Sunday, March 29, 2009

David Stockman Reprise

Concerning President Ronald Reagan's 1981 tax cut, in November 1981 David Stockman, director of the Office of Management and Budget, said this to William Greider of the Atlantic Monthly:

“Do you realize the greed that came to the forefront? The hogs were really feeding. The greed level, the level of opportunism, just got out of control. The administration’s basic strategy was to match or exceed the Democrats [on both tax cuts and spending], and we did.”

Stockman’s experience in Washington can be boiled down to one phrase: “There are no real conservatives in Washington.”

Stockman’s words to Greider apply equally to the first six years of President Bush’s two terms with Republican control of Congress, made famous by “the bridge to nowhere.”

Following suit, the greed level, the level of opportunism, just got out of control in the financial ssector. Bush’s administrators and regulators were either inept, asleep, or willing accomplices.

The few remaining outspoken conservatives in the Republican party have no credibility when it comes to federal spending or deficits. That mantle belongs to President Clinton.

Saturday, March 28, 2009

What? Another Tax Reform Commission?

How many tax reform commissions could reform taxes if a tax reform commission could reform taxes?

On January 7, 2005, President Bush established a bipartisan Advisory Panel on Federal Tax Reform. The panel, chaired by former Senators Connie Mack III and John Breaux, produced a 280 page report with several excellent ideas for simplification and reform. On November 1, 2005, they presented it to then Treasury Secretary John Snow, who promptly threw it in the wastebasket.

Previous blue ribbon commissions have fared little better. The work of their members is praised but disregarded by the president, the Congress, or both.

On March 25, 2009, President Obama asked Paul Volcker to head up yet another tax code overhaul review. Its members include Harvard’s Martin Feldstein, Berekeley’s Laura D’Andrea Tyson, Chicago’s Austan Goolsbee, and several other prominent individuals. They will doubtless make a sincere effort to recommend measures to overhaul the tax code. As in past reviews, their report will die in the executive branch or Congress, save for those measures that raise more revenue without too much political flak.

My suggestion in one sentence: Propose that every amendment enacted since January 1, 1987, be repealed and that the federal income tax be restored to the law extant on December 31, 1986, that is, the text of President Reagan’s Tax Reform Act of 1986. The total number of pages of federal tax rules (the tax code, regulations, and various IRS rulings) published in various annual issues of the Commerce Clearing House guide to the federal income tax has grown from 26,300 in 1984 to 54,846 in 2003 to surpass 70,000 in 2008. Restoring the code to 1986 would cut complexity by more than three-fifths and reduce the top marginal rate to 28%.

Sunday, March 22, 2009

Capping Pay — Part 2

On February 6, 2009, I blogged on the issue of capping pay and bonuses at $500,000 for financial firms receiving government (taxpayer) bailouts. Now the House of Representatives has reduced that limit to $250,000, with a punitive tax of 90% on income exceeding that amount. The Senate, for its part, is proposing 70%. I wrote on February 6:

“How far might we extend the cap? How about professors who have outside earnings from royalties, speaking, consulting, or business? Let’s cap them too. After all, almost every academic institution is either funded by state governments, and/or receives federal grants, and accepts tax-deductible (tax expenditure) contributions. Ditto for every other business, profession, or line of work that receives government support.”

Once the professoriate and other left-leaning professions rise up against the punitive tax on their above-cap earnings, the proposal will vanish from the political area.

Wednesday, March 11, 2009

To Counterfeit is Death

The words “To Counterfeit is Death” appear on the reverse side of the paper money issues of several of the British American colonies. Massachusetts was the first to issue government paper money in the Western world, followed by the other 12 original colonies. Paper currency augmented a scarce supply of gold and silver coin.

Two forms of colonial paper money were issued. One was backed by taxes dedicated to the redemption of a specific note issue, usually with the colonial Treasurer burning the redeemed notes before the colonial legislature. The second was a loan office, or land bank, issue described below. When necessary, sheriffs were ordered to foreclose on delinquent mortgagees.

Colonial governments were keen to preserve the value of their paper money against currency notes of other colonies and British sterling. To discourage counterfeiting, several colonial legislatures enacted the death penalty on convicted counterfeiters.

The concept of counterfeit money is an apt metaphor for the multiple credit instruments that contributed to the currency global financial crisis.

Begin with property. In general, mortgages of a specified duration and interest rate are issued for the purpose of purchasing residential or commercial property, which are collateralized by the property for which they are issued. In the colonial era, a borrower had to pledge twice the value of a loan in land or three times in real property to secure a loan. Modern practice traditionally required a down payment of 10-20 percent to insure that a lender could reclaim the full amount of its mortgage in the event the borrower failed to repay.

Contemporary money consists of banknotes and coins, bank reserves held at a central bank, and deposits held in commercial banks. Banks grant loans on the basis of some reasonable multiple of deposits on the assumption that depositors will not rush to withdraw all their deposits at the same time. Banks profit from the difference in deposit and loan rates.

