Borrowing, Taxes & Deficits – A Discussion

In my last post "Soaking the Rich” – A discussion" I set forth a discussion with various subscribers to my blog, which was initiated by an article written by Christopher Caldwell, a senior editor at The Weekly Standard the magazine founded by William Kristol, and a response thereto by a professor at the University of Warwick, Coventry UK.

One of my subscribers, Professor Robert Malchman of Brooklyn, NY has now prompted me into another discussion by sending me a post to his own blog I Am Not Bob.

I urge the reader to go that site and read both his post and the comments, which were exchanged between him and a reader who identified herself (I think it was a she) as bunny42. 

After reading those exchanges I found myself in disagreement with both of them, and accordingly wrote:

I find myself in disagreement with both the post by Robert Malchman and the comments posted by “bunny,” whoever she might be.

Professor Malchman posits a beautiful theory under which the US government is better off the more it borrows and “deficits don’t matter.” This is the first time I have heard this theory since VP Cheney declaimed this sentiment. See here.

Of course Cheney had no basis for his claim, since Reagan neither proved this, nor believed it. After a huge cut in taxes, Reagan worried enough about the deficit that resulted, that he instituted the biggest tax increase in history, “the Tax Equity and Fiscal Responsibility Act of 1982. TEFRA — which was designed to raise $214.1 billion over five years, and took back many of the business tax savings enacted the year before.” See here.

But Professor Malchman points out that conditions are now so unusual that the ordinary rules don’t apply. He points out that with interest rates below the rate of inflation, the government actually makes money by borrowing. But what Malchman overlooks is that if the funds obtained by this borrowing are spent, it will not be possible to pay back the T-Notes, except by further borrowing when they fall due. If at that time the present unusual situation no longer holds then the government would be forced into borrowing at a rate not advantageous. The only way new borrowing can be justified is because it is necessary to cover existing debt, or it is to be invested in projects that by the time the notes become due return a larger return than the cost of long range borrowing, not on the basis of temporary conditions. Investing in infrastructure, undoubtedly, meets this test, and other projects might, but this has to be the test, not temporary deviations from the norm.

Now Bunny is even more off base! She misinterprets Professor Malchman’s comments as recommending that people should buy these instruments. Just the opposite is true. Malchman is pointing out that people who buy these instruments are making a bad investment, since rather than making money, they are losing it. She then goes into a rant about the CRA, which I assume refers to the Community Reinvestment Act, passed in 1977, and which provides among other things, that loans “should be undertaken in a safe and sound manner, and does not require institutions to make high-risk loans that may bring losses to the institution. See here.

In any case there is no evidence that the agency required the type of predatory lending that brought about the housing crisis. All the available evidence indicates that banks and credit facilitators made and encouraged stupid loans, because they believed that with housing prices going up ad-infinitum, the real risk was much smaller than the apparent risk, and with the high rates of return, it was a very profitable business. “They made me do it” is a children’s excuse, and not one for adult sophisticated bankers. In any case if they felt they were being made to do something they didn’t want to do, no one ever heard their protests, Congressman Paul’s allegation notwithstanding.

Malchman then makes an unfortunate comment that has nothing to do with lending, i.e. that if the deficit needs to be cut (according to Malchman it need not be cut) it should not be “cut by eliminating spending (but) by raising taxes on millionaires.” My main concern with this is that it does not define millionaires. Is a millionaire one who has net assets over a $1million, or one who has an annual income of over $1 million? That makes all the difference in the world. But Bunny never raises this question. Instead she goes into a rant saying, “Historically, taxing the rich (the numbers I heard started at $250K) has caused them to circle their wagons and save their shekels.” for which she offers no evidence. In fact the evidence is just the opposite.

“… across the board, today's tax rates are low by historical standards--and for the rich they're very low.” See here. 

