Income Schm-income

Currently, in the United States, income from different sources is treated very differently for tax purposes. For example, capital gains are taxed according to a different schedule than regular income. And, long term capital gains are taxed preferentially to short term gains. I believe that we are making a mistake by treating different types of income differently.

I believe  that we should treat ALL individual income equally, whether that income comes from punching the clock, earning a fixed salary, receiving bonuses, or as a return on investment. You may notice I said "individual" income --- I am specifically talking about the income earned by individual taxpayers (or married taxpayers filing jointly), but NOT corporations. I will address corporations later on in this piece.

An enterprising individual, in the effort to earn money and amass personal wealth, will put all available resources to work in that effort. For someone with little or no savings to invest, this probably means getting a job and earning an income, either by the sweat of his brow or the sweat of his neurons, but by sweat nonetheless. However, with some success and prudent spending habits, that same individual can quickly become an investor who can begin to earn  income by investing his savings. To my mind, there is no reason to distinguish these activities from one another -- both are crucial and central to the growth of the economy and I challenge anyone to demonstrate that one deserves favor over the other.  With a good deal of success, an individual may find that by investing his money he can earn more than he could by laboring in a traditional job, and may eventually earn most or all of his income in this way, which is perfectly good and fine.

However, all this income should be treated the same the for purposes of federal income taxation.  This means that Social Security and Medicare taxes (so-called payroll taxes) must be applied to this income, up to the limits provided by law.  Buy stock in IBM for $100 and sell it a year later for $120? You will owe $3 (15%) in payroll tax on that gain, plus your marginal tax rate times $18.50 (the $20 gain less half of the payroll tax paid).  This is how self-employment income is treated in this country, and someone who is investing his savings and earning a profit is effectively "self-employed" in this regard. Similarly, money spent researching stocks, hiring financial advisers, paying commissions, etc., can be used to increase the cost basis of the investment and reduce taxable income, subject to limits set by law.

Earlier, I mentioned that I would touch on the issue of corporate taxes.  Currently, when a corporation earns a profit it pays a corporate tax on that profit, then distributes its after-tax profit in the form of dividends to shareholders, who in turn pay a tax on that money.  Therefore, corporate profits are subject to double-taxation. It is my opinion that earnings from C-corporations should NOT be taxed until they are distributed in the form of individual income as dividends.  For example, if a U.S. corporation earns $1.00 per share and pays in dividends $0.25 per share (thereby retaining $0.75 in cash as working capital), the $0.75 per share that they earn will not incur a tax bill and can be applied to the expansion of the business.  However, the $0.25 must be subject to U.S. federal income tax, regardless of the tax jurisdiction in which the recipient resides.  Ultimately, all the income of a corporation flows to individuals, be it in the form of share price appreciation or dividends, and will ultimately be taxed. However, this money should not be taxed while it is still actively at work in the balance sheet of the corporation.

However, what is stopping a U.S. corporation from stockpiling cash, tax-free, then merging with an off-shore entity operating in a tax haven who can, in turn, pay the cash in the form of dividends to foreign shareholders, effectively avoiding U.S. taxation? U.S. tax law will need to take into account this possibility and should obligate the U.S. entity to file a tax return and declare this income prior to the merger, resulting in a tax bill. What about foreign shareholders of U.S. corporations who do not currently file a U.S. tax return? Dividends paid to foreign investors would have to be taxed at the highest individual marginal tax rate at the time that they are distributed, otherwise a huge loophole would exist permitting corporate profits to escape our borders tax-free.

Also, what is stopping a C-corporation NOT listed on the open market from conducting a stock sale below par value (below the value of assets and cash, less liabilities) to a foreign entity, effectively moving the corporation off-shore, profits in tow, and avoiding a tax bill? Currently, there is no legal obstacle to this practice, so the transfer of shares below par must be prevented. In the open market, corporations often trade below par value, especially if they are facing serious legal problems or if the market for their goods and services has moved against them. However, this loss of shareholder equity is related to a decrease in "goodwill" and this goodwill offsets the intrinsic value of the entity. As long as the shares are liquid and traded in the open market based on accurate public information, the share price will tend to reflect this calculus and no other public policy mechanism should be needed.

