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TRICKLE DOWN ECONOMICS
Trickle-down economics is the derogatory term given to “supply side economics” by liberals, progressives, elitists, democrats and other lefties. Somehow this group cannot seem to get that it has been proven to work multiple times since 1960. The theory behind supply side economics can be found by putting Laffer Curve into your preferred search engine. Supply side economics advocates that there is an optimum income tax rate whereby the government will collect the most income tax revenue. If rates are raised above that point, the government will collect less tax revenue and if lowered below that point the government will collect less tax revenue. This theory bears out in practice because taxation takes place in a dynamic environment. People change their behavior as tax policy changes. If federal tax rates are increased, then taxpayers earn less taxable income by working less, deferring income, investing in investments that yield tax free income, or investing in assets like land and idle real estate because it does not generate income. (In those states that keep increasing taxes, the residents simply move to a state with lower taxes.) Additionally, the higher the tax rates the more incentive there is for people to cheat via under the table cash transactions and bartering. Basically, by increasing taxes the government entity ends up with less tax revenue and a shrinking economy. On the other hand, if rates are lowered, people will try to earn more income because they get to keep more. They are more likely to invest in the most profitable investment vehicles because they get to keep more of their income. Working more and investing in the private sector grows the economy and generates jobs. Since 1960 three major tax cuts have been implemented. The first was during the Kennedy administration where the maximum marginal income tax rate was reduced from 90% to 70%. The second was during the Reagan administration where the maximum marginal income tax rate was reduced from 70% to 50% and then from 50% to 28%. The third was during the George Bush administration which affected items such as capital gains and dividend income and reduced the Clinton’s maximum marginal tax rate from 39.6% to 35%. In all three cases the aggregate income tax revenue collected by the government increased and the economy grew. On the other side, we have the 1969 Tax Reform Act which increased taxes by trying to tax the wealthy (and is responsible for the alternative minimum tax affecting middle class taxpayers today), the 1976 Tax Act, and the Omnibus Budget Reconciliation Act of 1993. All resulted in the government collecting less taxable income and in slowing down the economy. The latter which went into effect in 1994 increased the maximum marginal tax rate from 28% to 39.6%, increased the motor fuels tax, and increased the taxable portion of social security benefits among other tax increases. The latter act was under Clinton’s watch. While he often gets credit for generating a budget surplus which is arguable and was not because of anything he did. The fact is that he was simply in the right place at the right time. Clinton inherited the most robust economy in history as a result of what is called the Reagan-Bush (really the Kemp-Roth) tax plan. His so-called surpluses were ten year projections based on a static analysis (no change in human behavior because of the change in the tax laws). The Congressional Budget Office is not permitted to consider changes in human behavior when making projections based on changes in the tax laws. When Clinton took office, his transition team recommended no change in economic or tax policy for fear that it would have a negative impact on the economy. If he had left well enough alone we could have had overwhelming economic growth. Even though Clinton inherited the most robust economy in history his tax legislation did begin to slow down the economy after it was implemented. Generally, the impact of tax legislation is not noticeable immediately. It takes several years for the impact to show up in the economy. Several years later it was clear that we were headed toward a recession (which is often blamed on the dot com bubble). So much so that in 1997 the Clinton administration signed into law the Taxpayer Relief Act of 1997 in an effort to curb the tide. It was too little, too late. Regardless of what proponents of tax increases want to argue, (1) the amount of income tax revenue collected by the government increases when income tax rates are reduced and (2) there are not enough wealthy people to solve the budget problem. Based on IRS data the so-called Bush tax cuts increased the tax burden on the wealthiest taxpayers from 35% of the total income tax revenue collected by the government to 39% while reducing the burden on lower income taxpayers. If the Democrats really wanted to increase the amount of tax revenue collected by the government, they would reduce tax rates and not increase tax rates. This tells me that their motive is not to generate more revenue--but to penalize successful taxpayers.
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THE DOWNSIDE OF
CORPORATE AVERAGE FUEL ECONOMY STANDARDS
During the Obama administration there have been two increases in the Corporate Average Fuel Economy Standards (CAFES). In the first instance auto manufacturers were required to meet a fleet average of 35.5 mpg by 2016. More recently this was upped to 54.4 mpg by 2025. Additionally, in President Obama’s State of the Union Address he touted the race to have “green energy” in place by 2035.
