Sunday, July 20, 2008

Do the rich pay for everything?

In reply to Thought Expirement, a reader commented
It's not that I disagree entirely with you but you build your satire around the assumption of the following extremes: the "rich" pay for everything - by rich do you mean MD rich ($300k / year) or CEO ($40 million annual income) rich? In your model is there a middle class whose collective resources benefit people of similar status?

I wasn't trying to imply that the rich pay for everything, but I could understand how somebody might draw that conclusion. With a satirical post, it's not always obvious which parts are satire and which parts are direct. What I was trying to suggest is that I think there are lot of people on the left who think that it's possible to pay for everything by taxing the rich. Their logic is that if the government needs more money to fund a program, it's only a matter of raising taxes on the wealthiest Americans. I believe this is fundamentally flawed and it has to do with the nature of money, wealth, and what it means to pay for something.

In terms of direct taxes, there are lots of statistics. The National Center of Policy Analysis has an article saying the wealthiest 1% pay 35% of the taxes. There are lots of studies about that, but I don't think they tell the full story. As I said, I am more interested in getting to the deeper nature of this question.

So let's take the most extreme example: people like Warren Buffet -- the wealthiest of the wealthiest. It should be possible to pay for many government programs by taxing these people more. The reality though is that even if we doubled the taxes paid by billionaires like Warren Buffet, it would likely have almost zero impact on their lifestyles or their consumption. Warren Buffet lives an extremely simple life. According to Wikipedia, "
He lives in the same house in the central Dundee neighborhood of Omaha that he bought in 1958 for $31,500, today valued at around $700,000." I heard his typical dinner is a cheeseburger from the local diner.

So what does it mean to tax Buffet more? It pretty much means that we'll take capital that Buffet would invest in productive companies and instead give it to the government. As history has shown, governments are terribly inefficient at allocating capital. This is why socialism and communism don't lead to productive economies. Most of the money government takes in is consumed. Some of it may be used to build infrastructure like roads and bridges, but very little of it will be used to create the next generation of great companies that will help make the world wealthier. There is a good reason why companies like Microsoft, Google, Intel, and Apple are all products of the private sector. Most of the money the government takes in goes to the military or to really inefficient capital allocation like farm subsidies. Some of the money is redistributive. It may help feed some poor people today, but for the most part, it won't be a real investment in their future. Little of it will be used for productive capital that will provide them jobs in the future.

What I am trying to say is that the wealthiest wouldn't really be paying the cost of these taxes -- everybody would. There was some level of taxation that would have prevented companies like Google or Microsoft from coming into existence. And everybody would be a lot worse off without those companies. There are some companies that would currently exist if more capital had been invested by the private sector in things people want (longer lives, better education for their children, better healthcare) than those things politicians want (a military empire, corporate welfare for their cronies, lucrative lobbyist jobs after they retire, etc.,). So somewhere out there are a handful of people that aren't billionaires because they didn't get to create those companies, but that isn't the real cost to society. The people who paid those taxes were average Americans who now won't get the benefit of those companies that never were created. As Henry Hazlitt wrote in Economics in One Lesson, "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

Now Buffet is the extreme example, but I believe the same is true for the majority of wealthy people whether it be the "MD rich" or the "CEO rich". Certainly, many of these people spend a lot more on consumption and lavish lifestyles than the average person. But I think the majority of these people are saving the money and investing in it like Buffet is. Many people may think of the worst excesses associated with being wealthy and that is what is often reported on television. But that is the outlier case (though the most entertaining for sure). For the most part, wealth is being invested in future production that will help improve the lives of everybody in the future. If you tax these people a little bit more, it will mostly have an unnoticeable impact on their lifestyle but have a large impact on how capital is allocated. If you tax them excessively, it can destroy the economy altogether because it takes the incentive out of making money. If my tax rate were 90% for example, there would have been very little benefit to me working hard as a software engineer. I would have hung out at the beach instead of integrating chat into Gmail. And there probably wouldn't have even been a Google or a Gmail at all because the other people I work with would have probably have been at the beach with me.

