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Archive for December, 2012

There’s no official agreement, so everything you read here may turn out to be nonsense, but it appears that the misfits in Washington have reached a deal on the fiscal cliff.

It seems as though my prediction about the outcome was correct. Not that this makes me happy.

First, the good news.

Oh, wait, there isn’t any.

Now for the bad news.

  • The top tax rate will increase to 39.6 percent for entrepreneurs, investors, small business owners, and other “rich” taxpayers making more than $400,000 ($450,000 for married couples). This is Obama’s big victory. He gets his class-warfare trophy.
  • The double tax on dividends and capital gains will climb from 15 percent to 20 percent (23.8 percent if you include the Obamacare tax on investment income).
  • The death tax rate will be boosted from 35 percent to 40 percent (which doesn’t sound like a big step in the wrong direction until you remember it was 0 percent in 2010).
  • The alternative minimum tax will still exist, though it will be “patched” to protect as many as 30 million households from being swept into this surreal parallel tax system that requires people to use a second method of calculating their taxes – with the government getting the greatest possible amount.
  • Unemployment benefits will be extended, ensnaring more Americans in joblessness.
  • Medicare spending will be increased as part of a “doc fix” to increase reimbursement payments for providers.

This is sort of like a late Christmas present, but we must have been naughty all year long and taxpayers are getting lumps of coal.

That being said, I was expecting even worse, so this deal (assuming it happens) almost seems like a relief.

Bipartisan cliff cartoonSort of like knowing that you were going to have your arm amputated, but then finding out that at least you’ll get some anesthetic. You’re not happy about the outcome, but you’re relieved that it won’t be as bad as you thought it would be.

But let’s not delude ourselves. This deal is not good for the economy. It doesn’t do anything to cap the burden of government spending. It doesn’t reform entitlement programs.

And we may even lose the sequester, the provision that was included in the 2011 debt limit that would have slightly reduced the growth of government over the next 10 years.

What a dismal ending to 2012.

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Back in mid-2010, I wrote that Portugal was going to exacerbate its fiscal problems by raising taxes.

Needless to say, I was right. Not that this required any special insight. After all, no nation has ever taxed its way to prosperity.

We’re now at the end of 2012 and Portugal is still saddled with a weak economy. And the higher taxes haven’t resulted in less red ink. Indeed, according to the Economist Intelligence Unit, government debt has jumped from 93 percent of GDP in 2010 to 124 percent of GDP this year.

Why did higher taxes backfire in Portugal? For the same reasons that higher taxes have failed in Greece, Spain, Bulgaria, France, Italy, the United Kingdom, and so many other nations.

  • Higher taxes undermine incentives for productive behavior, thus reducing an economy’s potential for growth. This means less economic output, which also means a smaller tax base. This Laffer Curve effect doesn’t necessarily mean less revenue, but it certainly means that tax increases rarely raise as much money as initially projected.
  • Higher taxes usually are a substitute for the real solution of spending restraint (i.e., Mitchell’s Golden Rule). Politicians oftentimes refuse to reduce the burden of government spending because of an expectation of additional tax revenue. Heck, in many cases, higher taxes trigger an increase in the size and scope of the public sector.

So did Portugal learn any lessons from this failed experiment in Obamanomics?

Hardly. Indeed, the government plans to double down on this approach – even though it’s increasingly apparent that higher tax burdens won’t translate into much – if any – additional tax revenue. Here are some excerpts from a report in the Financial Times.

Lisbon plans to lift income tax revenue by more than 30 per cent, raising the effective average rate by more than a third from 9.8 to 13.2 per cent. Anyone receiving more than the minimum wage of €485 a month, including pensioners, will also pay an extraordinary tax of 3.5 per cent on their income. …the steep tax increases facing many families have made the outlook for 2013 – the third consecutive year of austerity, recession and rising unemployment – the grimmest yet. Total tax revenue has fallen considerably below target this year, forcing the government to implement additional austerity measures… The coalition will be relying on increased state revenue to account for about 80 per cent of the fiscal adjustment required in 2013 – a reversal of the original bailout plan, in which consolidation was to be achieved mainly through spending cuts.

Amazing. The government imposes huge tax hikes, which don’t generate any positive results. Yet even though “tax revenue has fallen considerably below target,” confirming that there are significant Laffer Curve issues, the government chooses to repeat the snake-oil fiscal therapy of higher taxes.

Anybody want to guess what’s going to happen? The answer, of course, is that this will further dampen incentives to generate income and comply with the government’s fiscal demands.

