Thursday, December 23, 2010

The Folly of Government Investment

It's Back on the Road

Car’s Out of the Ditch; What’s Left of It Anyway!

– By: Larry Walker, Jr. –

Realistically, it doesn’t look like anyone’s going to be driving this car ever again, so the highway that it’s on is irrelevant. And as far as what they’re sipping on, why that would be Kool-Aid. It looks like we’re going to need a new car, or perhaps just a new President, one who knows something about restoration. What in the heck is a government investment? I mean has anybody ever attempted to figure out what kind of return the government is getting on its current “investments”? I find it rather alarming when I compare the nominal rates of change in GDP, Unemployment, and the Public Debt during the recessions of 2001 and 2008.

click to enlarge

click to enlarge

For example, we see that in 2001, while the number of unemployed Americans increased by 46.6%, GDP was still growing, and the Public Debt was still shrinking. Then in 2002, the second year after the recession, the number of unemployed only grew by another 4.6%, with a modest increase in the Public Debt of 6.4%. And in 2003, the third year post-recession, the Public Debt increased by 10.4%, while the number of unemployed dropped by -3.7%. Unemployment continued to decline in each subsequent year until the beginning stages of the financial crisis appeared, near the end of 2007. In 2007 the number of unemployed Americans rose by 13.4% with modest changes in both the Public Debt and GDP. Following is the question of the day from @danlothiancnn, and then we'll compare the periods of 2001 through 2003, with 2008 through 2010.

Year 1: The Recession of 2001 vs. 2008

The following statistics are drawn from the table and chart above. We are comparing nominal figures of the number of unemployed, gross domestic product, and the public debt. The percentages shown represent the rate of change from one year to the next.

  • In 2001, the increase in the number of unemployed was 46.6%, or nearly the same as the 48.1% increase in 2008.

  • In 2001, GDP growth was positive at 3.4%, versus an increase of just 2.2% in 2008.

  • The biggest difference was that the public debt decreased by -1.9% in 2001, versus an increase of 15.0% in 2008.

Year 2: Post-Recession 2002 vs. 2009

Moving into the year after the recession began, we notice a huge difference in the number of unemployed.

  • In 2002, the number of unemployed increased by just 4.6%, while in 2009 the increase was a whopping 33.9%.

  • You will also note that GDP increased by 3.5% in 2002, versus a decline of -1.7% in 2009.

  • Next, you will note that while the public debt increased by just 6.4% in 2002, the increase in 2009 was an astronomical 30.0%. What this indicates is that the government overacted in 2009 by implementing a barrage of stimulus, regulations, and bailouts which did little more than increase unemployment and slow economic growth.

Year 3: Post-Recession 2003 vs. 2010

Now let’s look at the 3rd year after the beginning of each recession.

  • In 2003 the number of unemployed declined by -3.7%, versus a decline of just -1.0% in 2010.

  • GDP grew by 4.7% in 2003, versus an increase of 4.4% in 2010.

  • Meanwhile, the public debt grew by 10.4% in 2003, versus an increase of 19.5% in 2010.

Summary

To summarize, the percentage changes over each three-year period were as follows:

  1. GDP was elevated by 12.0% in 2001-2003, while increasing by just 4.9% in 2008-2010.

  2. The Public Debt grew by 15.2% in 2001-2003, versus an escalation of 78.7% in 2008-2010.

  3. The number of the unemployed increased by 47.6% in 2001-2003, compared to mushrooming by 96.5% in 2008-2010.

Conclusion

There is no such thing as government investment. In spite of the government’s colossal spending campaign, which over the past three years has increased the public debt by 78.7%, in the end, the number of unemployed Americans expanded by an absurd 96.5%, and gross domestic product grew by just 4.9% (the same that was achieved in the single year of 2007). So it looks like the federal government's return on investment over the past three years has been negative. All we got out of the deal was a ballooning of the public debt by 78.7%, and a gargantuan uptick of 96.5% in the number of unemployed Americans. So much for that theory. Government investment amounts to nothing more than meaningless rhetoric.

Perhaps it’s time for the government to get in the back seat; what's left of it anyway. (1) Stop spending money that you don’t have, under the guise of making “investments”. (2) While you’re at it, you can stop playing God; enough with over-regulation. (3) And further, you guys can stop patting yourselves on the backs, because so far you have achieved nothing (nada). The car wasn't in that bad a shape when Obama took the keys. The policies which Obama, Pelosi, and Reid implemented in 2009 are directly responsible for expanding both the number of unemployed, and the amount of public debt. Now that the car has been totalled, good luck with the C.Y.A. campaign.

Photo Credit: http://stock-free.com

GDP: Bureau of Economic Analysis

Unemployment: Table 1-A, Bureau of Labor Statistics

Public Debt: Treasury Direct – Debt to The Penny

Monday, December 20, 2010

Tax Rates, Earmarks, and Weiners

Money to Burn

Put Up, or Shut Up!

- By: Larry Walker, Jr. -

Okay, it’s time for all you rich whiners (a.k.a. Anthony Weiner) and cry babies to man up. For those who think that a top federal tax rate of 35% is too low, there is a solution. How about forking over some of that excess lucre? How about putting your money where your mouth is? The time to stand up for your convictions has come. It’s time to make a voluntary donation towards the national debt.

If you meet all of the following criteria, then I’m talking to you:

  1. You don’t like the tax rate extension.
  2. You are overcome with guilt, and want to pay more taxes.
  3. You are a congressman, senator, federal employee, millionaire or billionaire.
  4. You don’t have a business or payroll to meet, and have money to burn.

If this is you, then it’s time to step up. You can make a voluntary gift to the Bureau of the Public Debt, earmarked towards the national debt. That's the only kind of earmark that we find acceptable. And the best part is that your donation is fully tax deductible. That’s right! You won’t have to pay taxes on any income you voluntarily contribute towards the national debt, not one dime. So what are you waiting for?

Only $2.8 million was donated in the last fiscal year. That's pathetic. Let’s get that up in the hundreds of millions, or billions. Harry Reid and Nancy Pelosi should be the first to write checks, since they're the ones who blew a $5 trillion hole in deficit. Where’s Warren Buffet? What about Anthony Weiner? What’s up with Bill Clinton? Is there an Obama in the house? It’s time to put up, or shut up. All those who love to talk trash, while advocating the squander of other people’s money, need to be the first in line. It's time to trifle some of your own. Otherwise shut the hell up.

How do you make a contribution to reduce the debt?

There are two ways for you to make a contribution to reduce the debt:

  • You can make a contribution online either by credit card, checking or savings account at Pay.gov
  • You can write a check payable to the Bureau of the Public Debt, and in the memo section, notate that it's a Gift to reduce the Debt Held by the Public. Mail your check to:

    Attn Dept G
    Bureau of the Public Debt
    P. O. Box 2188
    Parkersburg, WV 26106-2188

We will be following up in a couple of months to see how well you did.

Disclosure: 1. Before making a donation to the federal government or any other organization, be sure to review how it spends its money. 2. Voluntarily contributing to the same government that taxes you, may negate any (or all) potential tax savings. 3. Sorry, but I will not be joining you, as I do not fit the criteria.

Links: Treasury Direct ; Forbes Billionaire List

Thursday, December 16, 2010

Uncorrelated: GDP and National Debt

Flatlined

Charting Insanity

- By: Larry Walker, Jr. -

Sorry but I can’t seem to find the extreme left-wing’s touted correlation between government borrowing and economic growth. They say things like: “We have to spend more to keep from going broke,” and, “For every dollar spent on unemployment and food stamps, $2.00 is put back into the economy.” But such statements don’t appear to have any rational basis, and as we shall see, no basis in fact. For example, in 1988 while the national debt increased by 10.7% over the preceding year, real GDP* increased by just 4.1%, and then when the national debt shot up by 13.2% in 1990, real GDP merely increased by 1.9%. It looks to me like the more the government borrows, the worse the economy performs, but maybe it’s just me.

click to enlarge

From 1992 to 2000, while national debt growth was declining year-over-year, GDP remained relatively stable with growth rates between 2.5% and 4.8%, something that’s not supposed to happen in leftist ideology. But GDP growth only exceeded national debt growth for four short years (1997-2000), and then came more borrowing. In 2002 the national debt shot up by 7.2%, and GDP growth was an anemic 1.8%. The largest deviations were in 1991 and 2009. In 1991 while the national debt grew by 13.4%, GDP dropped by -0.2%. And again in 2009, the worst yet, as the national debt grew by 18.8%, GDP fell by -2.6%. In 2010, although national debt growth slowed a bit from the previous year, it still grew by a whopping 13.9%, yet the increase to GDP was barely 2.5%. So far there doesn’t seem to be any proof to support the absurd leftist beliefs.

