tax on wealth (as replacement for current investment income taxes), should indeed be the new battleground; but not as a revenue grab, as a matter of efficiency and equity, and a return to the guiding principles of both democracy and capitalism.   It should be obvious how preferential treatment of an elite class of citizen is contrary to the core precepts of democracy.  What is less obvious, but even more important, is how such preferences are antithetical to capitalism.

Capitalist theory posits that economic efficiency arises as the aggregate decisions of many individuals seeking advancement and self-interest drive collective progress and prosperity.  But Adam Smith’s famous Invisible Hand, like Lady Justice, is supposed to operate blind of managed objectives – and requires a level playing field.

“Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man or order of men.”

– Adam Smith (1723-1790), The Wealth of Nations

There is nothing in that core tenet of capitalism that supports preferential treatment of the investment class which has come to permeate our tax code – indeed preferential treatment, which distorts those private decisions undermines the entire concept.  I’m confident Mr. Smith didn’t contemplate an unequal competition where the already privileged were granted preferential tax treatment and note that “the laws of justice” offer a different threshold than “the whims of Congress or the IRS”.

The preferential treatment accorded to wealth and investments which has become embedded in our tax code constitutes cronyism, not capitalism, and it has distorted investment incentives to the point where tax avoidance and valuation manipulation have become far more profitable than productive enterprise.  It is the source of the misguided incentives that stimulate valuation bubbles and has fueled the increasing concentration of income and wealth in America.  A properly structured wealth tax offers the opportunity the reform our tax code to restore compliance with democratic and capitalist ideals and eliminate those misguided and inequitable preferences.

I conceive comprehensive reform should incorporate the following components:

  1. Reduction of the top marginal tax rate on earned income to no more than 25% (inclusive of what are now characterized as employment taxes), resulting in a meaningful rate reduction at all income levels.
  2. Replacement of all current investment income taxes, including the corporate income tax and personal taxes on interest income, dividends, and capital gains, and all estate, inheritance and gift taxes with
  3. A nominal annual tax, between 1 ½ % and 2 % of the fair market value of accumulated net wealth in excess of a reasonable threshold.
    • Assuming the WACC (Weighted Average Cost of Capital, i.e. average earnings capacity of invested capital) to range between 6% and 8%, the targeted tax rate is intended to be equivalent to the 25% tax rate assessed on earned income.
  4. Reform and elimination of essentially all preferential targeted tax expenditures.

A structure such as hypothesized above would have a confluence of beneficial effects related to key objectives which are often treated as though they are mutually exclusive:

ECONOMIC GROWTH

  • Repealing corporate income taxes will stimulate business hiring and make U.S. corporations more competitive
  • Flattening and reducing earned income taxes will stimulate growth in middle class disposable income and thus consumer demand
  • Removing the tax bias toward unrealized gains will stimulate more fluid and productive reallocations of private capital

EQUAL TREATMENT

  • Proposal normalizes effective tax rates between earned income and investment returns
  • Avoids regressive VAT or consumption taxes
  • Eliminates “double taxation” of corporate income and dividends/capital gains
  • Eliminates preferential treatment of the already privileged
  • Replaces the “pretense of progressivity” as depicted in our income tax rate schedules with equal treatment toward holders of wealth that will allocate a greater portion of the tax burden based upon a citizen’s real ability to pay.
  • Repealing the corporate income tax and reforming existing tax expenditures, thereby eliminating the morass of special treatment policies and loopholes now written into our tax code, will take investors’ and business’ hands out of our government’s pockets

FISCAL RESPONSIBILITY

  • A reduction in earned income tax rates will increase the ability of lower and middle-class families to accumulate savings and achieve greater financial independence
  • Increased tax revenues generated by eliminating preferential subsidies to investors are a required step toward a balanced budget
  • A balanced budget will convert the hidden taxes of inflation and debt imposed on future generations to a current tax burden,  which can thus be more readily and responsively monitored, managed and matched to expenditures
  • A balanced budget will stabilize the currency

It is notable that the long-term cost of inflation exceeds the cost of an annual asset tax which could control deficit spending and stabilize the currency.  It is often argued that inflation is a hidden tax upon the wealthy, but the grand bargain offered by the structure outlined above is that, if implemented in conjunction with sound monetary policies, the hidden penalty of inflation could be replaced by tax revenues flowing through the coffers of government to support the functions and services we require.  Any benefit from continuing willful inflation on the Public Debt is overwhelmed by the cost imposed upon Private Debt Holders, whose aggregate holdings are four times the amount of our national public debt.

Importantly, by improving the perceived equity of tax revenue policies through reforms such as these we should be able to minimize the divisive lobbying for government programs funded with Other People’s Money – and hopefully thereby also impose greater discipline upon disbursement programs and priorities.  We cannot marshal the collective will required to control growth in disbursements until we implement more equitable revenue policies.

Nearly two years ago Tax Notes published a more extensive and data-intensive analysis of how factual distortions that populate the public debate have obstructed consideration of a wealth tax such as conceived here.  The only substantive rebuttal offered to this proposed structure in the interim has been the prohibition of direct federal property taxes as incorporated by the founders in the Constitution.  Yet, arguably, it is that prohibition and the structural preferences and misincentives which it creates, that has set us upon our current unsustainable path.

Misguided preferences toward wealth have destabilized our economy and threaten our society.  Regardless of potential constitutional obstacles, I suggest that returning to the long term historic norm and utilizing property taxes as a component of our federal tax base offers an opportunity to put America’s fiscal future back in order.

The FED reports $72 trillion of accumulated wealth is held by the private sector.  If removing tax preferences that currently subsidize low-profit and unproductive asset allocations resulted in reallocation of 3 percent of that capital toward more productive investments, it would trigger $2 trillion of stimulus spending – far more than any stimulus program government could initiate – while simultaneously increasing governmental tax revenues.

If there is an alternative reform which could eliminate preferential treatment and correct current misincentives without facing a constitutional challenge by all means we should pursue it.  However, I perceive Mr. Cowen is right; taxing wealth may be, indeed should be, the new battleground.   Properly implemented, it offers an opportunity to remove distorting incentives and reinvigorate our economy.  Existing policies and preferences have been responsible for an extraordinary and increasing concentration of wealth and income in America.  Our current system of taxation is both inequitable and unsustainable.  It is not just a matter of finding the optimal tax rates, we need to be reforming the misincentives embedded in our tax structure.