Finally, what is stopping a U.S. corporation, with subsidiaries around the globe, from banking profits in a tax haven and absorbing costs in the United States in order to avoid paying corporate income taxes? Well, that is what they do today and my proposal would eliminate the need for this practice, since U.S. corporations could amass profits tax-free right here at home, money that would be held in U.S. banks and which would provide valuable capital for domestic investment.

While there are clearly details to be worked out to avoid possible tax evasion, I believe that my proposals can both simplify and make more equitable the taxation of income.  Other parts of the tax code, such as the mortgage interest deduction, the marginal tax rates, the individual and family exemption, etc., are not addressed here. However, I think that by treating all income the same regardless of its source, and by allowing corporations to reinvest their earnings tax-free, the tax code will be fairer and more effective in stimulating economic growth.

In a future post I will explain why the U.S. tax system, which generates almost all revenue by taxing income, creates perverse incentives to consume and not save and why a national sales tax is a good idea.

Who Needs War?

Update 29-Jan-2012: German leaders are currently insisting that Greece surrender control over their fiscal budget allocation to a commissioner appointed by the euro zone finance ministers, a proposal that Greek leaders are calling, "the product of a sick imagination". Once again I ask, who honestly thinks that this power grab by Germany and France can possibly end well?

It has been the goal of a long series of European leaders to achieve absolute domination of the continent, and it finally looks as if Germany will achieve that goal, with the aid of France.

Germany's Angela Merkel and France's Nicolas Sarkozy are pushing for radical changes to the European Union treaty that would provide centralized oversight of individual state budgets.  Since Germans are the ones footing the bill for this foray, they will no doubt expect to be the ones managing these other country's affairs.

It is my expectation, however, that these efforts will fail if they come to a vote in the individual state Parliaments. And, if the changes are not ratified, the individual states will not feel obligated to heed them in any event.  Therefore, this is a risky move that could lead to serious tensions in Europe.

My advice is to let the chips fall where they may.  Greece should renegotiate their sovereign debt obligations for about fifteen cents on the dollar, which is a manageable level for them.  Italy and Spain should do the same, but for about thirty to thirty-five cents on the dollar.  The yields on any new sovereign bonds issued will obviously spike in response, but these higher borrowing costs will help these countries focus their minds on the task at hand, which is to manage their finances in a sustainable way or lose access to the global credit markets.

I see no reason for Germany to bail out the rest of Europe, nor do I see any reason that the Euro can not continue as the common currency, even for use by those states that have had to restructure their sovereign debt.

Radically altering the EU treaty to usurp sovereign parliamentary discretion will simply serve to offend regional sensibilities, and lacking the force of might, will risk an escalation in tensions.

Superfail

Who is surprised that the United States Congress Joint Select Committe on Deficit Reduction, or the so-called "Supercommittee", will fail to find consensus on mandated budget cuts of $1.5T over ten years?  What makes this failure all the more absurd is the fact that $1.5T over 10 years is WHOLLY INADEQUATE and wouldn't even begin to set upright the fiscal ship of state.

It will be interesting to hear the blame game on the national talk shows, but I think one observation is important here: on average, the members of this committee (and the ranking members of the House and Senate for that matter) have served for a LONG TIME.

For example, the Senate members of the committee have served for an average of 15.5 years (and, this average takes into account two freshman members who haven't even served a full year yet), while the House members have served and average of 13.3 years.

How could this degree of incumbency possibly contribute to Superfail, as people are starting to call this fiasco, you might ask?  Because anyone who has served in Congress for so many successive terms (an average of over three in the case of the Senators if you discount the freshman, and an average of nearly seven in the case of the House members) has obviously placed a higher premium on their own political survival than on making the courageous decisions that they are empowered and obligated by the U.S. Constitution to make.

What has been sadly lost in terms of an ethos in Congress is the notion of the elected official as a public servant who leaves a successful business, farm, medical practice, etc., for a short time in order to advance the public good and then returns to private life.  Because of the exponential degree by which Congress has amassed authority over the decades, our elected officials have become addicted to the power of their office and cannot abide to surrender the reigns, even when it is time for them to move on.  Instead, Congress has gradually become overwhelmed by career politicians who have mastered the art of survival at the expense of the political leadership and risk-taking that is sorely needed.