The latest increases have stretched the tax system to the limit, says Carlos Loureiro, a tax partner at Deloitte. “The current model is exhausted. We need to do something different,” he says. “Any further increase in tax rates is unlikely to result in increased revenue.” Income from value added tax, the government’s biggest source of tax revenue representing about 36 per cent of the total, has been falling since 2008, despite a sharp increase in the rate – the main rate is now 23 per cent. Both the government and the European Commission have acknowledged the risks of depending on increased tax revenue, which is more growth sensitive, to meet fiscal targets and contingency spending cuts amounting to 0.5 per cent of national output have prepared in case of another tax shortfall.

I almost want to laugh at the part of the excerpt which notes that tax revenue “has been falling…despite a sharp increase in the rate.”

Maybe it’s time for these fiscal pyromaniacs to realize that revenues might be falling because rates are higher. In other words, Portugal not only isn’t at the ideal point on the Laffer Curve (collecting the amount of revenue needed to finance legitimate activities of government), it may even be past the revenue-maximizing part of the curve.

To be fair, there are lots of factors that determine economic performance, so higher tax burdens are just one possible explanation for why the tax base is shrinking or stagnant.

The one thing we can state with certainty, though, is that Portugal’s fiscal problem is too much government spending. The failure to address this problem then leads to very unpleasant symptoms, such as lots of red ink and self-destructive class-warfare tax policy.

If all that sounds familiar, that’s because it’s also a description of what President Obama is proposing for the United States.

Ummm…shouldn’t they be targeting politicians?

P.S. I don’t want to imply that Portugal is a total basket case. True, I’m not optimistic about the country’s future, but at least some lawmakers now acknowledge that Keynesian spending was a big mistake. And there are even signs that Portuguese officials are beginning to realize that lower tax rates should be part of the solution. But good policy may be impossible since so many people now have a moocher mentality.

P.P.S. At the risk of bearing bad news to close the year, research from both the Bank for International Settlements and the Organization for Economic Cooperation and Development shows the United States actually faces a bigger long-run fiscal challenge than Portugal.

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Chuck Asay has produced some great political cartoons, including personal favorites such as the Geithner-Obama tractor, the big-bad-wolf economic climate, and (his all-time best, in my humble opinion) the nothing-left-to-steal warning for statists.

Here’s one that’s quite appropriate for today since the politicians are busy negotiating over how to raise taxes while failing to address the real problem of a federal government that is too big and spending too much.

What makes this cartoon so perceptive is that it shows how many – if not most – Republicans are just as willing and happy as Democrats to exacerbate our fiscal problems.

Asay Kick the Can Cartoon

The only bad news is that the cartoon implies the Tea Party has the ability to stop Obama and the other big spenders from kicking the can down the road.

If only. We’re going to get a tax increase in January and there’s nothing the Tea Party can do to stop that from happening. They can’t force Obama, the Senate, or even the GOP leadership in the House to implement pro-growth spending reforms such as a Swiss-style spending cap.

But at least there are some lawmakers who are fighting to do what’s right. I don’t know if they’ll ever succeed, but at least some folks in Washington understand that something needs to happen to restrain the burden of government spending.

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Back in September, I shared a very good primer on the capital gains tax from the folks at the Wall Street Journal, which explained why this form of double taxation is so destructive.

I also posted some very good analysis from John Goodman about the issue.

Unfortunately, even though the United States already has a very anti-competitive system – as shown by these two charts, some folks think that the tax rate on capital gains should be even higher.

And it looks like they’re going to succeed, either because we go over the fiscal cliff or because Republicans acquiesce to Obama’s punitive proposal.

But this won’t be good for American competitiveness. Here’s some of what my colleague Chris Edwards just wrote about the issue.

Capital Gains Rates US v OECDNearly every country has reduced tax rates on individual long-term capital gains, with some countries imposing no tax at all. …If the U.S. capital gains tax rate rises next year as scheduled, it will be much higher than the average OECD rate. …Capital gains taxes raise less than five percent of federal revenues, yet they do substantial damage. Higher rates will harm investment, entrepreneurship, and growth, and will raise little, if any, added federal revenue. …Figure 1 shows that the U.S. capital gains tax rate of 19.1 percent in 2012 is higher than the OECD average rate of 16.4 percent.  These figures include both federal and average state-level tax rates on long-term capital gains. Next year, the expiration of the Bush tax cuts will push up the U.S. rate by 5 percentage points, and the new investment tax imposed under the 2010 health care law will push up the rate another 3.8 percent. As a result, the top U.S. capital gains tax rate will be 27.9 percent, which will be far higher than the OECD average. The federal alternative minimum tax and other provisions can increase the U.S. capital gains tax rate even higher.

The worst country is Denmark, at 42 percent, followed by France (32.5 percent), Finland (32 percent), Sweden and Ireland (both 30 percent), and the United Kingdom and Norway (both 28 percent).

Every other developed nations will have a capital gains tax rate below the United States level. And even some of those above the U.S. level often have provisions that spare many taxpayers from this pernicious form of double taxation.

