Stealth Wealth Tax

by Richard W. Rahn at http://www.cato.org

This article appeared in The Washington Times on September 20, 2011. 

The stealth wealth tax may be the single-largest tax ever imposed on the American people, yet virtually no one knows about it. What is particularly unconscionable about this tax is that it has been imposed upon the most responsible citizens and the elderly in a most disproportionate way, and the real tax rate on American savers has soared to record levels.

The Federal Reserve has held down interest rates so that the average person receives less than 1 percent on money-market funds or certificates of deposit — that is, money used for precautionary and low-risk savings. At the same time, the Fed has allowed inflation to rise to an annual rate of more than 3.5 percent. As can be seen in the accompanying chart, when inflation rates are higher than interest rates, people suffer an effective real tax rate above 100 percent. At present rates of interest and inflation, this means that most Americans pay effective tax rates on their savings ranging from 360 percent for lower-income people to 390 percent for higher-income people.

Inflation is a non-legislated wealth tax. If you had kept a $100 bill a year ago, today you would be able to buy just $96.20 worth of goods and services, given the current 3.8 percent inflation rate. The Fed, by its failure to preserve the value of the currency as it is charged to do, has imposed a stealth wealth tax on you.

The Internal Revenue Service (IRS) has made it worse by imposing a tax on nominal savings income, not just on inflation-adjusted income. The 16th Amendment to the Constitution gave the federal government the right to impose a tax on "incomes." A change in the price level caused by inflation is not income by any economic or sensible definition of the word. The IRS, in fact, recognizes that inflation is not income because it adjusts the individual income tax brackets each year to offset inflation. Yet it tries to impose a tax on the "imaginary income" of those who receive interest and capital gains. It cannot have it both ways. The Constitution does not grant the federal government the right to impose an individual wealth tax, which is what a tax on imaginary income is, nor has Congress legislated such a tax.

We have a situation in which tens of millions of American retirees are receiving real negative returns on their hard-earned savings yet the federal government, whose primary job is to ensure liberty and protect person and property, is, in essence, stealing from them. I ponder the question: Are the people at the IRS too dumb to understand what they are doing to their fellow Americans or do they just not care because they lack an ethical compass?

It is clear that hundreds of billions of dollars are being extorted from American taxpayers and savers without any legislated tax increase as required by the Constitution. So the question is: Who gains? The answer is those in the political class who spend other people's money on themselves or on their favorite contributors and supporters. Because the Fed is holding interest rates artificially low (and this can last only temporarily) the government is paying out less interest than free-market rates would allow, thus enabling the politicos to spend more because the deficit looks smaller than it is. But this is only a short-term illusion.

The economic consequences of this con game are grim. As people increasingly realize that the Fed and IRS are stealing their wealth, they will find ways to protect themselves by doing such things as buying gold and other nonproductive investments, choosing not to save or moving money to other countries. All of these reduce the amount of money for productive capital formation in the United States — that is, the money that would have been invested in new plants, equipment, and research and development — the money that would have been used to create real jobs.

The Fed and IRS are engaged in this wealth destruction with the very explicit support of the Obama administration and many in Congress. These are the very same people who are claiming that their most important goal is creating more jobs, yet they are doing the opposite of what is needed to create them. Confiscating and taxing away the wealth that is needed to boost demand and to provide cost- and time-saving tools for workers is no way to create jobs.

To mitigate the situation, Congress should explicitly require the Fed to keep inflation/deflation within 2 percent per year with the sanction that the Fed governors would be fired if they miss the targets. (New Zealand did a similar thing.) Congress also should explicitly prohibit the IRS from taxing imaginary interest or capital gains because of inflation and allow a taxpayer deduction for any real loss in principal of an investment caused by inflation.

Too many members of Congress have been more interested in protecting the IRS and the Fed than in protecting their own constituents. As voters become increasingly aware of the stealth wealth tax, will their representatives become more responsible?

