Tax Hikes, Budget Cuts and Inflation: Why the Fiscal Cliff doesn't Matter
For the politically minded, the 2012 holiday season was defined by frenzy as Washington, D.C. prepared to go over “the fiscal cliff.” With the self-induced crisis solved in the thirteenth hour, all working Americans will see their taxes rise by two percentage points.
But none of this matters. Regardless of tax increases, spending cuts or combination of the two, the fiscal situation of this country would not be improved. Both Republican and Democrat leadership are mostly wrong on this topic. Let’s discuss the economic implications of fiscal cliff solutions and the inevitable painful solution to America and the western world’s debt crisis.
The idea that tax increases or spending cuts will bolster economic growth is disingenuous. As most Republicans know and Regan/Thatcher economic dogma of the 1980s has taught, higher taxes choke the economy. In 2013, all Americans in work will receive smaller paychecks. Low income Americans, the same ones which voted for Obama, will feel the biggest pain. The tax hike will extract more money from the working poor and middle class than the wealthy.
I’d like to stress that the payroll tax hike only affects Americans who are actually in work. Those out of work will see no change to their immediate financial situations. In doing so, Washington exempted their three favorite groups of people – First, those who do not work and live on earned government benefits due to a circumstance outside of their control, such as severe disability or old age; Next, those who do not work because they live on unearned government welfare benefits; And finally, those who do not work because they live on capital gains income. These individuals, the truly wealthy – the very ones Obama turns into a bogyman but secretly loves – will be insulated from the Washington imposed shared sacrifice to repent for the borrowing of the past.
Either way, we have asked the highest and lowest income earners of the country to give up two percent of their to continue the welfare state, fund Chinese hegemony and fund studies to explore how future revenues should be spent.
Putting less income in your pocket will have detrimental economic impacts. American buying power decreases and poses a risk to economic growth. But spending cuts won’t solve anything either.
America’s economy has become dependent on Washington, D.C. Taking a knife to spending would be like solving dehydration with a sauna. This model was tried in the Mediterranean. The Greek debt solution has failed. No one has a job and there is no such thing as disposable income. Public budgets have been slashed, insolvent pensions have been right sized and government jobs have evaporated. This is because, like America – and the entire western world – state spending serves as a foundation for economic activity.
It shouldn't be this way.
The complacency of politicians toward the bureaucracy has caused this situation. Sure, cutting onerous red tape regulation would encourage the private sector, but, the administration will never sign up to that. Ending massive spending overnight would be to our own detriment. No matter which solution we choose we are selecting to end our quality of life. We either live on less or continue onward without regard to consequence.
The invisible hand of economics will solve this problem for us. It’s called inflation. For decades, politicians on the left and right have denounced this silent tax on thrift. This administration secretly is hoping for inflation.
Inflation punishes savers and rewards borrowers.
Our federal government, and therefore the dependent class subsisting on welfare, is a net borrower. The Obama coalition of failed, over-leveraged businesspeople and working class Americans trying to live a comfortable life on an artificially deflated salary are net borrowers. Inflation reduces the severity of our debts in real terms. Inflation makes it easier to payback debt when your liabilities are closer in ratio to your income without actually increasing productivity.
Inflation punishes savers. The wealthy of this country are savers. Most middle class families, at least as they near retirement, are net savers. No one spent themselves to wealth. Of course, Obama despises people who have significant wealth – or at least he pretends to. In truth, he despises people who don’t use their wealth for left-wing causes. Those who do will be bailed out from the inflation tidal wave. I’m not talking about radical hyperinflation, but rather a return the 1970s era, brisk but quasi-tolerable inflation. There's no better way to create "an even playing field" than by recalling everyone back to "Go." That's the aim.
Again, Obama wins. The debt doesn't matter to him. The middle class of America who have saved for retirement will see their nest eggs washed away. But they didn't vote for him anyway. Best of all for the administration, our debt becomes less severe and the welfare state will be less over-leveraged.
No matter which solution we used to solve this fiscal cliff crisis, we would have ended up with the same result – state sponsored incentive to not work and over taxation for those who chose to be productive; and in the end, we would devalue or currency and quality of life to ensure more of the same mistakes for generations to come.
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Go Beyond Income for Real Tax Reform
I want to explain why income tax reform which calls for eliminating the $1.3 trillion in tax expenditures (deductions, credits, exemptions and other loopholes which reduce tax revenue) is not doable. Begin with the understanding that the true tax burden on income includes the job killing 15% payroll taxes. 2010 tax revenue was about 14% of the $12.5 trillion income tax base. It produced $865 billion from the combined 15% payroll taxes and $898 billion from the individual income tax. So why not have a flat 14 or 15% income tax rate with no deductions? The reason is because wage earners, In general, pay the 15% payroll tax plus additional income taxes while those with earnings beyond the $110,000 payroll tax limit can take advantage of so many individual and business tax breaks that, on average, they pay less than 14%. Mr. Romney’s 13% effective rate was just one example of how this works. Even Warren Buffet who avoids tax on $5 to $7 billion capital growth each year, pays only a 17% or 18% rate on the $40 million in income he elects to take. Tax breaks for the well-to-do have been around for over a hundred years and few expect high earners to pay a true rate as high as middle class workers pay.
Tax reform advocates know the policy justification for tax breaks increases as the marginal rates exceed 15% and disappears with rates below 10%. With marginal rates extending to the mid 30’s the well-to-do will spare no expense to lobby congress to maintain their most important tax breaks. Even with reasonable spending cuts, the trick to get the combined income and payroll tax rates below 10% is to go beyond the income tax base with a net wealth and value added tax (VAT).
A "revenue neutral" 2% net wealth tax (excluding $15,000 cash and retirement funds) could replace the job killing payroll taxes and enable the income tax rate to be reduced to 8% for all (because no tax break for anyone can be justified at an 8% rate). Progressive tax liability is achieved with rich and poor paying the exact same rates because half the country only has 1% of the wealth while the top 10% have 75% of the $53 trillion in individual net wealth.
A 4% VAT on all business sales would also enable the corporate rate to be reduced to 8%. The U.S. would have the most competitive rates in the world and trillions in foreign corporate profits would be returned for investment in the U.S. This 2-4-8 Tax Blend is explained is greater detail at TaxNetWealth.com.