I hope I answered the question of who really pays the taxes.

Thought Experiment

Here's an idea that I think my socialist friends in San Francisco might love.

We'll have the city of San Francisco open up a chain of restaurants. We'll make them completely free and the city will pay for them with taxes. We'll tax wealthy people the most so that the people without much money won't have to pay any taxes for this service. Since it's free, it will have the additional benefit of causing most of the profit-seeking restaurants in the city to close down. Even though they may sell better food, it's hard to compete with something that is free to the customer. But since there's little competition, the food quality in our public restaurants may suffer or vary too much from neighborhood to neighborhood. The people in the wealthier neighborhoods may try to help their restaurants get better ingredients, but that wouldn't be fair to people in lower income neighborhoods. To solve this, we'll create a central bureaucracy that will set food standards across the entire city. Although the overhead of this bureaucracy will cost about 20% of the total cost of the entire operation, it'll be worth it because we'll have uniform standards set by professionals who know what is best for us. And it'll be funded for by taxes from wealthy people who already have too much money.

Some super wealthy people may choose to go to private restaurants, but it will be a tiny minority because few people can afford to pay taxes once for their public restaurants and then pay a second fee to private establishments. Those establishments will be very expensive because they will only cater to the wealthiest and the tiny demand will severely limit competition. Although our leaders will all dine at these elite establishments, they will stand behind the quality and cost of the public restaurants.

Some other people may choose to pay for raw ingredients and eat at home, but we'll demonize those home-cookers as being anti-social and weird. We'll wonder why they don't want to eat with the rest of us? Is our food not good enough for them? It would be too dangerous to let this trend catch on. But it'll be okay -- eventually one of them will screw up and that's when we'll pounce. Perhaps, one of them will get food poisoning and we'll feign outrage. Although the incidence rate of food poisoning is the same at both public and home kitchens, the general population knows that statistics lie. We'll say we must protect these home-cookers from poisoning themselves and we'll demand they change their ways and eat like the rest of us.

Hopefully, this model will become so successful that we'll replicate it to the state level. And then other states will copy it. To ensure that things are fair from state to state, we'll pass "No eater left behind" legislation to ensure consistent standards. We'll have to raise more taxes though to fund the Department of Gastronomy.

Of course, no system is perfect. Problems may arise from time to time. For example, the workers at these state-run monopolies may realize they have a lot more leverage than they would in a free marker. Where would people eat if they went on strike? They will negotiate lucrative contracts that guarantee it's virtually impossible to get fired and everybody will get a fair salary based on seniority instead of based on the quality of their work. After all, how would it be fair to pay Michelle more than David just because Michelle works longer hours.

Some people though may not like the food they are getting. They will demand better from their state government. Some forward-looking free market thinkers may realize that we should give these eaters more choices. We'll allow a few charter restaurants to be created. They will receive funds from the state and the eaters will get vouchers to dine at these quasi-private establishments. These charter restaurants will be loathed by the public restaurants. The employees of the public restaurants will not like the employment practices at the charter restaurants such as firing waiters who are under-performing or giving some cooks bonuses because their food is better. They will say that these charter restaurants don't meet the same standards as the public ones and demand that this be fixed to protect eaters. The charter restaurants will be forced to comply with the thousands of pages of regulations created by the public food bureaucracy, but it will be very difficult for them because they don't have their own giant bureaucracy for ensuring compliance. Some charter restaurants will stay around but only enough to placate the most unhappy eaters and not so many that the overall system is destabilized.

Now, isn't this so much better than the current model of having those profit-seeking restaurants of varying quality all over the city. Some of them are mom and pop places that go out of business when their customers don't like their food. How unjust is that!

There are those of you who may think this is a pretty silly idea. But if it works so well for primary and secondary education, why not replicate it to other areas. Hopefully, I've convinced the naysayers.

