Should the Rich Pay More Taxes?

It’s a multi-dimensional question.

The left says yes — income inequality has soared in recent years, and the way to address it (supposedly) is to tax the rich and capital gains at a higher rate. The right says no — that the rich already create more jobs and wealth, because they spend more money, and why (supposedly) should they pay more tax when they already pay far higher figures than lower-income workers?

Paul Krugman made the point yesterday that the tax rate on the top earners during the post-war boom was 91%, seeming to infer that a return to such rates would be good for the economy.

Yet if we want to raise more revenue, historically it doesn’t really seem to matter what the top tax rate is:

Federal revenues have hovered close to 20% of GDP whatever the tax rate on the richest few.

This seems to be because of what is known as the Laffer-Khaldun effect: the higher rates go, the more incentive for tax avoidance and tax evasion.

And while income inequality has risen in recent years, the top-earners share of tax revenue has risen in step:

So the richest 1% are already contributing around 40% of the tax revenue, taxed on their 34% share of the national income. And even if the Treasury collected every cent the top 1% earned, America would still be running huge deficits.

Yet the Occupy movement are still angry. A large majority of Americans believe the richest should pay more tax. More and more wealthy Americans — starting with Warren Buffett, and most recently Stephen King are demanding to pay more taxes.

King writes:

At a rally in Florida (to support collective bargaining and to express the socialist view that firing teachers with experience was sort of a bad idea), I pointed out that I was paying taxes of roughly 28 percent on my income. My question was, “How come I’m not paying 50?”

How come? Well, the data shows pretty clearly that it’s unlikely that revenues would increase.

They may have a fair point that capital gains above a certain threshold should probably be taxed at the same rate as income, because it is effectively the same thing. And why should government policy encourage investment above labour by taxing one more leniently?

But more simply, people like King think the status quo  is unjust far beyond the taxation structure. A lot of people are unemployed:

A lot of people are earning less than they were five years ago:

28% of homeowners are underwater on their mortgages. Millions of graduates face a mountain of student debt, while stuck in dole queues or in a dead end job like Starbucks.

We live in dark times.

From Reuters:

Nearly 15 percent of people worldwide believe the world will end during their lifetime and 10 percent think the Mayan calendar could signify it will happen in 2012, according to a new poll.

With all this hurt, there’s a lot of anger in society. Those calling for taxing the richest more are not doing the same cost-benefit analysis I am doing that suggests that raising taxes won’t raise more revenue.

But they’re not unfairly looking for a scapegoat, either. While probably the greatest culprits for the problems of recent times are in government Americans are right to be mad at the rich.

Why?

This isn’t about tax. This is about jobs, and growth.

The rich, above and beyond any other group have the ability to ameliorate the economic malaise by spending and creating jobs, creating new products and new wealth. The top 1% control 42% of all financial wealth. But that money isn’t moving very much at all— the velocity of money is at historic lows. It should not be surprising that growth remains depressed and unemployment remains stubbornly high.

And every month that unemployment remains elevated is another month that the job creators are not doing their job. Every month that the malaise festers, the angrier the 99% gets.  It is, I think, in the best interests of the rich to try and create as many jobs and as much wealth as they can.  A divided and angry society, I think, will find it even more difficult to grow and produce.

America needs the richest Americans to pay more tax dollars — but as a side-effect of producing more, and creating growth.

If the private sector doesn’t spend its way out of the current depression, eventually the government will have to, of course. But it can do that with borrowed money, not taxed money.

