Tag Archives: tax

Social Security Reform

I am familiar with the Senators’ stated positions, and with President Bush’s proposed framework in this early stage. I think that they may be able to kill two birds with one stone if they think outside the box. What I mean is that they could achieve tax simplification, private accounts, and permanent sustainability while lowering the payroll tax rate. Let me explain:

  1. Every citizen has a private retirement account “PRA”.
  2. Contributions to PRAs are income tax deductible, investments incur no dividend or capital gains taxes, and can receive rollovers from 401(k)s and existing IRAs. Contributions default to money markets unless directed otherwise.
  3. Automatically, 10% is deducted from all pre-tax income, with no cap: 5% goes into the PRA, and 5% goes into the general Social Security fund. More can be contributed to the PRA at the discretion of each person: up to $3k + 15% of income, again, with no cap.
  4. Early withdrawal penalties from PRAs mirror IRA regulations, except that any citizen 60 or older may withdrawl from their PRA, and only those with a worthless PRA will receive Social Security benefits from the general Social Security fund (equal or better than existing Social Security Benefits).
  5. Upon death, any remaining assets in a PRA may be transferred to beneficiaries. If the beneficiary is anyone other than a spouse, transfers are treated as income to the beneficiaries.

This plan achieves tax simplification, private accounts, and permanent sustainability while lowering the payroll tax rate. It also promotes an ownership society and increases the savings incentives for rich and poor alike.

    Let me sum up:

  • This system achieves both private accounts and a stronger social safety net.
  • It requires that the wealthy contribute to social security at the same rate as everyone else, but allows for tax advantaged retirment contributions even for the wealthy.
  • It reduces the role of government because the government assists only those who have need (those who have no value left in their retirement account).
  • It strengthens the social safety net of government because it increases funding and concentrates assistance on the needy.
  • Retirement savings tax rates are no longer determined by the employer, as the 401(k) system provides.
  • A single account for tax advantaged retirement savings will make administration much easier.
  • Everyone is encouraged to get rich, and those who outlive their savings are protected.
  • If funding surpluses are too high, the tax rate can be lowered.

Please promote Social Security modernization through your representatives.

Taxes and Concentration of Wealth

The concentration of wealth plays a role in economic growth and employment, crime rates, and just about every aspect of American society. The primary tools government uses to manipulate the concentration of wealth are tax and healthcare policies. In this article, we focus on how recent tax policy is reshaping the concentration of wealth.

Policies that distribute wealth and power more broadly are sometimes called “socialist” by those who argue against them. Similarly, policies that concentrate wealth and power too much are sometimes called “oppressive” or “fascist”. Both of these names are misleading. In a capitalist democracy, a wide range of policy decisions can set the stage for incentives and fair business; we’re still working to find the best balance.

Capital gains income tax:

Under President Bush’s tax cuts, investors are now paying 15% tax on income from capital gains. Meanwhile, income from work is taxed about twice as much, depending on your marginal rate. The tax code is effectively encouraging income from capital gains by giving back half the tax on that type of income. It’s not clear to me that the government should be in the business of encouraging one type of income over another, but if we do then we should be encouraging income from work. Investors may argue that they have already earned this money and paid taxes on it so it should not be taxed again. This is true; remember that you only pay tax on the new income. The original amount you invested is not considered income and is not taxed again.

Estate taxes:

Estate taxes were created along with child labor laws, voting rights for women, and the establishment of an income tax during the Progressive Era (1900-1918). President Bush is eliminating the estate tax, and has proposed to make this tax cut permanent in the coming term. The question of whether we should we maintain estate taxes or eliminate them is a subjective question. Rather than make this point myself, let me defer to the words of President Franklin Roosevelt: “Great accumulations of wealth cannot be justified on the basis of personal and family security. In the last analysis such accumulations amount to the perpetuation of great and undesirable concentration of control in a relatively few individuals over the employment and welfare of many, many others. Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our Government.” President Bush’s agenda for estate taxes is to reduce the estate tax over time to nothing, and in the next 4 years, his agenda is to make this permanent. If this happens, families of vast wealth will effectively be an elite class, removed from the rest of Americans by the virtue of birthright.