Some countries have exemptions for smaller investors. In Britain, for example, individuals can exempt from tax the first $17,000 of capital gains each year. Eleven OECD countries do not impose taxes on longterm capital gains, nor do some jurisdictions outside of the OECD, such as Hong Kong, Malaysia, and Thailand.

The nations on the list that don’t tax capital gains are Belgium, Czech Republic, Greece, Luxembourg, Mexico, Netherlands, New Zealand, Slovenia, South Korea, Switzerland, and Turkey.

I’m not surprised to see Switzerland on that list since that nation has some very sensible fiscal policies. And the Netherlands, notwithstanding its welfare state and long-run fiscal challenges, is very focused on global competitiveness.

But who would have thought Greece had any good policies?!? Or Belgium? Though maybe that’s one of the reasons why many successful French taxpayers are choosing that nation as a refuge.

Heck, even Russia has abolished its capital gains tax.

In his paper, Chris also gives a good explanation of the underlying tax theory in the capital gains tax debate. Simply stated, the statists like the “Haig-Simons” approach because it justifies class-warfare tax policy.

To maximize growth, we should “tax the fruit of the tree, but not the tree itself.” That is, we should tax the flow of consumption produced by capital assets, not the capital that will provide for future consumption. A Haig-Simons tax base—which includes capital gains—taxes the tree itself.  Why does a Haig-Simons tax base garner support if it is impractical and anti-growth? It appears to be because the liberal idea of “fairness” includes heavy taxation of high earners. Since high earners save more than others, they would be taxed heavily under a Haig-Simons tax base. …Today, many economists favor shifting from an income to a consumption tax base… Under a consumption tax base, savings would not be double-taxed, and capital gains would not face separate taxation because the cashflow from realized gains would be taxed when consumed. With regard to “fairness,” a Haig-Simons tax base penalizes frugal people and rewards the spendthrift. That’s because earnings are taxed a second time when saved, while immediate consumption does not face a further tax. That makes no sense because it is frugal people—savers—who are the benefactors of the economy since their funds get invested in the new businesses and new capital equipment that generates growth.

The right approach is to have a “consumption tax base,” which simply is another way of saying that income shouldn’t be taxed more than one time (as shown in this flowchart).

My video elaborates on all these issues and explains why the right capital gains tax rate is zero.

Writing about the death tax yesterday, I mentioned that it also is a perverse form of double taxation. And just as with the death tax, it’s worth noting that all the major pro-growth tax reform plans  – such as the flat tax or national sales tax – also have no capital gains tax.

It’s bad enough when the IRS gets to tax our income one time. They shouldn’t be allowed more than one bite of the apple.

P.S. Chris makes a very important point about higher capital gains taxes collecting little, if any revenue. Simply stated, there’s a large Laffer Curve effect since investors can choose not to sell an asset if the tax penalty is too high.

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Over the past few years, I’ve shared a handful of images that capture the essence of government.

Now I have something new to add to the list – an image showing the evolution of government.

Evolution of Government

I’m not quite sure what the next-to-last image is supposed to specifically convey, but the clear message throughout is that government means coercion.

And that coercion doesn’t become legitimate merely because 51 percent of the population decides to plunder 49 percent of the population.

Which is perfectly shown by the final image, which accurately portrays today’s system of government and the IRS.

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In some ways, it would be fun to be a leftist.

No, I’m not talking about living a life of idleness and letting others pay my bills, though I suppose that’s tempting to some people.

And I’m not talking about becoming a Washington insider and using corrupt connections to obtain unearned wealth, though I confess I’m actually friends with some of those people.

Instead, I’m talking about what it must be like to engage in reckless demagoguery and personal smears.

Remember during the presidential campaign when Mitt Romney was – for all intents and purposes – accused of causing a woman’s death because of his actions at Bain Capital?

The pro-Obama Super-PAC that produced that ad relied on indirect connections and overlooked some very salient facts that completely disproved even the indirect connections.

But even though the ad was exposed as maliciously false, the folks who put it together probably laughed all the way to the bank.

With this in mind, maybe it’s time to publicly ask why President Obama wants to kill old people.

“Time for your death panel appointment”

This isn’t a blog post about Obamacare, though there certainly are enough horror stories from the United Kingdom to make us fearful of government-run healthcare.

I’m referring instead to what might happen because of Obama’s proposal for a much more onerous death tax, which is part of his class-warfare agenda and would take effect in just a couple of days.

It seems that there’s good evidence this may lead to some premature deaths. CNBC reports.