Now the diviners of the left seem to think that the key to robust economic growth is more borrowing. It’s as if they’re clueless. Here’s a question for you: How did that work out in 2009? The rationale du jour seems to be that since national debt growth slowed a bit in 2010 it should be quickly brought back up to 2009 levels. After all, increased government borrowing always leads to sound economic growth, right? Wrong. In the real world, based on historical trends, economic growth probably will not follow, but the left will at least have been able to prove their point, whatever that is. My bet is that as government borrowing rises in 2011, GDP will head south again.

click to enlarge

Meanwhile, how about those interest payments? Woo hoo! The government has gone from paying interest on the debt of $214 billion per year in 1988, to $414 billion in 2010. Good thing interest rates are only around 3.007%. I mean with all the excess debt Congress has been piling on, it will probably be 'game over' when interest rates double to 6%, but I guess that will be the price of stupidity.

click to enlarge

And the debt grows on and on. Too bad we can’t invest in a national debt index fund. We could be making a killing. If GDP and national debt growth rates in the first chart were reversed, we would be on the right track, but unfortunately, Washington D.C. is on the wrong track. I don’t see any evidence of a correlation between government borrowing and economic growth. Sorry government guys, but real GDP has failed to grow above the 5% level in the last 23 years in spite of over $11.2 trillion of government borrowing. And how much did all of this borrowing cost? Well, over the past 23 years the government has paid $7.8 trillion in interest payments.

I’m still waiting on that 100% return that Nancy Pelosi promised on her last unemployment extension, you know, the one that was supposed to be the 'biggest bang for the buck' and all. And with all this new proposed spending I'm sure that unemployment probably won't go above 11.0%, but nobody's making that promise. ‘Maybe this time, it will be different’. Yeah, well either keep hoping, or jump ship. I recommend the latter. If there were any correlation at all between government borrowing and economic growth, it would probably be that the less the government borrows the better off the economy, but there doesn't appear to be any positive correlation.

* Note - GDP is expressed as Real GDP from BEA Table 1.1.1

Data Sources: Bureau of Economic Analysis ; Treasury Direct

Tuesday, December 14, 2010

The Pelosi Effect: Fatally Flawed

Highway Robbery?

Rational Expectations and Two-Bit Liars

- by: Larry Walker, Jr. -

It is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future. ~ The Theory of Rational Expectations

In Rational Expectations and Irrational Intentions, we attempted to show the cost of a deficit-financed $1 over time, as a rebuttal to Nancy Pelosi’s flawed analysis. There we used an interest rate of just 4%. But what if interest rates were to suddenly rise to 8%, something which is within the realm of reasonable possibilities? Well, as you can see below, when interest rates rise to 8%, the Pelosi Effect completely disintegrates. You see, while Ms. Pelosi has merely provided the benefit side of what should be a cost-benefit analysis, like-minded Americans are thinking about the cost.

Click to Enlarge

Well, with an interest rate of 8%, the benefit of Ms. Pelosi’s dollar disappears in just 7 to 9 years, when the cost, with financing, will then be between $1.71 and $2.00. In just 30 years the cost rises to $10.06. In 40 years the cost more than doubles to $21.72. In 50 years, it more than doubles again to $46.90. And at the end of 100 years, the cost to the treasury of just one additional deficit-financed dollar will be as much as $2,199.76. It’s highway robbery. It’s not even necessary to chart the next two centuries, as the nation will have been reduced to ashes in under 50 years. And moving forward, heaven forbid that interest rates should ever exceed 8%.

Excuse me, but when a politician, who is already personally responsible for adding over $5 trillion to the national debt in just four years, attempts to explain that borrowing just one more dollar (hundreds of billions more as is the case) will somehow add a benefit of $2 to the economy, and omits the most important part, the cost, she deserves to be swinging in the public square. Has the $5 trillion she has already flushed down the toilet returned two-fold as of yet? If so, then why hasn’t her debt been paid off, or why hasn’t our gross domestic product suddenly risen by $5 to $10 trillion? If not, then one can only conclude that this woman is a fraud, and should, at the very least, spend the rest of her days in a federal penitentiary. Nancy Pelosi is a fraud.

Photo Credit: Last public execution at Tyburn Gallows in London

Related: Rational Expectations and Irrational Intentions ; The Pelosi Effect: Mis-, or Disinformation ; Dismantling Nancy Pelosi

Friday, December 10, 2010

Rational Expectations and Irrational Intentions

π is an irrational number

The Pelosi Effect Revisited

- by: Larry Walker, Jr. -

“It has been said that we judge others by their actions, but judge ourselves by our intentions.” ~ The Philippian Jailer

On October 6, 2010, Lame Duck Speaker of the House of Representatives, and Democrat, Nancy Pelosi said, “For every dollar a person receives in food stamps, $1.79 is put back into the economy. It is the biggest bang for the buck when you do food stamps and unemployment insurance. The biggest bang for the buck." Now she’s boasting that for every dollar spent on unemployment and food stamps, $2.00 is put back into the economy. But as we pointed out in Rational Expectations vs. Obamanomics, “According to the theory of rational expectations, it is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future.”

So okay let’s pretend that it’s true that every dollar the government spends on unemployment and food stamps magically doubles across the economy. There is just one major problem with the Pelosi Effect. Since the initial dollar was borrowed, and interest payments on the debt are effectively being borrowed as well, that same dollar will wind up costing the government $2.03 within 18 years, and may wind up costing in excess of $1,355,196.11 over time.

The cost of a deficit-financed dollar will double to $2.03 in about 18 years at an interest rate of 4.0%. Since we are not paying down the national debt, and are in effect borrowing further to make the interest payments, the cost will continue to rise over time. By the 29th year the cost of that dollar will be $3.12. By the 37th year it will have cost $4.27. By the 100th year the cost skyrockets to $50.50. And finally, by the 360th year that same dollar will have cost a total of $1,355,196.11, ad infinitum (see chart and table below).


You see, it is one thing for the government to spend a dollar from surplus, but entirely another when that buck has been deficit-financed. Thus, the effect that the proposed spend and spend package will have on demand will most certainly not be positive. It all points back to the importance of not spending what you don’t have (i.e. PAYGO). What happened to that theory? With the national debt currently at $13.8 trillion, and growing by $5 billion per day; how is it ever to be repaid when hundreds of billions more is recklessly piled on with every whim? Lady, please!

Apparently the word compromise means payoff rather than paygo. One can only imagine how much that elusive deficit reduction plan will cost [sarc]. Oh give me a break!

_______________________________

Note - The dollar never gets fully returned to the government, or to the recipient of benefits. In the near term, unemployment is partially taxable, but the most the government will get back in taxes is 10%. The recipient will only effectively be receiving 90 cents due to federal income taxes, and less when you factor in State taxes (in Georgia that would be 85 cents). So we’re back to around $1.70 (0.85 * 2) added to the economy rather than $2.00. Then once the recipient has spent the money it’s gone. Unless they are able to find a job within 13 months they will be knocking again, ad infinitum. First 99 weeks, then 56 more, and the debt grows on, and on, and on.......