We’re All Nixonians Now

People have got to know whether their President is a crook

Richard M. Nixon

I often wonder who is worse: George W. Bush — the man who turned a projected trillion dollar surplus into the greatest deficits in world history, who bailed out the profligate Wall Street algos and arbitrageurs, who proceeded with two needless, pointless and absurdly costly military occupations (even though he had initially campaigned on the promise of a humble foreign policy), who ignored Michael Scheuer’s warnings about al-Qaeda previous to 9/11, who signed the Constitution-trashing PATRIOT Act  (etc etc ad infinitum) or his successor Barack Obama, the man who retained and expanded the PATRIOT Act powers under the NDAA (2011), who claimed the right to extrajudicially kill American citizens using predator drones, who expanded Bush’s expensive and pointless occupations (all the while having run on a promise to close the Guantanamo Bay detention centre and reverse Bush’s civil liberties incursions), who proceeded with Paulson’s Wall Street bailouts, authorised the NSA to record all phone calls and internet activity, and continued the destructive War on Drugs (even though he had in the past been a drug user).

The answer, by the way, is Richard Nixon. For almost forty years after that man’s resignation, it is arguable that almost every single administration (with the possible exception of  Carter as well as Reagan’s first year in office) — but especially that of Bush and Obama — has been cut from his cloth. It was Richard Nixon who inaugurated the War on Drugs — that despicable policy that has empowered the drug gangs and obliterated much of Latin America. It was Richard Nixon who so brazenly corrupted the White House and tarnished the office of the Presidency through the Watergate wiretapping scandal.  It was Nixon’s administration that created the culture of government surveillance that led directly to the PATRIOT Act. It was Nixon who internationalised the fiat dollar, so trampling George Washington’s warnings about not entangling alliances, and of course setting the stage for the gradual destruction of American industry that continued apace under NAFTA and into the present day, where America runs the greatest trade deficits in human history. It was Richard Nixon who set the precedent of pointless, stupid, blowback-inducing militarism, by continuing and expanding the Vietnam war. It was Richard Nixon whose administration authorised the use of chemical weapons (or as George W. Bush might have put it, “weapons of mass destruction”) against the Vietcong.

Presidents since have followed — to a greater or lesser extent — in his mould. This is particularly acute this election cycle; you vote for Obama and you get Richard Nixon, or you vote for Romney and you get Richard Nixon. Nixon’s words: “we’re all Keynesians now” have a powerful resonance; not only has every administration since Nixon retained the petrodollar standard and spent like a drunken sailor in pursuit of Keynesian multipliers, but every President since has followed in the Nixonian tradition on civil liberties, on trade, on foreign policy. Henry Kissinger — the true architect of many Nixonian policies, and Obama’s only real competition for most bizarre Nobel Peace Prize recipient — has to some degree counselled each and every President since.

It is hard to overstate the magnitude of Nixon’s actions. The demonetisation of  gold ended a 5,000 year long tradition. It was a moment of conjuring, a moment of trickery; that instead of producing the goods, and giving up her gold hoard to pay for her consumption habits (specifically, her consumption of foreign energy), America would give the finger to the world, and print money to pay her debts, while retaining her (substantial) gold hoard. The obvious result of this policy has been that America now prints more and more money, and produces less and less of her consumption. She has printed so much that $5 trillion floats around Asia, while the American industrial belt rusts. Industrial production in America is where it was ten years ago, yet America’s debt exposure has ballooned.

America has had not one but two Vietnams in the past ten years.

First, Afghanistan, in the pursuit of the elusive Osama bin Laden (or, “in the name of liberating women”, presumably via blowing their legs off in drone strikes), where young Western soldiers continue to die (for what?), even after bin Laden’s supposed death in a Pakistani compound last year.

Then, Iraq, presumably in the interests of preventing Saddam Hussein from using non-existent Weapons of Mass Destruction, or liberating more women by blowing their legs off (or as Tom Friedman  put it: “SUCK! ON! THIS!”).

Like Nixon’s Presidency, the Nixonian political system is highly fragile. Debt is fragility, because it enforces the inflexibility of repayment, and the Nixonian political system has created staggering debt, much of it now offshore. The Nixonian economic policy has gutted American industry, leaving America uncompetitive and dependent on foreign productivity and resources. The Nixonian foreign policy has created a world that is deeply antipathetic to America and American interests, which has meant that America has become less and less capable of achieving imperatives via diplomacy.