Dividend income tax:

Bush’s economic agenda for the next 4 years also includes eliminating the tax on dividend income (http://www.gop.com/GOPAgenda/AgendaPage.aspx?id=2). If this is passed, those who receive dividend payments will not pay any taxes on that income, giving them an after-tax raise of more than 50% (35% tax leaves 65%. Going from 65 to 100 is a 53.8% gain). That personal income will no-longer be contributing to the government revenues, and the shortfall will accumulate against us all in the form of budget deficit. If stopping the double-taxation of dividends is the goal, the correct way to deal with it would be to make dividend payments a deductible expense just like any other cost of doing business.

These recent tax cuts have been very effective in getting money back into the hands of Americans, but have put us into growing debt. The budget deficit is important because the national debt must someday be paid down, with interest. This is one of the most important factors that determines the value of the US dollar and international confidence in American investments. With extensive history and other nations as examples, we clearly see that as the debt gets bigger, we will experience inflation, not be able to buy as many foreign goods, and see less international interest in our stock markets. The U.S. budget deficit in 2004 will hit a record $445 billion, according to the White House. Not only would this be a record deficit, but also an unprecedented fall from record surplus.

Federal Budget Surplus or Deficit

Data source: http://www.cbo.gov/showdoc.cfm?index=1821&sequence=0

Instead, if income from all sources is simply taxed as income, then tax policy will be much more fair and government revenues will be higher. On this point, the Democratic agenda to roll back such specific portions of the recent tax cuts seems right. The timing, however, is sensitive: increasing taxes during economic recession can make problems worse.

In any event, the Federal Reserve (not tax policy) is the primary mechanism for managing economic recession. If the federal government uses changes in the tax code to manipulate the economic cycles, then it is acting as a backseat driver to the Federal Reserve. In addition to the complication this adds for the FED in determining the funds rate, it also makes it much harder for citizens and businesses to plan and prepare taxes.

The concentration of wealth threatens our nation. The poverty rate was 12.5% of all Americans in 2003. The numbers are even worse for children: 17.6% of Americans under the age of 18 are living in poverty (http://www.census.gov/hhes/income/income03/prs04asc.html). I hope you will agree that these numbers are too big. These Americans often disappear in our society and are not very well represented in politics: they may not apply for jobs or vote, they often do not have health insurance, they often do not pay taxes on the money they do earn; they hide from the system because the system demands taxes that they can’t afford to pay. Tax policy is exacerbating this problem and should be made fair in the ways I described above. Once the downward spiral of joblessness and poverty can be broken, the upward spiral of employment and fulfillment can begin. Increasing the workforce and reducing structural poverty is clearly in the interest of America.

Retirement savings reform

Company sponsored retirement programs are costly to administer, and provide employment benefits in the form of tax reduction. By providing employment benefits in this manner, government is subsidizing the businesses that submit to the administrative costs. Large companies can more easily afford this administrative cost. The intention to reward workers becomes a reward for working in a larger organization. When workers change or lose their jobs, they must transfer their 401(k)s and in some cases (when they are hired by a small firm or are not immediately re-hired) are no longer eligible for tax advantaged retirement savings. This compounds the pain of unemployment by effectively increasing the person’s tax rate. Finally, 401(k) rollovers have created an entire bureaucratic industry, tapping the productive force of many bright and hard-working people.

There is a simple solution: Replace 401(k) plans by increasing the amount all individuals can contribute to their traditional IRAs. And if a company chooses to administer it, a percentage of every check could be directly deposited. This change would help to level the economic playing field for small American businesses, eliminate the harsh tax penalty upon unemployment, and simplify the financial accounts of most working Americans. 401(k) plans can already be rolled into IRAs, so conversion from legacy policies would be painless.

What about the government’s intention to reward workers? The financial incentive of a pay check is designed to be just that, but additional reward might include a federal income tax holiday for the first $50k in earned income, for example.

Special cases of inconvenience and frustration are many, I’m sure, but consider the case of a married couple, both of whom work. One employer provides a 401(k) plan and the other does not. Saving equally, the person with a 401(k) takes home more money. This means that in order to save equally, one person is structurally required to subsidize the other. Adding structural financial conflict into marriage should be avoided as a matter of policy.

Outside-the-box Economics

The US, Japan, and other countries have converging economic policies which are not optimally stimulating growth within their national economies. The following is an attempt to eliminate inefficiencies and improve incentives: a discussion point, not a recommendation.