Wednesday, December 8, 2010

Ill-Conceived Stimulus Threatens to Gum Up Recovery

Government Revenue Growth Surpasses Spending

- by: Larry Walker, Jr. -

Here we go again. At a time when government revenues are actually growing faster than spending, in step the clueless to gum it all up again. Sure, we still have a spending problem, but the cure is not more of the disease. Lawmakers always attempt to solve what they perceive to be a problem, well after self-correction has begun, and in all their ill-conceived efforts always manage to muck things up. In the present lame-duck session, all that the people asked is for tax rates to remain constant. That’s all we requested, and that’s all that’s needed at this moment in time. But instead, politicians are still playing around with the failed stimulus ideal, a policy which has never worked in American history. The truth is that with tax rates at present levels, revenues have already begun to surpass spending on a percentage basis. Government revenues have been growing faster than spending since the 2nd quarter of 2009.

The following chart, courtesy of the Bureau of Economic Analysis shows that government revenues are currently growing at a faster rate than spending (click to enlarge).

Government Spending and Revenues (% Change)

The chart below (click to enlarge) shows the discrepancy between revenues and spending in dollars. Clearly what’s needed is for spending to decline while revenues remain constant.

Government Spending and Revenues ($ Change)

In my piece entitled, “Untimely and Proven to Fail”, the myth behind government stimulus programs was clearly exposed. During the most recent recession, at the end of 2007, economists recommended stimulus spending as a means of averting a full blown recession. In order to work successfully, such a stimulus needed to be large enough; timely, targeted, and temporary. Although such a plan was implemented, by the time tax refunds began to reach taxpayers, in April of 2008, economists declared that it was too late, and that recession was then unavoidable. In February of 2009 a second stimulus was enacted, well after the recession had begun, and nearly at the time it was over. What was the point? The only purpose of an economic stimulus program, although one has never actually worked, is to avoid a recession. Once a recession has commenced, an entirely different set of policies is required.

What is called for in our present crisis is both a reduction in government spending, and stability in tax rates. Although reductions in income tax rates worked in the 1960’s, 1980’s and 2000’s, the present administration did not appear to actually want to improve the economy when it had the chance. Instead, progressives have been fixated on gumming things up in order to achieve what they claim are more noble goals. What lawmakers have proposed in lieu of a common sense compromise is more temporary stimulus. Where government errs is that businesses don’t respond to temporary policies. We are focused on the long-term. If we could see a coherent tax plan, one in which tax rates remain stable for some period and then eventually decline, there would be stability and growth. The Bush tax cuts were gradual in nature and, like Reagan’s plan, culminated in the lowest rates at the end, while the current administration is still playing around with temporary policies which lead to an uncertain end. Taxpayers can only suspect that in the end, we’ll all get screwed.

In an August 2004 article of the Journal of Political Economy, two UCLA economists said they figured out why the Great Depression dragged on for almost 15 years, and they blamed a suspect previously thought to be beyond reproach: President Franklin D. Roosevelt. After scrutinizing Roosevelt's record for four years, Harold L. Cole and Lee E. Ohanian concluded that the New Deal policies signed into law 77 years ago thwarted economic recovery for seven long years. Ohanian and Cole blamed specific anti-competition and pro-labor measures that Roosevelt promoted and signed into law June 16, 1933.

"Why the Great Depression lasted so long has always been a great mystery, and because we never really knew the reason, we have always worried whether we would have another 10- to 15-year economic slump," said Ohanian, vice chair of UCLA's Department of Economics. "We found that a relapse isn't likely unless lawmakers gum up a recovery with ill-conceived stimulus policies."

"The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes," Cole said. "Ironically, our work shows that the recovery would have been very rapid had the government not intervened."

In conclusion, while policymakers should be focused on a plan which will reduce spending, and remove uncertainty, as the Fiscal Commission has already spelled out; instead what we are being served is another $700 to $900 billion stimulus program, this time three years after the fact. A lame-duck session is not a good time to consider a long-term strategy. All that we asked for was that tax rates remain stable until a solid plan may be implemented next year. We did not request another economic stimulus, but rather a stay, in order to remove the present cloud of unusual uncertainty. Will we ever have a government who gets it? I would rather see the current proposal fail and have tax rates rise for the first couple of weeks in 2011, than be herded into more bad policy by a bunch of incompetent lame ducks. Isn't this why they lost in the first place?

Monday, December 6, 2010

The Elitist Condescension Tax Credit

Charge It

A.K.A. Making Work Pay Tax Credit (a.k.a. 2% Payroll Tax Holiday*)

- by: Larry Walker, Jr. -

Bundled in the 2009 economic stimulus plan was the $400 ($800 for couples) Making Work Pay tax credit which provided a tax credit in 2009 and 2010 equal to 6.2 percent of earned income of up to $6,450 for individual filers and $12,900 for couples. The tax credit took effect in July 2009. Workers who have taxes withheld from their paychecks have seen a decrease in the federal income taxes withheld from each paycheck by about $15 per paycheck every two weeks ($30 for couples). The credit phases out by two percent of any income over $150,000 for couples and $75,000 for others. Couples earning more than $190,000 and individuals earning more than $95,000 do not benefit from the credit.

Washington elitists seem to think that handing an American a $7.50 per week bonus ($15.00 for couples) out of their broke treasury will actually help somebody. Yeah, maybe in 1929, but $30 to $60 per month won’t even cover room and board in 2010. All it really amounts to is waste and abuse. It’s a waste of taxpayer resources as it helps no one, and abuse because all it really does is add to the national debt. This is just another fine example of how the crooks of D.C. have built themselves a monumental national debt of $13.8 trillion. Politicians should learn how to say the word “No”. Come on say it with me, “No”.

According to some estimates, if made permanent, the Making Work Pay tax credit will cost the U.S. government an estimated $640 billion through 2018. Any idiot who would vote for something that cost so much and helps no one should be targeted and fired in 2012. If Obama continues to push this, he’s one and done. Hopefully he will, because I will enjoy listening to another year of complaints from his former base.

*Addendum: What a disaster. The proposed 2.0% payroll tax cut will amount to about the same thing, a $15 per week pay increase for a $40,000 per year wage earner, or $27 per week for a family making $70,000, paid for by additional deficit financing. Did anyone get the memo entitled, "Stop Spending"? The package which includes extending the college tuition tax credit and other breaks for middle-class families that were due to expire on Dec. 31, would add more than $700 billion to the rising national debt, said congressional sources who were briefed on the package.

____________________________

"You cannot help the poor by destroying the rich...

You cannot strengthen the weak by weakening the strong...

You cannot bring about prosperity by discouraging thrift...

You cannot lift the wage earner up by pulling the wage payer down...

You cannot further the brotherhood of man by inciting class hatred...

You cannot build character and courage by taking away people's initiative and independence...

You cannot help people permanently by doing for them, what they could and should do for themselves..."

~ Abraham Lincoln

Related: The Era of Flimflam Economics, Part II

___________________________

Tax Policy Center - Tax Stimulus Report Card

http://romans828pslm23.blogspot.com/2010/12/friends-e-mail.html?spref=tw

Sunday, December 5, 2010

Shared Sacrifice and a Free Lunch

Veto This

A Taxpayer’s Lips to God’s Ear

- by: Larry Walker, Jr. -

Shared sacrifice? I’ll think about that the next time I’m forking over a check for $8,000 in income taxes, while the person in front of me is walking out with an $8,000 refund check. Nobody is willing to pitch in any further to help out an irresponsible bunch of crooks in Washington D.C. The truth is that 53% of us have already been pitching in, while 47% of Americans have not been paying any income taxes at all. It’s the 47% who don’t pay income taxes, the ones reaping all the misconstrued benefits, who need to pitch in.

According to the Tax Policy Center, in tax year 2009 there were 151,500,000 tax filers excluding dependents of other taxpayers and out of those 71,000,000 (46.9%) had a zero or negative income tax liability. Those are the ones who need to start sharing and sacrificing. “But how”, you say? “There’s nothing to cut”.

Cutting Waste, Fraud and Abuse

There's always room for cutting waste, fraud, and abuse. For starters we can get rid of the following tax credits: Make Work Pay Credit, Economic Recovery Credit, Earned Income Tax Credit, Child Tax Credit, Hire Credit, and American Opportunity Credit. (And while we’re on the topic, no one asked for the first time home buyers credit, or cash for clunkers, so don’t get any new bright ideas.) No one really asked for any of this crap in the first place, it was all crammed down our throats by politicians thinking that they were helping us out by throwing away a little money that they didn’t have to begin with. And now they want us to pay more to cover their … tab? How irresponsible can you get? And what’s sick about it is that their real motivation was vote buying (probably with criminal intent).

