Category Archives: Politics

Before I forget: Happy Vernal Equinox, everyone!

And now, on to today’s tax topic:

States and municipalities often vie against one another to offer tax breaks to businesses moving into an area, but not so often to new businesses that are too small or too local.

Most new businesses fail within the first couple of years.

Those two situations together form a nice nexus of opportunity, in which new businesses that do not qualify for other tax incentives could be spared the full brunt of corporate taxation when they are most vulnerable.

We could choose whatever phase-in period was appropriate, but for the sake of argument let’s assume a four-year phase-in. In that case, a business’s corporate tax would be multiplied by x/4, where x is the number of years since the business started. The first year’s taxes would be 25% of normal, the next 50%, the third year’s 75%, and only in the fourth year and thereafter would the business have to pay their full tax. By reducing the tax burden on new businesses, it would give them more money to spend on stabilizing their businesses and making them successful.

Other adjustments could be added based on the size of the business, giving bigger breaks in the early years to businesses with more employees, or possibly based on the type of business. For example, a small manufacturer making a product important to national security might operate on a longer adjustment schedule.

How many businesses that would otherwise fail would succeed under this arrangement? We have no way of knowing. And perhaps it would be counter-productive, in that the businesses that would fail anyway might be better off failing sooner rather than later. But small- and medium-sized businesses are vital to the overall stability and health of our economy, so it seems prudent to give them the best possible chance to succeed.

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This proposal may be a nice adjunct to the Business Activity Tax Simplification Act favored by the National Taxpayers’ Union. That act makes it clear that cities, counties, and states may only levy business taxes on companies whose employees or property are actually within their jurisdiction. Read about the act here.

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Let me admit right up front that I don’t know all there is to know about fractional reserve banking. My degrees are in engineering and management, which seem to be less arcane fields than finance and banking.

Here’s what I understand, and my four regular readers or any curious visitors are welcome to correct me: fractional reserve banking allows a bank to hold a certain amount of money on deposit and lend a higher amount — i.e., lend more than they actually have on hand — charging more interest for the loan than they pay on the deposit, on the theory that the depositors will not claim their money all at once (make a “run on the bank”). As long as the depositors play along, they are safe in having the assets on their balance sheet consist mostly of accounts receivable.

Got it? You put a hundred dollars on deposit at the bank, to keep your money “safe” and receive your miniscule interest payment. If the bank is operating on a 10% reserve, they loan out ninety dollars, charging a higher rate of interest and noting the loan as an account receivable: an asset. The bank has $10 on hand, not $100, but your $100 is listed as a deposit and that $90 loan is an account receivable.

That ninety dollars is spent on something and the money is deposited in another bank or even your original bank. Then, on the basis of that ninety dollar deposit, the bank can loan out eighty-one dollars, which they again note as an asset while keeping only 10% in reserve. As banks repeat this process, they “create” money (and wealth); by the time they’re done, your $100 deposit has become close to $1000 in loans. But the banks hold only a fraction of their money on deposit; hence, they operate on a fractional reserve. (You can read more on this Wikipedia page.)

As I see it, part of the economic crisis we’re in — with the subprime mortgages and derivatives and all the other arcane manipulations of money, which (if I recall correctly) James Fallows referred to a long time ago in the Atlantic Monthly as “paper entrepreneurialism” — was started by banks and other lending institutions accepting far more “receivable” assets while holding far fewer assets in reserve. That is, they took excessive risk by exceeding a reasonable ratio of loans to deposits.

(If that doesn’t make any sense, take a look at this fairly long cartoon video that presents an intriguing look at the fractional reserve system and how it contributes to our mounting debt: “Money as Debt.”)

What does this have to do with taxes?

It seems there should be some way to penalize banks and other lending institutions that take excessive risk, and to do so in proportion to the risk they rake. If the “safe” ratio of loans to deposits is 9:1 — arguments could be made that some other ratio is better — then it seems the further they get from that ratio the more they should pay. Originally, I envisioned this penalty as coming in the form of an “excessive risk tax:” the idea being that an institution operating imprudently such that it may fail (leaving its depositors to collect deposit insurance), or that it may come to the government to be “bailed out” of a situation they could have prevented, should pay more into the government to cover that cost.

Unfortunately, that’s not a good idea: it would place a greater financial burden on an institution that is already operating on shaky ground. And I oppose enacting a regulation or law that would mandate any certain fractional reserve limit — risk taking is not the evil that some people, particularly those who want to protect everyone from everything, seem to think it is.

So what I propose is this: as part of a lending institution’s annual tax preparation, they should state how far they are from the “safe” fractional reserve level — and should do so in the clearest possible way, by providing a simple run chart covering at least the most recent ten years, showing the ideal and their distance from it. Those who show a consistent disregard for prudence would thereby be flagged for extra scrutiny of their books. In addition, the institutions should, as part of their adherence to the Federal Truth in Lending statutes and F.D.I.C. requirements, post that chart for all to see so that every consumer can decide if they want to choose a lender — or a bank — based on their stability as well as whatever interest rate they offer.