The Department of Energy was created in the mid ‘70s for the purpose of developing a national energy policy including the development of alternative sources of energy. Unfortunately it has accomplished nothing with regard to energy while becoming a bottomless pit for taxpayer dollars. Congress’s idea of a solution has been to prohibit exploration and development of existing energy reserves, subsidize the conversion of food into fuel (ethanol), and to enact CAFES. CAFES were a good as a first step with regard to the energy problem because it got the public and automakers to think about fuel economy and energy resources. However, the initial CAFES should have been replaced by a sound long-term energy policy--not continually increased over the years.
In response to the CAFES for the automobile fleet manufacturers had to build cars lighter and smaller to achieve the stipulated mileage requirements within the time frame allotted. The first unintended consequence of CAFES meant the end of the station wagon. But it did not mean the end of consumer demand for the station wagon. The market place has a way of satisfying demand with supply and consumers replaced the station wagon with the SUV. Prior to CAFES each of the Big 3 U.S. automakers built 20,000 to 30,000 SUVs a year, which, were primarily sold to sportsman. After CAFES were in full swing, automakers were building hundreds of thousands of them. Yes it was government regulation that spurned the SUV explosion and not the Have’s showing off to the Have-Not’s as the class warfare crowd would like you to believe.
The problem with all regulation is that it begins with good intentions but eventually becomes an entity onto itself. Regulation eventually exists for the regulators and not for its intended purpose. In fact, CAFES have morphed into a set of regulations that resemble the Internal Revenue Code. This situation opens the door for manipulation. Chrysler engineers actually designed the PT Cruiser to meet the definition of a truck as defined in CAFES. This permitted Chrysler to continue to market the less fuel efficient Hemi powered trucks while still meeting the mileage requirements for its truck fleet.
CAFES force auto manufacturers to build smaller and lighter vehicles in order to meet the fuel mileage requirements. Recent data suggests that this has resulted in an upward spiral in the number of automobile fatalities. It seems that vehicles can be made smaller and lighter but cannot be built to avoid the laws of physics. Vehicles may have gotten smaller but trees, power poles, bridge abutments, and retaining walls are still the same.
Electric vehicles do not meet the demand of most drivers in the U.S. Electric cars have limited range, require the use of fossil fuels to recharge the batteries, and there is the unknown factor regarding the long-term effects of battery disposal. Additionally, the production of fuel efficient vehicles requires the use of fossil fuel. Some engineers argue that the production of a Prius requires twice as much energy as it will save over its life. Battery vehicles are supposed to run about 100,000 miles. But if they don’t, replacing the batteries in an electric vehicle can run up to $7,000. It is cheaper to junk the vehicle and buy another one.
Both smaller gas-powered, hybrid powered, and electric powered vehicles lack towing and payload capability. People with boats and campers must still rely on the more traditional full size tow vehicle. Without these vehicles there would be massive layoffs in the boat and travel trailer industry.
We also have to consider the cost of CAFES to the taxpayer. Law enforcement agencies utilize vehicles in a way that most of us never dream of. As a result, heavier vehicles hold up better, last longer, and have lower maintenance cost. Agencies such as the Fish and Wildlife Commission must tow vessels and require full size trucks or SUVs. We are seeing an increase in the number of trucks and SUVs utilized by sheriff departments and by state police. The problem is that trucks and SUVs are more expensive than the cars that these agencies used in the past.
Hydrogen vehicles are often touted as a solution to the energy problem but present different problems. One report that I read stated that to drive a hydrogen powered vehicle from Mobile to Montgomery would require a vehicle the size of a Hummer towing a 3,000 pound fuel tank. Then there is the issue of refueling hydrogen vehicles. Refueling stations are not only scarce; refueling itself can be a tricky process.
So, if CAFES are the future of our energy policy, the country is in trouble. Basic economics indicates that countries utilize their natural resources to their benefit, either as consumable goods or to trade for resources that the country needs. In the U.S. we have a bounty of natural gas, coal, and oil. In fact, estimates indicate that we have enough of these three resources to meet all of our energy needs for the next 200-300 years.