My parents never got a child tax credit or an earned income tax credit. Neither did I. This stuff wasn’t around in the 60’s and 70’s, and though the EITC was around in my day, we always made too much to qualify. I always looked at these credits as a form of welfare anyway, and I have never taken welfare or food stamps. I slept in a homeless shelter for a week one time, but I never asked for anything from the government. I was on unemployment for two weeks one time, when I was laid-off by the federal government, and then quickly recalled, but I didn’t ask for a government handout. What I have asked for, and will continue to, is for the federal government to get its hand out of my pocket, to stop wasting my money, and to lower my tax rate. All I want is more of my own money, not someone else’s.

Mind Your Own Business

Politicians are quick to judge a private party’s income statement while ignoring their own. What they don’t realize is that there’s such a thing as a balance sheet. According to the government, corporate profits are up, and according to them ‘the bastards aren’t spending’. And so if they don’t spend, political crooks say, “We’ll take it, and spend it for them”. How unconstitutional of you. However, there are two forms of expenditures not included on an income statement of which financial illiterates have no knowledge. Corporate profits on an income statement don’t reflect the amount of money spent on principal repayments of debt, nor dividend payments, as these are not deductible as expenses. Politicians have no idea what obligations a private party may have.

They treat individuals in the same manner. For example, the federal government has no idea how much debt an individual has, or whether they have other obligations, such as child support payments. Let’s consider the issue of child support. When it comes to income taxes, there is no deduction for child support payments, and income from child support is not taxable to the recipient.

Single Mom

Let’s consider a single mother of three who receives $12,000 per year in child support, and makes a salary of $20,000, and let’s compare her to the father of the children who also makes a salary of $20,000. According to the government it’s the mother who needs taxpayer assistance, but in reality it’s the poor dad who has to work full-time and sleep in a tent.

The mom gets a tax refund of $8,297 while dad has to pay $784. The mom has disposable income of $38,767, $8,297 of which was stolen from other taxpayers and handed to her by the government, and $12,000 of which was contributed by the dad. Meanwhile the father is left with disposable income of just $5,686. Yeah, that’s right $5,686. But, according to the government, the mom needs more help, while dad can pay a little more in taxes.

Although the example is a bit simplistic, it is someone’s reality; and some degree of this reality occurs at all income levels. Been there, done that. The mom will probably cast her vote for the politicians filling her pockets with goodies, while the dad probably hates all politicians and doesn’t vote at all. The question is: Why is an extra $8,297 tax burden being put on other taxpayers to take care of this mother and her children? When the father gets a raise won’t the mom get one too, since child support is based on a percentage of gross income? Yeah, that’s how it works. So government should just stay the hell out of it, since it isn’t even assisting the right party.

Single No Kids

Now let’s consider a single homeowner, who has wages of $40,000 and pays $13,500 per year in mortgage interest and property taxes. This taxpayer bought the home for $200,000 and now it’s only worth $150,000 so he’s upside down. He has a total tax liability of $2,614 and is left with disposable income of $34,326. In effect, his tax debt of $2,614 has been transferred to the single mom above, who now has more disposable income than him, even though he makes twice as much money ($38,767 vs. $34,326). But when you ask politicians, they will again say that the single mom needs more help while the single homeowner can afford to sacrifice a little more, never mind his upside down mortgage.

Request Denied

Now politicians want to shake more money out of the 53.1% of working people who actually pay income taxes, to support spending for which they receive absolutely no benefit. Most of this excess spending isn’t even getting to the folks who really need the help anyway, such as the unemployed. To top that off, most of it isn’t even constitutional. By what authority does the government take money from one citizen and transfer it to another?

On behalf of the 53% who pay income taxes, the answer to your request for more sacrifice is 'hell no', 'request denied'. It’s time for those who are not pitching in at all to give up something. It’s time to cut the fat. It’s time to end the nanny-state. The era of big government is over. If the 71,000,000 Americans who currently don’t pay any income taxes were to pitch in just $1,000 each, the government could raise $71 billion per year, or as the CBO would say, “$710 billion over 10 years”. Yes it’s time for some shared sacrifice, and it’s time to end the free lunch. Get rid of the phony tax credits, extend the current tax rates, and look into the proposal entitled, Revitalizing the U.S. Economy through Unemployment Reform. Put that in your veto pipe and smoke it.

___________________

Note: MC = Medicare Tax of 1.45%; FICA = Social Security Tax of 6.2%

Tuesday, November 23, 2010

Tax Reform 201: The Optimal Tax Rate

Stuck on Static

Tax Rates, GDP, and Static Retrogression

- by: Larry Walker, Jr. -

Those immersed in the static conception of human behavior say that America will never grow its way out of debt. Well, that’s a self-fulfilling prophecy if we base our tax policy on the static view. So do they think we can tax our way out of debt? If that’s the case, we might as well extend unemployment benefits indefinitely, and break out the hot dogs and beans. But there is another conception, known as the dynamic view. Dynamic analysts know that lower tax rates have positive impacts on human behavior, investment, production, economic growth, and tax receipts. Those of us who are faithful to the dynamic conception of human behavior believe it is better to grow our way out, than to surrender.

Today’s top income tax rate of 35.0% is relatively low in terms of a top rate of 39.6% during the 1990’s, but relatively high compared to rates of 7.0% in 1913, 24.0% in the 1920’s, and 28.0% in the 1980’s. A careful analysis of gross domestic product (GDP), during the highest and lowest tax rates of the past 30 years, reveals that cumulative GDP growth was 45.7% (.26/.569) higher when the lowest tax rates were imposed. Based on economic data available from the Bureau of Economic Analysis, it appears that a top tax rate of 28.0% is optimal (and that’s including the tax expenditures available in the 80’s). So today, we’ll look at relative tax rates, then analyze the performance of GDP and government revenues at relatively low and high tax rates, and then try to figure out what Obama is talking about.

Relative Tax Rates

As Mark Perry points out, in Tax Cuts, Tax Hikes, It’s All Relative; tax cuts and tax hikes are indeed relative. “…Certainly, compared to the “Clinton tax hikes” that took effect in 1993 and raised the top marginal income rate to 39.6%, the reductions of the top tax rate to 38.6% in 2002 and 35% in 2003 were “tax cuts”. But if you go back further and compare the Bush tax rates to the highest marginal tax rates under Bush, Sr. (31%) and Reagan (28%), couldn’t the Bush II tax rates more accurately be referred to as the “Bush tax hikes”?

“Of course, the tax rates were much higher before 1988, here’s the full history back to 1913 in the chart below. Compared to most of the tax rates between the 1930s and the 1980s, couldn’t the Clinton tax rates also accurately be referred to as the “Clinton tax cuts”?”

Sure it's all relative, but what's the optimal rate? In order to find the answer, we need a measurement.

Cumulative GDP Growth and Tax Rates

An analysis of the cumulative growth of GDP for the periods of 1981 to 1988, and 1993 to 2000 reveals that with top tax rates capped at 28.0%, GDP grew at a cumulative rate of 82.9%; and that when top tax rates rose to 39.6%, GDP only grew by 56.9%. This refutes the myth that the economy performed better under Clinton’s burdensome tax rates. The economy performed better than when? In reality, the economy grew at a much higher rate under Reagan, in fact 45.7% greater (see the table and chart below).

GDP Growth 80's-90's

A top marginal tax rate of 28.0% is optimal.

Optimal Tax Rates - Click to Enlarge

Why did the economy perform so much better with lower tax rates? The answer may have something to do with behavioral psychology. Let’s face it, there’s a big difference between knowing that ones top tax rate will be under 30.0%, versus essentially 40.0%. Perhaps human behavior is both conditioned and determined by its own outcomes or consequences (rewards and punishments). As a commenter recently remarked, “My first customer, like my last, responded to stimuli that benefited him and his business, and at the best possible price.” And what are income taxes, if not a price?

