Monday, December 31, 2012

Hang On We're Heading Over the Fiscal Cliff

As usual, listening to the Washington Beltway crowd and their friends in the Mainstream Media one can easily conclude that the American economy is headed for a major crash as the economy careens over the January 1, 2013 Fiscal Cliff.

Despite Chicken Little scaremongering by the chattering classes, most people seem to be taking the cliff fairly calmly.  The stock market has declined a bit as it usually does when faced with uncertainty and potentially bad news but the nation has remained calm.

The so called Fiscal Cliff is basically a fiscal tightening or anti-stimulus that involves cuts in Federal spending and increases in taxes.  This is the opposite of a Keynesian obsession with throwing money at the economy.

Following the end of World War II we hit a major fiscal cliff in 1946 and beginning of 1947.  Then as now, Keynes and his followers were certain that going over the fiscal cliff would result in an economic crash and renewed economic depression. 

According to popular myth, World War II brought us out of the Depression.  Granted, everyone not drafted into the military had a job and factories, mines and farms were at full production throughout the war.  Government spending on materials needed to fight the war amounted to a huge economic stimulus which had the economy operating at maximum capacity.

While the statistics looked good, consumer production was minimal leaving workers with little on which to spend their earnings. Everyone had a job but only limited quantities of bare necessities were available for purchase by consumers.

It was in this immediate post war period that President Truman in a speech uttered words to the effect that war is hell but peace could be worse, alluding to the Keynesian belief that, without the continued stimulus of massive government spending, the economy would quickly collapse.

The dropping of the atomic bombs on Hiroshima (August 6, 1945) and Nagasaki (August 9, 1945) coupled with the Soviet Union joining the war against Japan on August 8, 1945 quickly brought the war to an end on August 15, 1945.

Not only did the war end much sooner than expected, but, under pressure from the people who were sick the austerity that marked the Depression and World War II, the U.S. government immediately began demobilizing the troops (which represented about 18% of the labor force), canceling contracts for military material and lifting wartime regulations and restrictions on consumer production.
In the1946 mid-term Congressional elections the Republicans retook the House of Representatives defeating 54 Democrats and 1 left wing Progressive Party member to obtain a majority of 246 seats against the Democrat's 188.  In the Senate the Republicans picked up eleven seats from the Democrats plus defeating the left leaning Progressive Republican Robert LaFollette the primary and keeping the seat for a 51 to 45 Republican majority in the Senate.

While Democrats and believers in Keynesian economic theories fanned fears that there would be a major Depression in 1946, it never materialized as the private sector, freed of many of the New Deal regulations and controls quickly switched from war production to civilian production. 

Federal spending fell from $84 Billion in 1945 to less than $30 Billion in 1946.  The sharp drop in spending  enabled the Federal Government to both quickly begin paying down the war debt. The deep cuts in spending also resulted in a small Federal budget surplus in 1947.

Both the Depression of the 1930s and the current massive economic downturn under President Obama have resulted from the ill conceived stimulus spending and massive increase in unnecessary regulations. 

Going of the Fiscal Cliff may not be that bad and could result in the economy quickly turning around and recovering early in 2013.

Click the links below for more on the feared Depression of 1946:

Stimulus by Spending Cuts:  Lessons from 1946 - Cato Institute Policy Report

Cheer Up!  The Cliff Doesn't Look So Grim - Barrons December 31, 2012 issue 


Monday, December 24, 2012

Will Charities Survive if Congress Eliminates the Charitable Tax Deduction?

The Christmas Season is upon us and this is a traditional season of giving.

It is not just the gifts for family and friends, but also the giving of goods and money to charitable causes. 

Giving and sharing with those less fortunate makes the giver feel good.  Giving is also a part of most cultures and is reinforced by the dictates of most religions which require believers to give as a part of their religious duty.

In the United States people who give money or goods to charities have an additional, financial, incentive to give and that comes in the form of lower income taxes.  Both the Federal government and most states with an income tax allow people to deduct the value of charitable contributions from their gross income for tax purposes.

Now with concerns about the fiscal cliff and the Federal government's need for more revenue to pay for its out of control spending the search is on for ways to increase revenue.

While logically the solution should be to bring spending into alignment with revenues, politicians and bureaucrats tend to take spending as a given and look to tax increases to make up the difference.

Currently, two approaches are being explored for increasing tax revenues.  One approach is to simply raise tax rates despite the fact that, historically, that tends to result in less revenue.  A second approach calls for keeping current rates but restricting or eliminating deductions.

Deductions allow people to subtract certain types of expenses from their gross income thereby reducing their income for tax purposes.  Eliminating or restricting deductions would certainly result in more revenue for the government as people's ability to reduce their taxable income would be curtailed.