 (C) S. Douglas Hopkins 2014

Is our American Democracy being subverted by Cronyism?

“An economy over-weighted toward trading and speculation, where investors receive preferential tax treatment while actively seeking shelter from uncertainty and risk, will not generate robust job growth.”

The American Founders were deeply suspicious of democracy, and structured a constitution designed to protect both personal liberties and property from the tyranny of the majority.  But the critical problem confronting America today is not the majority using its popular vote to seize property from the rich; it is structural tax preferences aimed at privileged elite holders of wealth that are obstructing the efficient workings of capitalism and thereby the American Dream and its Promise of Equal Opportunity.

Of course you won’t learn that if you listen to our leadership in politics, economics or the media.  Half of our leadership claims that the wealthy are currently overtaxed and threaten that any attempt to further increase the burden upon the most affluent and successful among us will cause those so-called job-creators to go on strike and stop working and/or investing.  The other half argues that the wealthy simply aren’t taxed enough and seeks to impose “higher tax rates on the rich”, framing their argument in discriminatory terms that make much of our population react instinctively in sympathy with the first half.  A respect for fairness and equal treatment is deeply ingrained as part of the American psyche;  so the call for higher tax rates imposed upon a select group of citizens enflame an emotional debate about “class warfare”… and who really wants to go to war against a class we all aspire to join?

But the simple truth is that both sides are conducting their analysis and debate from a flawed fact base.  The very wealthy currently pay much lower tax rates than the working middle class – and allowing the top marginal tax rate to revert to 39.6% is not going to change that fact.  Increasing tax rates on capital gains and dividends without addressing structural flaws and preferences in tax policy that encourage the wealthy to shelter and suppress investment income is a pointless and flagrantly counter-productive exercise.  Most importantly, cronyist preferences aimed at wealth distort investment decisions and are an obstacle to economic vitality and job creation.

But if we can’t, or won’t, acknowledge the simple facts of current policy, why is there any surprise that our public debate generates more emotional heat than intellectual light?  A large portion of our population argues and votes against their own strongly held principles and personal self-interest because our leadership has turned our public policy debate into a shell game of misdirection and deception.

Perhaps the most concise and cogent analysis of the cause of our recent financial crisis came from an insider at Merrill who observed “We fell for our own scam.”  I believe America’s political and economic leadership has done the same thing.  We’ve played so fast and loose with the facts that we’ve lost track of reality.

The reality is that the progressivity of our tax code, which we so energetically debate, is more illusion than fact.  Even our most respected analysts, like the CBO, JCT, and Tax Policy Institute understate effective tax rates paid by the poor (by characterizing social benefit and income support programs as income) and overstate the tax rates paid by the wealthy (suppressing the real income of the rich by ignoring unrealized gains and other shelters).  The more disingenuous sources distort it further by pretending employment taxes are functionally distinct from general tax revenues and that 47% of the population pays no taxes.  When we frame our conversation with such obvious and flagrant distortions, how can we possibly expect to have a productive debate?

It’s impossible in the short space available here to illuminate the full scope of the distortions and delusional beliefs that guide our policy debate.  In a society where public debate is increasingly conducted in 140 character bytes it may be impossible to improve the quality of our debate in any forum.  But I offer a handful of key data points for consideration:

  1. 44% of U.S. tax-filers live on a combination of income and government subsidies of less than $30,000 per year.  The difference between the average overall federal tax burden within this group and that of all taxpayers is an aggregate $141 billion, a modest $1,995 per person.
  2. A mere 0.6% of tax filers (958,000) have incomes greater than $500,000 per year.  The marginal tax rate of the Upper Middle Class (incomes between $75,000 and $500,000) is 34.9%, but the marginal rate for the Rich (incomes greater than $500,000) is only 23.7%, largely the impact of reduced taxes on realized capital gains.  In aggregate, the cost of providing the Rich with this reduced tax rate is $112 billion, or $116,840 per person.
  3. Our Trust Funds hold no stored value.  Social Security and Medicare are pay as you go social support programs.  The only functional result of calling employment taxes “contributions” is that it hides the fact marginal tax rates on middle class earned income are higher than rates paid on high earnings and investment income.
  4. There are roughly $1.1 billion per year of targeted preferences buried within our voluminous tax code, commonly called “tax expenditures” because they arguably are indistinguishable from spending programs.  A very modest portion of these are aimed at the poor and included in the figure cited in item 1 above.   A somewhat larger, but similarly modest portion, perhaps as much as 20% are aimed the Rich, those with incomes in excess of $500,000.  But the vast majority of tax expenditures represent benefits distributed unequally among the working middle and upper-middle class.
  5. Analysis of data reported by the Federal Reserve suggests that in the 20 year period between 1988 and 2008 an aggregate $37 Trillion in unrealized gains were sheltered from taxation.  Ranged between a 15% to 25% tax rate the aggregate cost to the Treasury of sheltering unrealized gains was $5.5 to $9.2 trillion or $275 – $460 billion per year.  It is estimated that 73% of the national wealth is held by 10% of the population (35% is held by the top 1%); thus the benefit of these tax policies was similarly concentrated among the lucky and privileged few at the top of our increasingly steep economic pyramid.

Conservative Republicans seem to believe that the cause of our fiscal and social problems is that 47% of our population doesn’t pay income taxes and are a burden on society.  But the burden of employment taxes, imposed on the first dollar of wages, is higher than Mitt Romney’s average overall tax rate and the reason nearly half our population doesn’t pay income taxes is that our economy is so unbalanced half our population has almost no income to tax.  If Conservatives really believe our problem is the burden of social programs aimed at the weakest and most vulnerable among us, they should stop pretending it’s a tax revenue issue, and examine the actual outlays aimed at that struggling cohort.  They would quickly be forced to recognize that the problem is a lack of jobs, not an encroaching welfare state.  Efforts to fuel anger at the “non-taxpayers” struggling to get a grip on the American Dream are not just despicable they are a willful distraction from the issues that need to be addressed if we are to reinvigorate our economy.  We won’t stimulate economic prosperity by increasing the tax burden on the poor, or reducing social support services provided to them.  We need to focus on increasing their opportunities and ability to work, save and invest.