Thursday, July 17, 2008

Nine Republicans Break Party Ranks: Send Impeachment Article to Judiciary for Hearings

I can't even find info about this in the mainstream press. There must be a press blackout on it. But here is a link to an article saying

In a stunning development which fell with the silence of a feather yesterday, nine Republicans broke with their iron-fisted party to put country first, and voted to send Rep. Dennis Kucinich's article of impeachment HR 1345 to the Judiciary, where Chairman John Conyers will hold a hearings on abuses of power by the Bush administration, according to the Congressional Quaterly's CQToday. The final vote was: Yea 238 - Nay 180.

The Nine Republicans are: Congressman Kevin Brady (TX) Congressman Wayne Gilchrest (MD) Congressman Walter B. Jones (NC) Congressman Don Manzullo (IL) Congressman Tim Murphy (PA) Congressman Ron Paul (TX) Congressman Dave Reichert (WA) Congressman Christopher Shays (CT) Congressman Mike Turner (OH)

One of the Republicans, Walter Jones, represents Camp LeJeune in North Carolina, one of the largest Marine bases in the country, and one which has borne heavily the sacrifice of the Iraq War.

I am glad that Ron Paul voted for this. He is a true patriot.

Wednesday, July 16, 2008

Ron Paul on Kudlow

Video link

They are giving Ron Paul a decent amount of speaking time. I guess they finally are starting to realize that he's been right all those years. It's certainly looking like that now.

Saturday, July 5, 2008

Inflation or Deflation (Taking Money Back - Part 2)

I was just rereading my previous blog post Taking Money Back and I think I could have done a better job connecting the dots. In the first paragraph, I talked about rising food and oil prices. In the second and third paragraph, I talked about monetary inflation and how this new credit and money was chasing too few investment opportunities. I didn't really explain how this is leading to higher food and oil prices. But before I get to that, I want to provide some more background.

There is a great debate among many economists that I read on whether we're experiencing inflation (the creation of money and credit) or deflation (the destruction of money and credit). And this is just among those who would consider themselves followers of the Austrian School of Economics. In one corner, there are people like Mike Sheldock of Mish's Global Economics Trend Analysis that argue we're seeing deflation. He points to the destruction of credit in the financial markets, the fall in housing prices, the downward pressure in wages of American workers, and the falling stock market. On the other side are people like Peter Schiff of Euro Pacific Capital who believe the Fed is inflating. He points to the rise in gold and commodity prices, the increases in M3 and other monetary measures, and the fall of the dollar. It is pretty interesting how economists that have very similar views on the market, the government, and central banks could disagree so dramatically on such a basic issue.

My opinion is that they are both partially right. As I pointed out in my previous post, we've seen global savings double in a very short period of time. This was due to massive inflation by central banks across the world. The Fed kept interest rates far below the market rate for years creating enormous amounts of credit and liquidity. The Bank of Japan had the most accomodating monetary policy imaginable with 0% interest rates. The Chinese and Middle Eastern countries were accomplices to the Federal Reserve with their dollar pegs that resulted in them inflating to keep up with the United States. This led to global savings doubling in such a short time. This wasn't simply real savings resulting in people deferring consumption in order to save for future consumption (what individuals do when they decide to save for a house instead of spending it on the movies). This was massive amounts of new money being created and lent out.

The reason this worked for so long is because we had massive productivity increases with the advent of computers, the Internet, and the growth in the BRIC economies. This helped mask the inflation. All these productivity gains should have caused prices to drop dramatically, but central banks fear falling prices and governments love inflation because it allows politicans to finance their pet projects. So we had years of massive inflation, but prices of most things we consume rose only modestly as the increases caused by the new money was somewhat offset by productivity gains and low wages of foreign workers. The purchasing power of savers should have rose dramatically, but instead it barely kept up.

But all that new money had to go somewhere and somewhere it went. Fixed income savings of $70T wants to get a good return. And getting a 1% return on treasuries when even the CPI is higher isn't a successful recipe for pension funds and insurance companies. All that money went into the biggest credit bubble the world has ever seen. And there's been plenty of good articles and blogs about this subject. I highly recommend This American Life's episode titled The Giant Pool of Money.

