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Archive for January 11th, 2011

There is a very bizarre race happening in Illinois. The Governor and the leaders of the State Senate and General Assembly are trying to figure out how to ram through a massive tax increase, but they’re trying to make it happen before new state lawmakers take office tomorrow. The Democrats will still control the state legislature, but their scheme to fleece taxpayers would face much steeper odds because of GOP gains in last November’s elections.

As a result, the Illinois version of a lame-duck session has become a nightmare, sort of a feeding frenzy of tax-crazed politicians. Here’s the Chicago Tribune’s description of the massive tax hike being sought by the Democrats.

The 3 percent rate now paid by individuals and families would rise to 5 percent in one of the largest state tax increases in Illinois history. …Also part of the plan is a 46 percent business tax increase. The 4.8 percent corporate tax rate would climb to 7 percent… In addition, lawmakers are looking at a $1-a-pack increase in the state’s current 98-cent tax on cigarettes. …Democrats will still control the new General Assembly that gets sworn in Wednesday, their numbers were eroded by Republicans in the November election. With virtually no Republican support for higher taxes, Democratic leaders contend it will be easier to gain support for a tax hike in a legislature with some retiring members no longer worried about facing the voters.

If Governor Quinn and Democratic leaders win their race to impose a massive tax hike, that will then trigger another race. Only this time, it will be a contest to see how many productive people “go Galt” and leave the state. John Kass, a columnist for the Tribune, points out that the Democrats’ plan won’t work unless politicians figure out how to enslave taxpayers so they can’t escape the kleptocracy known as Illinois.

The warlords of Madiganistan — that bankrupt Midwestern state once known as Illinois — are hungry to feed on our flesh once again. This time the ruling Democrats are planning a…state income tax increase, with more job-killing taxes on corporations… A few tamed Republicans also want to join in and support a tax deal, demonstrating their eagerness to play the eunuch in the court of the pasha. And though they’ve been quite ingenious, waiting for the end of a lame-duck legislative session to do their dirty work, they forgot something important. They forgot to earmark some extra funds for that great, big wall. You know, that wall they’re going to need, 60 feet high, the one with razor wire on top and guard towers, equipped with police dogs and surrounded by an acid-filled moat. The wall they’re going to have to build around the entire state, to keep desperate taxpayers from fleeing to Indiana, Wisconsin and other places that want jobs and businesses and people who work hard for a living. …With the state billions upon billions in debt, and the political leaders raising taxes, borrowing billions more and not making any substantive spending cuts, we’ve reached a certain point in our history. The tipping point. Taxes grow. Employers run. The jobs leave. High-end wage earners have the mobility to escape. What’s left are the low-end workers who are stuck here. …the Democrats aren’t about to disappoint their true constituents. So they don’t cut, they tax. Because the true constituents of the Democratic warlords are the public service unions and the special interests that benefit from all that spending. Why should politicians make cuts and anger the people that give them power, the power that allows them access to treasure? …we reach another tipping point: The point at which those who are tied to government, either through contracts or employment, actually outnumber those who are not tied to government. Do the math on Election Day.

Illinois is America’s worst state, based on what it costs to insure state debt. The greedy politicians in Springfield think a tax hike will give them enough money to pay bondholders and reward special-interest groups. But that short-sighted approach is based on the assumption that people and businesses will cheerfully bend over and utter the line made famous by Animal House: “Thank you, sir! May I have another?”

Moving across state lines is generally not something that happens overnight. But this giant tax hike is sure to be the tipping point for a few investors, entrepreneurs, rich people, and employers. Each year, more and more of them will decide they can be more successful and more profitable by re-domiciling in low-tax states. When that happens, Illinois politicians will get a lesson about the Laffer Curve, just as happened in Maryland, Oregon, and New York.

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Thanks to decades of reckless spending by European welfare states, the newspapers are filled with headlines about debt, default, contagion, and bankruptcy.

We know that Greece and Ireland already have received direct bailouts, and other European welfare states are getting indirect bailouts from the European Central Bank, which is vying with the Federal Reserve in a contest to see which central bank can win the “Most Likely to Appease the Political Class” Award.

But which nation will be the next domino to fall? Who will get the next direct bailout?

Some people think total government debt is the key variable, and there’s been a lot of talk that debt levels of 90 percent of GDP represent some sort of fiscal Maginot Line. Once nations get above that level, there’s a risk of some sort of crisis.

But that’s not necessarily a good rule of thumb. This chart, based on 2010 data from the Economist Intelligence Unit (which can be viewed with a very user-friendly map), shows that Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe, based on the market for credit default swaps, which measures the cost of insuring debt. Indeed, only U.S. debt is seen as a better bet.

Interest payments on debt may be a better gauge of a nation’s fiscal health. The next chart (2011 data) shows the same countries, and the two nations with the highest interest costs, Greece and Ireland, already have been bailed out. Interestingly, Japan is in the best shape, even though it has the biggest debt. This shows why interest rates are very important. If investors think a nation is safe, they don’t require high interest rates to compensate them for the risk of default (fears of future inflation also can play a role, since investors don’t like getting repaid with devalued currency).

Based on this second chart, it appears that Italy, Portugal, and Belgium are the next dominos to topple. Portugal may be the best bet (no pun intended) based on credit default swap rates, and that certainly is consistent with the current speculation about an official bailout.

Spain is the wild card in this analysis. It has the second-lowest level of both debt and interest payments as shares of GDP, but the CDS market shows that Spanish government debt is a greater risk than bonds from either Italy or Belgium.

By the way, the CDS market shows that lending money to Illinois and California is also riskier than lending to either Italy or Belgium.

The moral of the story is that there is no magic point where deficit spending leads to a fiscal crisis, but we do know that it is a bad idea for governments to engage in reckless spending over a long period of time. That’s a recipe for stifling taxes and large deficits. And when investors see the resulting combination of sluggish growth and rising debt, eventually they will run out of patience.

The Bush-Obama policy of big government has moved America in the wrong direction. But if the data above is any indication, America probably has some breathing room. What happens on the budget this year may be an indication of whether we use that time wisely.

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