We need to stop pretending that social security and medicare are self-funded savings and investment programs.  Contributions are not saved and invested.  Workers’ contributions aren’t funding their own future retirement; current taxpayers are funding benefits for current retirees and excess “contributions” have been consumed by other current government outlays.  The debate about rationalizing our entitlement programs cannot be conducted in a rational manner until we acknowledge those facts.  Social support programs are important national choices.  But we do not fund our own individual benefits, we choose as a group to fund benefits for others.  Our promises have exceeded our ability, or at least our willingness, to pay and we need to reevaluate those promises.  The first step is to acknowledge the fact that the Trusts contain no stored value.

Conservative Republicans would like us to believe that the only fair and reasonable path to revenue reform is elimination of tax expenditures, which they characterize as discriminatory and wasteful.  There is some real truth in that characterization.   But it is intellectually dishonest to pretend equal treatment is the goal while simultaneously protecting the preferences toward wealth and investment income that accrue to the most privileged among us.   Reforming the morass of often contradictory and counter-productive preferences in our tax code as a path to reducing tax rates and imposing more equal treatment is a worthy goal.  But eliminating tax expenditures without reforming structural preferences toward investments would impose a still higher portion of the burden upon the middle and upper-middle working class.

On the other side Obama and his Democrat allies insist the rich must pay higher tax rates.  But while they frame that proposal with populist rhetoric they ignore the structural preferences toward investments that allow and encourage the rich to shelter and suppress taxable income.  Imposing higher rates without correcting structural preferences and misincentives will not change the fact that the Rich pay lower tax rates than a laborer in a minimum wage job.  Indeed, higher rates imposed within our existing structure will inevitably increase tax avoidance efforts – and by doing so, further discourage productive investment and job creation.

Our media widely report the fact that a large majority of Americans believe the “rich” need to pay higher taxes.  But you can’t efficiently tax the Rich by taxing “income”.  Look it up in a dictionary.  Rich relates to wealth, an accumulation of resources, not income.  But our leadership class on the Left ignores that fact just as studiously as their brethren on the Right.

Neither conservatives nor liberals publicly acknowledge or address the tax shelter for unrealized gains.

The facts are quite clear.  Our tax code is riddled with targeted preferences – and despite protestations of populist intentions from both sides of the spectrum, the aggregate benefits of those preferences skew very heavily toward the already privileged holders of accumulated wealth.    America’s prosperity has not been threatened by the tyranny of the majority.  It has been imperiled by cronyism among the rich and powerful.

The shell game of factual distortion and delusion through which our leadership conducts public debate is the process by which this cronyism is allowed to flourish and expand.  But the problem is not merely the inequity of the result – it is the inefficiency.

The path to renewed, sustainable economic growth and job creation is the productive deployment of capital.  That is the central concept behind capitalist theory, which also posits that the impetus for productive deployment of capital arises from fair and diverse competition in pursuit of individual self-interest: the famous “Invisible Hand” posited by Adam Smith.  Cronyism tilts the playing field and distorts investment decisions and valuation metrics.  Our tax and monetary policies have made tax avoidance and valuation manipulation far more profitable than productive enterprise.

So why is anyone surprised that we are creating recurring asset bubbles instead of jobs?

The path to more efficient tax policies would be obvious if we would spend less time and energy distorting the facts.  We need to stop subsidizing unproductive capital.  If we stop sheltering wealth from direct taxation, and impose a nominal and even-handed assessment upon the earnings potential of capital, essentially returning to the long-term historic norm of taxing property, we would free the Invisible Hand to stimulate more productive capital deployments.    The primary objective and rationale of such structural tax reforms should be the increased economic efficiency, prosperity and job creation that would follow.  By simply removing the current misplaced subsidies that distort investment incentives we could expect to stimulate an aggressive reallocation of private capital into more productive uses.

More equitable distribution of the cost burden of government would, of course, be a secondary benefit.   But the more compelling arguments for structural tax reform are the principles of capitalism which suggest freeing the Invisible Hand offers a path back to growth and prosperity.

Reactions and rebuttals will be gratefully received, either publicly as comment to this post, or privately via the contact form nearby.

Douglas Hopkins

Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

A Call for Comprehensive Structural Tax Reform

Originally published on BigThink.com (NOVEMBER 11, 2012)

Forced compromise is not enough: in order to reinvigorate our economy and change the trajectory of our unsustainable budget, America needs to confront fundamental flaws in its investment tax policies and implement comprehensive structural tax reforms.

It is broadly recognized that President Obama did not receive a mandate for action in the recent election, and that America remains bitterly divided.  What is less broadly recognized is that the choice we were confronted with at the polls was a false choice, a Devil’s Dilemma of mutually undesirable alternatives.  Both sides are correct about the flaws in their opponents’ platform.

  • Doubling down on the failed strategy of tax cuts for the wealthy (the Romney/Ryan plan) would accelerate wealth and income inequality, increase budget deficits, undermine social welfare programs, and eventually lead to social unrest.
  • But unless we modify existing structural misincentives, higher tax rates (the Obama plan) will encourage more aggressive tax avoidance efforts and thereby exacerbate economic stagnation and instability.

Obama’s administration may have survived the election, but they should understand they cannot simply Stay the Course.   Nor can we reasonably hope that forced compromise in response to the pending fiscal cliff will lead to some magical middle ground between the policy alternatives we have been battling over for the past two decades.  There is no magical middle ground between these flawed alternatives that will lead to economic growth and fiscal stability.  Compromising two bad ideas will not lead to a better one.  We need to broaden our perspective and look with fresh eyes at the challenges we face.  We need stop clinging to bad ideas, take the blinders off, and examine the unintended consequences of our current structural approach to taxing wealth and investments.

Observation: Current tax and monetary policies are subsidizing unproductive asset allocations and a flight to safety for private capital; thereby obstructing economic recovery.

