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Note: The odd data point I keep reading about taxes is “half of Americans pay no Federal Income Tax.”

Do the math: 305 million people in America, and a Labor force of 145 million people.  The retired, the elderly, children, unemployed: Half of America does not pay income tax because they have little or no income. I don’t understand the misunderstanding here.

On that note, here is John Mauldin’s weekly commentary.

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Tax That Other Guy
By John Mauldin
February 25, 2012

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The Fair Tax
What About Those Who Will Not Vote for Any Tax?
What Should Seniors Do?
Why Shouldn’t Everyone Pay Something?
Comeback, America
California, New York, Orlando, Conferences, and Webinars

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Don’t Tax You, Don’t Tax Me
Tax that Man Behind the Tree!
– Senator Russell Long, Democrat Louisiana (1918-2003)

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Last week’s letter on taxes drew more response than any letter I have written in years. Questions that were raised simply beg for an answer, and some of the replies were very thoughtful, well-written suggestions for alternatives. This week I am going to do something I can’t ever remember doing, and that is to use the entire letter to involve and respond to my readers. Let me begin by thanking all of those who responded, and to observe that every response I read was polite and courteous, even when aggressively disagreeing. Not every site on the internet has such a civil discourse among its readers. I appreciate that. Next week we will return to All Greece, All the Time or whatever the crisis du jour is, although I am much more interested in China of late. I will have to address the world’s largest nation at some point soon. At the end of the letter, I provide some very interesting and fun links and a note on an upcoming webinar with investment legend Israel “Izzy” Englander. Now, let’s zero in on taxes.

The Fair Tax

A rather significant and vocal number of you wrote in support of what is called “the Fair Tax,” which is basically a national sales tax, suggesting it is a better alternative than a value-added tax (VAT). I should note that there are 70 members of Congress who have cosponsored a Fair Tax bill, so this is not outside the realm of possibility. It also speaks to the possibility of a tax on consumption being politically feasible, which I will again address later.

I am going to use a longer, well-written reply from Roger Buchholtz of Kalamazoo, Michigan. I will only interrupt him a few times with a reply in brackets […] and then add a longer reply at the end. Roger wrote:

“Dear Mr. Mauldin,

“I just finished reading your article “The Cancer of Debt and Deficits” and agreed with your conclusion that it is time for radical tax reform. Actually, what was radical was the adoption of the 16th Amendment in 1913, after our Founding Fathers had twice prohibited it in the Constitution.

“I am delighted to see that you recognize that consumption taxes are less damaging to an economy than income taxes. Income taxes tax productive behavior (work, saving, investing, etc.), thereby reducing the return/reward for that behavior. They, in essence, punish people when they are contributing to society.

“As you have apparently concluded, a simple, Flat Income Tax is not the answer. I agree, because it will remain neither for very long. It will just allow all the tax favors to be bought and sold all over again, which will exacerbate today’s corruption of our representative form of government to the point that our representatives too often represent special interests rather than their constituents. [I am not opposed to a flat tax, as I will address below.]

“In addition, the Flat Income Tax would only slightly reduce compliance and efficiency costs (as all records must be maintained and returns filed) and it would continue the practice of imbedding taxes in the prices of the goods and services that citizens buy. Today, an average of 22% of the producer price of all American-produced goods and services are taxes imbedded in the price. This practice of imbedding much of our tax burden in the prices of our products places American labor and business at a great competitive disadvantage with foreign labor and businesses. In essence, a Flat Income Tax would have no long-term benefits and could delay true tax reform for a generation.

[While I am not sure of whether it is exactly a 22% embedded tax cost, it is certainly high. There were several objections to a VAT because it would be a burden on businesses. I would note that ALL taxes are a burden. Others objected to a VAT as being a burden on consumers. As Roger points out, consumers are already paying a great deal in hidden taxes on what they purchase. Either the Fair Tax or a VAT can be structured to be revenue-neutral and eliminate the other embedded costs. What both proposals do is eliminate nearly all other taxes, including Social Security, which adds directly back into both employee and business income.]

“Now, let’s compare two consumption taxes: the Value Added Tax (VAT) proposed by Marc Sumerlin and Larry Lindsey in their book and the Fair Tax Act that is now before Congress with over 70 cosponsors and the subject of two best-selling books. Both proposals replace the current Internal Revenue Code and are revenue neutral. The Fair Tax (HR 25) replaces the income tax, Social Security & Medicare taxes, and death and gift taxes with a retail sales tax. [As does the VAT.]