And yet the rich “are savi(ng) shekels”. Using Bunny’s logic they should have been spending it. Yet they sent us into the worst recession since the ’29 depression. When Clinton became President (1993) he raised the marginal tax rate from 31% to 39.6% for those making over $194,000, and from 31% to 36% for those making over $108.696. See here. The economy boomed, coming out of a recession that led to the slogan “It’s the economy stupid.” Now I don’t believe that the tax increase caused the boom by itself - but the tax increase reduced the deficit, causing the Fed, under Allen Greenspan, to lower interest rates. Now interest rates are at an all time low, so reducing the deficit would not have the same beneficial effects, but neither would it do any harm if we returned to the rates under Ronald Reagan at say the beginning of his second term, in 1985 when they were 50% for those making over $169,000. Ibid.

As even Bunny should be able to see there is no correlation between taxes and economic expansion. After 1985 taxes went down drastically, and yet we had an economic slowdown, which was not addressed adequately until Clinton.

Bunny says: “So, just tax more? Why not just print more money. You'll get the same result.” No Bunny, printing money, frequently, though not always, leads to inflation, increasing taxes never does. But as you say, “whadda (you) know?

Let me see Bunny – in your second post you posit that increasing taxes on the rich would not make your life easier. No it wouldn’t – but cutting spending in many areas would make your life harder. Would you like your food to be unsafe, the water you drink unsafe, or have your children play with unsafe toys. Would you like your elderly parents to have no income, unless they made enough money to have a big 401K, or to be denied health care because they weren’t wealthy enough to afford the incredibly expensive health insurance at market rates? Or if they are younger, and they have health insurance through their employer, would you want them to go bankrupt because they got sick, lost their job and with it their health insurance. I could go on ad infinitum. Yes, our so-called entitlements are out of whack and need reform, and Ronald Reagan made Social Security reforms that saved the program, and we need to do something like that again. But Ryan’s plan would effectively do away with it, and still increases the deficit by $6 trillion over ten years. See here.

Bunny, you talk about “the self-made millionaires, … having worked for their success” - yes some have, but most inherited money, which they invested and made more from, and paid less taxes than people who actually do work. The people who work the hardest are the ones who make low wages and work on two jobs to make ends meet, and don’t have health insurance or pensions from their employers.

Please understand, Bunny, that employers aren’t hiring, not because taxes are too high, or because regulations are onerous, those have been around through good times and bad, they aren’t hiring because there is no demand. If you had a business and you couldn’t sell the goods you made, would you hire people to make more goods? It wouldn’t matter how cheap that labor is, or how much taxes are lowered, you wouldn’t hire until the demand was there. And if the demand was there you would hire regardless of taxes or regulations. If you double your gross, and taxes were 40% you would still be ahead of the game. If taxes were 40% and you made 10% more you would still be ahead of the game. You would simply have less of an increase. If you make $10,000 more and you pay 40% of that to the government you still have $6,000 more. Would you forgo that $6,000? I am all for cutting. God knows there are many places where we spend money foolishly, on our war on drugs, on subsidies for ethanol, etc. etc. etc. But we have to have enough revenue for the country's legitimate needs, and we have to get that money from those who can afford it – not because we hate them, but because they can afford it. Even half of 250,000 isn’t bad, half of a million isn’t bad. And half of a billion, I only wish. But nobody is advocating anything anywhere near an effective tax rate of 50%. Even a marginal tax* rate of 50% doesn’t amount to anywhere near an effective tax rate of 50% and nobody is advocating a marginal tax rate anywhere near 50%, though in 1945 the marginal tax rate was 94% on all incomes over $200,000. See here.

 A slightly higher marginal tax rate than we have now, would not hurt those who have so very much, and the point is not to hurt anyone.