The difference between top tax rates of 28.0% and 39.6% can be reasonably quantified as a cost, or benefit, of 45.7% in cumulative economic growth, over an eight-year period. The effect of tax policies on GDP is but one aspect of a dynamic tax policy. Lower tax rates lead to increased economic activity, and eventually to greater tax revenues.

Growth in Government Revenue and Tax Rates

In terms of government revenues, tax receipts grew at a cumulative rate of 75.8% during the 80’s, and at 85.6% during the 90’s. In other words, Clinton’s tax policies increased tax revenue by 12.9% more than Reagan’s (see table below). But when we bring GDP back into the picture, we see that Clinton's policies actually grew tax receipts by 50.4% more than GDP, while Reagan’s policies increased GDP by 9.4% more than revenue.

Government Revenues 80's and 90's

Under Clinton, government revenue grew at 85.6%, while GDP only managed 56.9%. Under Reagan GDP grew by 82.9%, while revenue increased by 75.8%. So which top tax rate is optimal? Although a top tax rate of 39.6% increased tax revenues by 12.9% more than a top rate of 28.0%, the cost to our economy was a loss of 45.7% in cumulative GDP growth. Again, a top tax rate of 28.0% is optimal. Think about it. What happens to you when your tax burden increases significantly faster than your personal income? Yeah, not a good thing; yet many idolize Clinton. And then there's Obama, who not only wants to raise top rates back to 39.6%, but also to reset the top tax bracket to where it was 17 years ago. What’s up with that?

Obama's Retrogression: Why $250,000?

Now that we know for sure that capping top tax rates at 28.0% leads to optimal economic and revenue growth, and that raising rates to 39.6% causes tax revenues to outpace the economy by 50.4%, the question is: What does $250,000 have to do with it? Well, a quick examination of the 1993 tax rate schedules reveals that the top tax bracket back then, seventeen years ago, was $250,000 (see table below).

1993 Tax Rates

Why is Obama regressing when it comes to the top tax bracket? He keeps saying he's moving ‘forward’, and 'making progress', yet when it comes to income tax brackets, he wants to put it in reverse. If that is indeed his intent, then the major flaw in Obama’s appraisal is that he has failed to adjust for inflation. In real terms, $250,000 of income today was equal to just $164,275 in 1993 (calculate it here). And, $250,000 earned in 1993 is the equivalent of $380,460 today. Annual inflation over the 17-year span has been 2.5%. In fact, the top tax bracket today would be $380,460 if properly adjusted for inflation, and yet in 2010 it is $373,650 (the same as in 2009).

So Obama’s proposal boils down to taxing those with current incomes of $250,000, in 1993 dollars, without the benefit of an inflation adjustment, while taxing everyone else in current dollars. And if approved, it will result in nothing more than ‘legalized theft’. In effect, taxpayers who made between $164,275 and $250,000 in 1993 would be pushed into the top tax bracket by 2011. If Obama was playing it straight, he would simply let the Bush tax cuts expire. But instead, we are being asked to tolerate the idea that some taxpayers deserve the benefit of an inflation adjustment, while others do not.

However, Obama’s static retrogression is implausible. If the imposition of a top tax rate of 39.6% were optimal for our economy, then Obama’s approach might be practical, however, in light of the facts, it is most unsuitable. History proves that our economy achieved maximum growth when top tax rates were limited to 28.0%. The difference amounted to a 45.7% increase in cumulative GDP growth over an eight-year period. Obama’s strategy of lowering the bar of the top income bracket, while raising the top tax rate will cost our economy more than 45.7% in cumulative growth over the ensuing eight years, as more taxpayers get bilked.

At a time when America really needs an across the board tax rate cut, Americans are being asked to accept higher taxes, and regressive income brackets. If we are dumb enough to accept Obama’s proposal, in time we will achieve what many long for, a flat-rate-tax. But unfortunately the rate will wind up being 39.6% for all who are fortunate enough to endure. We can do this, but we need to be dynamic. Don’t get stuck on static. Cut spending, lower taxes, step back, quit lecturing, and for God’s sake stop chanting.

In the beginning it was:

Yes we can!
Yes we can!
Yes we can!

Then those chants quickly evolved into:

Yes government can!
Yes government can!
Yes government can!

And just before fizzling into dead silence, it was:

More for government, less for us!
More for government, less for us!
More for government, less for us!

Now that this foolishness has been exposed, and a line has been drawn, the question is: Which side are you on? Do you side with the people, or with the government? You can’t be for both. Either you are in favor of keeping more of your hard earned pay, or you are for handing over more to the government. Either you are for individual freedom and personal responsibility, or more government control. You are either for you, or against yourself.

Prerequisites: Tax Reform 101: Stuck on Static; Obama’s Inverted Wealth Curve

Data Sources: Bureau of Economic Analysis; Office of Management and Budget

Thursday, November 18, 2010

Tax Reform 101: Stuck on Static

Lame Duck

Don't be lame. Be dynamic.

- By: Larry Walker, Jr. -

When it comes to tax policy, there are two schools of thought. Liberals and progressives cling to what’s known as static revenue analysis, while conservatives lean towards what’s known as dynamic revenue analysis. Today we will be comparing both concepts to gross domestic product, and government revenue between the years of 1993 and 2008. The objective is to open minds to the concept of dynamic analysis, and to prove once and for all that tax cuts lead to increased government revenues, and higher levels of economic activity. But first, lets look at a couple of examples:

Example 1: Static Revenue Policy – Joe the retailer owns a gift shop. One day Joe got sick and tired of lackluster sales and decided to raise prices by 100%. Joe believed that if he doubled prices, while maintaining the same volume of sales, that his revenues would double. Joe doubled prices but soon noticed that sales volume had dropped dramatically. Before the price increase, Joe averaged 1,000 customers per month, with average sales of $10 per customer, and total sales of $10,000 per month. After the price increase, the number of customers fell to 500 per month, with average sales of $20 per customer, and total sales of $10,000 per month. Joe soon realized that higher prices don’t necessarily lead to more revenue. Joe had applied a static revenue policy, and in the process learned that there’s more to business than meets the eye.

Example 2: Dynamic Revenue Policy – After taking a few businesses courses, Joe the retailer decided to give it another try. This time Joe decided to cut prices by 50%. Joe quickly noticed that sales traffic picked up dramatically. After the price cut, the average number of monthly customers rose to 2,000, with average sales of $10 per customer, and total sales of $20,000 per month. Why didn’t the average sale per customer fall from $10 to $5? Because, customers were already spending $10 per sale, and quickly figured out that they could now buy twice as much for the same amount; so consumption didn’t decrease. This time, Joe had applied a dynamic revenue policy, and in the process was able to double sales. Not only did sales double but, Joe was able to receive volume discounts from his suppliers for placing larger orders. Joe had finally arrived. Now, let's look at GDP.

Gross Domestic Product

A comparison of GDP between the periods of 1993-2000 and 2001-2008 can be looked at in two ways. Static minds will focus to the far right of the table below, and pontificate that GDP grew at a higher rate, an average of 5.79% under Clinton, than the lackluster 4.71% under Bush. What they miss is found in the third and fourth columns. Comparing the total amount of gross domestic product over each term, we see that total GDP under Clinton was only $65.4 trillion, while it was $98.4 trillion under Bush. We also see that average annual GDP under Bush was $12.3 trillion, while under Clinton it was a mere $8.2 trillion. In other words, total economic production grew by 50.4% during an era of lower tax rates.

Dynamic GDP Table - Click to Enlarge

So then why was the annual percentage growth rate higher under Clinton? That’s easy. If you make $10,000 per year and get a 10% raise, your pay will have increased by $1,000. Fair enough. But if you make $100,000 per year and get a 5% raise, your pay will have increased by $5,000. Which would you rather have, more money, or a larger percentage increase? I'll take the money.