According to T. Boone Pickens, if all of the 18-wheelers in the U.S. were converted to natural gas, there would be no need to import oil from the middle-east. Already we have cities and counties converting school buses, garbage trucks, and fleet cars to natural gas. Yes there are limited refueling locations, but if we can put a man on the moon this does not appear to be a serious issue.
So-called Green Energy calls for great technological strides. It is basically the development of an energy source starting from scratch. We already have the technology to utilize natural gas, coal, and oil. It is much easier to develop technology to make the use of fossil fuels cleaner and more efficient than it is to invent some entirely new energy source. Plus, in Europe, data suggests that for every Green Job created, two non-Green Jobs were lost. Something we don’t need given the present economy.
Last, the issue of global warming or climate change supposedly caused by fossil fuels. It is doubtful that climate change is a real phenomenon because the climate change models tend to lack validity. Models should be developed from past data. The validity of models is usually tested on a sample of past data and the higher the level of prediction, the better the model. But this is not so with climate change models which have nowhere near acceptable levels of validity. There is actually more evidence to indicate that climate change is nothing more than natural cyclical patterns in the weather that are not influenced by man. If by some remote chance climate change is real, technology will defeat the problem as it has defeated some many others.
The U.S. needs to develop a comprehensive energy policy using the resources that we have available to us. CAFES are a dead end.
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ROMNEY AND OBAMA’S TAX RATES
The recent release of Romney’s 2011 tax return has sparked the reporting of what has been termed the “effective tax rate” for both Romney and Obama. It has been reported that Romney’s effective tax rate was right at 14% while Obama’s effective tax rate was 20%. The problem with the reported information is twofold: (1) the effective rates being reported for both are not measured in the same way for both candidates; and, (2) the computation of the “effective tax rate” is incorrect. Because the U.S. tax system uses progressive or graduated income tax rates, the rates increase as the taxable income increases. The rate in each bracket is referred to as the “marginal tax rate.” The overall tax paid will be a combination of these multiple tax rates making the effective rate less than the marginal rate. In fact, one can never have an effective tax rate equal to the tax rate in the highest bracket. The tax rates are applied to “taxable income” which is after deductions and exemptions and before tax credits. In order to correctly compute the effective tax rate the total income tax paid should be divided by the taxable income. Based on the reported information the “effective rate” was not reported correctly for either candidate. Plus, the so-called effective rates are being computed differently for each candidate. The rate that is being reported for Romney is the total tax paid divided by the gross income before any adjustments, deductions, and exemptions. The rate being reported for Obama is the taxes paid divided by the adjusted gross income (after some adjustments to gross income but before deductions and exemptions). When the so-called effective tax rate is computed on gross income it will be lower than if computed on adjusted gross income or taxable income. When computed on adjusted gross income it will be somewhere in-between the lowest and highest possible rate. Because Romney donates such a large chunk of income to charity, this erroneous computation makes the so-called “effective rate” on his tax return look lower than the rate on Obama’s return when, in-fact, they should close to the same effective tax rate. Based on the reported information about Romney’s deductions, we can estimate his taxable income. Using this number to correctly compute Romney’s effective tax rate, the rate is right at 25%. This number cannot be computed for Obama as my research has yet to uncover the amount of his deductions. But it will be higher than 20% and close to 25%. This whole story is much ado about nothing as the media continues to “make” news. Based upon my experience, the “effective tax rates” for the upper middle income and high income earners tend to range from 20% to 25%. Based on my experience, both candidates (as well as Warren Buffet) are paying a typical “effective tax rate” for taxpayers in their respective income tax bracket.
