Alternative Insight
The Tax Deception Revisited
How do
taxes affect the economy?
Quote Oliver Wendell Holmes: "A good catchword can obscure
analysis for fifty years." Without proof, the media has pushed catchy expressions
into our lexicon, casually and with absolute conviction. Three of the most
prominent are:
Raising taxes during a recession will harm the economy.
Lowering taxes during a recession is a necessity.
Small businesses are the lifeblood of the economy and are hampered by tax
increases.
In the world of probability, all types of statements might prove correct at certain times. As one example, supporters of lowering taxes during recessions mention Herbert Hoover's tax increase during the 1931 year of the Great Depression, and Franklin Roosevelt's 1936 tax increases in the top brackets as examples of destructive tax measures. In both cases, economic downturns followed the tax increases. Sounds logical, that if A occurred before B, then A must be responsible for B. However, simple relationships don't automatically constitute logical arguments. In both cases, the presidents raised taxes to balance the budgets and stop runs on the U.S. dollar. By forcing budget revenues to follow budget expenses, those administrations refused to pump the economy with deficit spending and limited the budgets from reacting to the wants of fragile economies. Besides, in 1932, the economy was already falling rapidly, and in 1936, substantial increases in union wages added to corporate uncertainties. Capital rebellion followed the labor rebellion
No damage done when policy makers treat expressions as extravagant words from agenda pushers; major harm occurs if they are used as a guide to regulate the economy. Many oft-quoted phrases are shibboleths; "a saying by adherents of a party, sect, or belief and usually empty of real meaning." Challenging the lack of inquiry formulating these shibboleths contributes to preventing them being considered as drivers of economic policies.
Obama's
deficit spending halted the bleeding. What must the administration do to create
jobs and diminish unemployment? Debatable. Add to the debate an analysis that
unproven shibboleths, such as maintaining low taxes, confuse the issue and are
counterproductive. Preferred guides to renovating an egregious economy are:
Taxes are used to balance the budget and not to regulate the economy.
Ever since the demands of the United States Civil War, social and economic
circumstances forced American governments to tax its citizens according to
budget needs. Massive industrial growth, population expansion and rapid change
in all sectors of society prompted government intervention to maintain the
national ship on even keel and prevent calamities. Budgets adapted to sharply
changing and disparate conditions, forcing immediate responses to wartime,
peacetime, and distressed times.
A
responsible budget solicits taxes to obtain national benefits that exceed the
benefits obtained from leaving an equal amount of tax revenue with the wage
earners. The budget expense often promotes wage increases that far exceed the
added tax assessments. One example is the interstate highway system, which
escalated the automobile industry to become
Opposition to specific taxes and tax rates deserve debate, but general assumptions, which only transfer public spending to private spending, and don't increase total spending, skew the economy. Optimizing tax programs is a challenge, and proceeds from not disturbing a suitable quality of life for wage earners, and allowing sufficient profit margins for capital reinvestment. Taxes respond directly to the budget, and not in accord with the shibboleth that taxes can regulate the economy. If the latter were true, then the Federal Reserve market operations would be superfluous. Corporations, small business, and the public have operated well in all types of tax situations. Domestic and government spending enter the economy, start from different allocations, and eventually circulate at similar rates.
In
the present
"The
Romers' (College professors Paula and Christina) conclusion, which is at odds
with most traditional Keynesian analysis, was that the tax multiplier was 3 -
in other words, that every dollar spent on tax cuts would boost GDP by $3.
Valerie Ramey of the University of California, San Diego, finds a
government-spending multiplier of about 1.4 - a figure close to what the Obama
administration assumed, but much smaller than the tax multiplier identified by
the Romers. Similarly, in recent research, Andrew Mountford (
http://togetrichisglorious.blogspot.com/2010/06/economic-stimulus-tax-cuts-vs-spending.html
"we
also examined years of large fiscal expansions, defined as increases in the
cyclically adjusted deficit by at least 1.5% of GDP. Over 91 such cases, we
found that tax cuts were much more expansionary than spending increases."
http://online.wsj.com/article/SB10001424052748704271804575405311447498820.html
"Mark
Zandi, chief economist for Moody's Economy.com, provided estimates of the one
year multiplier effect for several fiscal policy options. The multipliers
showed that increased government spending would have more of a multiplier
effect than tax cuts. Making the Bush tax cuts permanent, had the second lowest
multiplier, 0.23. A payroll tax holiday had the largest multiplier for tax
cuts, 1.29. Refundable lump-sum tax rebates, the policy used in the Economic
Stimulus Act of 2008 had the second largest multiplier for a tax cut."
Zandi also notes that extending food stamps and unemployment insurance
benefits, and increasing infrastructure spending are the three most effective
way to prime the economy's pump.