Warren Buffett’s Tax Story Is Bogus

Posted by Chris Edwards athttp://www.cato-at-liberty.org/warren-buffetts-tax-story-is-bogus/


For years, Warren Buffett has been claiming that his secretary pays a higher tax rate than he does. Recently, President Obama has taken that claim and run with it. I don’t know Mr. Buffett’s particular tax situation, but I do know that his claim as a general matter is bogus.
Let’s look at some numbers. The first chart shows IRS data for income tax rates by income group for 2009. These are average effective tax rates, calculated as income taxes paid divided by adjusted gross income (AGI). The chart shows that taxpayers with incomes above $500,000 had tax rates averaging about 25 percent. Middle-income taxpayers had tax rates of half of that or less. A few years ago, Buffett claimed that his secretary earned $60,000 and paid a 30 percent tax rate. But looking just at income taxes, that seems way off. (Note that this data doesn’t include the “refundable” portion of tax credits, which wipes out taxes for many people at the bottom end).

Perhaps Buffett was referring to the fact that his secretary pays a heavy load of payroll taxes in addition to income taxes. But when you look at data which includes all federal taxes, the system is still highly graduated with much higher rates at the top end.
Chart 2 shows CBO data for 2007 on average effective tax rates, including essentially all federal taxes—individual income, corporate income, payroll, and excise. Buffett’s secretary would fit into the fourth group in the chart, where the average tax rate was 17.4 percent. So if she is really paying 30 percent, then Buffett needs to show her some of his tax-reduction tricks. Note in the chart that Buffett’s peers in the top 1 percent paid an average rate of 29.5 percent, which is double the rate paid by middle-income taxpayers.

In 2007, Buffett said that he paid a 17.7 percent tax rate. Alan Reynolds notes that Buffett earns large amounts of capital gains, which are taxed at a maximum federal rate of 15 percent. People in the top income groups do report a lot of capital gains, which reduces their overall effective tax rate. However, capital gains are included in chart 1, above, and you can see that the top income groups still pay much higher tax rates than others on average. One reason is that a large amount of income at the top is small business income, which is hit by ordinary income tax rates of up to 35 percent.
You have to go to the extreme top end of the income spectrum in order for capital gains realizations to really push down overall effective tax rates. The IRS publishes data for the 400 highest-income taxpayers. For these taxpayers, the average effective income tax rate in 2008 was 18.1 percent.
Since the beginning of the income tax, we have nearly always had special treatment of capital gains for some very good reasons, as I discuss here. I point out that virtually all high-income nations recognize that capital gains are different and that special rules are needed. A number of OECD nations have long-term capital gains tax rates of zero, including New Zealand and the Netherlands.
Another important aspect to this debate regards the link between capital gains and dynamism in the economy and dynamism in tax payments. The political left makes it seem as if there were a permanent aristocracy at the top end of the income spectrum in America. However, IRS data show the exact opposite—the top 400 are a highly dynamic group. Notice first in IRS Table 1 that 57 percent of AGI for these taxpayers is capital gains. That is a key reason why the people in this group are constantly changing—large capital gains realizations are occasional events that rocket people to the top of the AGI heap. One example is when an entrepreneur sells her successful and longstanding business and retires.
The last table in the IRS document reveals the dynamism. The IRS traced the identities of all taxpayers who showed up in the top 400 anytime between 1992 and 2008. The IRS found that there were a huge 3,672 different taxpayers who appeared during that timeframe. Of these 3,672, fully 73 percent only appeared once in the top 400! And 85 percent appeared only once or twice.
So at the top end of our capitalist system is a continual generation of new wealth and new wealthy people, and that dynamism reflects the still-energetic and free-wheeling nature of our economy.

Ron Paul’s ‘Plan to Restore America’

Posted by Tad DeHaven at http://www.cato-at-liberty.org/ron-pauls-plan-to-restore-america/


Presidential candidate Ron Paul has released a fiscal reform plan that would dramatically cut spending and rein in the size and scope of the federal government. My reaction to the proposal can be summed up in one word: hallelujah.
Republican policymakers – including the current GOP field of presidential candidates – talk a good game about reducing spending, but very few are willing to spell out exactly what they’d cut. As NRO’s Kevin Williamson puts it in the title of his write-up on the plan, “Ron Paul Dropping a Reality Bomb on the GOP Field.”
The following are some of the plan’s highlights:

• Paul would immediately eliminate five cabinet-level departments: Commerce, Education, Energy, HUD, and Interior.