If the banks had to disclose how much risk they were taking as well as what return they offered, consumers would be able to choose where to put their money. That’s a reform with real benefit to regular people.

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If you haven’t read The Cheating Culture by David Callahan, I recommend it. It’s disturbing, and I don’t think I absorbed all of its implications, but it’s an important book. I bring it up because it catalogued many examples of corporate cheating — cheating their customers, cheating their stockholders, and cheating the government.

Let me say first of all that I believe the U.S. corporate tax rate is too high, and acts as an incentive for companies to move out of the U.S. to friendlier places. Unfortunately, I don’t see any signs of it coming down under the current Administration and current Congress, because the loudest voices in the public sector seem to cry out in favor of punishing private sector success instead of making more success possible. I fear for the long-term effects.

That said, I don’t believe elevated tax rates justify the kinds of corporate cheating that Callahan wrote about. And one of the potential cheating tactics that seems possible to confront is the practice of reporting earnings on tax returns that differ from earnings reported in annual reports to stockholders.

Until the recent economic and financial turmoil, many companies posted profits every quarter even if it took some creative accounting to record those profits. Some of those companies got caught cooking the books, but usually not until they had collapsed or were close to collapse. They got into this habit in order to satisfy public perception and stockholders’ expectations, because no one wanted to mention the Emperor’s nakedness in terms of how unrealistic those expectations were. I understand that some of those companies that reported near-constant growth and profits in their annual reports, however, somehow produced lower earnings or even losses when it came to filing their taxes.

It doesn’t seem right for companies to tell their stockholders something different than they tell the government, especially if they’re telling their stockholders they made a profit in order to boost their share price, and then telling the government they took a loss in order to avoid paying taxes. Some might argue that this practice is only the difference between preliminary and final numbers, i.e., that it’s just a matter of “corrections” — I understand about honest mistakes, but it seems to me that either their accounting is good at the time it’s done, or it’s not good at all. If there are questions, resolve them before you issue the report with your name on it.

How can this influence tax policy? Let companies file their annual report as their tax return. Or, if that puts too much onus on the IRS to figure out any tax liability, let them submit the annual report along with their tax documents and show that the two match. If they don’t agree, or they differ more than some small allowance, assess a penalty based on the difference. (This would be irrespective of the company’s actual performance, and only related to what the company reported.)

In other words, split the difference between the return and the report, since we apparently can’t have complete faith in either one.

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For those who are interested, The Cheating Culture has its own website at http://www.cheatingculture.com/.

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Quick question: Have lobbyists improved the political situation in Washington? Have they achieved consistency in policy-making, and clarity in directing governmental affairs? Or have they, taken all together, produced a confused mess of infighting and backbiting and self-serving that has helped to drag our political discourse off any true course?

If you think lobbyists — even those with whom you disagree — do more good than harm, then you won’t like this proposal.

I think most forthright observers on either side of the political aisle would admit that the numbers and types of lobbyists and political action groups have polarized more than they have unified our nation, especially since every group that starts to lobby for their interests seems to spawn another group to lobby for the opposite interest. They attract attention and money, which they dole out to their political advantage — even taking part in writing legislation that directly affects their interests — because that’s what they’re designed to do.

So, then, I propose requiring lobbyists to pay more up-front for the privilege of lobbying.

I propose that all lobbyists — whether individuals or organizations, whether for-profit or non-, whether affiliated with a political party or completely independent — should have to match every dollar given to every candidate or cause, whether directly through donation or indirectly through advertising or other action, with a dollar given to the general fund of the U.S. Treasury. Very simple: do an audit, find out what was spent on lobbying, and cut a check directly to the government for the same amount.

Of course the counter-argument would be that such a tax would inhibit free speech, but what lobbyists have right now is not free speech: it’s privileged speech, with steady access to power-brokers and audiences that most citizens don’t have. The question is whether that ready access is worth paying a premium. I suspect it would be, just as I suspect that, if anyone took this proposal seriously and tried to enact it, the lobbyists would rise up in one accord against it — because the only thing that would unite them would be a threat to their well-built structures of power and influence.

Oh, that government of the lobbyists, by the lobbyists, and for the lobbyists would indeed perish from this earth.

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Another plug for the “Raleigh Tax Day Tea Party,” which will be held on Wednesday, April 15th (of course), from 6:30 – 8:30 p.m. at the North Carolina State Capitol. This event is one of many national grassroots “Tea Parties” in cities across the country. The Tea Parties began as a means to focus attention on the so-called stimulus plan — which has not, will not, and probably can not stimulate the economy as much as its proponents promised, but has burdened us and will burden our descendents with even more unreasonable amounts of national debt.