Let that sink in.  There will be no sustainable economic rebound until we recognize that our tax and monetary policies have created structural misincentives and destabilized our economy.  An economy over-weighted toward trading and speculation, where investors receive preferential tax treatment while actively seeking shelter from uncertainty and risk, will not generate robust job growth.  If the productive deployment of capital is the key driver of economic growth and prosperity (the central tenet of capitalist theory) then, “Our political and economic leadership need to examine and address the ways our tax and monetary policies subsidize unproductive private capital.”  We offer preferential tax treatment to investment income with the stated objective of encouraging productive investment.  But the structure of our policies is inadvertently subsidizing unproductive, illiquid, and speculative investments – and penalizing capital allocations most directly responsible for job growth.

How so?  Let’s say I have $2 million of capital available to invest.  If I invest it directly as equity in a productive enterprise, generating jobs and profits, I become subject to substantial equity risks as well as multiple layers of taxation; on profits, dividends and capital gains.  Alternatively, I can minimize my tax obligations and in most cases my principal risk, by seeking a multitude of alternative asset allocations.  I can park my money in cash or Treasury bonds.  I can receive favorable tax treatment for debt instruments.  I can speculate in gold, real estate, or other tangible assets.  I can speculate in valuation fluctuations of publicly traded equities or complex structured securities and derivatives (which is distinct from investing in productive operations).  In nearly all cases, the lower my risk, the lower my taxes.  The only real exception to the low risk/low tax relationship is where I have actual losses; yet even there government steps in and subsidizes them with tax loss offsets, thus rewarding failure while taxing my successful competitor more heavily.  If I don’t need income, I can minimize taxes by sheltering profits and deferring gains, often to near perpetuity.  Our tax policies are skewed to favor and subsidize low-profit, unprofitable, and illiquid capital allocations.

America’s tax and monetary policies have made tax avoidance and manipulation of asset values far more profitable than productive enterprise.  Those policies have stimulated dangerous and unstable financial engineering and created recurring asset bubbles and collapses – while simultaneously triggering the transfer of billions of dollars in investment capital and millions of productive jobs overseas.    Offering preferential tax treatment to our investment class is not just inequitable, applying disparate treatment to our citizenry, more importantly those preferences distort investment incentives; and imposing them converts capitalism to cronyism.

If we desire to stimulate job growth, priority number one should be examining and correcting the structural flaws in our tax policies that distort investment decisions.  We have to stop trying to re-inflate the bubble and turn our attention to the underlying fundamental misincentives of tax policy.  The FED may be able to boost asset values and stock market indexes temporarily, but doing so will not produce a broad, sustainable, productive economy.

By favoring unproductive capital we have abandoned Adam Smith’s Invisible Hand – to our great detriment.  The key to robust job growth is comprehensive structural reform of investment tax policies and a return to the principle of equal treatment which lies at the core of both democracy and capitalism.

We tend to think of economic stimulus as requiring governmental disbursements.  I posit that if Governments would simply level the playing field and stop subsidizing unproductive capital with ill-conceived preferential tax and monetary policies the natural response would be an aggressive reallocation of private capital that would provide far greater economic stimulus than anything government can afford to offer directly.  How big might the potential impact be of such a policy shift?  The Fed reports aggregate Household and Nonprofit asset holdings total approximately $72 Trillion.  Reallocate 3% of that toward more productive activities and you will unleash $2.1 trillion of private stimulus investment.

If we eliminate misplaced biases and subsidies in existing tax policy private capital will flow naturally toward more productive investments, stimulating job growth and sustainable economic expansion.  If we simultaneously flatten and reduce earned income tax rates, that will stimulate real growth in wages for the working middle class and thus boost consumer demand.  I believe that structural reform of our investment tax policies would allow us to 1) equalize effective tax rates between labor and capital, while simultaneously 2) stimulating more productive capital investment and thereby job creation.

There is not space here to argue all the merits (or potential pitfalls) of the comprehensive structural tax reforms I envision.  Indeed, more important than arguing the merits of any particular proposal, my point is that fresh ideas and new solutions are urgently required.  The first step to finding them is weeding out the bad ideas.  Effective, equitable, growth-oriented tax reform will not come from cobbling together compromise over bad ideas.  But if we expand our view and debate outside the boundaries of those bad ideas this year might be different.

If we reevaluate the facts and acknowledge the flaws of our current policies and proposals, if we listen more carefully to criticism and open our minds to fresh ideas and alternative perspectives, then cooperation might be a path to a fresh and more promising approach to reform. The overlap of the pending fiscal cliff with a post-election lull in political bickering may offer us the best opportunity and incentive to do so, but our immediate challenge is more than just crafting political compromise.  We need to re-acknowledge the concept of a “loyal opposition,” and embrace our shared societal goals, set aside the hyper-partisan rancor that blinds us to weaknesses in our own ideas, and productively cooperate in assessing fresh alternatives.

We need to find a better path.  In order to achieve renewed growth and vitality, and preserve the American Dream, America needs to address fundamental structural flaws in tax policy and instability in our economy that neither party has yet even acknowledged.

I urge and invite you to read more about the questions and perspective I offer in the short post Want Job Growth? – Reinvigorate Capitalism or a longer Tax Notes’ article Factual Distortions Derail Productive Debate on Tax Reform.  A brief description of the specifics of the proposed structural reforms I envision and its perceived beneficial incentives is viewable at Premise.

Reactions and rebuttals will be gratefully received, either publicly as comment to this post, or privately via the contact form nearby.

Douglas Hopkins

Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

Has ECON 101 turned Americans into Lemmings?

The following essay was originally published (December 12, 2012) on BigThink.com Lemmings

It’s hard to know what leads lemmings to race willfully to their own demise.  But I’ve come to believe that the suicidal tendencies embedded in American tax and fiscal policy arise directly from the teachings of modern economic theorists.

One of the first lessons of introductory economics is a simple truism:  Savings is Deferred Consumption.  It is intuitive and obvious.  Wealth is value; when one obtains or creates wealth one can choose to either consume it today, or save it for the future.