• Paul says his plan would cut spending by $1 trillion in the first year alone, and balance the budget in three years without increasing taxes.

• Funding for the wars would end. That’s not isolationism – it’s a common sense position that also reflects popular opinion. In addition, foreign aid spending would be zeroed out.

• Intelligent government reforms are proposed, including privatizing the Federal Aviation Administration and repealing costly Davis-Bacon rules.

• On entitlements, younger people would be given the freedom to opt out of Social Security and Medicare. Spending would be frozen for Medicaid and other welfare programs and they would be converted to block-grant programs.

That’s an ambitious agenda to say the least, and one that the press is likely to dismiss as a pipe-dream. Then again, Paul has managed to single-handedly turn the Federal Reserve into a campaign issue, which nobody could have foreseen just several short years ago. In fact, several of Paul’s fellow candidates for the GOP nod have taken to echoing his anti-Federal Reserve sentiments. Hopefully, the other candidates will copy Paul again by getting specific on what they’d cut. If not, they should be prepared to explain to the electorate why taxpayers should keep funding the departments that Paul would ax.

The Federal Reserve, the ‘Twist,’ Inflation, QE3, and Pushing on a String

Posted by Daniel J. Mitchell at http://www.cato-at-liberty.org/the-federal-reserve-the-twist-inflation-qe3-and-pushing-on-a-string/


In a move that some are calling QE3, the Federal Reserve announced yesterday that it will engage in a policy called “the twist” — selling short-term bonds and buying long-term bonds in hopes of artificially reducing long-term interest rates. If successful, this policy (we are told) will incentivize more borrowing and stimulate growth.
I’ve freely admitted before that it is difficult to identify the right monetary policy, but it certainly seems like this policy is — at best — an ineffective gesture. This is why the Fed’s various efforts to goose the economy with easy money have been described as “pushing on a string.”
Here are two related questions that need to be answered.
1. Is the economy’s performance being undermined by high long-term rates?

Considering that interest rates are at very low levels already, it seems rather odd to claim that the economy will suddenly rebound if they get pushed down a bit further. Japan has had very low interest rates (both short-run and long-run) for a couple of decades, yet the economy has remained stagnant.

Perhaps the problem is bad policy in other areas. After all, who wants to borrow money, expand business, create jobs, and boost output if Washington is pursuing a toxic combination of excessive spending and regulation, augmented by the threat of higher taxes.

2. Is the economy hampered by lack of credit?

Low interest rates, some argue, may not help the economy if banks don’t have any money to lend. Yet I’ve already pointed out that banks have more than $1 trillion of excess reserves deposited at the Fed.

Perhaps the problem is that banks don’t want to lend money because they don’t see profitable opportunities. After all, it’s better to sit on money than to lend it to people who won’t pay it back because of an economy weakened by too much government.

The Wall Street Journal makes all the relevant points in its editorial.

The Fed announced that through June 2012 it will buy $400 billion in Treasury bonds at the long end of the market—with six- to 30-year maturities—and sell an equal amount of securities of three years’ duration or less. The point, said the FOMC statement, is to put further “downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.” It’s hard to see how this will make much difference to economic growth. Long rates are already at historic lows, and even a move of 10 or 20 basis points isn’t likely to affect many investment decisions at the margin. The Fed isn’t acting in a vacuum, and any move in bond prices could well be swamped by other economic news. Europe’s woes are accelerating, and every CEO in America these days is worried more about what the National Labor Relations Board is doing to Boeing than he is about the 30-year bond rate. The Fed will also reinvest the principal payments it receives on its asset holdings into mortgage-backed securities, rather than in U.S. Treasurys. The goal here is to further reduce mortgage costs and thus help the housing market. But home borrowing costs are also at historic lows, and the housing market suffers far more from the foreclosure overhang and uncertainty encouraged by government policy than it does from the price of money. The Fed’s announcement thus had the feel of an attempt to show it is doing something to help the economy, even if it can’t do much. …the economy’s problems aren’t rooted in the supply and price of money. They result from the damage done to business confidence and investment by fiscal and regulatory policy, and that’s where the solutions must come. Investors on Wall Street and politicians in Washington want to believe that the Fed can make up for years of policy mistakes. The sooner they realize it can’t, the sooner they’ll have no choice but to correct the mistakes.