Many families are faced with a stark proposition. If the life of an elderly wealthy family member extends into 2013, the tax bills will be substantially higher. An estate that could bequest $3 million this year will leave just $1.9 million after taxes next year. Shifting a death from January to December could produce $1.1 million in tax savings. It may seem incredible to contemplate pulling the plug on grandma to save tax dollars. While we know that investors will sell stocks to avoid rising capital gains taxes, accelerating the death of a loved one seems at least a bit morbid—perhaps even evil. Will people really make life and death decisions based on taxes? Do we don our green eye shades when it comes to something this serious? There is good evidence that there is some “elasticity” in the timing of important decisions about life and death.

And what does that mean? Well, according to some of the academic research, the President is going to have proverbial blood on his hands.

Gans and Leigh looked into another natural experiment. In 1979, Australia abolished its federal inheritance taxes. Official records show that approximately 50 deaths were shifted from the week before the abolition to the week after. “Although we cannot rule out the possibility that our results are driven by misreporting, our results imply that over the very short run, the death rate may be highly elastic with respect to the inheritance tax rate,” Gans and Leigh write. This isn’t just something peculiar to Australia. Economists Wojciech Kopczuk of Columbia University and Joel Slemrod of the University of Michigan studied how mortality rates in the United States were changed by falling or rising estate taxes. They note that while the evidence of “death elasticity” is “not overwhelming,” every $10,000 in available tax savings increases the chance of dying in the low-tax period by 1.6 percent. This is true both when taxes are falling, so that people are surviving longer to achieve the tax savings, and when they are rising, so that people are dying earlier, according to Kopczuk and Slemrod. “Death elasticity” does not necessarily mean that greedy relatives are pulling the plug on the dying or forcing the sickly to extend their lives into a lower taxed period. According to a 2008 paper from University of Pittsburgh Medical Center Doctor G. Stuart Mendenhall, while tax increases give potential heirs large economic incentives to limit care that would prolong life, distressed patients may “voluntarily trade prolongation of their life past the end [a low tax period] for large financial implications for their kin.

I’ve previously cited the research from Australia, and also wrote a post about incentives to die in 2010, when the death tax temporarily was abolished, so this research makes sense.

What’s the bottom line?

…based on past reactions to changes in taxes, it at least seems likely that some deaths that might otherwise have occurred shortly after January 1 will occur shortly before. Death may slip in ahead of the tax man for some with estates worth over $1 million.

In the grand scheme of things, I have a hard time feeling anguish about some elderly rich guy dying today rather than one week from now. But there is real data to suggest that Obama’s policies will cause premature deaths.

And these premature deaths will only occur because the President is greedy for more revenue from a tax that shouldn’t even exist. Indeed, it’s worth noting that every pro-growth tax reform plan – such as the flat tax or national sales tax – eliminates this pernicious form of double taxation.

Since I’m an economist, I can’t resist a final comment about this tax having a terrible impact on capital formation. This is bad for workers, since it translates into lower wages.

And it’s definitely not good for U.S. competitiveness.

P.S. Whatever you do, don’t die in New Jersey.

P.P.S. It’s a morbid topic, but there is such a thing as death tax humor.

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By the time you read this post, it’s possible that the buffoons in Washington will have announced a deal on the fiscal cliff. Or perhaps we’ll have another month or more of fake drama.

Regardless of when the deal is announced, I fear the final result will be some sort of victory for Obama, with class-warfare tax policy that will undermine the economy’s long-run growth and reduce American competitiveness.

So let’s at least enjoy some good cartoons while taking another step in our journey to Greek-style fiscal collapse.

If you wonder why I’m feeling so glum, this cartoon is a pretty good summary of the debate. Or perhaps I should say bad summary. No wonder I’ve been wearing my red jacket to cheer myself up.

GOP Dem Fiscal Cliff Cartoon

By the way, don’t think the higher taxes will be balanced by any spending restraint. Click here to see a very depressing chart about Obama’s “balanced” proposal.

At the beginning of the month, I posted a bunch of cartoons that portrayed Obama as being very dogmatic and inflexible in the negotiations, while showing Republicans as being clueless and naive. Well, here’s another one with the same message.

Obama Fiscal Cliff Cartoon 2

So true. If anyone thinks we’ll get something good out of this, such as entitlement reform, get in touch with me because I have some great oceanfront property in Kansas that I’m willing to sell you.

This one targets Congress instead of Republicans, but the idea’s the same.

Obama Fiscal Cliff Cartoon 1

And in the middle of the month, while speculating why the GOP has been losing the debate, I shared a couple of cartoons illustrating potential explanations. Here’s a Chuck Asay cartoon based on the “co-conspirator” theme in that earlier post.

Boehner Fiscal Cliff Cartoon

The part in the final frame about the fiscal cost of Obamacare is a nasty touch, but sadly true.

All told, this is a very unpalatable situation. We’re going to give more of our income to a bunch of spendaholics, and they’re going to use the money to increase the burden of government spending and dig us into a deeper fiscal hole.

Heckuva start to 2013!

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