Future historians may finger George W. Bush as the worst President in history, and the one who broke the American empire. But smarter scholars will pinpoint Nixon. True, the seeds of destruction were sown much earlier with the institution of permanent limited liability corporations. This allowed for the evolution of a permanent corporate aristocracy which eventually bought out the political echelon, and turned the Federal government into an instrument of crony capitalism, military Keynesianism and corporate welfare. Nixonianism has been the corporate aristocracy’s crowning achievement. And to some extent, this period of free lunch economics was a banquet, even for middle class Americans. The masses were kept fat and happy. But now the game is up — like Nixon’s Presidency — its days are numbered.

A Tale of Two Bens

Paul Krugman has an interesting post up on Ben Bernanke’s contrasting economic policy positions. Simply, the younger Bernanke was much more Krugmanite than the older Bernanke:

[The younger Bernanke] endorsed, at least as possibilities:

– Targeting long-term interest rates
– Currency depreciation
– Money financed deficit spending
– A Krugman-style inflation target

After 2003, however, his menu seemed to have been reduced to:

– Guidance on future short-term rates (the rates the Fed sets)
– Purchases of long-term bonds and other nonconventional assets
– “Oversupplying reserves”, that is, just pushing up the monetary base

Krugman concludes — quite rightly — that Bernanke has been “assimilated by the Fedborg.” Krugman should probably know that Ben’s main goal has nothing whatever to do with inflation, or “aggregate demand” or currency depreciation. Nothing. These are all handmaidens to one thingthe rate that the Treasury is paying on its debt.

America is in an impossibly tough fiscal position:

Even at the government’s impossibly cheap projections, a lot of money is going to be pushed out from the Treasury to creditors.

And so the Fed’s main implicit goal is to keep Treasury rates as low as possible without excessive inflation  — the more inflation, the more creditors will ditch Treasury debt, thus forcing the Fed to monetise more. This is a foreign policy imperative: the bottom line is that America has gotten herself deeply in hock to foreign creditors. The Fed’s task is to keep the creditors buying debt, and to minimise rates so as little capital gets out of America as possible. Ben Bernanke has become precisely what many American accuse China: a currency manipulator.

There are a few secondary goals: reflating housing is one (more home equity means more consumption), and reflating equities is another. But all of these are subordinated to keeping rates cheap and thus delaying America’s inevitable fiscal (and thus foreign policy) meltdown.

Of course, under present circumstances, this is an impossible task. And without another round of QE, rates are rising.

From Bloomberg:

U.S. government securities lost 1 percent from the start of the year to March 29, Bank of America Merrill Lynch indexes show.

And that — in one sentence — is why Bernanke will be printing again soon.

Great Success!

From Business Insider:

The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its goal to devalue the dollar by 33 percent over the next 20 years. The debauch of the dollar will be even greater if the Fed exceeds its goal of a 2 percent per year increase in the price level.

Regular readers will know that I believe that the dollar in its present form is extremely unlikely to exist in twenty years, due to the systemic fragilities of a system softened up by forty years of unrestrained credit creation, securitisation, (including over a quadrillion dollars of derivatives), and a free lunch of Arabian oil and Asian goods rolling off the printing press.

But in any case, let’s have a look at just how successful the FOMC has been in debasing the dollar:

Past performance shows the only way is down, down, down.

After all, the FOMC central planners determined long ago that deflation — a natural phenomenon that has occurred repeatedly throughout history, and which actually has a useful function of liquidating bad businesses and debts — was bad, and that they were going to print, print, print ’til it was eradicated.

Does anyone else think that there might be things worse than deflation?

Like — oh, I don’t know — currency collapse?