Of course, organizations and businesses, whose activities or products are affected by people's ability to reduce their tax bills by contributing to or buying from these organizations, are opposed to this solution - at least as far as their activities are concerned.

However, while it is clear that deductions for home mortgage interest and local real estate taxes provide a powerful incentive for people to buy rather than rent their living quarters, there is some question as to whether allowing people to deduct charitable contributions is an incentive for people to give to charity.

Proponents of eliminating the deduction cite statistics showing that charitable giving in the U.S. has remained a relatively constant 2% of Gross Domestic Product despite numerous changes in tax laws affecting such giving. 

Charitable giving also has a long history going back to ancient times - long before there was an income tax and the need for income tax deductions.  Long before governments became involved in building social safety nets, churches were involved in soliciting money from members to help those less fortunate.  Hospitals, orphanages, poor houses, etc. all began as services provided and paid for by churches.

In the Western world the idea of people having a duty to look out for those less fortunate has long been ingrained in the culture.  Sharing one's good fortune with those less fortunate is the thing to do for many people.

As one who not only contributes to charity but also keeps records of contributions for tax purposes and benefits from the deduction, I can honestly say that I would miss the deduction but, after reviewing my contributions haven't found any that I would stop donating to in the absence of the deduction.  Friends I have spoken with have said the same thing about continuing their contributions in the absence of a tax deduction.

That being said, eliminating the tax deduction will reduce contributions to many non-profits.  Part of this will result from people taking a closer look at an organization, its mission and how efficient it is with their money. 

In the absence of  a tax deduction, those donating to charities will be apt to take a closer look and how the charity uses their money.  Those charities in which administrative and/or fundraising consumes most of each dollar received will find contributions being redirected to other charities where the bulk of each dollar goes to helping those in need.

Tuesday, December 18, 2012

French Actor Gérard Depardieu's Reply to Prime Minister Ayrault

 Conservatives and reputable economists for years have argued and used income tax data to show that high marginal income tax rates result in lower tax revenue as people adjust their work to reduce income and the tax burden or avoid the tax by leaving the jurisdiction.

So it was no surprise when French actor Gérard Depardieu, best known as the star of the world-wide 1990 hit movie Green Card, quietly relocated his residence to the Belgium town of  Néchin, located a stone's throw from the French border, earlier this month.

It was obvious that Depardieu's move, like that of many other wealthy French people in recent weeks, was in reaction to Socialist French President François Hollande's plans to levy a 75% tax on incomes above 1 million euros.

Most of the others left France quietly as Depardieu tried to do.  However, unlike some of the others who ignored the insults from socialist government officials and France's far left press, Gérard Depardieu reacted publicly and with anger this past weekend following last Wednesday's (Dec 12) harsh and insulting comments about him by France's Socialist Prime Minister, Jean-Marc Ayrault.

Speaking on the television channel France 2, the Prime Minister referred to Depardieu's decision to leave France as being "rather pathetic."   Adding “He’s a great star, everyone loves him as an artist,... [but] to pay a tax is an act of solidarity, a patriotic act.”

The actor responded the Prime Minister's comments with a three page, open letter that was published in the Saturday (December 15th) edition of the French weekly Journal du Dimarche.

In his letter, which I translated using Google Translate, Depardieu starts by writing:

Miserable, you say "pathetic"? As it is pathetic.

I was born in 1948. I started working at the age of 14 years as a printer, then as a warehouseman then as dramatic artist. I always paid my taxes regardless of the rate under all governments.

He goes on to state that he has always paid his taxes, including his 2012 taxes and further notes that over his 45 year career he as paid over 145 million in taxes to the French government. 

In a telling line he states:  I am leaving because you consider that success, creativity, talent, in fact, the difference must be punished.  

And toward the end of the letter he adds, 

I am a free being, sir,...

These last two comments reveal what the true objectives of socialist leaders like French President Hollande and U.S. President Obama with their tax the rich policies.  The goal here is to discourage individual initiative and freedom and, instead replace it with dependency on government.

While not good for freedom loving individuals, this is the perfect prescription for big government politicians who want to ensure the continued growth of big government.

Tuesday, December 11, 2012

Capital Stock and Retiree Income

Social Security and pensions are a growing concern for many people these days.  Retired people and those nearing retirement are especially concerned about these issues as they affect such people directly.

Most people look upon this crisis as a financial or money issue and it is true that a growing lack of money available in retirement funds is the main indicator that a problem is at hand.

However, money itself is merely the means by which we measure the ability of the government or private employer to pay the promised retirement benefits.
No one can survive without access to the food, clothing and shelter needed to sustain life.  And, most want more than the basic necessities of life.

There are only two ways to obtain necessities and desired extras and that is to either work and produce these things or rely on the labor of others.   However, relaying on the labor of others assumes that the others in question are both able to produce more than they need and are willing to share the surplus they produce.