Let’s also take this issue to the next level. Some people are explicitly arguing in favor of more “quantitative easing” because they want some inflation. They argue that “moderate” inflation will help the economy by indirectly wiping out some existing debt.
This is a very dangerous gambit. Letting the inflation genie out of the bottle could trigger 1970s-style stagflation. Paul Volcker fires a warning shot against this risky approach in a New York Times column. Here are the key passages.

…we are beginning to hear murmurings about the possible invigorating effects of “just a little inflation.” Perhaps 4 or 5 percent a year would be just the thing to deal with the overhang of debt and encourage the “animal spirits” of business, or so the argument goes. The siren song is both alluring and predictable. …After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations — as the Fed and most central banks believe — why not 3 or 4 or even more? …all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. That’s when the word stagflation was invented to describe a truly ugly combination of rising inflation and stunted growth. …What we know, or should know, from the past is that once inflation becomes anticipated and ingrained — as it eventually would — then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with “stability,” but invokes inflation as a policy, it becomes very difficult to eliminate. …At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.

Last but not least, here is my video on the origin of central banking, which starts with an explanation of how currency evolved in the private sector, then describes how governments then seized that role by creating monopoly central banks, and closes with a list of options to promote good monetary policy.

And I can’t resist including a link to the famous “Ben Bernank” QE2 video that was a viral smash.

Jobs-Creation Lesson from the Past

by Richard W. Rahn from http://www.cato.org

This article appeared in The Washington Times on September 7, 2011. 

The Obama administration and others on the left seemed to be stunned when the Bureau of Labor Statistics reported no new net jobs last month. When President Obama makes his "jobs speech," the American people will see whether he and his advisers have learned anything from the three years of Obamanomics failures.

Historically, the American economy has been a phenomenal job-creating machine. In a well-functioning economy, the increase in jobs parallels the increase in population. As can be seen in the accompanying table, during eight Reagan years, jobs grew at a much faster rate than did the population, as many disheartened workers re-entered the labor force after the Carter economic fiasco. Almost 17 million new civilian jobs were created from 1981 through 1989, which was 9 million more than can be explained by population growth. Likewise, during the Clinton years from 1993 through 2001, 7 million more jobs were created than can be explained by population growth alone.

But during the presidencies of George H.W. Bush and George W. Bush, job growth did not keep up with population growth. If it had, there would have been approximately 3.7 million more jobs created between 1989 and 1993 and 5.9 million more jobs between 2001 and 2009. The Obama record is far worse. The total number of jobs actually has decreased by 2.6 million since January 2009; if job growth had merely kept up with population growth during that period, there would be 4.8 million additional jobs. At the end of recession, the number of jobs normally grows far faster than population, but not this time.

The unemployment rate is a flawed measure because during weak economic periods, many discouraged people drop out of the labor force; thus, the labor force/population ratio declines and the real unemployment rate is understated.
As President Obama searches for solutions to the jobs problem, he ought to look at the policies that worked successfully during the Reagan and Clinton administrations. The Reagan administration sharply reduced marginal tax rates in both the first and second terms, but there was only a small reduction in the tax burden as a percentage of gross domestic product (GDP) — about 1 percent of GDP from 1981 to 1989. However, the job-creating businesspeople knew with great certainty that the tax cost of hiring new workers and investing in new plants and equipment would be going down, not up. They also knew that the administration was serious about applying cost-benefit tests to proposed regulations. In spite of all the talk about reducing government spending, spending as a percentage of GDP did not fall during the first Reagan administration because the cost of the military buildup offset the reductions in domestic spending. Spending as a percentage of GDP dropped 2 full percentage points during Reagan's second term, which was also the period of the most rapid job growth.

Government spending dropped during both terms of the Clinton administration, from 21.4 percent of GDP in 1993 to 18.2 percent of GDP in 2001. President Clinton did increase taxes during his first term but signed the reduction in the capital gains tax rate in his second term. However, most have forgotten that the economy had stagnated at the end of the second Clinton term and the economy was in recession in the first quarter of 2001, when George W. Bush took office — well before Sept. 11, 2001. In retrospect, Mr. Clinton should have cut taxes more sharply in his second term.