So now the housing bubble has popped. Billions if not trillions of dollars of credit are being destroyed. When somebody defaults on their house and the bank can only sell it for 60% of the mortgage, that other 40% is just gone. That's true deflation. That is destruction of money and credit. The money came into existence out of thin air when central banks and the financial system created it and when that loss is written off, it just goes back into thin air. This is the deflation Mish is referring to. But what is the inflation Peter Schiff is referring to? Ah, this is where it gets connected back to rising oil and commodity prices. While there may be some credit deflation happening, most of that $70T is still in existence and it's trying to find a new place to go to find a return. The interest rates on treasuries are very low partly because the Fed has dropped the fed funds rate to 2%. That is a negative real return on money when compared to even the understated CPI. If these investments can't get a decent return on bonds, some of it is going to go to other places like precious metals and commodities.

But this is still only part of the story. The United States created so many dollars in the past and the world just doesn't need that many more. China and the countries that supply us with oil receive enormous numbers of dollars, way more than they need to buy stuff that we produce that they want (i.e. the trade deficit). And because the dollar has been the world's reserve currency for decades, all the wealthy countries in the world have already accumulated huge numbers of dollars. And they are beginning to wonder why they should keep accumulating this paper. And basic supply and demand says that if the demand for dollars is decreasing, the prices of things denominated in dollars will rise. And they are. The entire world wants more oil and food. They want fewer dollars.

So that's pretty much the story and we can expect it to continue for a while. Even if there's lots of deflation happening in the credit markets, that deflation is small compared to what will appear to us like inflation if all the countries that have accumulated trillions of dollars start sending them back to us to purchase real goods. The purchasing power of the dollar will keep going down until the imbalances are fixed. And then it may overshoot because markets often overshoot. Politicans will predictibly blame "evil" speculators and the "dangerous" free market. Funny that they didn't blame speculators and the free market when housing prices were rising. At any rate, the blame lies fully with the government. None of this could ever have happened under a gold standard.

Taking Money Back

I read an essay by Murray N. Rothbard called "Taking Money Back" that recently appeared in the newsletter of the Ludwig von Mises Institute. I think it's timely as rising oil and food prices have become such a talking point in the media and a central issue of the 2008 presidential election. Political and economic pundits mostly argue about whether speculators are causing the rice in prices or whether it's being caused by the fundamental supply and demand. One aspect that is rarely talked about in the mainstream press is the role of money and monetary inflation.

In The Giant Pool of Money, the guest explains how world savings increased from $36T in 2000 to $70T in 2006. That's almost a doubling of world savings in just six years. It basically took a couple thousand years for world savings to get to $36T and then only another six years for it to double. The guest further points out that although world savings doubled, the number of investment opportunities didn't double and this combined with absurdly low interest rates thanks to Alan Greenspan resulted in a the housing and credit bubble.

Basically, the problem was that there was too much money chasing too few investments. The question is how can this possibly happen. How is it possible for there to be too much money in the world? Most people probably think that there is a fixed amount of money in the world. It would seem like that based on how our lives work. I buy groceries at the supermarket -- the supermarket now has more dollars and I have fewer. I get a paycheck from my employer -- their accont decreases by the amount of my paycheck. It all seems like a zero-sum game. Sometimes we do get hints that this isn't how things work. A bottle of coke used to cost 5 cents and now it costs a dollar, although it takes far less labor and resources to make a coke than it did in the 1940's.

To understand why this happens, one should read this essay by Rothbard:

Full article at

Taking Money Back
Murray N. Rothbard

Money is a crucial command post of any economy, and therefore of any society. Society rests upon a network of voluntary exchanges, also known as the "free-market economy"; these exchanges imply a division of labor in society, in which producers of eggs, nails, horses, lumber, and immaterial services such as teaching, medical care, and concerts, exchange their goods for the goods of others. At each step of the way, every participant in exchange benefits immeasurably, for if everyone were forced to be self-sufficient, those few who managed to survive would be reduced to a pitiful standard of living.

Direct exchange of goods and services, also known as "barter," is hopelessly unproductive beyond the most primitive level, and indeed every "primitive" tribe soon found its way to the discovery of the tremendous benefits of arriving, on the market, at one particularly marketable commodity, one in general demand, to use as a "medium" of "indirect exchange." If a particular commodity is in widespread use as a medium in a society, then that general medium of exchange is called "money."