“Actually, Sumerlin and Lindsey’s VAT and the Fair Tax have much in common, but the differences are critical.

*Both proposals replace the current Internal Revenue Code

*Both are revenue neutral

*Both tax final consumption only once

*They have the exact same tax base, if they both have no exemptions

*Business to business purchases are not taxed

*The full amount of the tax is paid by the consumer

*Both improve U.S. international competitiveness, as neither of them taxes exports, and are border-adjustable

“How are they different?

“The Fair Tax has a prebate, so that no individual pays taxes on their personal consumption up to the poverty level. This eliminates the perceived regressive nature of a consumption tax. The $100,000 personal exemption of their VAT serves a similar purpose, but everyone under their VAT will pay imbedded taxes that are even greater than they are today.

“The Fair Tax collects the tax at the retail level, which is simple to understand and comply with. Only sellers of goods or services for final consumption (retail businesses) file monthly sales tax returns. This would reduce tax filers and compliance costs by about 90%.

“The VAT, on the other hand, is collected from all businesses at every stage in the production process. Each business has to keep track of what taxes they paid on their purchase of inputs and subtract it from the tax they owe. This is called a credit-invoice system. It is complex record keeping and especially difficult for small businesses who don’t have in-house tax experts.

“The Fair Tax is transparent, the amount of the Fair Tax being clearly stated on the retail receipt. VAT retail receipts may state the rate of tax, but they generally do not state the actual amount of taxes paid. The visibility of the Fair Tax provides the natural restraint on the size and reach of government intended by our Founding Fathers.

“European countries have tried to solve the perceived regressive nature of VAT taxes by creating all kinds of exemptions in attempts to make necessities tax-free. This opens the door for more and more exemptions, and vendors start gaming the system to qualify for the exemptions. These exemptions and gaming add to the already high cost of compliance under a VAT and encourage the buying and selling of tax favors, similar to today’s corrupting trade in tax favors that occurs in the U.S. under our income tax system.

“This combination of the Fair Tax Prebate (monthly payment to every legal household which offsets taxes paid on spending up to the poverty level, similar to today’s personal exemption on our income tax return) and taxing ALL consumption at the same rate creates a consumption tax that treats everyone the same, is transparent, and is much simpler and much less costly to comply with. In addition, it eliminates the argument for exemptions, as all necessities are not taxed. That is the genius of the Prebate.

“There is no evidence that the Fair Tax will encourage tax evasion via black markets or barter systems. In fact, the compliance rate for the Fair Tax, projected to be around 94%, is expected to be many times better than the 69% of the current tax system. Some of the reasons the Fair Tax will have a high compliance rate are:

“Major corporations account for over 90% of all retail sales today, with 3.6% of corporations collecting 87.5% of all sales taxes (I don’t think I’ll be able to convince the clerk at Walmart not to charge me the tax),

“Items most likely to be subject to barter are used goods, and used goods are not taxed by the Fair Tax,

“Under an income tax or a VAT it takes only one individual to cheat on a tax return, but under the Fair Tax both the seller and buyer must cheat (Would you like to go to jail for me?), and

“Because the Fair Tax reduces the number of collection points by over 90% (just retail businesses collect the tax) there will be considerably more audit capability by the government on those collection points.

“With over $23 million in research on the Fair Tax, it is one of the most researched public policy issues in history. The many studies on its economic and social impact can be viewed at www.fairtax.org.” – Roger Buchholtz

I understand the philosophy behind the Fair Tax. Part of it is to get rid of the income tax and all the inequities that are built into the current tax code. And I like the fact that it is a consumption tax. Truth be told, if this is what came to the floor of Congress, I would be for it, over simply tinkering with the current system.

And with a VAT, one could use a “prebate” type of structure as well, to deal with the regressive nature of a consumption tax, or exempt food or other items, as many countries do with a VAT. What I wrote last week was not meant to be a detailed analysis but more along the lines of a general proposal. The current system is broken. Rather than trying to “fix” it, let’s use the coming need for reform to truly restructure the tax code.

What About Those Who Will Not Vote for Any Tax?

The next response comes from Stanley Harrison:

“John, How can we accept your current plan or any similar (Simpson/Boles) plan that requires compromise to implement when large numbers of Republican congressmen have pledged to vote ‘no’ to any tax increase? They will not compromise, yet the founders of this republic had to compromise. Are you going to campaign against them?”