Corporatism and Income Inequality

In a tremendous, and essential article for Project Syndicate, Nobel laureate Edmund Phelps, and regular reader Saifedean Ammous team up to obliterate the view that the West is at present a capitalist system, and that the problems of the West are problems of capitalism:

The term “capitalism” used to mean an economic system in which capital was privately owned and traded; owners of capital got to judge how best to use it, and could draw on the foresight and creative ideas of entrepreneurs and innovative thinkers. This system of individual freedom and individual responsibility gave little scope for government to influence economic decision-making: success meant profits; failure meant losses. Corporations could exist only as long as free individuals willingly purchased their goods – and would go out of business quickly otherwise.

Capitalism became a world-beater in the 1800’s, when it developed capabilities for endemic innovation. Societies that adopted the capitalist system gained unrivaled prosperity, enjoyed widespread job satisfaction, obtained productivity growth that was the marvel of the world and ended mass privation.

Now the capitalist system has been corrupted. The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system, however, is not capitalism, but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

The costs of corporatism are visible all around us: dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

I too have spent a whole lot of energy and time lambasting our present system of corporatism.

The trouble is, the advocates of the status quo, and everything that means — government intervention in markets, central planning of the economy, the welfare-warfare state, bailouts, huge deficits, surveillance (for the purposes of taxation) and so forth — do not see themselves as corporatists, so much as they see themselves as go-gooders who want to “manage” the economy to a better place. They oppose the free market because they believe they know better than the market. They believe that our system today is a form of “constrained” capitalism which averts its worse excesses. Most significantly, they believe that the problems with the present system — income inequality and corporate power — are problems of capitalism, and that freer markets would make these problems worse.

As Ammous and Phelps suggest, they are blaming “capitalism” for the problems of corporatism.

There is strong evidence against doing so.

The growth in corporate power and income inequality seems to be largely an outgrowth of giving banks a monopoly over credit creation. In 1971, Richard Nixon severed the link between the dollar and gold, expanding the monopoly on credit creation to a carte blanche to print huge new quantities of dollars and give them to their friends.

Unsurprisingly, this led to a huge growth in the American and global money supplies:


This new money was not exactly distributed evenly:


A lot of that money seems like it ended up in corporate profits:


A shrinking share has gone to wage labour:


It is this stuff — the decrease in real wages, the growth in corporate profits, the growth in CEO pay, the growth in the wealth of the top 1% — that has inspired and informed movements like Occupy Wall Street. Sadly, such movements have largely avoided confronting the reality that this monstrous outgrowth of corporatism has developed in a heavily-regulated, socially-engineered, managerialist and interventionist economy, and not in a capitalist economy or in a free market, as so many occupiers claim.

It is completely inaccurate to paint these figures as problems of capitalism.

As I wrote earlier this week:

This psychological trend can be summed up as the idea that the first recourse for social and economic problems is more government action. Too much inequality? Regulate against it. Too little innovation? Legislate for it. Too little demand? Stimulate it. Too much bad government? Elect a better one, who will do more of the things we “love”, and less of those we “hate”.

The idea, in the simplest terms, is that changes to society should come from the great overhanging monolith, and not from the little individuals on the ground. No, we are just fish swimming in an ocean of dialectical chaos. We are just flecks of paint on the great canvas of humanity. No, let us not agitate or gravitate. Instead, we must “co-ordinate” and “unite” under the aegis of government; the blind painter.

The climax of this bizarre psychological trend was the election of Barack H. Obama. After all the misdeeds of Bush and Cheney, he would be the one to restore government to its “proper” role: “helping the people”, “creating a better America”, “investing in tomorrow”, etc, etc, etc, blah, blah, blah.