Zandi, Mark. "A Second Quick Boost From Government Could Spark
Recovery." Edited excerpts from congressional testimony
"
$100 billion of additional government spending will lead to an increase in GDP
of approximately $150 billion. This means that $100 billion of additional spending
will lead to 1 million additional jobs, while a temporary cut in payroll taxes
will generate 860,000 jobs. By contrast, a $100 billion cut in corporate taxes
will lead to just 200,000 new jobs."
http://www.cepr.net/documents/publications/2009-01-Spending-Vs-Tax-Cuts.pdf
"A
personal income tax cut has a slightly lower initial effect on GDP, inflation
and the current account than a corresponding government spending shock. Hence,
a 1 per cent of GDP tax cut raises GDP by one-half to one per cent compared with the one to one and three quarter percent
GDP effect following a government spending shock of similar magnitude. This is
basically because part of a tax cut is saved rather than consumed, hence reducing
the initial effect on domestic demand. Otherwise, the adjustment mechanisms are
rather similar to those described above and the medium-term outcome is almost
the same as in a government spending shock.
http://www.oecd.org/dataoecd/29/13/1890595.pdf
Which
conclusions are more acceptable? If reorientation of the economy is a
prerequisite to economic recovery, and the government is able to operate in an
optimum theoretical framework, then the OECD result, which uses a macro
econometric model, is most credible. The other analyses proceed from data that form
statistical surveys.
Analytically,
it is not apparent how there can be any multiplier. A dollar spent on goods
returns a dollar to the marketing chain leading to the manufacturer. A dollar
spent on a service can circulate from service to service, and give the appearance
of increasing the GDP, but that increase occurs without tax cuts. Nevertheless, anything the taxpayer can do
with tax cuts to advance the economy, a responsible federal government can do
with added tax revenue. Being able to redistribute the tax revenue to the most
meaningful projects (increasing infrastructure spending) and spenders
(unemployment insurance) is an immediate plus. The minimum economic advance is
to spend the taxes randomly on purchases of services and products. Spending a
tax deduction on imports is deadly. Good by money and hello to more government
deficit to support the credit needed to return the funds to the
The
taxpayer does not have the tools available to the government to stem a downturn
and spur growth.
Can
consumers supply the funds for new industries in the energy field? Can
consumers implement infrastructure projects and employ workers? Knowing the
answers to these questions, the tax reduction advocates exaggerate another
shibboleth: Tax breaks to small businesses, defined as those with less than
500 employees, are necessary to drive the national economy. Although, the
U.S. Small Business Administration (SBA) reports that small businesses account
for 52 percent of all
The pharmaceutical industry needs doctors, distributors, lobbyists, pharmacies
and other small businesses to sell their products, but the small business don't
drive the products; the products drive the establishment and scope of the small
businesses. Forbes top 20 most profitable small businesses
are all dependent on the economy (doctor services, accountant services,
suppliers,), and none drive the economy. This is another example of
overestimating the worth of tax cuts; select a shibboleth - small businesses
are the lifeblood of the economy and are hampered by tax increases -
without digging deep, and using the spurious supposition to prove an argument.
Another often-quoted and spurious shibboleth - The government can't create
jobs, only private industry creates jobs. Given the profits in the last
year, the latter should have no problems creating jobs - and it has, mostly
overseas. According to The Economic Policy Institute, "American companies
have created 1.4 million jobs overseas this year, compared with less than 1
million in the
In this recession of excessive unemployment, caring for the needs of the deprived comes before adding to the wants of funds those who have sufficient resources.
Lowering taxes mainly assists the already employed, and that is not the major priority during a recession. Who pays taxes - the employed? Who receives tax breaks - those who pay taxes? In effect, lowering taxes redistributes federal assistance from needy persons to the employed and active. Which is preferable? Redistributing income so the employed have more to spend or redistributing the income so the unemployed have something to spend?
Add
another benefit: The added tax revenue supports public works (not make works)
programs, which repair infrastructure and elevate productivity. The hiring of
unemployed, especially youngsters, reduces psychological and social problems.
The pill producing industry might suffer and the employed might have less
material goods, but all of
The
statements, "Raising taxes during a recession will harm the
economy," and "Lowering taxes during a recession is a necessity,"
are shibboleths and not facts.?
Lowering taxes is counterproductive if it increases budget deficits.
Stimulating the economy by tax breaks is a psychological phenomenon. The talk,
exaggerations, promises and general optimism of tax breaks fashion a more
optimistic public, which stimulates spending, investment and courage to carry more
debt. The tax breaks add to a major complaint - budget deficits. Not only will
the deficit increase, but interest rates will increase. The interest on the
national debt is its most important component - principal is rolled over, but
interest, which in 2010 was not much higher than in 2005, must be paid.
How significant is this factor. Sufficiently significant for Moody's to warn "that it could move a step closer to cutting the U.S. AAA rating if President Barrack Osama?s tax and unemployment benefit package becomes law." Moving up the curve of the deficit curve, while moving down the curve of creditor patience, moves towards steep slopes. Bankruptcy often occurs quickly.
Renovating
physical and capital infrastructures are top priority.
Reducing government and trade deficits are equally high priority.
All
this fuss disguises the major problem, the complexity and discord generated by
the tax code. Its revision is also a top priority.