The short answer is yes. Not dealing with the deficit will cause so much economic pain that it is hard to get people to imagine it. That has to take priority over not raising taxes. It is not a matter, at least for me, of what is desirable, but of what is necessary. I would prefer a smaller government, lower taxes, etc. But unless Republicans manage to install far more members of Congress than seems likely today, that’s not going to happen. Waiting until there is a train wreck to fix the track is not sound public policy.

What Should Seniors Do?

Bill Daugherty wrote:

“One very large obstacle to the idea of VAT replacing income taxes would seem to be the seniors lobby. ‘What? I paid taxes on my income all my earning life, and now you want to change to tax me on my spending life as well?’ Getting from Here to There will always be a problem. No solution can be beneficial to all age and earning cohorts.”

And David Oldham answered:

“I think a VAT with exports exemption is a good idea. The point made in comments here about VAT hitting retired folk already hit by low savings returns is valid (I am in that category myself), but one has to ask the question, what do we older generations deserve for being instrumental or oblivious to creating such a mess for our kids and grandkids? We will all have to suffer the ultimate consequences.”

David makes a very solid point. Borrowing from our children, which they must pay in the future, to enjoy our benefits today is not right, any way you look at it. And with a prebate, that should take much of the argument away.

Read the rest of this entry »

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For each $1 paid in Federal taxes, how much does your state receive? (Political orientation approximated by the parties of states two Senators).

This is done on a per state basis, I’d like to see the data depicted on a per capita basis as well — both the paying and the receiving.

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Source:
Red Staters Use The Safety Net Too
BRIAN BEUTLER
TPM, FEBRUARY 22, 2012  
http://tpmdc.talkingpointsmemo.com/2012/02/the-map-that-proves-red-staters-use-the-safety-net-too.php

Property laws? Civil Liberties? Not when they stand in the way of profits:

“Corrections Corporation of America (CCA) has reached out to 48 states as part of a $250 million plan to own existing prisons and manage their operations. But in return CCA wants a 20-year contract and assurances that the state will keep the prisons at least 90% full.”
-AllGov

90% occupancy? I guess the marijuana laws cannot be overturned then or it would violate this 20 year contract.

Here is my compromise: Let’s fill the prisons with CCA Executives!

I warned before the 2008 election that regardless of the outcome, the reckless borrowing & spending of the Bush years would lead to inevitable deficits and tax increases. As Milton Friedman once said, an unfunded tax cut is a tax increase on our children.

That day of reckoning has been coming ever closer. As the coming year’s proposed budget suggests, tax increases, especially on the wealthy, are here.

$1.4 trillion in new tax revenue over the next decade, heavily weighted to the top of the income scale, has been proposed.

Those of you interested in deficits, accounting, tax policy — or simply are high earners — may want to take a close look at the proposals:

• Top individual income tax rate of 39.6%, starting in 2013 (up from 35%)

• Long- term capital gains top rate of 20%, up from 15%.

• 3.8% tax on unearned income of couples earning $250,000 or more; individuals making$200,000 — is to take effect in 2013 to pay for the 2010 health- care reform law.

• Dividends are treated like ordinary income. Top Federal bracket for some taxpayers = 43.4% (including dividends). Top dividend tax rate is now 15%

• The AMT is replaced with a 30% minimum tax for individuals with annual incomes of at least $1 million.

• The Carried Interest option benefiting hedge fund managers and private equity managers moves to ordinary income rates instead of a preferential 15%

Ultimately, this is an election year manuever that most of the Left expected in tear p1 of the Obama presidency. It is likely to be popular amongst the swath of the public that earns under $100k per year (read most of them), though by no means unanimously. It also seeks to paint the GOP as defenders of the rich as the expense of everyone else.

I suspect there are built in compromise points — the dividend rate wont go up to 43%, but may end up at 20% with long term capital gains.

For more reading on this, see: Bloomberg, NYT, WSJ,

Bruce Bartlett on Where the Right Went Wrong from BillMoyers.com on Vimeo.

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Source:
Bruce Bartlett on Where the Right Went Wrong
Moyers & Company, February 10, 2012
http://billmoyers.com/segment/bruce-bartlett-on-where-the-right-went-wrong/

To see a certain category of spending provisions, click on one of the following: Accountability | Aid to People Affected by Economic Downturn | Aid to State and Local Governments | Business | Education | Energy | Health Care | Other | Science and Technology | Transportation and Infrastructure

Too see full list click here

Source: Pro Publica

Catherine Mulbrandon updated her 2010 graph on top marginal tax rates.