What is less obvious, at least to me, is the leap of faith that economists take in building upon that truism.  At what point and on what basis have modern economists concluded that savings requires and deserves government subsidy?  Perhaps it is simply a puritan ethic that sees virtue in self-denial and deferred gratification?  Whatever its rationale, I believe it represents group think and flawed dogma.

I have been advised that I will be unable to find a living economist anywhere who doesn’t believe that sound economic policy demands and deserves preferential tax treatment of savings over consumption.  Initially I found it hard to believe that any three economists could find complete consensus on any common principle.  I was incredulous at the idea that all economists could agree on a single principle.  But now, having researched the issue at some length, I posit that universal agreement on a flawed proposition may be the proximate cause of our progressive decline.

On what basis have we decided that individual self-interest is not an adequate incentive to ensure that people prepare for the future?  More pertinently, how have we come to construct incentives that seem so obviously to fly in the face of a key principle of both democracy and capitalism?  The concept of equal treatment is so integral to democracy that it hardly requires elaboration; but fair and equal treatment is fundamental to the efficient workings of capitalism as well.

“Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man or order of men.”
-Adam Smith (1723-1790), The Wealth of Nations

Mr. Smith was not advocating an unequal competition (of industry or capital) in which the wealthiest and most privileged among our society are subsidized with preferential tax rates. Yet modern economists who claim to be advocates of capitalism have flung the principle of equal treatment to the ground and are diligently attempting to stomp it to death.  Who would have believed that a society governed by majority vote would over-burden its working middle class in order to provide tax preferences to its privileged elite?

But that is exactly what we do when we offer preferential tax treatment to investment income.

There are only two arguments available to justify preferential treatment of the already privileged: Power or Efficiency.  Either the rich and powerful extract preferential treatment because they can, or society grants preferences to the rich in pursuit of a greater good.  Giving modern economists the benefit of the doubt I am prepared to accept that many believe we are pursuing a greater good, but objective analysis of actual effect argues strongly to the contrary.

As a simple matter of cost benefit, cursory examination of America’s wealth concentration should make it obvious that the bulk of current tax incentives are wasted; an enormous tax cost is aimed at the portion of our population who least need it and whose behavior is least changed by it.  Much of the preferential tax benefit of reduced rates on investments accrues to individuals who couldn’t possible consume all their wealth and income.  73% of the national wealth is held by the top 10% of our population; 35% is held by the top 1%.  A combination of high income and/or ample accumulated wealth among this contingent means that the Rich and High Earners are going to save regardless.  Are the Top 1%, or the top 10%, really going to spend down their assets if their marginal tax rate goes up?  Of course not.  What is the cost in reduced and deferred tax revenues that is allocable to a portion of the population upon whom it has no perceivable effect?

As importantly, the misguided incentives we build into our policies impose very serious distortions upon investment decisions.  As a result, much of the capital that is accumulated is inefficiently deployed.  We have inadvertently made tax avoidance and valuation manipulation far more profitable than productive enterprise, thereby destabilizing our economy.  We justify preferential tax policies aimed at savings and investment because we say they will lead to productive activity – but we avert our eyes and ignore the fact that structural subsidies in the form of preferential tax treatment are diverting capital and energy away from productive enterprise.  Intellectual capital runs to Wall Street and gambles on valuation manipulation (and over-compensated transactional extortion) and productive enterprise flows (largely unimpeded) offshore in a race to the lowest wage jurisdictions.

The tax preferences we intend to stimulate investments instead stimulate Asset Bubbles.  We deplete our treasury and debase our democracy bribing the rich – to no productive effect.

I perceive a need for fundamental structural reform of our tax code – starting with critical examination of the misguided preferential tax treatment that over-burdens our working middle class at the same time it distorts investment decisions.  It is easy to understand preferential tax treatment of investment income as self-interest among influential key campaign contributors who now hold sway over our political class – but I dispute it as sound economic logic.  If it is not possible to justify preferential treatment of the already privileged as a matter of economic efficiency and thereby a greater societal good, and I believe it objectively is not, then the starting point for comprehensive tax reform should be examination and elimination of those preferences – at least among those for whom such preferences are an unnecessary subsidy, not an effective incentive.

There is of course merit in policies that encourage and assist our struggling working classes to save for the future.  But today the benefits we shower upon our investment class require us to impose higher tax burdens upon our working class – thereby obstructing savings where they most need to be encouraged.  If we equalized effective tax rates between labor and investments we could reduce both our budget deficit and the tax rate on earned income.  Reducing the marginal tax rate on earned income and putting more discretionary income in the hands of laborers would be a far more effective method of stimulating savings where we most need it – than continuing to siphon money from the middle class into the hands of current wealth-holders.

Reactions and rebuttals will be gratefully received, either publicly as comment to this post, or privately via the contact form nearby.

Douglas Hopkins

Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

Inflation or Taxes?

Why the wealthy should willingly pay higher taxes. 

Long ago Milton Friedman quipped, “Inflation is taxation without legislation.”  His underlying observation:   our real total tax burden is not limited to government tax collections; it is defined by the amount of government spending.  Today, many people describe inflation as a “tax” on financial assets.  But while inflation is a penalty and a burden, it is not a tax; at least not in the sense of funds that flow through the Treasury to support the operations of government.  This leads to what should be an obvious choice:  Is it better to have inflation?  Or taxes? 

At heart, habitual deficit spending and the inflation it fuels, is just an invidious form of cost shifting:  part of the increasingly complex shell game of misdirection and outright deception our government plays as it selectively doles out services and tax preferences among its favored constituencies.  Once again, I will quote Milton Friedman, “When a man spends someone else’s money on someone else, he doesn’t care how much he spends or what he spends it on. And that’s government for you.”  The truth behind that observation is the source of much of the public’s anger at government – government has become a game of commerce in which our leadership willfully seeks to provide benefits to one party while they extract funding from another.    While the public may be angry about it, we’re also complicit. 

Government’s attempt to provide services funded by Other People’s Money, and the public’s persistent demands that they do so, sit at the root of our fiscal dysfunction and profligacy.  The first step toward more responsible disbursement policies is to stop trying to make someone else pay our bills. 