That is why I believe that the time is come to once again debate the idea of congressional term limits in order to inject fresh blood into the body politic.

If the members of the "Supercommittee" cared more about the future of this great nation than their own prospects for re-election, they would have reached an agreement and sent a message to the country that democracy DOES work.  Instead, they failed and we are all that much more cynical as a result.

S&P Flubs Another One

In an admitted "technical error", the international credit rating agency Standard & Poors downgraded French sovereign debt on Thursday, triggering extreme market volatility, before reversing the downgrade and restoring France's AAA rating.

This incident brings to mind S&P's downgrade of U.S. sovereign debt from AAA to AAa earlier this year.  At the time, S&P acknowledged that they had made significant mistakes in their longer-term fiscal projections, but that these errors did not substantively change the U.S. credit outlook, sparking outrage and cries of foul play from the Treasury Department.

Also, it is important to recall that S&P had maintained investment-class ratings on the mortgage-backed derivatives, called CDO's, literally up to the very moment that the market for these securities collapsed, leading to the demise of Bear Stearns and Lehman Brothers.  When challenged by a Senate panel as to their decision to grant CDO's an investment-class rating, when in reality they merited junk status, executives for S&P stated that their credit rating decisions are merely "opinions" that enjoy First Amendment protections. 

"Opinions shielded by the First Amendment"?  They have got to be kidding.  The posts on my blog, for which I receive no remuneration, are opinions shielded by the First Amendment.  Credit ratings are the result of professional analysis that the credit rating agencies are fee-contracted to perform, and these ratings are the basis on which important investment decisions are made.  If mistakes are made that result in money lost by investors who have paid a credit rating agency for their guidance, then the credit rating agency should be held be liable for civil damages.

I strongly urge Congress to enact legislation regulating the credit ratings agencies and providing for a mechanism by which they can be held legally accountable for their malfeasance.

Eat The Rich

There seems to be a serious backlash against the rich afoot these days in America. Statistics are bandied about as to the degree of polarization of wealth, such as that the top 1% in terms of net worth surpass the bottom 90% COMBINED. While this statistic is stark in its imagery, there has always been a certain degree of polarization in wealth in this country, so this is really nothing new.

What is different at this time is that the U.S. fiscal deficit and national debt are off-the-charts out of control and have to be brought down soon. And, who is in a better position to make a down payment on our children's future than the ones with all the money?

Therefore I believe we should consider the following policy changes:

1. Restore the Clinton-era tax brackets and tax capital gains as regular income. Capital gains are currently taxed at a preferential rate of as little as 15%; since the aforementioned 1% receive 99% of their income in the form of capital gains, they are enjoying a huge tax advantage in spite of their wealth. If we restore the Clinton-era tax structure and tax long-term capital gains as regular income (short-term capital gains should carry a 5% penalty on top of the long-term rate), the capital gains tax rate for the 1% will jump to 39.6%, yielding a huge windfall for the cause of deficit reduction.

2. Keep the Estate tax intact. There has long been a campaign afoot to eliminate the estate tax, but the fact is that this tax is a big winner for the Federal government. Additionally, there is plenty of evidence that large sums of money that are inherited tend to have a corrosive effect on the next generation, which is why many of the super-rich decide to give away their wealth before they pass on.

3. Enact a 2% National Sales Tax for the express purpose of debt reduction. The simple truth is that there is a huge segment of the population that pays nothing to the Federal government in the form of direct taxes. A 2% sales tax will give everyone skin in the game, including those who pay no income tax.

Of course, if Congress uses this added revenue as an excuse to postpone fiscal discipline, all will be lost.

Therefore, these taxes must be enacted only AFTER significant spending cuts have been enacted. Current expectations are that the budget will be cut by $2T over 10 years, but that is wholly inadequate and will barely budge the needle.

If consensus can be found to reduce federal outlays by $4T over ten years, coupled with sensible entitlement reform and my tax proposals, our country will restore its greatness and the resulting confidence boost will drive productivity gains for decades.

Athens Is Burning

While we watch scenes of street protesters lobbing molotov cocktails at riot police, one begins to wonder how did the world ever imagine that the Greeks would go along with the proposed austerity measures?