The first President Bush abandoned his "flexible freeze" to control spending shortly after taking office and reneged on his "no new taxes pledge," both of which turned out to be mistakes. The second President Bush did cut tax rates but allowed spending to rise 2 full percentage points of GDP during his two terms.
The lessons should be obvious to Mr. Obama and his advisers. Increases in government spending are associated with lower — not higher — job creation and vice versa. (This has been true for the 100 years for which there are good records.) Job creators do not hire workers when they fear higher taxes in the future. Temporary tax and spending gimmicks such as infrastructure projects also have proved not to create net new jobs.

The president should say in his Thursday speech: "I pledge not to propose any increase in taxes until unemployment is under 5 percent. I promise to come forth with a budget next month that will reduce spending each year, so within four years, it will be no higher than 19 percent of GDP. And I am issuing a freeze on all new regulations, which will remain in effect until each new proposed regulation can be shown to be cost-effective." That would take him about 30 seconds to say. Most listeners would be happy to turn to the football game, the markets would soar on Friday, businesspeople would start hiring, and the president might even be re-elected.

Obamacare Is Bigger than Roe v. Wade

Posted by Ilya Shapiro @ http://www.cato-at-liberty.org/obamacare-is-bigger-than-roe-v-wade/


This morning, as expected, the Supreme Court agreed to take up Obamacare.  What was unexpected — and unprecedented in modern times — is that it set aside five-and-a-half hours for the argument.  Here are the issues the Court will decide:

1. Whether Congress has the power to enact the individual mandate. – 2 hours
2. Whether the challenge to the individual mandate is barred by the Anti-Injunction Act. – 1 hour
3. Whether and to what extent the individual mandate, if unconstitutional, is severable from the rest of the Act. – 90 minutes
4. Whether the new conditions on all federal Medicaid funding (expanding eligibility, greater coverage, etc.) constitute an unconstitutional coercion of the states. – 1 hour

In addition to the length of argument, which we can expect to be heard over multiple days in March or April, perhaps the biggest surprise is the Court’s decision to review that fourth issue.  There is no circuit split here — in large part because 26 states are already in this one suit — and no judge has yet voted to uphold what also be described as a claim that the federal government is “commandeering” the states to do its bidding.  The Court probably took the case precisely because so many states have brought it; that former solicitor general Paul Clement is their lawyer also doesn’t hurt.  As a practical matter, this could be a bigger deal than the individual mandate because, while Congress had never before tried an economic mandate, it certainly does attach plenty of strings to the grants it gives states — and the spending power is thought to be even broader than the power to regulate commerce.
In any event, the Supreme Court has now set the stage for the most significant case since Roe v. Wade.  Indeed, this litigation implicates the future of the Republic as Roe never did.  On both the individual-mandate and Medicaid-coercion issues, the Court will decide whether the Constitution’s structure — federalism and enumeration of powers — is judicially enforceable or whether Congress is the sole judge of its own authority.  In other words, do we have a government of laws or men?

The End of the Euro?

Posted by Gerald P. O'Driscoll at http://www.cato-at-liberty.org/the-end-of-the-euro/

Global equity markets are falling, with the Dow Jones Industrial Average down around 250pts. A benchmark 10-year Italian government bond is yielding 7.4%. Every country whose sovereign debt went over the 7%-mark has required a bailout. I was in Italy a month ago, and the yield was under 6% (still pricey for a developed country).
A bailout of a country Italy’s size would be a gargantuan task — probably a larger effort than heretofore. It is beyond the capacity of the EU. Italy’s debt is just too large. I doubt China would purchase any real assets until labor-market reforms and pension reforms were enacted. China actually wants a return on its investments.
If the IMF gets involved, it would require massive new funds for which the US taxpayer would be on the hook for around 18%. I wonder how that would go over in the US House or even the Senate? That doesn’t mean the Obama administration won’t try to organize a rescue. The Fed has been backstopping the EU banks for some time.
Will the Euro survive? Will the global financial system survive?