The money-commodity becomes one term in every single one of the innumerable exchanges in the market economy. I sell my services as a teacher for money; I use that money to buy groceries, typewriters, or travel accommodations; and these producers in turn use the money to pay their workers, to buy equipment and inventory, and pay rent for their buildings. Hence the ever-present temptation for one or more groups to seize control of the vital money-supply function.

Many useful goods have been chosen as moneys in human societies. Salt in Africa, sugar in the Caribbean, fish in colonial New England, tobacco in the colonial Chesapeake Bay region, cowrie shells, iron hoes, and many other commodities have been used as moneys. Not only do these moneys serve as media of exchange; they enable individuals and business firms to engage in the "calculation" necessary to any advanced economy. Moneys are traded and reckoned in terms of a currency unit, almost always units of weight. Tobacco, for example, was reckoned in pound weights. Prices of other goods and services could be figured in terms of pounds of tobacco; a certain horse might be worth 80 pounds on the market. A business firm could then calculate its profit or loss for the previous month; it could figure that its income for the past month was 1,000 pounds and its expenditures 800 pounds, netting it a 200 pound profit.

Gold or Government Paper

Throughout history, two commodities have been able to outcompete all other goods and be chosen on the market as money — two precious metals, gold and silver (with copper coming in when one of the other precious metals was not available). Gold and silver abounded in what we can call "moneyable" qualities, qualities that rendered them superior to all other commodities. They are in rare enough supply that their value will be stable, and of high value per unit weight; hence pieces of gold or silver will be easily portable, and usable in day-to-day transactions; they are rare enough too, so that there is little likelihood of sudden discoveries or increases in supply. They are durable so that they can last virtually forever, and so they provide a safe "store of value" for the future. And gold and silver are divisible, so that they can be divided into small pieces without losing their value; unlike diamonds, for example, they are homogeneous, so that one ounce of gold will be of equal value to any other.

The universal and ancient use of gold and silver as moneys was pointed out by the first great monetary theorist, the eminent 14th-century French scholastic Jean Buridan, and then in all discussions of money down to money and banking textbooks until the Western governments abolished the gold standard in the early 1930s. Franklin D. Roosevelt joined in this deed by taking the United States off gold in 1933.

There is no aspect of the free-market economy that has suffered more scorn and contempt from "modern" economists, whether frankly statist Keynesians or allegedly "free market" Chicagoites, than has gold. Gold, not long ago hailed as the basic staple and groundwork of any sound monetary system, is now regularly denounced as a "fetish" or, as in the case of Keynes, as a "barbarous relic." Well, gold is indeed a "relic" of barbarism in one sense; no "barbarian" worth his salt would ever have accepted the phony paper and bank credit that we modern sophisticates have been bamboozled into using as money.

But "gold bugs" are not fetishists; we don't fit the standard image of misers running their fingers through their hoard of gold coins while cackling in sinister fashion. The great thing about gold is that it, and only it, is money supplied by the free market, by the people at work. For the stark choice before us always is: gold (or silver), or government. Gold is market money, a commodity which must be supplied by being dug out of the ground and then processed; but government, on the contrary, supplies virtually costless paper money or bank checks out of thin air.

We know, in the first place, that all government operation is wasteful, inefficient, and serves the bureaucrat rather than the consumer. Would we prefer to have shoes produced by competitive private firms on the free market, or by a giant monopoly of the federal government? The function of supplying money could be handled no better by government. But the situation in money is far worse than for shoes or any other commodity. If the government produces shoes, at least they might be worn, even though they might be high-priced, fit badly, and not satisfy consumer wants.

Money is different from all other commodities: other things being equal, more shoes, or more discoveries of oil or copper benefit society, since they help alleviate natural scarcity. But once a commodity is established as a money on the market, no more money at all is needed. Since the only use of money is for exchange and reckoning, more dollars or pounds or marks in circulation cannot confer a social benefit: they will simply dilute the exchange value of every existing dollar or pound or mark. So it is a great boon that gold or silver are scarce and are costly to increase in supply.

