Browsing the blog archives for July, 2015.

Rand Paul’s fat tax

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Senator and presidential candidate Rand Paul launched a flat tax proposal last month. It’s received a lot of criticism from all sides. Some has been warranted, but much of it is really designed to mask a deeper problem.

Paul proposed a single 14.5% income tax rate with no tax on the first $50,000 of income for a family of four, and deductions for mortgage interest and charitable contributions. The plan also eliminates the worker share of payroll taxes, gift and estate taxes, and all tariffs and duties. Capital gains would also be taxed at the 14.5% rate.

The left doesn’t like Paul because he has a way of encroaching on some of their constituencies. A July 10 op ed piece in the New York Times exemplifies the liberal opposition to the plan. It’s flawed because (1) it retains two popular deductions, (2) it would reduce government revenue, and (3) it helps the rich at the expense of everyone else. If these are really legitimate problems, then the NYT could address these concerns by countering with a proposal that (1) eliminates all deductions, (2) contains a higher rate that increases revenues, and (3) excludes more income. They didn’t because they don’t like the idea of a flat tax anyway. The arguments they made are but a smokescreen.

The NYT piece makes an interesting claim:“ Arguments about the proper role of government aside, a population and an economy that are growing in size and complexity cannot thrive with a shrinking government.” In other words, an economy can only grow when government grows. This statement is patently false and exposes their bias.

In fairness, a critical analysis of Rand’s proposal is in order. The $50,000 exemption and the 14.5% rate are arbitrary. Arguing to raise or lower them requires in-depth analysis of economic data, so I’ll set this issue aside. Suffice to say that government revenues would likely decline as a result, but Paul’s answer would simply be to spend less anyway.

An ideal tax system would contain no deductions, but the two retained in the proposal are logical. The mortgage tax deduction should be eliminated over time because it requires a higher tax rate to finance, and it distorts the housing market. Abolishing it (all at once) could have negative repercussions because individuals have become accustomed to the current system. I would prefer phasing it out over 4-6 years, adjusting tax rates down with each cut in the deductible amount. Nonetheless, one could argue that keeping it retains stability in the housing market. It’s also a political decision.

The charitable deduction is entirely logical. If charities don’t have to pay income taxes, then individuals should be able to assign a portion of their income to charities and avoid the taxes as well. I prefer a fair tax (i.e., sales tax) to a flat tax in part because it eliminates the entire question of charitable deductions. However, retaining this deduction makes perfect sense if you’re going to have an income tax.

Does Paul’s proposal “hurt” the poor? This is really a complex question. Eliminating the worker portion of social security would help low wage earners because this tax is paid on the first dollar of income. Not taxing the first $50,000 of income should be fair enough, but there are so many giveaways embedded in the tax code that this might actually hurt some low-income filers. If so, it only tells us how far we drifted into a tax code that’s entirely a game of redistribution and social engineering.

In the end, I’d propose a fair tax, or a slightly different flat tax. That having been said, no proposal like this has any chance of getting through Congress without changes anyway, so knit picking the details at this point is an exercise in futility. Consider the big picture. Paul’s plan would be a substantial improvement over the status quo. It would cut the influence of special interests, and save billions in compliance costs. Anyone who opposes it should provide an alternative.

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The Greek Crisis

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The size and scope of government has ballooned in Greece. Ordinarily this type of problem would be confined to a single nation, but not when there is a common currency. The problems of Greece affect the entire continent, particularly those in the EU. And what affects the Europe affects the entire world.

Investors fear government default, prompting the rest of to negotiate a bailout. The International Monetary Fund (IMF) is a key bailout vehicle, ultimately transferring a chunk of the European risk to U.S. taxpayers. We have been told that a bailout is in our best interest, lest this crisis reap havoc on the global economy. This might be true in the short run—as it was the last time Greece was bailed out—but the problem only gets bigger when you kick the can down the road.

The EU nations are demanding sacrifices from Greece in return for some debt relief, but the Greeks are balking and may actually hold some bargaining chips in this game of chicken. The negative ripple effect of a default would hurt the rest of the EU, so there are strong incentives for a deal favorable to the Greeks. The country is run by leftist Alexis Tsipras who, bolstered by a 61% vote against the latest proposal, continues to call for a more “sustainable” solution. That means a larger bailout.

You might remember the ~2011 Greek bailout. Austerity measures then included a government hiring freeze, giving more flexibility to private companies with regard to layoffs, and extending the retirement age beyond 61. The imposed budget was supposed to balance by 2014. It didn’t, and Greece defaulted on a €1.6 billion debt repayment last week. Greece owes the European Central Bank €3.5 billion on July 20, with another large payment due in August. Greece’s current debt level is 175% of GDP, compared to about 100% in the US.

This is unchartered economic waters, but it is doubtful that Greece will depart the EU. Tsipras was quick to note that a no vote on the bailout/austerity plan was not a no vote to leave the Eurozone. Clearly, Tsipras wants the benefits associated with being a weaker member of the EU collective without paying all of the dues. Of course, austerity will come to Greece anyway, either by means of a negotiated agreement or through the market’s invisible hand.

Could this happen in the US? Not exactly or at least not now, primarily because the US economy arguably remains the strongest in the world and the dollar is a preferred global currency. With a massive national debt, trillions in unfunded mandates, and seemingly no political will to change, financial crisis of some magnitude is in our future.

But there’s another lesson here. A common currency is a horrible idea because it fosters “moral hazard,” a situation when one party in a contract can benefit at someone else’s expense. When each nation has its own currency, the strength or weakness of the currency depends on government and economic factors within the nation. Exchange rates fluctuate and punish those that are fiscally irresponsible. But when nations share a currency, their politicians have an incentive to game the system to their own advantage. Of course, member nations “agree” to follow certain guidelines designed to eliminate the moral hazard, but these are not airtight, as evidenced by the Greek fiasco. When Europe’s central planners originally promoted the Euro, they set the stage for the current crisis. It was only a matter of time.

Unfortunately we are experiencing the same type of problem in the U.S. States that overspend turn to the federal government for help, which—directly or indirectly—must come from other states that are more fiscally responsible. Liberals are happy to oblige, thereby creating greater dependency on Washington and ensuring more irresponsibility in the future. Of course, the root of this problem can be traced to Washington’s ability to churn out more dollars through Fed and Congressional recklessness.

Whether it’s Greece or Detroit, governments should be held accountable for their actions and must make the tough decisions necessary to balance their own books. Bailouts simply breed more destructive behavior. The antidote for moral hazard is personal responsibility.

The EU was all about “strength in numbers,” but this can easily turn into “the producers carrying the non-producers” when the irresponsible learn to game the system or refuse to make tough choices. The EU is not obligated to bail out Greece, but the collective system they have created allows financial poison from one country to spread more easily to its neighbors. This creates incentives for Germany, France, and others to support bailout efforts, as well as for less prosperous members to engage in risky growth and development schemes because they won’t be held fully accountable for their actions.

Thanks to the European Union, Greece’s financial catastrophe is a collective problem. Because of the common currency, neighboring countries can’t afford to let Greece (or any other country in the EU) implode, so a bailout is required. A common currency formally links one country’s economic destiny to that of others in the group. Collective oversight—de facto one-world government—is always part of the arrangement, and the strong and responsible will always end up paying for the weak and irresponsible. This is why we should never give serious consideration to a North American currency, much less a global one.

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