In recent years, financial innovations changed the treatment of loans. Financial institutions began to bundle up mortgages (credit card balances, auto loan balances, etc,) and sell them as securities to third party investors. These securities are known as asset backed securities (ABSs), specifically mortgage backed securities (MBSs) for property. MBSs, which included substandard, sub-prime mortgages, were diced, sliced, and combined into new securities known as collateralized debt obligations (CDOs). Financial institutions wrote credit default swaps (CDSs) to insure against losses on these various products.

One way to think about this alphabet soup of derivative securities is that they represent counterfeit forms of money. Once that discovery occurred (due to falling home values), banks, non-bank financial institutions, and other firms quit trading these securities among each other, demanding payment in non-counterfeit money. As in the case of counterfeit money, the derivative securities based on defaulted mortgage loans became worthless.

We no longer put counterfeiters to death. Nor has the Congress enacted legislation stipulating which derivative forms of money are counterfeit. To reduce the likelihood of future financial crises, it may be worthwhile to try to define the status of new financial instruments more precisely (without stifling productive innovation) and toughen penalties against counterfeiting.

Monday, March 9, 2009

Obama on Track

A Great Debate is taking place across the political spectrum of economists, financial analysts, and politicians over the several measures put in place by the Congress, the Federal Reserve Board, and the Treasury. The disputes center on whether the stimulus is too large or too small; whether the timing of its expenditures is correct or too late; whether the mix of spending and tax relief is most productive; whether the Federal Reserve Board is keeping up with or is behind the curve; whether Treasury secretary Tim Geithner is up to the job; and, whether and how many more stimulus, Treasury, and Fed packages are required.

A hundred schools of thought are contending to show the way forward, how to reduce the length and severity of the recession, and how best to foster a recovery with stable prices.

One might suppose that President Obama is having sleepless nights, trying to determine the best way out of the economic and financial mess created by years of cheap money and the manufacture of credit instruments that no one fully understood.

Despite strong rhetorical protestations, President Obama and most of his Democratic party are probably pleased with the shape of things. If the economy continues to decline and/or remains stagnant through 2009 and the first half of 2010, the government could end up owning a majority or controlling stake in the country’s leading financial institutions. So, too, for the insurance, auto, medical, and who knows which other sectors that request federal assistance. Democrats will be in no rush to return state-controlled enterprises to private hands nor will they be under pressure from their supporters to do so. Government ownership and control of key sectors, known in China as “Socialism with Chinese characteristics,” means a market economy with government control of leading sectors.

The flood of money released into the economy should begin to show a positive effect on jobs sometime in 2010. If so, Obama will attribute improving economic conditions to the stimulus package and other regulatory measures the Democrats put in place. Democrats will have the upper hand in the November 2010 Congressional elections, along with control of the flow of credit and leading industrial sectors. The “mixed economy” is a Democrat’s dream, completing Roosevelt’s economic transformation and bringing about another long period of Democratic governance.
Obama on Track

A Great Debate is taking place across the political spectrum of economists, financial analysts, and politicians over the several measures put in place by the Congress, the Federal Reserve Board, and the Treasury. The disputes center on whether the stimulus is too large or too small; whether the timing of its expenditures is correct or too late; whether the mix of spending and tax relief is most productive; whether the Federal Reserve Board is keeping up with or is behind the curve; whether Treasury secretary Tim Geithner is up to the job; and, whether and how many more stimulus, Treasury, and Fed packages are required.

A hundred schools of thought are contending to show the way forward, how to reduce the length and severity of the recession, and how best to foster a recovery with stable prices.

One might suppose that President Obama is having sleepless nights, trying to determine the best way out of the economic and financial mess created by years of cheap money and the manufacture of credit instruments that no one fully understood.

Despite strong rhetorical protestations, President Obama and most of his Democratic party are probably pleased with the shape of things. If the economy continues to decline and/or remains stagnant through 2009 and the first half of 2010, the government could end up owning a majority or controlling stake in the country’s leading financial institutions. So, too, for the insurance, auto, medical, and who knows which other sectors that request federal assistance. Democrats will be in no rush to return state-controlled enterprises to private hands nor will they be under pressure from their supporters to do so. Government ownership and control of key sectors, known in China as “Socialism with Chinese characteristics,” means a market economy with government control of leading sectors.

The flood of money released into the economy should begin to show a positive effect on jobs sometime in 2010. If so, Obama will attribute improving economic conditions to the stimulus package and other regulatory measures the Democrats put in place. Democrats will have the upper hand in the November 2010 Congressional elections, along with control of the flow of credit and leading industrial sectors. The “mixed economy” is a Democrat’s dream, completing Roosevelt’s economic transformation and bringing about another long period of Democratic governance.