For roughly four decades now the battle to control spending has focused upon constricting tax revenues… and it has very conspicuously failed.  Regardless of how logical it may have seemed; Starving the Beast has not worked.  Part of the reason it hasn’t worked is that we pretend someone else is paying the bill:  Tax Corporations!  Tax the Rich!  Tax Imports!  Tax Consumption!  Tax the Working Class!  Tax Future Generations!  Tax the Man Behind that Tree!  Until and unless we impose more equitable revenue policies so that every citizen pays a fair share of the full burden of government spending, America will never marshal the collective will to make difficult decisions about spending priorities. 

Today our leaders in Washington, responding to the demands of their constituents, shower the public with services while they play a game of musical chairs with the bill: shifting the costs, hiding the future obligations, and pretending the music is never going to stop.  In response the public moans and groans, complains about irresponsible politicians… and reelects whoever delivers the most pork.  As an alternative, imagine what would happen if, for one single election cycle, every American citizen received a tax bill for a fair allocation of the full government operations during the preceding year?  We would have 100% turnover in the following election.   

Decoupled from spending restraints, as it now is, Grover Norquist’s Anti-Tax Pledge is an inducement to theft.  It is, not coincidentally, the driver for a massive wealth transfer from the working middle class to the privileged and lucky few who stand at the very top of the ladder of success.  But that wealth transfer cannot continue; the structural imbalances created by preferential tax treatment of investment income and wealth have destabilized our productive economy and ultimately threaten those at the top as well as the bottom. 

Thus, the question: Is there a grand bargain to be made, converting the burden of inflation which stealthfully erodes the value of financial assets, into a legitimate tax that funds the current operations of government?  I believe there is.  By restructuring our approach to taxing investments and wealth we could improve both the equity and efficiency of our tax policies. 

Economists and central bankers keep trying to tell us that they have inflation under control.  But anyone who’s been near a restaurant, grocery store or gas pump in the last three decades has objective cause to question the legitimacy of that claim.  Admittedly, there’s been little recent wage inflation, at least among the working class.  But the cost of living increases that weigh most heavily upon the poor and middle class are real and painful… and assuming continuation of current monetary policy, soon to get much, much worse.     Inflation is an insidious burden upon investors and consumers alike.  It subsidizes borrowers, encourages speculation and distorts investments.  

The long term cost of inflation exceeds 2% per year.  A 2% annual assessment on net assets, as a replacement for all the various inefficient and inconsistently applied mechanisms now used to tax investments, could balance the budget almost immediately.  Assume a long term WACC of 8%, and a 2% asset tax is the equivalent to a 25% effective tax rate on the income potential of capital.  Drop peak earned income tax rates to the same 25% and you will have balanced the budget while simultaneously equalizing effective tax rates between labor and capital.  As a practical matter, it would also force the FED to put a floor under interest rates. 

A balanced budget and more equitable tax distribution are both desirable objectives; but they pale beside the potential benefit of economic stimulus that could arise from removing subsidies to unproductive capital. 

The Fed reports aggregate Household and Nonprofit asset holdings total approximately $72 Trillion.  Reallocate 3% of that toward more productive activities and you will unleash $2.1 Trillion of private stimulus.  If we level the playing field and stop subsidizing unproductive capital with preferential tax and monetary policies the natural response will be an aggressive reallocation of private capital that would provide far greater economic stimulus than anything government can afford to offer.  The key to job growth is comprehensive structural reform of investment tax policies. 

I offer this suggested revenue reform not as an alternative to government spending reductions, but because I perceive it is a prerequisite to imposing fiscal discipline upon our budget process.   Unless and until we address the issue of equity (real and perceived) in our tax revenue policies we will be unable to marshal the collective public will to implement the important changes in entitlements and other program disbursements that we clearly and urgently need. 

Those who believe we can find a path to fiscal solvency by cost-cutting alone, while continuing to down-stream tax burdens onto the working middle class, are deluding themselves.  We already impose the penalty of high government spending via the burden of inflation.  It seems intuitively obvious that converting that hidden and unproductive burden to real taxes that flow through the treasury would allow us to both a) distribute it more equitably and b) manage it more efficiently. 

Reactions and rebuttals will be gratefully received, either publicly as comment to this post, or privately via the contact form nearby.

Douglas Hopkins

Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

 

Stimulating Job Creation

Observation:  Current tax and monetary policies are subsidizing unproductive asset allocations and a flight to safety for private capital; thereby obstructing economic recovery. 

Let that sink in.  There will be no sustainable economic rebound until we recognize that our tax and monetary policies created structural misincentives and destabilized our economy.  An economy over-weighted toward trading and speculation, where investors receive preferential tax treatment while actively seeking shelter from uncertainty and risk, will not generate robust job growth.  If the productive deployment of capital is the key driver of economic growth and prosperity (the central tenet of capitalist theory) then ”Our political and economic leadership need to examine and address the ways our tax and monetary policies subsidize unproductive private capital.”  We offer preferential tax treatment to investment income with the stated objective of encouraging productive investment.  But the structure of our policies is inadvertently subsidizing unproductive, illiquid, and speculative investments – and penalizing capital allocations most directly responsible for job growth. 

How so?  Let’s say I have $2 million of capital available to invest.  If I invest it directly as equity in a productive enterprise, generating jobs and profits, I become subject to substantial equity risks as well as multiple layers of taxation; on profits, dividends and capital gains.  Alternatively, I can minimize my tax obligations and in most cases my principal risk, by seeking a multitude of alternative asset allocations.  I can park my money in cash or Treasury bonds.  I can receive favorable tax treatment for debt instruments.  I can speculate in gold, real estate, or other tangible assets.  I can speculate in valuation fluctuations of publicly traded equities or complex structured securities and derivatives (which is distinct from investing in productive operations).  In nearly all cases, the lower my risk, the lower my taxes.  The only real exception to the low risk/low tax relationship is where I have actual losses; yet even there government steps in and subsidizes them with tax loss offsets, thus rewarding failure while taxing my successful competitor more heavily.  If I don’t need income, I can minimize taxes by sheltering profits and deferring gains, often to near perpetuity.  Our tax policies are skewed to favor and subsidize low-profit, unprofitable, and illiquid capital allocations. 