Apparently, it was the perception of many, including former Goldman Sachs CEO and Governor of New Jersey, John Corzine, that the wealthy members would bail out the weaker members of the Euro zone.

However, they obviously forgot that European nationals have a long, storied history of disdain for one another, so the idea that they could come together in a caring, sympathetic way to aid a struggling member of their currency union was naive from the start, nor do I think it is a good idea in any event.

The European Union is, above all, a currency union designed to remove currency cost from cross-border transactions, and to aid in payment clearing by a centralized bank.  The EU does not have the kind of authority or control at the Parliamentary level to ensure that member states adhere to fiscally conservative guidelines; the "solution" put forth by France and Germany (major salary cuts, benefits cuts, etc.) is, at best, a suggestion and has no teeth whatsoever.  The only thing that the European Central Bank can do is to stop buying Greek government debt, which will force the default that the austerity proposals are designed to avoid.

Therefore, I view Greek default to be inevitable.  Who suffers the most in the case of Greek default?  Those with significant exposure to Greek sovereign debt, of course, but Greek debt is a drop in the bucket for many  of these creditors, and the IMF and European Central Bank may come to their aid to preserve a portion of their principal in any event.  Of course, the Greeks are headed for a rude awakening when they have trouble borrowing to meet their huge budget shortfall and see the value to their newly minted drakma deposits diminish by 1/3 or more relative to their previous euro valuation.

However, a Greek default will be the best solution for all concerned.  It will put an end to Greece's debt-fueled binge.  In the end the Greeks will benefit in that they can begin putting their fiscal house in order and the investors in Euro Zone debt can finally be disabused of the notion that European sovereign debt is somehow more valuable if the party to the debt is a member of the European Union.

Shaking Up the West Bank

The paradigm that has been the basis of peace negotiations between the Israelis and Palestinians is fundamentally flawed, and Mahmoud Abbas' quest for statehood is shining a bright light on the fundamental corruption of current Israeli policy.

It has long been my opinion that Israel has not been negotiating with the Palestinians in good faith.  The problem that I see is that Israel holds all the cards, and has within its power to annex the West Bank in its entirety tomorrow and grant the people who live there Israeli citizenship (whether they want it or not), effectively putting an end to this charade.  On the other hand, the Palestinians do not have it within their power to define and defend the borders of their proposed nation in a way that could halt Israeli incursion and settlement building.  Therefore, to posit peace based on the premise that the Israelis and Palestinians can negotiate as equal partners is ludicrous.  Asking this today would have been like asking Czechoslovakia to negotiate with Germany over the annexation of the Sudetenland in 1938.

So, it seems clear that each subsequent peace summit is simply an effort to buy time until Israel finally decides what it is they want to do with the occupied territories.  Within Israel there are conflicting camps and the debate is not just between Israel and the rest of the world, but very much between Israelis.  Many Israelis view it as their right, based on biblical history and by virtue of land gained during the 1967 War, to occupy all the land up to the Jordan River.  Other Israelis believe that the Palestinian people, who were expelled from Israel during the 1948 Arab-Israeli War, deserve to have a land to call their own and not live under Israeli occupation.  In the mean time, each subsequent Israeli government has supported settlement building, so the de facto position of the Israeli government is, and has been since 1967, that the West Bank is theirs to do with as they wish.

However, and this is why I say that the Israeli negotiating position is fundamentally corrupt, no Israeli leader that I can recall has ever stated that it is their intent to annex the West Bank and rewrite the map of Israel to extend to the Jordan River, even while their actions say otherwise.

In a speech he delivered to the U.N. General Assembly today, President Obama painted a beautiful picture of how, in light of the "Arab Spring" that has swept across the region, it is now finally time for the Palestinians to taste freedom, but cynically concluded that this could only be possible in the context of an Israeli/Palestinian peace accord.  In other words, Obama recognizes that the current situation is fundamentally immoral and unjust, but that he is not prepared to abandon the corrupt paradigm that has been a cancer and a source of regional tension for decades.

This is why Mahmoud Abbas is going to the U.N. to seek statehood for the occupied territories: he is taking the decisive political action that Israel has failed to do for over forty years.