Thoughts on the economy

[ziggy29]

I'm in favor of setting the dividend and capital gains tax rates equal to the rates on labor income.

I could probably convince myself to agree on two conditions:

1) The double taxation of dividends was eliminated by allowing businesses to pass dividends to shareholders before tax (i.e. treat all dividends more like REIT dividends);

2) The cost basis on long term capital gains was adjusted for inflation. If you sell an asset you held for 20 years where 75% of the "gain" was due to inflation, it would be punitive to apply ordinary income tax rates to all the nominal "gain".

Do those two things, and I might be on board.

 

[clifp]

At the end of WWII the US national debt was about 120% of GDP. Twenty years later it had dropped to 40%. How did the US manage to pay off so much of the cost of the war in twenty years? It never did. The economy grew. The stimulus from the war spending lasted a very long time.

When the govt borrows money and spends it, the effect on the economy is the same as when a company does. The "profit" to the govt comes from higher tax collections on an economy that grows.

Japan's spending during their two lost decades has produced a national debt greater than their GDP, either 120% or 200% depending on how you count. The interest rate on 10 year Japanese Treasury bonds is currently less than 1%. If their is a level of debt that the Japanese economy cannot support, they haven't found it yet.

The situation was vastly different after WWII than today. There was a huge pent up demand for consumer goods since virtually all production of consumer goods from autos to nylons was stopped during the war. Unlike today where as society, we have tons of things and I'd argue that ubiquitous internet reduces demand for many products, like entertainment.

Second consumer were flush with cash, much of in the form of War bonds. In WWII almost all debt was held domestically, same thing is true today in Japan, today 1/2 the US debt is owed to oversea investor and 1/2 of that is Chinese. So government interest payments provided twice the stimulus to the economy than today. Today US consumer are heavily in debt.

Finally, US companies had virtually no competition domestically, with everybody else factories destroyed during the war. Today we live in a global economy, and much of the money spent by either tax cuts or government programs will be spent overseas.

Re Japan, John Maudlin's recent newsletter had some interesting observations.

Japan, as I am wont to say, is a bug in search of a windshield. They have transmuted the savings of two generations into the largest debt ever for a country that I am aware of (in terms of GDP). It is now approaching 220% and rising at a prodigious pace, about 10% in 2011. They have gone from a savings rate of 16% to around 1%, largely due to an aging population that is now living off its savings.
When that savings rates goes negative, and it is a demographic certainty that it will, Japan will either be forced to pay higher interest rates or print massive amounts of yen or cut government spending by equally massive amounts. All of those options are ugly in the short term. If interest rates rose by a mere 2% for Japan, they would be spending more than 70% of their budget on just interest expense within a few years. That is not a workable business model. .

 

[Hamlet]

I think that this is a sensible reform to make. I would advocate getting rid of the corporate income tax almost entirely. The only exception would be that I think that we would need a nominal tax on cash and other low-risk assets to prevent the creation of corporations that serve only as a tax-avoidance vehicle for interest.

Tax all capital gains and dividends at ordinary income rates, indexing long-term cap gains for inflation.

One big advantage of this system would be that it would remove the incentive for our big multinational companies to hoard cash overseas. It would also put non-international companies on an equal footing with the multinationals. Currently, the multinationals can game the system so much that their effective tax rate is really low.

I'm not clear on whether this would result in more or less revenue over the long term though.

I could probably convince myself to agree on two conditions:

1) The double taxation of dividends was eliminated by allowing businesses to pass dividends to shareholders before tax (i.e. treat all dividends more like REIT dividends);

2) The cost basis on long term capital gains was adjusted for inflation. If you sell an asset you held for 20 years where 75% of the "gain" was due to inflation, it would be punitive to apply ordinary income tax rates to all the nominal "gain".

Do those two things, and I might be on board.

 

[Gumby]

. . . capital gains are a significant factor to investors who provide capital that businesses need to grow and prosper.

My interest in equities would be much lower if maximum capital gains tax rate was 40%. Why take on such risk if the rewards are subject to up to 40% tax (plus state taxes on top of that where applicable)?

Maybe you are an outlier:

Study: Tax Cuts for the Rich Don

A study* from the Congressional Research Service — the non-partisan research office for Congress — shows that “there is little evidence over the past 65 years that tax cuts for the highest earners are associated with savings, investment or productivity growth."

* looking for the actual study now. And here it is http://graphics8.nytimes.com/news/business/0915taxesandeconomy.pdf

 

[pb4uski]

Maybe you are an outlier

Wouldn't be the first time. Nor the last I'm guessin'.

 

[traineeinvestor]

I could probably convince myself to agree on two conditions:

1) The double taxation of dividends was eliminated by allowing businesses to pass dividends to shareholders before tax (i.e. treat all dividends more like REIT dividends);

2) The cost basis on long term capital gains was adjusted for inflation. If you sell an asset you held for 20 years where 75% of the "gain" was due to inflation, it would be punitive to apply ordinary income tax rates to all the nominal "gain".

Do those two things, and I might be on board.