If we desire to stimulate job growth, priority number one should be examining and correcting the structural flaws in our tax policies that inadvertently distort investment decisions.  We have to stop trying to re-inflate the bubble and turn our attention to the underlying fundamental misincentives of tax policy.  The FED may be able to boost asset values and stock market indexes temporarily, but doing so will not produce a broad, sustainable, productive economy. 

Unfortunately, instead of addressing this fundamental challenge our current public tax debate is A BATTLE OF BAD IDEAS.  America is headed to the polls in November faced with a false choice. 

  • Doubling down on the failed strategy of tax cuts for the wealthy (the conservative choice) will accelerate wealth and income inequality, increase budget deficits, undermine social welfare programs, and eventually lead to social unrest. 
  • But unless we modify existing structural misincentives, higher tax rates (the liberal choice) will encourage more aggressive tax avoidance efforts and thereby exacerbate economic stagnation and instability. 

Neither party is addressing the fundamental structural flaws and misincentives in our investment tax policies.   By inadvertently favoring unproductive capital we have abandoned Adam Smith’s Invisible Hand and are distorting investment incentives – to our great detriment. 

We tend to think of economic stimulus as requiring governmental disbursements.   I posit that if Governments would simply level the playing field and stop subsidizing unproductive capital with ill-conceived preferential tax and monetary policies the natural response would be an aggressive reallocation of private capital that would provide far greater economic stimulus than anything government can afford to offer directly.   The key to job growth is comprehensive structural reform of investment tax policies aimed at restoring the principle of equal treatment which lies at the core of both democracy and capitalism. 

I believe that by fundamentally re-thinking the structure we use to tax capital and investments, and eliminating misplaced biases and subsidies, private capital will flow naturally toward more productive investments, stimulating job growth and sustainable economic expansion.  As a secondary effect, it also provides the opportunity to reduce marginal tax rates on earned income and equalize tax rates between labor and capital; an opportunity which is both a) a desirable objective in and of itself, and b) a useful and compelling argument that could generate broad public support for reform. 

 I urge you to read the short post Want Job Growth? – Reinvigorate Capitalism or the longer Tax Notes’ article Factual Distortions Derail Productive Debate on Tax Reform.   A brief description of the specifics of the proposed structural reforms and its perceived beneficial incentives is viewable at Premise

Reactions and rebuttals will be gratefully received, either publicly as comment to this post, or privately via the contact form nearby. 

Douglas Hopkins

Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

The Reasons I Lie Awake at Night

The Best Kept Secret In America

Open any general interest newspaper or periodical published in the last two years and you are likely to see the same question:  “Why is this a jobless recovery?”  While professional pundits and media talking heads treat this question as a deep dark mystery, I suggest the answer is all too obvious.  It is the same reason why job growth stalled over the last two decades and the middle class stagnated while wealth and income increased its concentration at the top.  

Our tax and monetary policies have been aimed at protecting and increasing wealth, not stimulating productive enterprise.

Too-eager pursuit of Alan Greenspan’s “wealth effect” has inadvertently stimulated recurring asset bubbles and destabilized our economy.  Regardless of how well-meaning those policy choices may have been – they have been extremely damaging. 

*******

Conservative economists argue that incrementally higher tax rates discourage investment and work, and cause people to horde their pennies (presumably in lumpy mattresses) while they saunter off to sulk on the beach.  There is, of course, an active debate about how high is too high, and what might be an optimal balance.  But the dominant voices on both sides of the spectrum seem to me to be missing the more important and most destabilizing aspect of our existing tax structure and policies.   

The issues that keep me awake nights are –

1)      Existing structural tax preferences, intended to stimulate savings and investment, inadvertently subsidize unproductive capital allocations and stifle growth.    

  • We’ve made tax avoidance and valuation manipulation far more profitable than productive enterprise. 
  • Our tax and monetary policies have stimulated dangerous and unstable financial engineering and created recurring asset bubbles and collapses – while simultaneously subsidizing the transfer of billions of dollars in investment capital and millions of productive jobs overseas. 

2)      America is headed toward the polls in November faced with a false choice between two mutually flawed options. 

  • The hyper-partisan battle in Washington is a power struggle of bad ideas in which both sides turn a blind eye to the underlying structural flaws that have destabilized our economy. 
  • Unless we modify existing structural misincentives, higher tax rates (the liberal choice) will encourage more aggressive tax avoidance efforts and thereby exacerbate economic stagnation and instability. 
  • Doubling down on the failed strategy of tax cuts for the wealthy (the conservative choice) will accelerate wealth and income inequality, increase budget deficits, undermine social welfare programs, and eventually lead to social unrest.   

Alternative:  Evaluate and Implement Structural Tax Reforms 

  • We need to stop subsidizing unproductive capital with preferential tax treatment – so that holders of private capital will be incentivized to put their money more productively to work. 
  •  We need to eliminate the Crony Capitalism through which government focuses on protecting wealth – to allow the free workings of legitimate capitalist theory to stimulate more productive private investment and economic growth. 
  • I believe it is possible to equalize effective tax rates between labor and capital while simultaneously stimulating more productive investment. 

But political and economic theorists have abandoned capitalism’s core principle of the Invisible Hand in favor of preferential tax treatment for holders of wealth.   

If we desire to make progress toward broadly shared prosperity and growth, we need to illuminate the discrepancies between fact and dogma on both sides of the argument – and seek to reconcile the strengths and weaknesses of opposing positions.   Our investment incentives have become distorted.  We cannot simply argue about the rate schedules utilized in a flawed structure.  We need to be analyzing and evaluating structural changes that will stimulate more productive capital allocations. 

I believe the place to start that analysis is by assessing the factual misperceptions and outright distortions that characterize our current public debate and obscure the path to more equitable and efficient policies.  I urge you to consider the discussion and analysis on this topic published 6/18/12 in Tax Notes under the title Factual Distortions Derail Productive Debate on U.S. Tax Reform.  

Our rigidly polarized debate upon tax reform is built upon erroneous facts and assumptions that offer flawed options and false choices.  I invite you to consider a fresh perspective aimed at reconciling the strengths and weaknesses of the opposing arguments into a viable alternative path.  See  A Confluence of Benefits posted nearby.