Eliminate all taxes, and print the money that the government needs to handle it’s budget. Tax would be implied by the inflation of the currency. The US government’s annual budget of $1.864 Trillion in 2001 represents a small portion of the total US assets and capital. I don’t know the total number–I’m not sure if anyone does–however, GDP in the US is $9.8 Trillion. With a total US currency capital base of only twice GDP, the marginal increase in money supply would be about 10%. M3 (The broadest indicator of money supply, including bank deposits and money-market mutual funds) rose by almost 14%, year-on-year, to the end of October, 2001, meaning that the US gov’t annual budget would add another 42% to the increase in M3. Meanwhile inflation is about 3%. If we increase the inflation rate by the same factor, we get 4.25% inflation. And no taxes.

The stimulation of the economy would be furious for a few reasons: 1) Elimination of taxes increases disposable income by 50% (assuming 33% average tax, which is probably low), 2) an increase in inflationary expectations creates an increase in spending, and 3) enormous increases in efficiency.

In terms of efficiency, the entire IRS and tax calculation and collection processes would be unnecessary. In addition, the legal complication surrounding estate taxes, loopholes, alternative minimum taxes (AMT), purchase basis tracking, tax avoidance, foreign tax safe-havens, audits, etc. would become unnecessary.

Sales taxes, including targeted taxes to discourage some goods or behaviors could (and should) still be used.

Currently, there is no tax on wealth. Instead, taxes are paid for income, sales, and other movements of capital. The current mechanism creates an inefficiency in a huge range of transactions. Inflation, on the other hand, is an effective tax on wealth, and in doing so, eliminates the inefficiency on transactions while discouraging hoarding and encouraging investment and spending.

The base of wealth is so much higher than the base of incomes that taxing wealth can bring in the same revenues with a much lower tax rate. Closing all the loopholes and eliminating inefficiencies should also boost tax revenues substantially.

The U.S. Government should implement an Investment Company, Financed by a Federal Corporate Income Tax

Technology has changed market dynamics, and new economies of scale are making it increasingly hard for small businesses to compete.  National and international communications and transportation have increased the global nature of businesses, so scale and international optimization of supply chains make enormous advantage for the largest businesses. Another important example is the nearly infinite ratio of fixed to marginal costs in information businesses that leads to increasing pressure toward consolidation.  Meanwhile, the value of public companies shifting from 40% intangible assets in 1996 to 75% in 2000. These forces push toward anticompetitive oligopolies, and are newly strengthened because of the new communications and transportation infrastructures.

Unfortunately, when you combine the globalizing economy with massive consolidation pressures, the natural equilibrium is a monopoly.  A monopoly can act in its own best interest and harm consumers.  America has a long history of working to ensure consumer markets remain competitive.

If you want to reduce the burden on the Federal Trade Commission lawyers, then we should implement a structural incentive that acts to offset any negative changes in the economic dynamics.   Specifically, we could create a new incentive for competitive markets.

This can be achieved with a progressive federal corporate income tax that finances an investment company and, in turn, finances companies that can improve competitive pricing or innovate.   The progressive tax could begin at a high profit level so that competition would be encouraged. Not a very popular suggestion among stockholders in the largest corporations, I suspect, but the benefit in the long run would be very great.

Necessity is the mother of invention, and monopolists can sustain their position with far less innovation than occurs in competitive markets. We will see advancements in communications, transportation, environmental protections, health care, entertainment, safety, and even life span. These innovations will occur inevitably, but it is our decision as a society how we structure ourselves to best approach this evolution.

Note – The Government-financed investment company should probably be independent in a similar model to the federal reserve.

Note – The competitive application for the funds of the Government-financed investment company avoids the incentive problems associated with socialist policies.

Note – The investment company would consist of many competing portfolios, managed by accountable teams, and with regular culling of underperformers.

Note – This would be a particularly effective economic stimulus mechanism because it supports high velocity of money in productive markets and more directly drives employment.

Note – The enormous potential financial gain from the investment company would be reinvested and used to reduce corporate, individual, and other tax rates.  It has the potential to create a self-financing government.

Note – The investments of the investment company would be direct – new equity or debt capital – not the purchase of existing securities.