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Click to enlarge:

(Top Marginal Tax Rates graph is also available for sale as a tabloid size 11″x17″ poster).

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Source:
Comparing Income, Corporate, Capital Gains Tax Rates: 1916-2011
Visualizing Economics by Catherine Mulbrandon

Government Debt – How Much Is Too Much?
Satyajit Das
January 23, 2012

Economists and policy makers like simple nostrums. Popularised by Economists Carmen Reinhart and Kenneth Rogoff, the unsustainability of a sovereign debt level above 60-90% of a country’s Gross Domestic Product (“GDP”) has become accepted wisdom.

But government or corporate debt rarely ever gets repaid. The real question is whether that debt can be serviced and investor confidence maintained to allow it to be refinanced.

The level of tolerable sovereign debt depends on a multitude of factors.

One factor is the currency of that debt. Where it borrows in its own currency, a sovereign’s capacity to borrow is only constrained by the willingness of investors to purchase its securities and the cost of that borrowing.

Where the borrowing currency is also a major reserve currency, used in global trade or favoured as an investment by central banks, the scope for borrowing is commensurately higher. The combination of these factors has enabled the USA to continue to borrow large amounts to finance its budget and trade deficits.

The inability to print money to service debt has been a significant issue in shaping the European debt crisis.

Where a country has a large domestic saving pool, like Japan, the ability of the government to finance its expenditure is significantly enhanced. A country reliant on foreign investors for its funding is far more restricted, limiting its debt levels.

A significant portion of government debt of weaker European states is held by foreign investors –Greece (91%), Ireland (61%), Portugal (53%) and Italy (51%). For some stronger nations, the level of foreign ownership is also high – Belgium (58%), France (50%) and Germany (41%). In contrast, only 28% of Spanish debt is held by foreign investors. Most of this debt is held within the Euro-Zone as the average holding of government debt outside the area is 25%.

The portion of government debt of other large economies held by foreign investors is lower – US (30%), UK (19%) and Japan (15%).

Significantly, when the net external liabilities of the economy (external liabilities adjustment for foreign assets) is considered, only Japan, Germany and Belgium are owed more by foreigners than they owe externally. All others have a net external liability. Interestingly, Spain’s relatively low level of foreign ownership of government debt is replaced by net external liabilities equivalent to 88% of GDP reflecting high levels of overseas borrowing by Spanish financial institutions and businesses.

The level of interest rates also determines the level of acceptable debt. Higher interest rates and the resultant larger claims on public revenues to service the borrowing limit the level of debt. Extremely low interest rates, such as those in Japan and more recently in the USA and Europe, enable higher level of borrowing.

A further consideration is the maturity structure of the debt. Short term debt increases vulnerability to market disruptions, limiting the level of borrowing. Conversely, longer maturities and low concentration of maturing debt in an individual period can increase debt capacity. The inability to re-finance maturing debts was a crucial catalyst in the European debt problems.

Sustainable debt levels also depend on the size and economic structure of the country. A large, varied economy with a substantial potential tax base can sustain far more debt than a narrowly based and tax revenue poor country. Peripheral European economies, such as Greece, Portugal and Ireland, are heavily dependent on few industries and also a limited tax base.

But perhaps the most important determinant is the level of current and expected economic growth. A dynamic economy capable of high levels of growth, with the attendant ability to generate additional tax revenues and attractive investment, can maintain a higher level of debt than one with lower growth prospects.

While not exact, the sustainable level of debt can be approximated by another formulation, which links the existing level of public debt (% of Gross Domestic Product (“GDP”)), the current budget position (% of Gross Domestic Product (“GDP”)), interest rates and growth rates:

Changes In Government Debt = Budget Deficit + [(Interest Rate – GDP Growth) times Debt]

Italy illustrates the relationship between debt levels and GDP growth. Assuming borrowing costs of 4% and a debt to GDP ratio of 120%, Italy needs to grow at 4.8% just to avoid increasing its debt burden where it budget is balanced. At current market borrowing costs of 6%, Italy has to grow at an unlikely 7.2% just to avoid increases in its debt levels.

Like most of Europe, Italy is projected to have anaemic growth of 1-2 %. Its current borrowing costs are elevated (around 6%) although its overall borrowing costs are lower as the bulk of its debt is at lower rates. This means that Italy must reduce its debt levels significantly to avoid the risk of insolvency.