Pass through of dividends is done is some countries already (Australia, New Zeland have both being doing it since the 1990s).

It works by imputing the amount of tax the company pays to the dividend. If the company has paid enough tax, then the dividend effectively becomes tax paid income in the hands of the shareholder. If the company has paid no tax at all then the income is fully taxable in the hands of the shareholder.

One of the consequences of this is that AU/NZ listed companies tend to pay out a high proportion of their profits as dividends and do not keep large piles of cash sitting around.

 

[ERD50]

...My interest in equities would be much lower if maximum capital gains tax rate was 40%. Why take on such risk if the rewards are subject to up to 40% tax (plus state taxes on top of that where applicable)?

Maybe you are an outlier:

Study: Tax Cuts for the Rich Don

A study* from the Congressional Research Service — the non-partisan research office for Congress — shows that “there is little evidence over the past 65 years that tax cuts for the highest earners are associated with savings, investment or productivity growth."

The excerpts from that study suffer the same flaws I see time and time again with these claims. First, they substitute 'top tax rates' for the actual amount of taxes collected:

The CRS study looked at tax rates and economic growth since 1945. The top tax rate in 1945 was above 90 percent, and fell to 70 percent in the 1960s and to a low of 28 percent in 1986.

Very high marginal rates were also accompanied by plenty of legal exemptions ('loopholes'). So if they don't look at the actual collected tax rates, they are hiding something.

The second thing it ignores is external factors. According to 'studies' like this, if I add insulation to my attic, and then we have an exceptionally cold winter, that would 'prove' that higher insulation levels are associated with higher heating bills. But we know better.

Risk/reward has such a solid common sense element to it, and we see it in action in every facet of our lives, that denying that it exists seems indefensible, and/or has an agenda attached to it.

-ERD50

 

[pb4uski]

Pass through of dividends is done is some countries already (Australia, New Zeland have both being doing it since the 1990s).

It works by imputing the amount of tax the company pays to the dividend. If the company has paid enough tax, then the dividend effectively becomes tax paid income in the hands of the shareholder. If the company has paid no tax at all then the income is fully taxable in the hands of the shareholder.

One of the consequences of this is that AU/NZ listed companies tend to pay out a high proportion of their profits as dividends and do not keep large piles of cash sitting around.

That sounds pretty complicated and inconsistent with tax simplification. I think I have a better idea, how about we assume that a certain amount of tax has been paid at the corporate level and give individuals a preferential rate on dividend income to reflect the previous taxation at the corporate level? 15% sounds about right to me.

 

[traineeinvestor]

That sounds pretty complicated and inconsistent with tax simplification. I think I have a better idea, how about we assume that a certain amount of tax has been paid at the corporate level and give individuals a preferential rate on dividend income to reflect the previous taxation at the corporate level? 15% sounds about right to me.

Not sure if I understand what is inconsistent about it? It simply avoids double taxation alltogether without creating any anomolies.

It is not complicated at all - each shareholder gets a statement showing the notional gross dividend, imputed tax and net dividend which they copy on to their tax returns. From the company's perspective it is a very simple calucation. It's painless, simple and transparent.

Two other benefits:

1. it makes it more attractive to invest in companies that pay taxes than those which do not

2. it favours low income earners - people whose marginal tax rate is below the imputed coprporate rate effectively get a tax credit. People whose marginal tax rate is higher than the imputed coporate rate will still have to pay the difference.

They have been doing it for nearly 20 years. As an investor when it was introduced, I had no issues at all.

 

[Gumby]

The excerpts from that study suffer the same flaws I see time and time again with these claims. First, they substitute 'top tax rates' for the actual amount of taxes collected:



Very high marginal rates were also accompanied by plenty of legal exemptions ('loopholes'). So if they don't look at the actual collected tax rates, they are hiding something.

The second thing it ignores is external factors. According to 'studies' like this, if I add insulation to my attic, and then we have an exceptionally cold winter, that would 'prove' that higher insulation levels are associated with higher heating bills. But we know better.

Risk/reward has such a solid common sense element to it, and we see it in action in every facet of our lives, that denying that it exists seems indefensible, and/or has an agenda attached to it.

-ERD50

Did you bother to read the actual study? (Which I helpfully attached). It does indeed track the average tax rate, not just the marginal rate. See Figure I.

 

[ERD50]

Did you bother to read the actual study? (Which I helpfully attached). It does indeed track the average tax rate, not just the marginal rate. See Figure I.

Yes, and I did see Figure 1 (the only one that addresses average tax rates). However, all their 'conclusions' are based on Figures 2-9, which all reference 'top tax rates', excepting Figure 6 which is unrelated to either average or top tax rates.

If you substitute the 'average' rates for 'top rates', those scatter diagrams of correlation would change dramatically. Not only would it undermine their 'point', it might even reverse it - but we can't really say that either because that still would not take external factors into account.