Thursday, March 5, 2009

How Do I Tax Thee? Let Me Count Five More Ways

President Obama’s FY 2009 budget puts federal outlays at 27.7% of GDP, up sharply from the FY 2008 estimate of 21.0%. With receipts of 15.4% of GDP, the budget deficit is estimated at 12.3% of GDP. Thereafter, spending and deficits are projected to decline.

Obama’s plans for health reform, indefinitely extending the “Making Work Pay” tax credit, and numerous other measures that advance his agenda of bigger government are likely to keep spending well above recent levels of 21-22%. At some point, rising interest rates will limit the amount of new debt the federal government will be able to market, which means that new and higher taxes will be required.

I previously blogged five fresh sources of federal revenue. To that list let me add five more:

(1) Poll taxes on adults. Poll taxes were a principal source of revenue in the American colonies. Although regressive in nature, the need for additional revenue makes this an appealing source of revenue. To ease the sting, poverty-level households can be exempted from the tax.

(2) Higher excises on alcoholic beverages.

(3) New and/or higher royalties on natural resource extraction and pipeline deliveries.

(4) Sumptuary taxes on clothing, cosmetics, jewelry, and other luxuries.

(5) Federal tax on ATM withdrawals.

Ridiculous? Wait and see.

Tuesday, March 3, 2009

How Do I Tax Thee? Let Me Count the Ways

In his FY 2010 budget President Obama set forth an agenda of higher taxes on the top 2% of income-earning households to fund tax and spending benefits for low- and middle-income households. Among others, it includes restoring the higher 36% and 39.6% rates of the Clinton years, increasing capital gains tax rates, and limiting the tax benefits of itemized deductions to 28%. Future increases include imposing social security taxes on annual wages and salaries exceeding $250,000.

These increases are likely to fall short of the funds needed to pay for Obama’s health reform, provide refundable tax credits for low-and middle-income households, and reduce estimated annual trillion dollar deficits to around $500 billion in 2012.

If Obama needs still more money, what is left to tax?

(1) H.R. 1068 introduced by Representative DeFazio and seven others on February 13, 2009, referred to the Committee on Ways and Means, would impose a tax on certain securities transactions. Cited as the “Let Wall Street Pay for Wall Street’s Bailout Act of 2009,” a quarter percent (0.25%) tax on the sale and purchase of financial instruments such as stock, options, and futures, could raise $150 billion a year.

(2) “Stop Tax Haven Abuse Act,” introduced on March 2, 2009, by Senator Carl Levin and three others, with a counterpart bill introduced in the House, targets the use of tax havens by American residents to avoid federal income taxes. Levin estimates that offshore tax abuses cost the Treasury an estimated $100 billion a year in lost revenue, of which $40-70 billion is from individuals and $30-60 billion from corporations.

(3) A modest wealth tax on households with substantial assets—the top 1% of the population controls in the neighborhood of 40% of the nation’s wealth—could collect several hundred billion dollars.

(4) A stamp tax, a commonly-applied levy in current and former British-dependent territories, could be applied to a wide variety of public documents, from property deeds to newspapers to checks to playing cards. The Stamp Act of 1765 imposed by the British Parliament on its 13 American colonies levied stamp tax on 55 separate kinds of documents with applicable rates.

(5) A small value-added tax (VAT) on consumption (the tax equivalent of a national retail sales tax but with better enforcement provisions) could raise hundreds of billions of dollars.

“Thoughtful Ideas” does not advocate any of these measures. Nonetheless, taxpayers should not regard them as hair-brained schemes with no to little likelihood of enactment. The power to tax is limited only by the imagination of the taxing authorities.

Monday, March 2, 2009

Welcome to Denmark and Sweden

Summer travelers to Denmark and Sweden enjoy long evenings, where the sun shines almost round the clock in late June. Winter is another story.

Those enamored of their summer vacation in the two countries might consider living for a year or two as residents, working and paying taxes as do Danes and Swedes. Statistics published by the Organization for Economic Co-operation and Development (OECD) in Paris, France, show total tax revenue in Denmark and Sweden in 2007 at 48.9% and 48.2% of gross domestic product respectively. Combined federal, state, and local government tax revenue in the United States was 30.3%.

A broader measure of government is spending, the share of national resources consumed by government. Budget deficits require borrowing which ultimately leads to higher taxes to repay principal and interest. Total U.S. government spending was 33.3% of GDP in the second quarter of 2008.

President Obama’s first budget for fiscal year 2010 (October 1, 2009 - September 30, 2010), if enacted in full and if the budget’s economic assumptions materialize, shows a deficit of 12.3% of GDP for FY 2009, raising projected expenditure to 27.7% of GDP (revenue of 15.4% plus deficit of 12.3%). Including state and local government raises the figure to around 40%. Government spending in both Denmark and Sweden in 2008 was 52% of GDP. In a few short years, if the FY 2010 budget is enacted largely unchanged, Obama will have cut in half the large difference in taxation and the size of the government between the U.S. (all levels) and the two Scandinavian countries.