Assuming interest costs of 4% and growth of 2%, Italy would have to run a budget surplus of 5% per annum for 10 years to reduce its debt to 90% of GDP. Alternatively, it must sell state assets to reduce its debt. Such sharp contraction in net government spending would reduce growth significantly in the absence of other helpful circumstances.

The relationship illustrates the problem facing many governments currently. A toxic cocktail of high levels of existing debt, large and seemingly irreversible structural budget deficits, low growth rates and high borrowing costs makes the position of many countries unsustainable. Europe’s beleaguered economies have to run a budget surplus (through spending cuts and tax increases), grow at very high rates, decrease its borrowing costs or combination of these to merely stabilise its debt.

The US is not immune from these problems. Assuming average borrowing costs of 3% and a debt to GDP ratio of around 100%, America needs to grow at 3.0% just to avoid increasing its debt burden where its budget is balanced. To the extent that growth levels are lower than the interest cost, it needs to offset the difference by running equivalent budget surpluses in order to keep its debt from increasing further.

The status of the US dollar as reserve and major trade currency, the ability of the Fed to print dollars and the flight to quality has allowed the US to avoid too much scrutiny of its own debt problems, at least for the moment. But the relationship highlights the vulnerability of heavily indebted economies. A combination of intractable, corrosive budget deficits, low growth rates and increased pressure on borrowing costs, as a result of investor concern of its creditworthiness, can result in a rapid slide into a debt crisis.

Following the global financial crisis, governments expanded their borrowing, replacing the private sector, especially consumer, debt, in a heroic bet to engineer a recovery. The increase in government debt will prove unsustainable if growth does not return quickly to high levels, driving a new phase of the global financial crisis.

Note: A shorter version was published in the FT previously.
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© 2012 Satyajit Das All Rights Reserved.
Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011)

Click to enlarge:

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Bloomberg’s Chart of the day (hat tip: Zero Hedge) ostensibly shows a relationship between the US debt ceiling extensions and price of Gold.

Color me unconvinced.

It has a few specific problems. First is the timing: The chart is dated August 1, 2011. Since then, the US credit rating was downgraded, and Gold took a big swan dive. Up 33% YTD at the time of that chart, it finished the year up 10% — certainly respectable, but no where near the home run it was as of August.

The second issue with this chart is that we only see a small slice of history. The correlation may or may not be spurious. We don’t see what took place prior — the pre 1997 era. Prior to this period, there was little correlation between the two. That sort of selective use of a time segment leads to questionable conclusions based upon that one time frame.

I bring this up today because last week, President Obama formally requested the raising of the debt ceiling (again). This is a different debt ceiling structure than the August debacle. Congress now has 15 days from that date to pass a resolution disapproving of this request before the limit is lifted.

David Semmens of Standard Chartered Bank gives us the details why that is unlikely to occur:

“It is important to note that a bill would have to be passed to stop the raising of the debt ceiling this time around – a far more straight forward mechanism that was built into the Budget Control Act of 2011 to ensure a relatively trouble free procedure.

The first hurdle will come in the House of Representatives which returns today (Tuesday 17^th Jan) and is expected to vote on Wednesday (18^th Jan), with the  Republican controlled legislative branch expected to pass a bill of objection which will be sent to the Senate. The Democratic majority Senate resumes after finishing its holiday break next Monday (23^rd Jan) and is expected to reject any move to block the extension, shortly after that. While we would expect that there will be some political posturing surrounding the vote with the House Republicans passing a bill to reject the extension, this would almost certainly be blocked in the Democrat controlled Senate and failing that receive a presidential veto. If the second reading of the bill were to follow a presidential veto, a two thirds majority would be required in both houses to override the presidential veto. A $1.2trn extension will see the debt ceiling raised to 16.394trn and given current projections see the US through until early 2013 before this issue is revisited.

There are plenty of good reasons to own Gold. I remain unconvinced that the debt ceiling is one of them . . .

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Source:
David Semmens, CFA
Gold vs. Debt Ceiling
Global Research, Europe
Standard Chartered Bank

He also has done stand up: Grover Norquist Doing Stand Up Comedy

Grover Norquist: ‘I Engaged In A Week-Long Drug-Fueled Orgy With Corporate Income Taxes’
President of Americans for Tax Reform Grover Norquist confirms that he carried on a 28-year salacious affair with taxes.

Grover Norquist: ‘I Engaged In A Week-Long Drug-Fueled Orgy With Corporate Income Taxes’
Newsroom (1:59)