Here’s what this looks like graphically:

Dynamic GDP Chart - Click to Enlarge

Government Revenues

Now let’s look at total government revenues over the same period. Static minds will focus to the far right of the table below, and lecture that government revenues grew at a higher rate, an average of 8.05% under Clinton, than the lackluster 3.04% under Bush. Again, what they miss is found in the third and fourth columns. Comparing the total amount of revenue raised over each term, we see that total revenues under Bush were $17.2 trillion, while under Clinton revenues were only $12.4 trillion. We also see that average annual revenue under Bush was $2.1 trillion, while under Clinton it was a mere $1.5 trillion. In other words, total government revenue grew by 38.7% during an era of lower tax rates.

Dynamic Revenue Table - Click to Enlarge

Lower tax rates lead to greater tax revenues, and a larger economy. That's the whole point. It’s the number of dollars that matters, not the rate of increase. The fact that revenue growth is achieved at lower annual growth rates is a bonus, especially when it comes to tax rates. The only problem we have is that the demands of government have grown faster than both revenues and GDP, but that’s another story. Remember: "Government is not a solution to our problem, government is the problem." ~ Ronald Reagan

If we want to grow the economy and spread wealth, tax cuts are the way to go. It all depends on ones philosophy. Liberals and progressives want to grow the size of government, at the expense of the economy. Conservatives want to grow the economy at the expense of government. So let us all think clearly now, and not be stuck on static. Have a Merry Lame Duck session.

Sources: Bureau of Economic Analysis and Office of Management and Budget

Tuesday, November 16, 2010

Real Tax Reform II : Taxing Corporations

Not Cash Cows

Ending Tyranny

- By: Larry Walker, Jr. -

In Part I, we focused on unfair tax policies surrounding S-Corporations and Partnerships. The prospect of increasing tax rates on business owners is a far cry from what most of us would consider meaningful fiscal reform. Part II examines how government, both federal and state, milks corporations, and specifically small Personal Service Corporations (PCs) out of billions of dollars every year. In terms of combined taxes, if we add together federal and state corporate taxes, payroll taxes, and taxes levied on the wages and dividends of its owners; when the smoke clears, government walks away with approximately 76.6% of a PC's pre-tax profits, and 45.4% of its gross income.

And just what is the end result of all the government’s efforts to hoard and redistribute our wealth? Well, as far as the federal government is concerned, with revenues of $2.2 trillion in fiscal year 2010, and a national debt of $13.6 trillion, it appears that Congress has already spent all of next year’s revenue times six. So when is enough, enough? Meaningful fiscal reform necessarily involves massive spending cuts, and major tax cuts. Our problem is government spending. Tax cuts have the effect of broadening the tax base, and are the only way to effectively increase government revenues.

“An unlimited power to tax involves, necessarily, a power to destroy; because there is a limit beyond which no institution and no property can bear taxation.” ~ John Marshall, McCullough v. Maryland, 1819

What is a Personal Service Corporation?

A personal service corporation (PC) is a corporation composed of employee-owners who perform substantially all of its services. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. Like other C-corporations, PCs are subject to income taxes; but unlike regular C-Corps, PCs are taxed at a flat rate of 35% of taxable income.

Corporate Income Tax Rates

The following table shows the 2010 federal income tax rates assessed on corporations. [In the examples which follow, the company is based in the state of Georgia and is subject to its corporate tax rate of 6% of taxable income.]

Corporate Tax Rates - Click to Enlarge

Sample Personal Service Corporation

In the following example, Taxed Enough Already, PC (TEA-PC) is a small personal service corporation with ten employees, and annual revenues of $800,000. In tax year 2010, TEA-PC paid salaries and wages of $300,000, payroll taxes of $25,805, and had pre-tax profits of $474,195. The total amount of corporate income tax paid was $194,420, after-tax profits were $279,775, and employee-owners were paid dividends of $150,000. TEA-PC’s sample income statement follows:

TEA Income Statement

The Issue: Combined Taxes

Examining its total contribution to federal and state taxes, we find that TEA-PC paid $220,225 in combined payroll taxes, and corporate income taxes. We also discover that its employee-owners paid an additional $112,950 in social security, Medicare, and federal and state income taxes. Finally we see that TEA-PC’s employee-owners got soaked for another $30,000 in taxes on dividends received out of the company’s after-tax profits. Overall, TEA-PC has been milked out of $363,175 in combined taxes. In other words, TEA-PC’s employee-owners have been assessed total taxes amounting to 76.6% of their pre-tax profits. That’s pathetic. How can American businesses grow, when they are being milked out of 76.6% of pre-tax profits every year?

Combined Taxes

Proving that TEA-PC was responsible for all of these taxes is easy. We know that the company directly pays payroll taxes on its employee’s pay, and corporate income taxes. What many non-business types don’t understand is that a corporation is also responsible for withholding and paying its employee’s share of taxes. Also, since in this case, the employees are owners, their after-tax dividend receipts are subject to double taxation. Dividends are first levied a 35% tax at the corporate level (plus 6% in state taxes), and then subject to another 15% on the owner’s personal income tax returns (plus 5% in state taxes).

Tax Ratios

An examination of TEA-PC's tax ratios reveals the following:

  1. Corporate payroll and income taxes paid were 27.5% of gross income.

  2. Corporate payroll and income taxes paid were 46.4% of pre-tax profit.

  3. The company was directly and indirectly responsible for paying combined taxes of 45.4% of gross income.

  4. The company was directly and indirectly responsible for paying combined taxes of 76.6% of pre-tax profit.

  5. The total taxes paid on dividends, which are taxed both at the corporate and individual level, amounted to 61% ((35% + 6%) + (15% +5%)).

Tax Ratios

The Proposal

In order to make the tax code more equitable, Personal Service Corporations, as well as regular C-Corporations, should be allowed to take a deduction for annual dividend distributions. This will lower corporate taxable income and the amount of corporate income taxes paid, put an end to double taxation; and enable more income to be distributed as dividends, and/or reinvested towards future growth. This is accomplished by adding a line to page one of Form 1120 for the dividend deduction.

In addition, the tax rate on PC’s should be cut dramatically. According to the tax rate schedule above, PC’s are taxed at the same rate as corporations with taxable income greater than $18,333,333. Why are PC’s with taxable income of $50,000, $100,000, or $400,000 taxed at the same rate as corporations making over $18,333,333? Does this sound like a pro-growth strategy? The government’s present fiscal commission is recommending cutting corporate rates to 26%, while others want them to be repealed entirely. Under the Revenue Act of 1926, the tax on corporations was 13.5% of net income (individual tax rates ranged from 1.4% to 25%). Today, we have a complex set of codes, rules, and regulations, which basically amount to nothing more than government lordship. It’s time to level the playing field so that no corporation has an unfair advantage over another, and so that government may no longer oppressively impose itself over private enterprises. I therefore propose a maximum corporate tax rate of 13.5% of net income.

The Effect

My proposal will effectively lower the amount of taxes paid by corporations, and personal service corporations by ending the double taxation of dividends. By allowing corporations a deduction for the amount of dividends paid, more income is distributed to the personal level for efficient consumption. Also lowering corporate tax rates to the level imposed during the Roaring 20’s will allow our economy to return to a policy of robust growth. Once enacted, my proposal will result in economic growth on steroids, massive jobs growth, skyrocketing levels of entrepreneurship, greater freedom, and less dependence on the federal government.

Related Posts:

Real Tax Reform I: Taxing Small Business

Tax Revolt of 2010 Authentic

Saturday, November 13, 2010

Real Tax Reform I : Taxing Small Business

Not Cash Cows

Stop Swindling Paper Profits

- By: Larry Walker, Jr. -

Much of the debate against raising tax rates on the upper bracket centers around how income taxes are computed on small business owners. The debate focuses on the way that pass-through income, which is earned by the shareholders of S-Corporations and Partnerships, gets taxed. What we need is a fundamental transformation in the way that businesses are taxed. A business should be treated as an investment, not a person. Once we have correctly defined the nature of a business, and how businesses ought to be taxed the rest of tax reform is easy.