The tax code, especially its provisions for tax expenditures, needs an overhaul
before tax rates are decided. Missing from the debate is a central issue,
renovating the tax code. How do we determine fair tax rates with a tax code
full of loopholes and unfairness? Warren Buffet said that he was taxed at 17.7
per cent on earnings of $46 million, while his secretary, who earned $60,000,
was taxed at 30 per cent. Tax expenditures, which are spending programs
implemented through the tax code, by providing subsidies to individuals and
companies through special tax credits, deductions, exclusions, exemptions, and
preferential rates, are the principal culprit. Not all of them need repeal, but
all of them need scrutiny. When a taxpayer receives a deduction for charitable
contributions, all taxpayers, without their approval, are participating in the
contribution. Their taxes compensate for the loss in tax revenue due to the
deduction. According to the Washington Post: "The new tax credits, which
will eventually cost the government more than $50 billion a year, are part of a
growing array of federal benefits offered through the tax code. Known as
"tax expenditures" in budget jargon, such tax breaks were worth more
than $1 trillion to recipients last year."
Examine
the mortgage interest deduction.
Does the buyer actually gain from the mortgage interest deduction? Home
sales, and its ever present real estate agents, eagerly show the buyer that,
due to the interest deduction, the mortgage paid is much less than the
calculated mortgage. Not mentioned is that as equity builds, interest decreases
and the tax deduction slides downward. Calculations demonstrate the mortgage
interest deduction is a marketing deception.
An
example:
A $300,000 house is bought with 10% down payment and a 5% interest rate. The
monthly payment on a 30 year loan for the $270,000 principal is calculated to
be $1500/month. If someone's tax liability is in the 25% tax bracket, then the
tax deduction is $362 and the virtual payment (in the early years) is $1138.
Sounds good, but is it? When purchasing a home, buyers will maximize the
mortgage interest, going to the limit of affordability. The mortgage interest deduction is included
in the affordability factor. In the example, the figure is $1138. The same
basis of affordability applies to other buyers.
What
if there was no mortgage interest tax deduction? Housing prices and interest
rates will decline to satisfy the lower national affordability factors. In this
example the affordability factor of $1138 will allow a mortgage of $212,000.With a 10% down payment, the house cost is
$235,000, $65,000 less than buying with the interest deduction. The buyer saves
$7,000 on the down payment of $23,000, some hundreds annually on the lower tax
assessment and will find the equity accrues faster as the mortgage is paid. Is it
possible that the house, which is now priced at $235,000, will be $65,000
inferior in quality? Some of the reduced cost will be in less of a home, but
the major reductions will be due to reduced profit, lower land costs and lower
interest rates. If the interest rate is reduced (a certain possibility), and the
buyer uses the complete $30,000 for the down payment, the purchaser will gain
the equivalent home at the lower affordability basis.
Conclusion:
The buyer is financially better without the deduction and the government
deficit will decline. Reuters estimates the mortgage interest tax deduction
will cost the government $104 billion in 2011.
Who
does the mortgage interest deduction mostly help? Obviously, it is the home builders who command
higher prices, the banks who command higher interest rates, and the real estate
agents who gain slightly higher commissions.
We
can't ignore corporation taxes.
Heard throughout the land is that the
An
example:
A corporation makes 10% profit on sales of two products, one of which sells for
$100 and another which sells for $10.
With a 36% tax rate, the corporation pays a tax of $3.60 on each sale of the
$100 product and a tax of $0.36 on each sale of the $10 product.
Cut the tax rate to 26% and the corporation now pays a tax of $2.60 on each
sale of the $100 product and a tax of $0.26 on each sale of the $10 product.
What does the corporation do with the savings? To increase competitiveness (the
argument for lower taxes), the corporation reduces the price of the $100
product by one dollar to $99, and the price of the $10 product by10 cents to $9.90.
Will the slightly lower price overcome competition? Not likely. More likely is
that the increased net profit will go to the stockholders.
Next to be resolved is
fraud.
An Internal Revenue Service analysis of 2001 returns estimates 30 to 40 percent
of taxpayers cheat on their returns, defrauding the government of $290 billion
a year.
Last is the loss of revenue due to loopholes.
A Reuters report,
Re-adjust the tax code, scrub earmarks, cut unnecessary spending, including foreign aid and defense, and the federal budget might balance. Instead, we have the conflicting requests for a vigorous economy with low taxes, balanced budgets, earmarks, tax credits, and forget the loopholes and fraud; they aren't worth the effort to investigate.
Will
the tax cuts benefit the economy more than government spending?
Is it that easy - rescue a difficult economy by lowering tax rates? Another
patch by the economic doctor, who has many patches available. Corporate profits
will increase, but will the production engine recharge, will unemployment
decrease, and will the nation fulfill its obligations to those most suffering
from the downfall? If so, why hasn't this happened in the ultra-low tax
environment?
Media salutations, public relations, and political expediency have brightened
the private sector and darkened the public sector, conditioning the citizenry
to feel comfortable with private initiatives and to question public thrusts. To
appease a confuse electorate, political compromise has replaced public
responsibility - a route to disaster.
alternativeinsight
january, 2011
updated august 2011
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