Tax man cometh.

The recent refusal to cut taxes and raise revenues had me consider three things. First I will lay out an example:

The median income of a family in America (4 people), roughly, is $50,000. Lets for simplicity purposes say that an effective 2.5% tax-cut is passed and is only for those making less than $10 million versus tax cuts for all income brackets. A 2.5% tax-cut at the $10 million level is $250,000. If we take that 2.5% tax cut ($250,000) we can give an additional 10% ($5000) tax cut to 50 families (a family = 4 people) or 200 people. (I realize I am slightly altering the tax cut to give a larger tax cut to those making $50,000)

But my real question is how much more is behavior going to be impacted for someone at the $10 million dollar level with an extra $250,000? Is that person going to spend it all or spend some and save some?

What about that family that got the extra $5,000? In my opinion the family is more likely going to spend that money than the millionaire.

A recent study by Moody's Analytics found that food stamps (for the most impoverished) increases economic activity by $1.73 for every dollar spent. Unemployment insurance improved by $1.62 for every dollar spent and most other types of tax-cuts is less than $1 dollar of economic activity. Clearly, those on the bottom of the economic pyramid seems to spend more and save less. (Source: Economist- July 16th 2011)

The argument on the behalf of those making $10 million is that they are a job growth creator. But why isn't the person making $50,000 also a job growth creator? That family may go on vacation, but clothes, or fix that broken dishwasher.

Moreover, there is a key difference between giving a tax-cut to an individual making $10 million and a business that is grossing revenues above $10 million. In my opinion, the two often get mixed up when we hear politicians get on their soap boxes. I am all for giving tax breaks to our businesses and improving the regulatory environment. However, I am less convinced that the propensity to spend and stimulate the economy does not diminish (as higher income brackets save more) when we rise up the income ladder.

On another level, a more philosophical one, is the $250k tax cut given to the person (or even family of 4) making $10 million going to impact 200 people? Is buying that exotic watch or car (most likely foreign made) going to improve our economy? From a strictly utilitarian perspective spreading out those tax cuts is more useful in my opinion.

Lastly- giving tax cuts is effective only if it is spent in a productive manner. What if that person making $10 million puts $50,000 into a mutual fund that invests in stocks? Or what if that person uses it to put a downpayment on their third house? Is there any consideration that this may cause asset bubbles (i.e. too much cash chasing too few houses and overvaluing stocks?)

In fact, historically, Americans in the top income brackets were taxed as high as 70%. The money was used to build our roads and improve our infrastructure. These days our infrastructure is rotting because there is not enough money in our government's coffers.

But then again my whole analysis (light on rigorous empirical detail) might be biased in that I am not making $10 million.

Are U.S. Corporations overtaxed?

Lets just begin by assuming they are. The draconian taxes of the United States is what is preventing American companies from expanding in the U.S. The trillion dollars that is parked outside of the United States is often used as a proxy to argue that our country is not "business friendly."

But does anyone care about where these "low tax rates are?" The money is not being parked in Europe. It is not being parked in India and China. It is being parked in small Nordic countries (oh the Dutch) and islands (i.e. Cayman Islands) where the only requirement is that the company maintain a post office box to able to park their money. How can we possibly match the 5% tax rates of these countries for corporations and still maintain our roads, fight two wars, and pay our entitlements?

The whole argument that our tax rates are too high is a red herring. There will always be a tiny island in the middle of nowhere that can undercut our tax rates. Companies will always move their money off-shore or find a more tax friendly area. We, as one of the largest Republics in the world, cannot compete with tax rates of an island that is the size of one of our states and an economy that maybe one of our country's towns can equal.

But the discourse has been that we have very high corporate tax rates.

Finally, where is the mad rush for these corporations to invest in? India and China. No one will reasonably argue that these countries are more business friendly. American carmakers, for example, are required to partner up with indigenous firms in China (for example) to be able to tap those markets. Onerous much?

But despite these regulations--companies are trying to aggressively invest in these markets because the demand is there. Maybe its not high tax rates that is preventing companies from investing in American but simply a function of a depressed economy and weak demand.

This is not to say that we cannot do anything to make it more business friendly for corporations. However, saying that our country taxes our companies to death is--in my opinion--at least questionable.

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I also stumbled upon this:

http://thinkprogress.org/economy/2011/07/05/260535/graph-corporate-tax-second-lowest/

The Road Less Traveled

Robert Frost's poem rings true when considering the current divergence of policies between Europe and the United States. It goes:

Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.