Figure 1. Average Tax Rates for the Highest-Income Taxpayers, 1945-2009 ................................. 3
Figure 2. Top Marginal Tax Rate and Top Capital Gains Tax Rate, 1945-2010 .............................. 4
Figure 3. Private Saving, Investment, and the Top Tax Rates, 1945-2010 ...................................... 7
Figure 4. Labor Productivity Growth Rates and the Top Tax Rates, 1945-2010 ............................. 8
Figure 5. Real Per Capita GDP Growth Rate and the Top Tax Rates, 1945-2010......................... 10
Figure 6. Shares of Total Income of the Top 0.1% and Top 0.01% Since1945 ............................. 12
Figure 7. Share of Total Income of Top 0.1% and the Top Tax Rates, 1945-2010 ........................ 13
Figure 8. Share of Total Income of Top 0.01% and the Top Tax Rates, 1945-2010 ...................... 14
Figure 9. Labor Share of Income and the Top Tax Rates, 1945-2010 ........................................... 15

-ERD50

 

[pb4uski]

Not sure if I understand what is inconsistent about it? It simply avoids double taxation alltogether without creating any anomolies.

It is not complicated at all - each shareholder gets a statement showing the notional gross dividend, imputed tax and net dividend which they copy on to their tax returns. From the company's perspective it is a very simple calucation. It's painless, simple and transparent.

Two other benefits:

1. it makes it more attractive to invest in companies that pay taxes than those which do not

2. it favours low income earners - people whose marginal tax rate is below the imputed coprporate rate effectively get a tax credit. People whose marginal tax rate is higher than the imputed coporate rate will still have to pay the difference.

They have been doing it for nearly 20 years. As an investor when it was introduced, I had no issues at all.

I never said it couldn't be done - we apply a different tax rate to qualified dividends today. Just wouldn't be my first choice. Better than ordinary rates though.

 

[Gumby]

Yes, and I did see Figure 1 (the only one that addresses average tax rates). However, all their 'conclusions' are based on Figures 2-9, which all reference 'top tax rates', excepting Figure 6 which is unrelated to either average or top tax rates.

If you substitute the 'average' rates for 'top rates', those scatter diagrams of correlation would change dramatically. Not only would it undermine their 'point', it might even reverse it - but we can't really say that either because that still would not take external factors into account.




-ERD50

If one compares Figure 1 and Figure 2, one sees that the decrease in average tax rates paid by the top .1% or top .01% generally follows the decrease in the top marginal rates over the same period. While the precise numbers may be slightly different (I don't see where the scatter diagrams would "change dramatically"), the trend is clear and the conclusions likely hold.

I have never heard that the Congressional Research Service has a bias.

 

[ERD50]

If one compares Figure 1 and Figure 2, one sees that the decrease in average tax rates paid by the top .1% or top .01% generally follows the decrease in the top marginal rates over the same period. While the precise numbers may be slightly different (I don't see where the scatter diagrams would "change dramatically"), the trend is clear and the conclusions likely hold.

The slope would change by a factor of ~ 2:1, that's beyond a matter of 'precision'. Certainly that affects any correlation measurements.

Regardless, they are comparing very different time frames. Are the differences really due to tax rates/collections, or due to the differences in the economy in the post-war 1950's and the post-bubble 2000's? It's difficult to adjust for these factors, but they didn't even try, and barely acknowledged it (the following is not mentioned in their summary nor their conclusions):

Furthermore, the observed positive association between real GDP growth and the top tax rates shown in the figure could be coincidental or spurious because of changes to the U.S. economy over the past 65 years

Like my insulation analogy - if the seasons vary, usage patterns vary, and fuel costs vary, I may not be able to show a good correlation between adding insulation and lowering heating costs. Costs might well increase. But it takes little more than common sense to know it helps in relative terms. How can it be otherwise?

Likewise, it takes little more than common sense to know that taxing something, and effectively raising the cost of it (or reducing the reward), will lower the relative demand for it. How can it be otherwise?

It's also questionable to attempt to determine much of anything from the top 0.1% or 0.01% segment of the population. Would we set health care policy based on the 0.1% healthiest, or the 0.1% sickest people? We would look at a sample of the entire cross section of the population. Capital Gains rates and dividend rates affect far more than just the top 0.1%.

I have never heard that the Congressional Research Service has a bias.

And I wouldn't (and didn't) accuse them of such - I'd have to get in their heads to determine that. But I can often read a study and determine if it really sheds light on a situation or not. This one clearly is lacking. Any claims of correlation need to at least attempt to take outside effects into account. The motivations (or lack of) for not highlighting that important issue are unknown to me.

-ERD50

 

[Khufu]

Not to mention the 3% VA loans the vets got to buy those $5,000 homes being built.........

By 1947 costs for implementing the GI Bill were 15% of the govt budget. With the Bonus March of poor WWI veterans in 1932 fresh in their minds, the Congress passed the GI Bill to prevent civil disorder which could have been on a vast scale since the military was about 12 million people in 1945, most of whom would be demobilized. The effect of such a stimulus was vast causing the build out of suburbia and became one of the large contributors to the post war boom. That stimulus was a bonanza.