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Archive for September 26th, 2011

Whether I’m criticizing Warren Buffett’s innumeracy or explaining how to identify illegitimate loopholes, I frequently write about the perverse impact of double taxation.

By this, I mean the tendency of politicians to impose multiple layers of taxation on income that is saved and invested. Examples of this self-destructive practice include the death tax, the capital gains tax, and the second layer of tax of dividends.

Double taxation is particularly foolish since every economic theory – including socialism and Marxism – agrees that capital formation is necessary for long-run growth and higher living standards.

Yet even though this is a critically important issue, I’ve never been satisfied with the way I explain the topic. But perhaps this flowchart makes everything easier to understand (click it for better resolution).

There are a lot of boxes, so it’s not a simple flowchart, but the underlying message hopefully is very clear.

1. We earn income.

2. We then pay tax on that income.

3. We then either consume our after-tax income, or we save and invest it.

4. If we consume our after-tax income, the government largely leaves us alone.

5. If we save and invest our after-tax income, the government penalizes us with as many as four layers of taxation.

You don’t have to be a wild-eyed supply-side economist to conclude that this heavy bias against saving and investment is not a good idea for America’s long-run prosperity.

By the way, Hong Kong’s simple and fair flat tax eliminate all those extra layers of taxation.

That’s the benefit of real tax reform such as a flat tax. You get a low tax rate, but you also get rid of double taxation so that the IRS only gets one bit at the apple.

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This is getting surreal. We now have layers of bailouts around the world.

Different nations are doing their own bailouts. On top of that, the Europeans have set up something called the European Financial Stability Facility, which does bailouts across the continent. And then there’s the International Monetary Fund, doing bailouts on a global basis. (and we’re not even counting the indirect bailouts from the Federal Reserve and European Central Bank)

So how is this system working? Well, if you understand the principle of moral hazard, you won’t be surprised to learn that it’s a big flop. Giving bailouts is like trying to cure an alcoholic with more booze.

But the problems are much deeper than promoting bad behavior. Bailouts also undermine growth by misallocating capital. And, most ominously, they create even bigger problems down the road.

Which is now what’s happening. The queen bureaucracy of bailouts, the IMF, may run out of bailout money, and presumably will demand more handouts from member nations – with the United States on the hook for providing the biggest share. Here’s a blurb from the story in the Daily Telegraph.

The head of the IMF has warned that its $384bn (£248bn) war chest designed as an emergency bail-out fund is inadequate to deliver the scale of the support required by troubled states.In a document distributed to the IMF steering committee at the weekend, Ms Lagarde said: “The fund’s credibility, and hence effectiveness, rests on its perceived capacity to cope with worst-casescenarios. Our lending capacity of almost $400bn looks comfortable today, but pales in comparison with the potential financing needs of vulnerable countries and crisis bystanders.”

At the risk of stating the obvious, the IMF should not get any more money. This is one of those moments for which the phrase “Hell No!” was invented.

The time has come to stop the cycle of bailouts. As Greece has demonstrated, bailouts simply give politicians some breathing room to postpone necessary reforms.

But it’s not just that bailouts encourage bad behavior in the public sector. They also promote moral hazard, leading financial institutions to make excessively risky loans because of an expectation that taxpayers will be coerced into making up any losses.

To understand why bailouts and moral hazard are so misguided, here’s a video narrated by Nicole Neily of the Independent Women’s Forum.

The video largely focuses on American policy issues such as Fannie, Freddie, and TARP, but the principles apply to all bailouts.

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