One by one the European Union states have decided/considered to go on a spending diet. The era of debt and spending came to a sudden halt. Please view an old speech that warned of the impending debt crisis:




Austerity measures were instituted from Great Britian to Greece. Keynesians were worried that reducing government spending during a recession was ill timed and could slow the economic recovery. Even Nouriel Roubini, an economist who has been predicting financial disaster due to unsustainable debts, has hedged his bets by saying that he is concerned that European government's may be cutting back too much, too soon. Across the Atlantic, however, the United States passed a large tax cut. In a compromise that tried to please everyone--concessions on improving the welfare net (extension to the unemployment insurance) met with trickle down economics (tax cuts for the wealthy) at the finest. The cost would be a staggering $800 billion. Which method will win out needs the benefit of hindsight.

Reducing taxes for two years continue to leave uncertainty. Most business plans of large institutions look farther out that two years. After all, for example, if the payroll taxcut (a measure of the bill) is supposed to increase hiring--you as a business know that two years later it may not exist. Are you seriously going to spend months looking for a worker because of the payroll tax cut or are you going to hire because you really need a worker?

So what does this tax cut accomplish? Reinforce that model--it wants Americans to continue to spend more, save less. The concept of saving, leaving money on the "side lines" as opposed to in the equity markets/risky investments, or pushing off a purchase for another day is unacceptable. Unfortunately, as the old saying goes, someone's got to pay the piper. This unsustainable model needs to be changed through investment and well managed, decentralized industrial policy.

First, our educational system is failing us. Every day the news is filled with fears (some exaggerated) that we are not graduating enough math and science students. The shortfall in primary care physicians in the coming years is just one metric to measure this. Why don't we provide incentives, a cornerstone of behavioral economics, to influence a high school graduate's decision to take harder math and science classes? A public-private fund should be setup where any student who maintains decent grades, plans on studying math or science, can apply for a large grant as long as he/she maintains certain criteria through college. Again, this should be driven solely on merit. I recently read an article talking about how a business in Michigan is having trouble hiring mechanical engineers to build electric batteries, wind turbines, and other futuristic technologies. These businesses should be given large tax credits for setting up scholarships to attract students into the "hard" science classes. Google, for example, has been bringing students into their offices to ignite their fascination for technology. Intel has science competitions that are very popular. All these are efforts are in the right direction, but must be scaled up. However, it needs a boost from the government.

Second, we need to promote exports. Currently, a handful of mega companies are the largest exporters. Small and medium size businesses don't consider exporting their goods. This is in part due to the difficulty of navigating other economies. After all, why would anyone want to invest in expanding in another country's economy when they are home to the largest economy in the world? BUT -- with the rising middle class in the emerging world, opportunities abound. Many people often mistakenly think that other countries rising in wealth is a threat to America, in effect a zero sum game. However, with our industries geared towards meeting the needs of these consumers we can develop a virtuous cycle of dependence that in the long run may prevent disastrous consequences.

Take Singapore, for example, --a government agency is devoted to helping its companies export goods--whether it is navigating the legal issues in other countries or having the proper paperwork done. A similar system, again public-private, should be set up where any small/medium business with ambition can get low cost services and set them up for exporting to another country. After all, the "American" brand is still coveted around the world. Imagine being defined by numerous American companies instead of just the usual gold arches, swoosh tick mark, or a mermaid selling coffee. Though the commerce department has offices trying to promote that a more active effort that makes exporting cost effective for a mom and pop down the street should be, in my opinion, an eventual goal.

Third, government should promote basic research. Industrial policy is often controversial. The last thing I want is a million bureaucrats dictating which industries should get funding. BUT--if highways were not built by the government to make it easy for companies to ship their goods and people to move around--would we have such a prosperous country? If the internet was not funded by the government, would so many businesses have benefitted from building on it? Amazon and Google may not have existed! A conscious effort to deal with large scale projects should be considered:
- dealing with our aging electric grids
- improve our bridges and roads
- utilizing both fossil fuels and alternate technologies to reduce our energy dependence. To get both sides of the political aisle together, why not for every kilowatt of energy produced by a nonrenewable resource a kilowatt of renewable resource should be produced?
- increasing access to broadband