Let’s Abolish Spin

I’d like to start a crusade to return honesty to public discourse.  Is anyone interested in joining? 

Here’s my premise:  It is exceptionally rare for good decisions to arise from bad facts or shoddy reasoning.  So why don’t we try to stamp out “spin”.  Spin is, of course, simply a polite word for willfully distorting the facts: torturing logic to obscure sound interpretation and balanced assessment of circumstances, causes, effects and implications.   The ability to “spin” facts is also, much to our detriment, our most highly valued political talent.  How did that come to be? 

In a logical and rational world, one would expect obvious practitioners of spin to be shunned and despised.  In American political circles “spin doctors” are highly praised and compensated. 

H L Mencken claimed no one ever lost money, or public office, by underestimating the intelligence of the public.  But America is heading toward financial Armageddon, at least in part, because our leadership doesn’t trust or respect the intelligence of our citizenry.  Our leadership distorts reality, often using gross misrepresentations of the facts to shape public opinion, because they simply don’t trust the public.  In fairness, for some I’m sure it is the result of wishful thinking and self-delusion, not willful deception.   But the persistent manipulation and distortion of facts, and broad acceptance of the practice, has done enormous damage to the quality of our public discourse. 

The competition of allegations between politicians and pundits, telling people what they want to hear and building arguments in support of pre-determined dogmatic opinions, has become so prevalent that avoiding difficult judgments and choices has become a simple process.  All one has to do to justify an opinion is pick a different source from which to cite facts.  It is human nature to sort new facts into one’s existing view of the world.  But it is an abdication of responsibility when our political leadership and media stop applying intellectual rigor to the challenges that threaten our future. 

Today we are engaged in a critical debate over the fiscal profligacy and dysfunction of our tax and budget policies.  We allow that debate to be framed by the allegation that “nearly half the public pays no taxes”.  When crafted with care, specifically defining “income taxes”, that allegation is semantically accurate.  But in substance, it is demonstrably false.  Our federal government collects more employment taxes than income taxes.  Inclusive of employment taxes, the working middle class pays higher marginal tax rates than the most affluent and privileged among us.  Warren Buffett and his billionaire peers pay tax rates half as high as their office staff.  Our leadership pretends we have progressive tax policies and argues vociferously over relatively minor changes in the income tax rates.  But our progressive rates apply to less than 25% of the overall federal/state/local tax burden and unless we fundamentally change the structure we use to tax investment returns changing those personal income tax rates will not make a significant dent in the preferential treatment now extended to holders of accumulated wealth.  Yet a large portion of the population argues against their own principles of equal treatment and their personal self-interest, because we distort the facts upon which we conduct our debate.   

Nearly thirty years of experience in crisis management and business workouts suggests to me that when disputing parties don’t share a common knowledge and understanding of the facts, compromise is extraordinarily difficult and productive agreement is functionally impossible.  So why do we allow politics to be conducted in a fact free zone?  Why are we surprised that politicians can’t agree on a course of action when we know they habitually cite conflicting, irreconcilable “facts” – and we allow them to do so largely unchallenged.  

So join me in calling for the abolishment of “spin”.  Encourage our political class and media to stop deliberately twisting the facts to fit their theories; demand they test and reconcile their theories against objective reality.  Will we still have disagreements about the facts and implications of our circumstances?  Of course we will.  But if we start by honestly debating the facts, simple things like, “Who hands a higher proportion of their income and wealth over to the government each year?” and “Does deferring taxes on unrealized gains stimulate investment, or obstruct fluid capital reallocations to more productive uses?”, then maybe we could make some progress on the critical challenges that confront us. 

Our representative government is becoming increasingly dysfunctional; largely because we ignore or distort inconvenient facts.  Public debate, that examines the pros and cons of alternative positions and cooperatively works through the issues, is fundamental to the democratic process.  But surely, a commonsense minimum requirement of that process is to demand a more honest and objective discussion of the facts upon which those debates and decisions rely. 

Douglas Hopkins Author – A Citizen’s 2% Solution: How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

A Confluence of Benefits

Advocates for tax reform typically seize upon one of three alternative objectives which they treat as though they are, of necessity, mutually exclusive.  The proposal outlined in detail upon the pages of this site is designed to offer simultaneous stimulus toward all three of those equally worthy objectives. 

 1.       ECONOMIC GROWTH

  • Repealing corporate income taxes will stimulate business hiring and make U.S. corporations more competitive
  • Flattening and reducing earned income taxes will stimulate growth in middle class disposable income and thus consumer demand
  • Removing the tax bias toward unrealized gains will stimulate more fluid and productive reallocations of private capital

2.       EQUAL TREATMENT

  • Proposal normalizes effective tax rates between earned income and investment returns
  • Avoids regressive VAT or consumption taxes
  • Eliminates “double taxation” of corporate income and dividends/capital gains
  • Eliminates preferential treatment of the already privileged
  • Replaces the “pretence of progressivity” as depicted in our income tax rate schedules with equal treatment toward holders of wealth that will allocate a greater portion of the tax burden based upon a citizen’s real ability to pay. 
  • Repealing the corporate income tax and reforming existing tax expenditures, thereby eliminating the morass of special treatment policies and loopholes now written into our tax code, will take investors’ and business’ hands out of our government’s pockets

3.       FISCAL RESPONSIBILITY

  • Increased tax revenues are a required step toward a balanced budget
  • A balanced budget will convert the hidden taxes of inflation and debt imposed on future generations to a current tax burden,  which can thus be more readily and responsively monitored, managed and matched to expenditures
  • A balanced budget will stabilize the currency

The long-term cost of inflation exceeds the cost of a 2% asset tax which could control deficit spending and stabilize the currency.  Any benefit from inflation on the Public Debt is overwhelmed by the cost imposed upon Private Debt Holders, whose aggregate holdings are four times the amount of our national public debt. 

By improving the perceived equity of tax revenue policies we can minimize the divisive lobbying for government programs funded with Other People’s Money – and hopefully thereby also impose greater discipline upon disbursement programs and priorities.