The ability of working people to support themselves plus those who are unable to work is dependent upon the availability of capital, developed land, knowledge and organization accumulated through past savings and investment. 

These tools make workers more productive and better able to produce sufficient quantities of goods and services to meet both their own needs and desires as well as the needs and desires of those not working.

Investment requires that some production be diverted from production of consumption goods and devoted to producing the capital goods needed to both replace capital stock that is wearing out due to use as well as creating the additional capital goods needed to keep the economy growing and expanding.
Savings requires sacrifice.  Sacrifice in the form of choosing to forgo consuming a portion of one’s income now by either setting that portion aside for a future emergency or investing it in tools that will enable them to produce more in the future.

In times past a farmer could increase his wealth by a combination of working extra hours clearing new fields for planting and then he and his family tightening their belts and saving and extra portion of the current year’s crop as seed to plant in the new fields next year.

Then, instead of enjoying all of the new, larger crop, some could be sold or bartered in exchange for better equipment and/or draft animals to enable him to produce more in the same amount of time.

Modern urban workers do the same by setting aside money out of current income for emergencies and as savings for retirement.  

This savings takes the form of investments in income producing assets such as bank accounts, stocks, bonds, real estate, a business, etc.  Unless the worker owns a business in which he is investing in and growing, the savings is usually assigned to organizations or professionals who do the actual investing on behalf of the worker.

It doesn’t matter whether the worker is a famer or small business person investing in their farm or business or simply one who places their savings with professional investors.  The result is the same, namely resources going into the production of tools to enable workers as a whole to produce more in the same amount of time.

Continuing investment is needed for two reasons.

First, a certain level of current investment is continually needed to replace equipment that wears out and is no longer operational.

Second as the population increases or, as is happening in many nations, ages and the aging workers retire, existing workers have to produce more simply to provide for themselves and the young, old and infirm who cannot work and produce. 

While older retired workers are still consuming but no longer working and producing the legacy of productive capital produced from their savings leaves the new generation of workers with the ability to produce and support both themselves and the retirees.

Next:  Why Social Security and Pensions are in Trouble

Monday, December 03, 2012

Allowing Bush Tax Cuts to Expire Now Makes no Eonomic Sense

 As we approach the December 31st Fiscal Cliff one of the major points of debate is taxes.  Specifically increasing taxes on the rich.

President Obama and other left-leaning Democrats are targeting three types of income the taxes on which were reduced during the administration of former President Bush and which are slated to automatically increase at the start of 2013.

The first is the tax on dividend and capital gains income.  Capital gains refer to the difference between what a person paid for and asset (with stock being the most common asset affected) and what that person received when the asset was sold.  If the sales price is higher than the purchase price the difference or profit is referred to as a capital gain.

Dividends,of course, refer to the periodic dividends or portion of a company's profit that corporations pay to their stockholders.  Profits are already taxed once in the form of the  tax that the Federal Government levies on a corporation's  profit (i.e., revenue minus expenses).  Any dividends paid come out of the corporation's after tax profits.  Stockholders then have to turn around and pay additional tax on the dividends they receive.

The Bush Tax Cuts eliminated the tax on capital gains and dividends for those in the two lowest income tax brackets which are currently the 10% and 15% brackets and set the maximum tax on these for people in the brackets above these two bottom brackets at 15%.

These two taxes will go up unless the current rates are extended by Congress

The second area of income affected will be income from sources other than capital gains and dividends.  This is basically wages, salaries, bonuses and other income earned as compensation for work performed.  

Here the President is claiming to want to keep current rates for those with this type of income below $250,000 and raise the rates on those earning more than $250,000.

Since our income tax system is progressive this means that the government will accomplish this increase by increasing the tax rate on upper brackets of income as well as creating some new brackets at the top end of the bracket scale.

The problem with increasing the tax rates on the top income brackets is that many wealthy people have the ability to reduce their income by working less.

It makes sense to work less when the tax rate on the higher income resulting from working longer and harder is such that most of this extra income is taxed away. 

When high income earners do this the government not only loses the projected tax revenue that the high top rate would be applied to but also stand to lose taxes from other workers in lower brackets.

Take a small business owner planning to expand by adding an additional production plant, restaurant, store etc.  The expanded business will result in more income for the owner.  However, the expansion will also require the small business owner to hire more people. 

With almost 8% of the workforce currently out of work and looking for work and an additional 6% to 8% or more of the workforce wanting to work but has given up looking for work (thereby no longer considered by the Department of Labor as being in the workforce and unemployed) the government could collect considerably more taxes if large numbers of these unemployed people were earning wages and paying taxes on those wages.

The only things that President Obama will accomplish by raising taxes in the current economic climate will be to continue the present recession and continue running large deficits.