Lastly, access to small business credit should be much easier. Currently, the best route to attracting venture capital funding--for example--is by initially proving your success. This means that if I want to start a business, I first need to attract "angel" investors or be independently wealthy. This is very difficult. But why not have more hubs of entrepreneurial activities by having a public-private partnership where loans are given out to those with good ideas. Now instead of setting up a large government agency--the money should be given to local banks, venture capitalists as well as large banks with the explicit purpose of funding companies. The institutions decide what rates to charge, but the barrier to entry should be lower. Obviously, many of those companies will fail. However, those that succeed will serve as engines of economic growth. After all, we just need one Google or Apple to have a dramatic effect on the lives of numerous Americans. More broadly, even if one or two companies succeed for even eight or ten failures--ambitious businessmen know that they can get access to credit in an easy way. Obviously, issues of moral hazard as well as how the funds will get dispersed should be worked out. But this will in effect scale up the silicon valley model to hopefully a silicon valley nation that produces great American companies.

I concede that I simplify these broad issues and may even have missed major issues with some of these ideas. And while I understand change can be a good or bad thing, it is imperative we break our bad habit of spending too much and reverting back to the entrepreneurial, risk taking, hard working formula that has defined our decades of success.

A Set of Paradoxes

An adversarial backdrop, in my opinion, has recently defined many of our interactions with the international community whether it is foreign, economic, or scientific in nature. To many there are predictions of a seismic shift where the West gives way to the rest. Just like fair-weather fans who cheer on the winning team, the statistics have certainly been laid in their favor: anemic growth in the United States, a growing debt problem in Europe and gridlock amongst Western policy makers. Not surprisingly, a Chinese hedge fund that wants to protect itself from a cataclysmic deterioration of the U.S. economy is in talks with Nassim Taleb who owns the hedge fund Universa. Taleb coined the term 'Black Swan' after the once popular myth that all swans were white. This myth was disproved when black swans were found in Australia. Taleb in his book "The Black Swan" encourages investors to use options to buy insurance against what economists call the fat tail risk of highly improbable events becoming a reality. The hedge fund believes that the cost of letting options expire and replenishing them will be made up when that inevitable 'crash' happens. Sadly, actions such as these which root for the titans who set the world standard to falter are troubling.

And the news marches on: China overtook Japan to become the second largest economy in the world. Germany--a bright spot in the West--has shattered all its previous GDP growth rates by exporting its way out of its financial troubles. But questions remain: Is the Chinese economy overheating? (Think rising wages and Foxconn suicides) How long can Germany keep exporting its Benz's? (Think anemic growth in developed countries.)

Irrespective of whichever side of the  aisle your're on--the message has changed very little. When was the last time a conservative offered a new idea? When was the last time a liberal challenged established views? A mentality of stubbornness has pervaded our consciousness where we continue to dismiss others and believe that our system is the best, second to none. We refuse to change our way and this is the heart of our problem. 

The analogy reverberates strongly: the crumbling of the Roman Empire was because of high debt, far flung wars, and a stubborn and out-of-touch leadership. I will concede that a multitude of other factors also played a role in the Ancient Empire's demise but historians are quick to point out that most great empires and countries fall prey to the same problems time and time again. Little has changed despite having the benefit of a rear view mirror. After all, the sun did settle on the former British Empire. 

What about our Pax Americana? How do we prevent the fate of others who fell from the perch of power? This is not to cast a doomsday scenario or claim that America's best days are not ahead, but is more a warning shot--if you will--that serious and concerted effort is absolutely necessary.  Change--as expected-- is riddled with uncertainty; the status quo is a lot easier. And the change I am referring to is not the habitual switching of policies between Republicans and Democrats. We need to do what other countries did to spark their engine of prosperity: follow the model that worked. A wellspring of liberalized markets, educated workforces, and American styled markets came into fruition around the world because countries realized it worked. Now why not take copy those who seem to have success today?

Germany, for example, subsidized worker's wages and made companies hold onto their workers instead of laying them off. This way worker's did not get discouraged (as is a huge problem in America) and continued to hone their skills. China is powering ahead with broad based investment in high-speed rails, solar power plants, and advanced technology. India is investing more money into educating its future. Britain is considering broad based cuts in the military as well as other government services.

All these things challenge the ego of American might. We want to have the fastest growing economy. We want to have the most powerful military. We want to reduce our budget deficits. We want to regulate Wall Street and prevent asset bubbles/leveraging that fueled our growth.

How can we have and eat our cake? These demands all conflict with each other and unless serious leadership prioritizes and pushes through difficult reforms the Roman analogy may (in some form) affect our great nation as well. Only time will tell.