This is a licence for more central planning, more interventionism and more government largesse. There are two problems here:

  1. Regulatory Capture: As David Rothkopf has argued: “Geography, pedigree, networking and luck unite a superclass of 6000 individuals that possess unparalleled power over world affairs.” Obama’s top contributors are the same old people. Obama appointed more ex-Wall Street figures to his administration than anyone before him. Ultimately, the people chosen as central planners have a track record of enacting policies that enrich themselves more than everybody else. The people lining up at Davos calling for a new system, i.e. more government, are the same elite who have ruined the old one. As Jonathan Weill writes: “It’s becoming hard not to suspect that the annual gathering in Davos has become a conclave for global elites to promote crony capitalism and state-backed enterprise, ensuring that national coffers remain available to be tapped for private gain.”
  2. Unintended, and Unexpected Consequences: Central planners are often pretty bad at the job. Bernanke and Yellen failed to predict the end of the housing bubble (that their predecessor Alan Greenspan helped create) with terrible consequences. Tim Geithner lashed that there was “no chance of a downgrade” right before S&P downgraded US Treasuries. Angela Merkel demands austerity from a frail and ailing Greek economy suffering from a severe contraction that is only worsened by austerity. The Iraq and Afghani wars created more terrorists than they killed, and added a multi-trillion dollar shackle of debt to the American government. America’s deindustrialisation (in the name of cheaper Chinese goods) has created huge unemployment in America, as well as making the American economy ever more dependent on the fragile flow of trade for components and energy. History is dominated by black swans — and the history of  central planning is dominated by unintended consequences. We just don’t understand reality well enough to centrally plan it.

After many decades of central planning and interventionism we are left with monstrous income inequality and corporate power.

Is it not fair to conclude that the two are intrinsically connected?

Ignoring the Correlation

Paul Krugman waxes about income inequality:

Apologists for rising inequality often argue that since most Americans’ income has risen despite rising inequality, there’s no reason to complain about inequality other than envy.

You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.

This is real stuff, not some trivial envy-driven concern. But we must be very, very quiet about it, right?

Krugman is very quiet about one thing: the fundamental change in the monetary system that took place in 1971, the year that Richard Nixon made the dollar a completely fiat currency by removing its peg to gold. After that event, income inequality has really raced ahead.

Now I know full well correlation does not imply causation. But I also know that giving central bankers free rein to print as much money to hand out like candy to their friends in big finance does imply that they will do it. How do I know that? Because they do:

From the Levy Institute:

The bottom line of crisis of 2007-9: a Federal Reserve bailout commitment in excess of $29 trillion.

My hypothesis is that leaving the gold standard was a free lunch: headline GDP growth could be achieved without any real gains in productivity, or efficiency, or in infrastructure, but instead by pumping money into the system and assuming that this would have a positive effect on the economy as a whole. After all — say the Keynesians — “aggregate demand (i.e. money circulation) is the state of the economy”.

But in reality “higher GDP” and “higher aggregate demand” just mean more money circulating. It’s perfectly possible for more money to circulate while the real economy (productivity, labour, technology, infrastructure, etc) deteriorates. In fact, in many respects this is exactly what happened during the Bush administration, where trillions of dollars of productive capital was burnt up on military adventurism.

Now maybe I have a thick skull. If so, could someone explain to me what I’m missing? The Federal Reserve was set free to print as much money as it wanted and give it to its friends with little oversight, and in the following years income inequality soared.

Seems like simple cause and effect.

Populism & the Fed

A bizarre piece from Gregory Morris writing for Bloomberg:

Today, as its 100th anniversary approaches, many followers of both the Tea Party and Occupy Wall Street movements are calling to “End the Fed.” The rich irony here isn’t that reactionaries and radicals are in agreement on something; after all, they are both passionately populist. The irony is that it was populist outrage and calls for reform that created the Fed in the first place.

The three decades from the demise of the second central bank to the point where the Lincoln administration began printing greenbacks to finance the Civil War were known as the years in the wilderness for American finance. Banks printed their own notes — and let the buyer beware. Bank runs and panics were a common fact of life.