“An unlimited power to tax involves, necessarily, a power to destroy; because there is a limit beyond which no institution and no property can bear taxation.” ~ John Marshall, McCullough v. Maryland, 1819

Defining Pass-Through Income

S-Corporations and Partnerships do not pay income taxes. Instead, income is passed through to its owners and taxed on their individual income tax returns. Owners of pass-through entities receive income from their businesses in primarily two ways. The first way is through salaries and wages, and the second is through K-1 distributions. Salaries and wages are reported on W-2 Forms and are subject to withholding, social security, Medicare, and federal and state unemployment taxes. K-1 distributions are reported to the shareholder on Schedule K-1, and are not taxable, nor subject to withholding or payroll taxes.

What are K-1 Distributions?

K-1 distributions represent distributions of profit paid to the owners of S-Corporations and Partnerships. K-1 distributions get their name from the tax schedule on which they are reported, Schedule K-1. In addition to reporting the amount of K-1 distributions, Schedule K-1 also reports the shareholders share (as a percentage of ownership) of net business income, non-deductible expenses, capital gains income, and any pass-through deductions and credits (i.e. accelerated depreciation).

K-1 distributions are similar to the dividends paid by C-Corporations, with one key exception. Taxable dividends are reported on Form 1099-Div, and taxed to the recipient as current year income. K-1 distributions are reported to the recipient on Schedule K-1, but are not taxed to the recipient as current year income. The recipient of Schedule K-1 is instead taxed on the entire net income of the business, which is usually far greater than the amount physically received as a distribution.

The Issue

The discrepancy lies in that S-Corporation and Partnership shareholders are taxed on their share (as a percentage of ownership interest) of the net income of the business, not on the amount of distributions they physically receive.

Example - A small business has net income of $400,000, only one shareholder, and paid the owner a salary of $100,000 plus a distribution of $50,000.

Under current tax law this shareholder has taxable income of $500,000, the entire net income from the business of $400,000, plus a salary of $100,000. But in reality, the owner has only physically received $150,000, a salary of $100,000, and a distribution of $50,000. The remainder of $350,000 was earned by the company, but has yet to be spent or distributed. Is it fair to tax the small business owner on $500,000 of income when she has only physically taken custody of $150,000? Foul! Anyone who thinks this is fair should make a voluntary tax-deductible charitable contribution to the federal government, and earmark it towards the national debt, which by the way is allowed under the tax code.

This is the issue at hand. On one side, you have those who want to treat the lowly small business owner as a millionaire, and to tax her on income she has yet to receive; and on the other side, you have those who think it hurts the economy to tax unrealized small business profits, which businesses need to retain for future expansion.

The Proposal

In order to make the tax code more equitable, shareholders of S-Corporations and Partnerships should only be taxed on the amount of income actually received. The amount of income received is comprised of salaries, wages, and K-1 distributions. Small business net profits should not be taxed until they have been physically paid out to shareholders. What is required is a simple change to Schedule K-1, instructing the shareholder to report the amount of distributions as taxable income, instead of the amount of net profit.

Other pass-through income, losses and deductions will be capitalized at the corporate or partnership level and kept up with on a cumulative basis. When the business is sold, or otherwise disposed of, the original investment, plus any capitalized earnings, losses and deductions will be taken into account in determining whether the sale or disposition is a long-term capital gain, or loss.

The Effect

What my proposal will do is simply return businesses to their original purpose. A business is an investment, not a cash cow for the government. Think about it. If you invest in $100 worth of corporation stock, and the value goes up to $10,000, you are not taxed on the unrealized gain each year, but rather on the realized gain which occurs when the stock is sold. Businesses are investments and should be allowed to grow as investments, and the only way this is going to happen is for the government to stop taxing unrealized business appreciation.

My proposal will effectively lower taxes on small businesses which are operating as S-Corporations and Partnerships. Once enacted, it will result in economic growth on steroids, massive jobs growth, skyrocketing levels of entrepreneurship, greater freedom, and less dependence on the federal government.

Q&A

[Q] What if the S-Corp never distributes all of its income?

[A] The income will eventually be distributed either in the form of K-1 distributions, salaries and wages to the owner, salaries to new employees; or it will be used to re-invest in new plant and equipment, or to make acquisitions. Any remaining accumulated profits will eventually be taxed upon the sale or disposition of the business. Among the reasons a business retains its income in the first place are to invest in the future, to repay debt, and to guard against future downturns.

[Q] What about the tax on distributions in excess of a shareholders basis?

[A] This problem is simplified by taxing pass-through shareholders on all distributions. There will therefore no longer be a need for tracking the shareholders basis for the purpose of taxing excess distributions. The shareholders basis will instead be tracked for the purpose of determining gain or loss upon the eventual sale, or other disposition of the business.

[Q] Is a business an investment or a person?

[A] Check the corporate resolutions. A business is an investment, which is owned by investors (i.e. shareholders).

[Q] What about the issue of double-taxation on C-Corporations?

[A] I believe it's wrong to subject a C-Corporation to income tax, and then to turn around and tax a recipient of dividends on the same income. This is double taxation. A simple solution is to give C-Corporations a deduction for the amount of dividends paid. It's just that simple.

Friday, November 12, 2010

Obama’s Tax Fallacy III

WH Rubbish

More White House Rubbish

- by: Larry Walker, Jr. -

Does keeping the current tax rates in place constitute a tax cut? No. Only a reduction in current tax rates could be considered a tax cut. Keeping the current tax rates on one group, while raising tax rates on another, constitutes a net tax hike (i.e. 0 + 1 = 1). That’s just common sense. Let’s face the facts; there are really only five logical possibilities:

  1. Lower Tax Rates on Everyone = Tax Cut

  2. Raise Tax Rates on Everyone = Tax Hike

  3. Maintain Current Tax Rates on Some + Raise Tax Rates on Others = Net Tax Hike

  4. Maintain Current Tax Rates on Everyone = No Change

  5. Raise Tax Rates on Some + Cut Tax Rates on Others = It Depends*

Net Tax Hike

Let’s focus on number three, which seems to be Obama’s solution. To raise tax rates on a few is to raise them on everyone. For example, let’s say that we have a two-person society, of limited resources, composed of Joe the employee, and Joe the employer. If tax rates are left alone on Joe the employee and raised on Joe the employer what will happen? Joe the employer will either have to cut back on expenses, one of which is Joe the employee’s wages, or raise prices in order to maintain the status quo. Either reaction will curtail economic growth. This drag on the overall economy will decrease the amount of income earned, and the amount of taxes paid by both Joe’s. Of course there are other possibilities, one of which would be for Joe the employer to fire Joe the employee, and move his operations to another country, one that has lower wage demands, which leaves Joe the ex-employee totally dependent on the State. The point is that the imposition of a net tax hike will have negative consequences.

One Economy

While Obama has neatly dissected the American economy into classes based on annual income, our economy is actually one. There is no lower class, middle class or upper class America; there is just one United States of America. It doesn’t matter whether you are a doctor, lawyer, accountant, CEO, manager, teacher, or wage earner; we are all interconnected. We all rely on the products and services of one another. To increase tax rates on one is to raise them on all, to cut tax rates on one is to lower them on all.

Defining the Problem

Now, since Obama has come up with a solution, the question we need to ask ourselves is, what is the problem? Are we looking for a way to grow the economy and to create jobs? Or, are we looking for a way to reduce the federal budget deficit? If the goal were to grow the economy and create jobs, then the logical solution would be to implement across the board tax cuts. Under number five* (above); a tax cut would imply cutting taxes by more than they are raised; otherwise only number one will suffice.

However, if the objective is to reduce the federal budget deficit, then tax policy alone will not suffice. The reason that tax policy will not solve our budget woes is that our budgetary problem is comprised of two variables: revenues and expenditures. The main reason for the present imbalance is expenditures. In fiscal year 2010, the federal government spent around $1.6 trillion more than its revenues. So can this problem be solved through implementing a $1.6 trillion tax increase? Not hardly. We already know that drastic spending cuts are required.

