A Citizen's 2% Solution

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

Archive for July, 2012

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