*Marginal Tax rate is the tax owed on income above a certain amount. Thus taking the Clinton tax rates as of 1993 on someone making $300,000, we find that the marginal tax rate is 39.6%, which according to the table comes to 39.6% on all incomes over $250,000. With an income of $300,000 that comes to $50,000, or a tax of $18,800; 36.0% on all income over $140,000 but below $250,000 which comes to $110,000 at 36% and a tax of $39,600; 31% on all income over $89,150 but below $140,000; 28% but on all income over $36,900 but below $89,150 and 15% on the remaining income. If my arithmetic is correct, the marginal tax rate is 36.9%, but the effective tax is 31.86%.

Comments are welcome and will be distributed with attribution, unless the writer requests that he/she not be identified.

“Soaking the Rich” – A discussion

As my readers surely are aware, I spend a great deal of time researching and writing on the issues of the day. I do this, not so much to convince anyone of the soundness of my views, but rather to lay a foundation for these views, for to hold views without a foundation, in fact and logic, is empty rhetoric. However in addition to writing for my blog, I often get into discussion with various people, which are worth sharing.

So today allow me to share with you a discussion that was based on an article that was written by Christopher Caldwell, a senior editor at The Weekly Standard the magazine founded by William Kristol. In order for you to follow this discussion it will be necessary for you to read the article, which you can find here.

This prompted a letter from Dean Machin, Dept of Philosophy, University of Warwick, Coventry, UK reading as follows:

Sir, Christopher Caldwell’s article was dispiriting and uplifting in equal measure. First was the hackneyed argument that increasing taxes on the rich will not “suffice” to address the US’s (or indeed any state’s) debt problems. Of course this is true, but as there is no single measure that will achieve this end the point is irrelevant. Second, he is right about the disproportionate political influence of the rich. So, here’s a proposal: make the rich choose between increased taxes or no political influence. Let them vote (as if they care about that). But ban lobbying, funding political parties, meeting politicians and controlling media outlets. Good consequences may follow and this proposal would go some way to returning politics to the control of the people who are doomed to be affected by it; and away from those individuals who are footloose and mobile.

Now I find the letter more revealing than the article by Caldwell. 

Mr. Manchin writes:

First was the hackneyed argument that increasing taxes on the rich will not “suffice” to address the US’s (or indeed any state’s) debt problems. Of course this is true…

But it is not true and it reveals one of the major flaws in the rebuttals that liberals make in responding to spurious allegations. They accept their facts as true, without asking themselves whether they are, in fact, true. That is a poor way to effectively rebut an argument.

The American Enterprise Institute, the organization that speaks more than any other for the wealthy, tells us in an article entitled, “Guess Who Really Pays the Taxes”: “The top 5 percent pay well over half the income taxes.” and further down under (2) “The wealthiest 1 percent of the population earn 19 per­cent of the income but pay 37 percent of the income tax.” According to Forbes magazine “The 400 Richest Americans Pay An 18% Tax Rate” and according to the Tax Foundation “the top 1 percent of tax returns paid 36.7 percent of all federal individual income taxes” (see the third full paragraph in the article).


If we look at the tax projections of the Office of Management and Budget for 2013 (click to enlarge) we see that they estimate receipts from the income tax of $1 trillion 344 billion. 

37% of that is $497 billion or almost half of a trillion. Over ten years that comes to $5 trillion. If by making capital gains income and interest income taxable at the same rate as earned income (i.e. income earned by working) and such other adjustments as necessary, we increased their contribution to the common weal by 50% or an effective income tax rate of 27% (and there is no reason why it should not be much higher) we would add to the treasury another 2 1/2 trillion, probably enough to wipe out the deficit without any cutting. I said that there is no reason why it should not be much higher because there is ample precedence for a much higher tax rate. Under the Republican Eisenhower Administration (1953-1961) the top tax bracket was 91% on incomes over $200,000, and it remained there until 1964 when the top rate was changed to 77% on incomes over $400,000 and 66% on all income over $100,000, which adjusted for inflation comes to $2,895,000 and 3/4 of a million respectively. See here. These high rates of taxation did not prevent the US from enjoying prosperity, but they did prevent the incredible skewing of wealth upwards.