But if government manages to establish paper tickets or bank credit as money, as equivalent to gold grams or ounces, then the government, as dominant money-supplier, becomes free to create money costlessly and at will. As a result, this "inflation" of the money supply destroys the value of the dollar or pound, drives up prices, cripples economic calculation, and hobbles and seriously damages the workings of the market economy.

The natural tendency of government, once in charge of money, is to inflate and to destroy the value of the currency. To understand this truth, we must examine the nature of government and of the creation of money. Throughout history, governments have been chronically short of revenue. The reason should be clear: unlike you and me, governments do not produce useful goods and services that they can sell on the market; governments, rather than producing and selling services, live parasitically off the market and off society. Unlike every other person and institution in society, government obtains its revenue from coercion, from taxation. In older and saner times, indeed, the king was able to obtain sufficient revenue from the products of his own private lands and forests, as well as through highway tolls. For the State to achieve regularized, peacetime taxation was a struggle of centuries. And even after taxation was established, the kings realized that they could not easily impose new taxes or higher rates on old levies; if they did so, revolution was very apt to break out.

Controlling the Money Supply

If taxation is permanently short of the style of expenditures desired by the State, how can it make up the difference? By getting control of the money supply, or, to put it bluntly, by counterfeiting. On the market economy, we can only obtain good money by selling a good or service in exchange for gold, or by receiving a gift; the only other way to get money is to engage in the costly process of digging gold out of the ground. The counterfeiter, on the other hand, is a thief who attempts to profit by forgery, e.g., by painting a piece of brass to look like a gold coin. If his counterfeit is detected immediately, he does no real harm, but to the extent his counterfeit goes undetected, the counterfeiter is able to steal not only from the producers whose goods he buys. For the counterfeiter, by introducing fake money into the economy, is able to steal from everyone by robbing every person of the value of his currency. By diluting the value of each ounce or dollar of genuine money, the counterfeiter's theft is more sinister and more truly subversive than that of the highwayman; for he robs everyone in society, and the robbery is stealthy and hidden, so that the cause-and-effect relation is camouflaged.

Recently, we saw the scare headline: "Iranian Government Tries to Destroy U.S. Economy by Counterfeiting $100 Bills." Whether the ayatollahs had such grandiose goals in mind is dubious; counterfeiters don't need a grand rationale for grabbing resources by printing money. But all counterfeiting is indeed subversive and destructive, as well as inflationary.

But in that case, what are we to say when the government seizes control of the money supply, abolishes gold as money, and establishes its own printed tickets as the only money? In other words, what are we to say when the government becomes the legalized, monopoly counterfeiter?

Not only has the counterfeit been detected, but the Grand Counterfeiter, in the United States the Federal Reserve System, instead of being reviled as a massive thief and destroyer, is hailed and celebrated as the wise manipulator and governor of our "macroeconomy," the agency on which we rely for keeping us out of recessions and inflations, and which we count on to determine interest rates, capital prices, and employment. Instead of being habitually pelted with tomatoes and rotten eggs, the chairman of the Federal Reserve Board, whoever he may be, whether the imposing Paul Volcker or the owlish Alan Greenspan, is universally hailed as Mr. Indispensable to the economic and financial system.

Indeed, the best way to penetrate the mysteries of the modern monetary and banking system is to realize that the government and its central bank act precisely as would a Grand Counterfeiter, with very similar social and economic effects. Many years ago, the New Yorker magazine, in the days when its cartoons were still funny, published a cartoon of a group of counterfeiters looking eagerly at their printing press as the first $10 bill came rolling off the press. "Boy," said one of the team, "retail spending in the neighborhood is sure in for a shot in the arm."

And it was. As the counterfeiters print new money, spending goes up on whatever the counterfeiters wish to purchase: personal retail goods for themselves, as well as loans and other "general welfare" purposes in the case of the government. But the resulting "prosperity" is phony; all that happens is that more money bids away existing resources, so that prices rise. Furthermore, the counterfeiters and the early recipients of the new money bid away resources from the poor suckers who are down at the end of the line to receive the new money, or who never even receive it at all.