One Simple Reason (and Two Easy Steps) to Show Why Obama’s Soak-the-Rich Tax Hikes Won’t Work

Posted by Daniel J. Mitchell @ http://www.cato-at-liberty.org/one-simple-reason-and-two-easy-steps-to-show-why-obama%E2%80%99s-soak-the-rich-tax-hikes-won%E2%80%99t-work/#utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Cato-at-liberty+%28Cato+at+Liberty%29&utm_content=Google+Reader


It’s hard to keep track of all the tax hikes that President Obama is proposing, but it’s very simple to recognize his main target — the evil, nasty, awful people known as the rich.
Or, as Obama identifies them, the “millionaires and billionaires” who happen to have yearly incomes of more than $200,000.
Whether the President is talking about higher income tax rates, higher payroll tax rates, an expanded alternative minimum tax, a renewed death tax, a higher capital gains tax, more double taxation of dividends, or some other way of extracting money, the goal is to have these people foot the bill for a never-ending expansion of the welfare state.
This sounds like a pretty good scam, at least if you’re a vote-buying politician, but there is one little detail that sometimes gets forgotten. Raising the tax burden is not the same as raising revenue.
That may not matter if you’re trying to win an election by stoking resentment with the politics of hate and envy. But it is a problem if you actually want to collect more money to finance a growing welfare state.
Unfortunately (at least from the perspective of the class-warfare crowd), the rich are not some sort of helpless pinata that can be pilfered at will.
The most important thing to understand is that the rich are different from the rest of us (or at least they’re unlike me, but feel free to send me a check if you’re in that category).
Ordinary slobs like me get the overwhelming share of our income from wages and salaries. The means we are somewhat easy victims when the politicians feel like raping and plundering. If my tax rate goes up, I don’t really have much opportunity to protect myself by altering my income.
Sure, I can choose not to give a speech in the middle of nowhere for $500 because the after-tax benefit shrinks. Or I can decide not to write an article for some magazine because the $300 payment shrinks to less than $200 after tax. But my “supply-side” responses don’t have much of an effect.
For rich people, however, the world is vastly different. As the chart shows, people with more than $1 million of adjusted gross income get only 33 percent of their income from wages and salaries. And the same IRS data shows that the super-rich, those with income above $10 million, rely on wages and salaries for only 19 percent of their income.
This means that they — unlike me and (presumably) you — have tremendous ability to control the timing, level, and composition of their income.
Indeed, here are two completely legal and very easy things that rich people already do to minimize their taxes – but will do much more frequently if they are targeted for more punitive tax treatment.

1. They will shift their investments to stocks that are perceived to appreciate in value. This means they can reduce their exposure to the double tax on dividends and postpone indefinitely taxes on capital gains.  They get wealthier and the IRS collects less revenue.
2. They will shift their investments to municipal bonds, which are exempt from federal tax. They probably won’t risk their money on debt from basket-case states such as California and Illinois (the Greece and Portugal of America), but there are many well-run states that issue bonds. The rich will get steady income and, while the return won’t be very high, they don’t have to give one penny of their interest payments to the IRS.

For every simple idea I can envision, it goes without saying that clever lawyers, lobbyists, accountants, and financial planners can probably think of 100 ways to utilize deductions, credits, preferences, exemptions, shelters, exclusions, and loopholes. This is why class-warfare tax policy is so self-defeating.
And all of this analysis doesn’t even touch upon the other sure-fire way to escape high taxes – and that’s to simply decide to be less productive. Most high-income people are hard-charging types who are investing money, building businesses, and otherwise engaging in behavior that is very good for them – but also very good for the economy.
But you don’t have to be an Ayn Rand devotee to realize that many people, to varying degrees, choose to “go Galt” when they feel that the government has excessively undermined the critical link between effort and reward.
Indeed, if Obama really wants to “soak the rich,” he might want to abandon his current approach and endorse a simple and fair flat tax. As explained in this video, this pro-growth reform does lead to substantial “Laffer Curve” effects.
But you don’t have to believe the video. You can check out this data, straight from the IRS website, showing how those evil rich people paid much more to the IRS after Reagan cut their tax rate from 70 percent to 28 percent in the 1980s.