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We've Hit The Tipping Point with Over 50% Not Paying Taxes

My friend Dan Mitchell, senior fellow at the Cato Institute, had a frightening blog post today.  According to the Ways and Means Committee, 51% of households paid no income tax in 2009.  Click here for his piece.

This is a dangerous tipping point as with over half of households paying no taxes, the incentives to increase government spending are horribly skewed in the voting population.  Why not vote for increased spending when it costs you nothing…. at least not immediately?   As we’ve seen across the world, the entire economy suffers when the government consumes too much of the economy, but that doesn’t always sink in when an individual is at the polling booth, looking for the easiest way to protect their own short-term interests.

Aside from the obvious moral hazard of this type of code, skewing the tax burden so heavily towards the higher income earners makes for vastly more volatile tax receipts than would result from a more broad-based system.  Higher income earners tend to have more volatile income levels, thus their annual tax payments vary more.  Government typically does not cut spending when there is a decline in tax receipts, but rather continues to increase expenditures year after year, regardless of receipts.  Simple math leads one to recognize that a system which generates volatile receipts and a government that tends to spend above the highest tax receipt level, will generate deficits more often than not thus growing national debt will be the name of the game.  This is not a sustainable system.

An Alternative To Increasing Taxes

I hear politicians and pundits talking about the massive federal debt and assume that the only way to deal with the problem is to raise tax rates.   Raising rates in tough economic times can be very damaging to the economy and may in fact, result in lower tax receipts as tax payers can shift their behavior in response to higher taxes.  Dan Mitchell of the Cato Institute put together a video on the subject.

The Rahn Curve

As I head off to Las Vegas for an exceptionally inspiring conference called FreedomFest, I thought I’d leave you with a great video from my friend Dan Mitchell about the Rahn Curve, (developed by Richard Rahn) which graphically illustrates the relationship between the size of government and the economic success of a country.  On the one extreme, anarchy is incredibly expensive and suppresses productivity.  On the other extreme, an large government, with onerous tax burdens is also debilitating for an economy.  As an investment advisor I watch the direction the nation is taking, as over the long-run that will affect overall GDP and investment opportunities.  We are currently on a disconcerting trajectory of government expansion, with increasing sovereign debt and onerous rules and regulation to control and limit the growth of business.  While Europe moves away from Keynesian economics as they realize the consequence of entitlement programs they cannot afford, we continue to expand ours.

What does Fiscal or Monetary Policy mean?

What does Fiscal or Monetary Policy mean?

We hear a lot of talk about which government policies can help get the economy back on its feet. I thought I’d provide a quick cheat sheet on just what these various terms actually mean.

This chart shows the complete list of tools that the federal government has to affect the economy.  There are two main types of policy, monetary and fiscal.  When you hear monetary policy think Federal Reserve.  When you hear fiscal policy, think IRS and federal spending.

The Federal Reserve can alter two things to affect the economy, the Fed Funds rate and the Money Supply.

Interest Rates:  The Federal Funds target rate is the interest rate at which private depository institutions, (mostly banks) lend the funds they hold at the Federal Reserve to each other, generally overnight.  It can be thought of as the rate banks charge each other.  This target rate is identified in a meeting of the members of the Federal Open Market Committee which usually meets eight times a year.  The New York Fed affects this rate by trading government securities.

Money Supply:  The Federal Reserve typically alters the money supply by increasing or decreasing bank reserves.  (See prior post on Fractional Reserve Banking for details on bank reserves.)

Tax and Spend:  What else need be said?  Fiscal policy involves the government increasing or decreasing taxes and the amount of federal spending, which let’s face it, pretty much just goes up.

Why The Capital Gains Tax Should Be Abolished

As many of you who follow this blog can probably surmise, I am not a big fan of the the current capital gains tax and now the administration is looking to increase the tax 33%, from from 15% to 20%.  A friend of mine over at the Center for Freedom and Prosperity, (he’s also a senior fellow with the Cato Institute) put together a great video on why this tax should be abolished, using simple, common sense rationale.

The Insanity of the Federal Tax Code

After the horror of yesterday’s tax filing and the corresponding drop in my net worth, I decided to do a little research.  In 1913 the federal tax code was about 400 pages long.  Today it is around 70,000.  Americans spend 7.6 billion hours a year preparing taxes, which equates to about 3.8 million skilled workers, making the tax compliance industry SIX TIMES the size of the U.S. auto industry, (source National Taxpayer Advocate).  Imagine what growth could be achieved in our country if those resources were directed towards productive endeavors rather than filling out forms and trying to decipher vague and conflicting rules. 

82% of Americans need help preparing their taxes, 60% hire a professional tax preparer and 22% use software.  The federal government requires funding for those powers it is to exercise under the Constitution, but I cannot for the life of me understand why a nation that was founded on the rule of law has a tax code that is impossible to follow accurately with any degree of confidence and requires such outrageous expenditures by individuals and businesses.