Even with the terrible economic conditions we’ve seen in the past few years, it’s difficult today to comprehend the precarious state of business and personal finance in those days. Not only was there no central bank to restrain economic swings, there was no deposit insurance and no social safety nets. Banks were chronically undercapitalized and went bust with alarming frequency. There was no recourse for depositors. Farms and shops were foreclosed, families put on the street.

Really? Populist outrage led to the creation of the Fed?

I thought it was a cabal of bankers and financiers meeting in secret.

From Wikipedia:

At the end of November 1910, Senator Nelson W. Aldrich and Assistant Secretary of the U.S. Treasury DepartmentA. Piatt Andrew, and 5 more of the country’s leading financiers, who together represented about one-fourth of the world’s wealth, arrived at the Jekyll Island Club to discuss monetary policy and the banking system, an event led to the creation of the current Federal Reserve. According to the Federal Reserve Bank of Atlanta, the 1910 Jekyll Island meeting resulted in draft legislation for the creation of a U.S. central bank.

Now I know that depositors want their deposits insured. I know that a world of bank runs and panics is not a very reassuring atmosphere for businesses. But let’s be honest — things weren’t that bad. Here’s real GDP-per-capita from the end of the Civil War to the end of World War I:

Does that look like stagnation or weakness to you? No — it looks to me like a consistently rising standard of living powered by significant wealth creation. Sure — bank runs and panics, and bank failures and foreclosures were common. That’s the nature of creative destruction — good ideas can much more easily succeed if bad ideas are free to fail. That meant that society, and the economy, were much more experimental. And that’s the cost of innovation, and endeavour and experimentalism — an atmosphere of volatility.

The real issue is that the Fed’s defenders don’t really like creative destruction, because it is too risky. They cling to the comfort blankets of mild-to-moderate yearly inflation via money printing, significant government intervention to save failed businesses like GM, AIG and Bear Stearns, and an economy and political system swung (if not controlled) by too-big-to-fail megabanks, and their CEOs. Most fiercelythey cling to the risk-free 6% dividend they receive year-in-year out — a risk-free 6% of which most private citizens and investors can only dream.

The reality is that modern economic planning is the art of papering over the cracks. The social safety net, and depositors insurance are there not to create wealth (for they do no such thing) but to keep the febrile masses from rioting. The Fed’s defenders are puzzled that after all those monetary helicopter drops (stimulus, QE, QE2, etc, etc) the masses (Tea Party, Occupy) are still demanding more. The “great moderations”, and free lunches have (as I have explained in detail here and here and here) created a hyper-fragile monolith of delayed crises — America’s huge debt load, youth unemployment, biflation, etc — ready to crash down on society.

Loose monetary policy has created tsunamis of malinvestment, and bubbles (housing, NASDAQ, etc) that ultimately drag the economy back down to earth, resulting in crises that — as Paul Krugman so memorably put it back in 2001 — are reinflated, and reinflated, and reinflated by more and more and more interventionism, and new bubbles to replace the old.

That isn’t sustainable economics, or sustainable growth. Sustainable growth is driven by investment in the things that society wants and needs. It’s driven by people working, saving, and investing in products, services and businesses that they deem to be valuable. That is the nature of a free market, not the government or central bank firing off trillions of dollars to whoever they designate as “systemically important”. Sustainable growth is driven by experimentalism. If an experiment fails, it falls to pieces and a gap in the market is opened for the next experiment. Sustainable growth is not driven by bailouts and moral hazard — ever. That means that investors and financiers will think long and hard before committing capital, instead of throwing it into ponzi schemes and derivatives-black-holes.

There is a sensible middle ground between creative destruction and modernity. If anyone is to be bailed out, it should be the poorest, not billionaire bankers and Wall Street megabanks. Let the government insure the deposits of the masses. Let the government provide a safety net to prevent homelessness and starvation, and sickness — so long as it is funded sustainably from tax revenues, and not borrowing.

But let failed businesses fail. Let bad experiments end. Let bad debtors default on their debts. If the financial system is fundamentally weak then let it crumble — let a new system take its place.