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TAX THE MILLIONAIRES & BILLIONAIRES
This seems to be the constant and incessant rally cry of the administration regarding the deficit and the national debt. Unfortunately it indicates either complete ignorance of the subject or deliberate deception. The amount of taxable income of an individual has nothing to do with whether or not they are a millionaire/billionaire. Millionaires and billionaires are determined by something called the fair value of net assets. This is measured by taking the fair value of everything they own (assets) and subtracting all of their debts (liabilities). If that amount equals or exceeds one million dollars, then they are considered a millionaire. It has nothing to do with how much income they earn. One can be a millionaire and have zero income and one can earn one million dollars a year or more and have negative net assets. For instance, I can own land valued at one million, have no debts, live with my parents, and have zero income. Or I could have paid one million for a house that has a $750K mortgage and a fair value in the current depressed market of only $500K. In this case my net assets are negative regardless of how much I earn. Voters would be surprised at the number of ordinary Americans who worked at the same job most of their life, saved their money, paid their bills, and are now millionaires—and living on $40,000 to $60,000 per year of retirement income. Many will need all of these assets just to cover their medical costs in old age. Politicians do not seem to realize that changes in the income tax law create a dynamic environment. When taxes are increased, taxpayers find a way to legally pay less tax, or worse yet, find ways to earn income off the books. The result is that the government collects less total tax revenue and not more. An alternative available to the very wealthy is the ability to take advantage of the tax law to reduce their taxable income. When the founder of the Dodge Motor Corporation retired his widow sold the company to Chrysler Corporation. The deal was structured such that she was paid in municipal bonds. Yes, the gain on the sale of the company was taxable but she lived the remainder of her life on nontaxable municipal bond interest income. In the case of a high income earning businessman or physician, they simply work less and earn less. Despite the current rhetoric concerning taxing those earning over $250K this group of taxpayers are largely small business people. Small business employs the overwhelming majority of Americans. I have seen numerous tax returns for small business owners where the tax liability (amount owed the government) exceeded $250,000. These are certainly not people we would consider billionaires. Taxing people in the highest income categories only serves to reduce the number of people they hire, increasing unemployment, generating less tax revenue to the government. So why deliberately mislead the populous?
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There is an old joke that a “tax loophole” is a tax benefit that your neighbor gets and you do not. That is pretty much how the term is used today. Any tax benefit utilized by an individual or business that others do not like is referred to as a loophole. Technically a loophole is something that the law is silent on. The tax law is silent when it does not specifically permit a deduction, exclusion, or credit to the taxpayer; nor, does the law specifically disallow a deduction, exclusion, or credit to the taxpayer. The general rule used by tax professionals is that if the law is silent, take advantage of it. The Internal Revenue Code (IRC) is enormous and loopholes are few and far between. When someone does find a loophole that involves significant money, it is immediately challenged by the IRS. If the government does not prevail in the case, then Congress quickly amends the IRC to disallow the use of that loophole in the future. Public corporations that pay zero in income taxes make the news but are quite rare. Businesses and individuals that appear to pay disproportionately low income taxes are simply following the letter of the law. GE paid no income taxes last year but did so quite legitimately. Congress created this situation, not corporate management. GE avoided the income tax by purchasing credits from a foreign subsidiary that had no need for the credits and using those credits to reduce their U.S. tax liability. Money flowed out of the country so that GE could avoid remitting funds to the U.S. government. Congress enacts the tax law and can fix these questionable items at any time. In fact, they make changes to the law frequently. Several years ago they added a special tax break known as the “Starbucks Footnote.” It doesn’t mention Starbucks by name, but by description and provides them with a tax benefit that most other coffee houses cannot take. In the 1980s the head of the House Ways and Means Committee (where tax laws originate) wrote in a provision making season football tickets at LSU a charitable contribution. When the bill got to the Senate Finance Committee the Chair wrote in the same thing for the University of Texas. Again, they described the schools instead of mentioning them by name and this provision applied only to those two schools and to no other schools. This provision has since been eliminated but it does illustrate that the tax law is not written for you and me. The current tax code is immensely complex and easily lends itself to this type of abuse. What really needs to happen is for the corporate income tax to be abolished. The fact is that businesses simply pass the income tax and payroll taxes incurred onto the consumer in the form of higher prices for goods and services. Consumers really pay these taxes. Some investors actually look for the corporations that pay the least in income taxes or have the highest deferred tax amounts on their balance sheets. The theory is that if the business incurs lower taxes, then management must have a prudent tax planning scheme. Additionally the products/services of businesses that pay the least in income taxes can be sold for less than those of the competition giving them an advantage in the marketplace. The fact is that it is time for the IRC to be rewritten from scratch. We need to move to a single flat tax rate with no deductions, three tax rates with no deductions, or to a national sales tax to replace (not in addition to) the current income tax structure. I vote for the latter alternative.