But the important point here is that the allegations by a senior editor at The Weekly Standard have no basis in fact, and yet were readily accepted by Professor Machin.

But let us go back and look at Mr. Caldwell’s argument further. He says: “The rich pay less because capital gains and carried interest get taxed at a low rate. As Mr. Buffett puts it, “those who make money with money” are treated better than those who “make money from a job.” In saying this, Mr. Buffett subscribes to the religious understanding of money that was universal in the Christian world before the rise of Florentine banking (and of Protestantism) and has been restated in our own time by practitioners of Islamic finance. People are alive but money is not, which makes it wrong – because it is life-denying – to prefer the latter.”

There is only one thing wrong with this – neither Mr. Buffett nor any one else has made this argument, so why is this straw man being rebutted.

Caldwell concedes that there is a problem with the super rich. He sees a problem from “their influence over the political system.” But he dismissed the influence from campaign contributions by asserting that, “even more comes through the deductibility of “charitable” contributions. Yet it is interesting to note when the President recently suggested that the rich should not be able to deduct these contributions, the scream from Mr. Caldwell’s cohorts was deafening.

But most of all they load the question through the constant refrain that those who want all to contribute to the common weal, are advocating a policy of “Soak the Rich”, which isn’t at all what anyone wants to do.

As I said in my contribution to this discussion at the time the discussion went forward:

I have seen a number of Letters to the Editor that show a misunderstanding of what the graduated income tax is all about. It is definitely not about "soaking the rich." It is about raising enough revenue to allow the government to meet its obligations without putting a burden on people that is greater than what they can afford. I have seen one Letter to the Editor that claimed that those making less than 1 million dollars annually are not rich and therefore tax increases should not be applied to those in that income category. This totally misses the point. Who is rich and who is not is irrelevant. We tax those who can better afford it because that is the source where money can be found without imposing a hardship. As people have more income they can afford to pay more and therefore should. 

We are supposed to be a society that follows the Protestant ethic of valuing work, yet we tax income obtained through work at a substantially higher rate than that obtained from return on Capital. I have never seen any justification for this and this is what Buffet is addressing, for it is that distinction which makes our graduated income tax a hoax and allows the rich, and particularly the very rich, to pay less in taxes as a percentage of their total income, than their secretaries.

                       

Milton Friedman, who I assume is the intellectual inspiration for Republican policies, advocates a flat tax, but includes in income both Capital Gains and Dividends without any distinction or favorable treatment.

                       

We will never have a meaningful graduated income tax until all income is treated equally.

                       

Thus it is not a question of soaking the rich. It is a question of obtaining money from those who can afford it in proportion to their ability to pay; thus the graduated income tax with many brackets. Reducing the brackets is not desirable because it gets us away from affordability. Nor does it create meaningful simplification.

                       

Ditto on exemptions. Many are bad. Corporation for example should not be allowed to choose between LIFO and FIFO for income tax purposes. This distorts their true income and allows them to manipulate it. FIFO should be the standard. This alone would increase corporate taxes allowing them to be lowered somewhat. But I have a real problem taking away the charitable deduction, because without it too many worthy causes would suffer.

                       

The oil depletion allowance and the ethanol subsidy should go, but not the deduction on municipal bonds which cities depend on, nor the deduction on mortgages on first homes, but yes on second or more homes. Nor should we allow the deduction on refinancing mortgages, unless it is shown to be for home improvements. What about 401Ks? They favors higher incomes, but have taken the place of standard pensions, so we need to keep them. But we have so many tax deferred accounts now including the education, medical, etc. deferments, that we should be discussing the merits of various deductions, before we wake up to a mass elimination of good ones and the retaining of those that favor higher incomes. It may be that we should keep all of that type, but limit their total exemption to a fixed amount, e.g. $20,000 per annum.

                       

None of the columnists have even touched on this. We need to start a conversation because this is definitely on the horizon.

Comments are welcome and will be distributed with attribution, unless the writer requests that he/she not be identified.