It has already been proven time and again that the act of lowering tax rates has the effect of broadening the tax base and increasing revenues. It has also been proven repeatedly that increasing tax rates has the opposite effect. A recent example would be the NY cigarette tax. As the NY Post reported, “Sales of taxed cigarettes have plummeted a staggering 27 percent statewide since the highest cigarette tax in the nation took hold in July.” So did over a quarter of NY smokers quit smoking? Not exactly, they simply started buying cigarettes outside of the state. So the plan to increase revenues by raising cigarette taxes actually wound up creating a budget shortfall.

We already know that a tax increase will not spark economic growth or aid in job creation; only a tax cut will suffice. It is also clear that a tax increase won't solve the budget dilemma. So why is Obama stuck on number three? What problem is he trying to solve? There is only one logical possibility: wealth redistribution (i.e. class warfare). Is this really where we should be focused at this moment in time? I say no. To me this is just a bunch of rubbish (i.e. partisan trash talk).

Certainty

Lowering tax rates would begin a new era of growth, like I personally experienced between the years 2003 through 2006, while a tax hike will only cause further cutbacks. Maintaining current tax rates would have one benefit, and one alone: certainty. Small business owners, such as myself, are just not able to function under the present cloud of unusual uncertainty. My experience this year has been that where I should have concrete answers, I have none. Most of my advice, and all of my decisions regarding asset acquisitions are on the shelf. It’s probably too late to change anything for 2010, but there’s always next year. However, there won’t be any definite decisions until there is certainty. And for me, certainty means stability. In other words, a temporary fix or patch won’t cut it. I’m holding out for a clearly defined long-term plan, such as W’s 10-year tax plan.

If I have to endure any more partisan rubbish from the White House, I will explode. I don’t think I can bear listening to another two years of partisan campaign trash. One and done son. One and done. For God’s sake, repeal the AMT, and either cut tax rates now, or extend the current rates, and then work on the out-of-control spending problem next year. These are the only logical options.

Related: Obama's Tax Fallacy II and Obama's Tax Fallacy

Wednesday, November 10, 2010

Fiscal Commission: Tax Reform I

Review of Tax Reform Proposals -

By: Larry Walker, Jr. -

I am in agreement with the Fiscal Commission's goals on tax reform. Although the details are a little vague, it's clear to me that Option 1 is probably out of the question, Option 2 is promising, and Option 3 is pretty much a joke. I think that those who have discounted this initial 'draft' report at face value are doing the commission a disservice. And as far as the Trash Talker In Chief, who has already started spouting off without even reading it, I have nothing but contempt for the comments I heard today out of South Korea.

I personally had a falling out with President Bush, when he put together a special commission on the War, and then proceeded to ignore everything they said. So I hope that someone in Washington takes this commission seriously and implements some of their more excellent ideas (the right ones). If not, there will probably be another major falling out.

Of course, the following tax reform proposals go along with proposed cuts in spending. I am just looking at the tax aspects today, but as long as spending is cut as proposed, there is hope of some kind of compromise on taxes. I think we do need to simplify our tax code and lower tax rates however, our main problem right now is spending. Thus, spending reform should occur prior to any type of tax reform, and of course the repeal of Obamacare is number one on that list. At the top of the tax reform list today is passing another patch for the AMT, and extending the 2010 tax rates for another couple of years. There's no time to waste on partisan trash talk.

My likes and dislikes are below in blue type, and a link to the original report is at the bottom.

Comprehensive Tax Reform

Goals:

  • Lower Rates
  • Simplify the Code
  • Broaden the Base
  • Cut Spending in the Tax Code (Tax Expenditures)
  • Improve Compliance (Tax Gap)
  • Make America the Best Place in the World to Start and Grow a Business
  • Reduce the Deficit

I have no problem at all with the commissions outline of goals for comprehensive tax reform. I think they are in agreement with what every fiscal conservative has been chiming for decades.

Option 1: The Zero Plan

  • Consolidate the tax code into three individual rates and one corporate rate
  • Eliminate the AMT, Pease, and PEP
  • Eliminate all $1.1 trillion of tax expenditures
  • Dedicate a portion of savings to deficit reduction and apply the rest to reduce all marginal tax rates
  • Add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero-expenditure low

Option 1: The Zero Plan

*Note: All options set aside $80 billion for deficit reduction and treat capital gains and dividends as ordinary income. Rates based on very rough static estimates. No behavioral effects are assumed. Magnitude of tax expenditures estimated broadly.

Although I like the idea of lowering the tax brackets and consolidating them down to the three, and having one lower rate for corporations, the elimination of all tax expenditures is problematic. Having survived through a household with four young children, I have empathy for parents of young children. Between day care, food, medical, and the extra running around that parents deal with, it would be right to extend the child tax credit. Although it wasn't there in my day, it would have given us some badly needed relief.

I am however not a fan of the EITC (earned income tax credit). I think the EITC discourages people from being all that they can be, and instead keeps them locked within a certain range of income. So the EITC can be dumped.

I agree with repealing the AMT (alternative minimum tax), in fact, we ought to just go ahead and do that right now. And I agree with repealing the limitations on itemized deductions (Pease), and personal exemptions (PEP).

I disagree with taxing dividends and capital gains at ordinary rates. I think we should encourage investment by extending more favorable tax rates to investment income.

I would like to see the continuation of deductions for mortgage interest, property taxes, state and local income taxes, and charitable contributions.

I am in favor of keeping deductions for retirement contributions such as IRAs and SEPs which are not addressed in this summary.

Thus, Option 1 falls short of the mark because by the time one adds back all the desirable tax expenditures, we're right back where we started. However, Option 2 is more appealing.

Option 2: Wyden-Gregg Style Reform

Individual Tax Reform

  • Repeal AMT, PEP, and Pease
  • Establish 3 rates –15%, 25% and 35%
  • Triple standard deduction to $30,000 ($15,000 for individuals)
  • Repeal state & local tax deduction, cafeteria plans, and miscellaneous itemized deductions
  • Limit mortgage deduction to exclude 2nd residences, home equity loans, and mortgages over $500,000
  • Limit charitable deduction with floor at 2% of AGI
  • Cap income tax exclusion for employer-provided health care at the amount of the actuarial value of FEHBP standard option
  • Modify and repeal several other tax expenditures
  • Dedicate portion of savings to deficit reduction

Again, the repeal of the AMT, PEP, and Pease are most desirable, fundamental to both options and should be done now, today.

I like the idea of having just the three tax brackets.

The tripling of the standard deduction is very appealing. It would take the place of the mortgage interest deduction for many, allow non homeowners a higher deduction, and not impair those with larger mortgages (under $500K). I think limiting the mortgage deduction on 2nd homes and mortgages over $500K is prudent. Why are we subsidizing 2nd homes anyway?

I'm OK with the limitations on charitable contributions, and the employer health care exclusion.

I don't know what is meant by 'repealing several other tax expenditures.' The commission needs to be more specific.

Corporate tax reform

  • Reduce corporate tax rate to 26%
  • Permanently extend the research credit
  • Eliminate and modify several business tax expenditures, including:
    • Domestic production deduction
    • LIFO method of accounting
    • Energy tax preferences for the oil and gas industry
    • Depreciation rules
  • International tax reform including a territorial system

The corporate tax reform ideas seem reasonable, but of course more detail is required.

Option 3: Tax Reform Trigger

  • Call on Finance and Ways & Means Committees and Treasury to develop and enact comprehensive tax reform by end of 2012
  • Put in place across-the-board “haircut” for itemized deductions, employer health exclusion, and general business credits that would take effect in 2013 if reform is not yet enacted
  • Haircut would limit proportion of deductions and exclusions individuals could take to around 85%* in 2015. Similarly, corporations would only take some proportion of their general business credits
  • Set haircut to increase over time until tax reform is enacted

*This is a very rough estimate of the haircut necessary to reduce the deficit by $80 billion in 2015

Option 3 is absolutely out of the question. Throwing tax reform back into the hands of politicians virtually assures that nothing will be accomplished for another 40 years. The use of the word 'trigger' pretty much sums it up. Who's going to pull it?

Source: http://www.fiscalcommission.gov/news/cochairs-proposal