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I always thought it was odd that I had to record interest I was paid on money in my savings account as income.

Okay, sure, it’s “income” in that it’s money coming into my hands, but the more I have in the bank for the bank to use to create more money (through the magic of fractional reserve banking, which we’ll cover another day), the better for society as a whole, right? And then as banking fees became more prevalent — because they weren’t making enough money off of the money people already had on deposit — it seemed even more ridiculous to pay the government for the privilege of having a savings account. I guess a case might be made that we’re paying for the deposit insurance, but I’m skeptical.

Contrast the fact that interest received is taxable “income” with the standard advice that everyone should have six months’ income in savings for use in emergencies. It’s free money for the government, so to speak, but hardly an incentive to maintain a “rainy day” fund.

So I propose that there be no tax at all on interest earned on savings accounts if the total amount in savings is equal to or less than 50% of adjusted gross income. In other words, your rainy day savings remain tax free if they include up to a half-year’s pay — and if you start earning more, then you can save proportionally more.

The same principle could be applied to corporations, with respect to their cash reserves — the idea being that people and corporations should be able to maintain, without penalty, reserves against fluctuations in financial markets. Imagine how the current economic situation would be different if businesses, when short-term credit became harder to obtain, could have fallen back on cash reserves to keep paying employees and placing orders.

Would more people store up emergency funds if the interest was non-taxable? I don’t know. In our consumer-driven economy, maybe not. But at least they wouldn’t be penalized for having a little bit of savings.

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As we wrote yesterday, the “Raleigh Tax Day Tea Party” will be held on Wednesday, April 15th (of course), from 6:30 – 8:30 p.m. at the North Carolina State Capitol. It’s part of the national grassroots “Tea Parties” movement, consisting of events in cities across the country to voice opposition to the stimulus package, which will stimulate less than its proponents think and saddle our citizens and our descendents with even more unreasonable amounts of debt.

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With respect to capital gains from sales of stock and other assets, Form 1040 Schedule D instructs us to divide them into short-term and long-term gains, with long-term referring to investments held for one year or more. But is a year really “long term”? Thinking of a single year as long term is part of the problem we have with rewarding speculation over investment.

It was, after all, speculation in derivatives and risky mortgages that contributed to the housing bubble and its subsequent burst. (Call it “investment” if you like, but I disagree: investment connotes long-term, and the way these strange instruments were traded and manipulated and traded again never sounded like a long-term strategy.) The speculation filtered down to home buyers, many of whom did not buy a home in which they planned to live for years but instead bought one which they hoped to sell quickly as soon as rising home prices inflated their equity. Many people made a lot of money this way;* unfortunately, many more seem to have lost much more.

How do we encourage investment — real long-term investment — instead of speculation?

I propose that we structure the capital gains portion of the tax code to reward investment. Simply, the longer you hold a stock, shares of a mutual fund, or other investment vehicle, the less tax you would have to pay on any capital gains from the sale. The “investment tax” would be a “regressive” tax in which the actual tax rate would fall with the passage of time, down to whatever is considered a nominal rate.

The main benefit I see from this would be more stability in the stock market and more investment capital available for use as the basis of creating more wealth. The opportunity for speculation and making a quick killing on a stock deal would still exist, but the cost would be higher than if the stock were held longer. The different rates, the appropriate time scale, and the final nominal rate would all be determined based on what is expected to contribute most to economic stability and sound currency.

The same inversely-proportional tax rate could apply to dividends paid by the investment vehicle, with the exception that dividends automatically reinvested should not be taxed; only dividends paid when part of the investment is redeemed. (The key here is “automatically” — no cheating by taking the dividend and then investing it in something else.)

As an added bonus, we could allow for the ultimate “grandfather” clause by stipulating that investors over 70 years of age would not be taxed at all on dividends or capital gains received.

I suspect this idea would affect the venture capital business as well, but the tax level on short-term gains should still be reasonable enough to encourage investing in start-ups and expanding businesses. The idea is not to eliminate short-term investment or even speculation, but to encourage more long-term investment.

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While we’re on the subject of taxes, we’re a month away from the “Raleigh Tax Day Tea Party.” It’s part of the grassroots “Tea Parties” held in cities across the country against the stimulus package, which will stimulate less than its proponents think and saddle our citizens and our descendents with even more unreasonable amounts of debt.

Here’s a little about the national movement. The Raleigh event will be Wednesday, April 15th (of course), from 6:30 – 8:30 p.m. at the North Carolina State Capitol.

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*Sour grapes alert: We had the chance to do just that, and did not take it. Who knew we were going to be stationed in Northern Virginia for five years, when we expected to be there for two? Timing, as they say, is everything.

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