New money injected into the economy has an inevitable ripple effect; early receivers of the new money spend more and bid up prices, while later receivers or those on fixed incomes find the prices of the goods they must buy unaccountably rising, while their own incomes lag behind or remain the same. Monetary inflation, in other words, not only raises prices and destroys the value of the currency unit; it also acts as a giant system of expropriation of the late receivers by the counterfeiters themselves and by the other early receivers. Monetary expansion is a massive scheme of hidden redistribution.

When the government is the counterfeiter, the counterfeiting process not only can be "detected"; it proclaims itself openly as monetary statesmanship for the public weal. Monetary expansion then becomes a giant scheme of hidden taxation, the tax falling on fixed income groups, on those groups remote from government spending and subsidy, and on thrifty savers who are naive enough and trusting enough to hold on to their money, to have faith in the value of the currency.

Spending and going into debt are encouraged; thrift and hard work discouraged and penalized. Not only that: the groups that benefit are the special interest groups who are politically close to the government and can exert pressure to have the new money spent on them so that their incomes can rise faster than the price inflation. Government contractors, politically connected businesses, unions, and other pressure groups will benefit at the expense of the unaware and unorganized public.

Read the rest.

Wednesday, July 2, 2008

Obama Tax Plan

I was doing some number crunching tonight on how the Obama's tax plan would affect wealthy wage earners. I think this is an interesting analysis because some of the biggest donors to Obama's campaign and the Democratic party are wealth lawyers, doctors, and bankers.

The main changes in the plan with respect to income (ignoring capital gains for now) are
  1. Highest marginal tax rate increases from 35% to 39%,
  2. Social security taxes apply to anything over $250K.
A married lawyer in a single income household making $500/year would see his federal taxes (income tax + payroll taxes) increase $32K from $176K to $208. This represents an overall tax rate increase from 35.1% to 41.5%. If this person lives in New York City or California, they are likely to pay over 9% of their income to the state. This means they are getting very close to paying most of their income to the government. At $500K it's pretty close to half depending on deductions and exemptions. Anything much higher and it's squarely in the category of paying more than half to the government. A neurosurgeon in the same situation making $1,000,000/year is going to see his taxes increase by $90K putting him at paying close to 54% of his income to the government if he lives in California.

I wonder if there's a psychological effect when somebody realizes that 7 months of the year are spent working just to pay the government.

This includes only the direct effects of the taxes on high wage owners. It's not clear if the companies paying these earners will have to pay an additional 7.5% also on the wages over $250K. If so, these lawyers and doctors may see their wages decreased or more likely for the costs to be passed on to the customers.

I wonder if Obama will really be able to pass this tax plan. He will be taking a lot of money away from his largest contributors. Then again, maybe these contributors making it back on the flip side. Univeral healthcare would be a huge handout to the medical industry. Increasing the regulatory framework that is likely under a Democratically controlled Federal government will mean huge new business for lawyers. Tax laywers are likely to see a surge in their services as higher rates driver incent wealthy people to find more ways to protect their money from the government. And a big bailout of deliquent homeowners from an Obama plan would be an enormous gift to the banking industry. And could Obama really simplify the tax code by sending the majority of Americans a tax bill instead of requiring them to buy Turbo Tax or go to H&R Block? I learned recently that Intuit and other tax lawyers spend ridiculous amounts of money lobbying the Federal government to keep the tax code complex to maintain their businesses. Is Obama going to take away their customers?

If this plan does pass, I predict it will result in a bigger government spending more money on things we don't need. For example, Obama wants to increase the size of the military and add more subsidies for ethanol. The main outcome will be increased price inflation which will mostly affect the people Obama most wants to help. It will result in loss of jobs and economic growth. The fastest growing economies are outside the United States where taxes are much lower. We're already seeing a problem retaining talent in this country. University students from China and India studying here used to stay here and take jobs. We're now seeing them return to their countries after they get their degrees. I think this will become the norm.