Optimal Fiscal Reform
Tech, Semiconductors, Telecom, Internet
Seeking Alpha Analyst Since 2010
Today we have a narrow window of opportunity to fix a broken US fiscal system. Below is a general outline for fiscal reform:
1) Simplify tax code which will raise revenue, improve fairness, and boost productivity and economic growth via:
a. 1% net wealth tax combined with elimination of estate and capital gains tax
b. Simple two-to-three step personal income tax rates without loopholes at lower personal income tax rates than today. These lower income tax rates can serve as an offset to the elimination of the mortgage interest deduction.
c. Make the tax code so simple that most Americans can fill-it out without a tax accountant
d. Allow a tax holiday for the trillions of corporate offshore dollars to return to the US (can tie it to investment/jobs in the US)
2) Improve Federal Government efficiency which will reduce spending, improve services, and eliminate waste and inequities via:
a. Political Finance Reform for campaign contributions, lobbyists, and others that represent any special interests. By attacking the disease, we can eliminate the wasteful spending symptoms and improve efficiency, by removing the blockage of special interest groups that hurt the majority of Americans.
b. Military spending can be retargeted to a leaner, mobile, better trained and equipped force with leading-edge technology.
c. Cut egregious social security retiree benefits such as multiple government pensions among others that are bilking the system, and transfer some of those funds to the millions of Americans that are likely to receive a fraction of what they put in today. Relatedly, it would be good to offer an option for all young Americans with long time horizons to put a small percent of their social security contribution into equity and venture. Why should only wealthy Americans benefit from this growth?
d. Adjust social security benefits to today's reality of longer life spans.
e. Improve Obama-care to focus on increasing the supply of doctors, have technology and automation replace the expensive vestiges of today's wasteful patient referral and diagnostic procedures (a simple cardiovascular exam becomes a several thousand dollar odyssey), and generally learn from the rest of the world who offer comprehensive care at half the cost per GDP of our country's non-comprehensive care.
3) Benefits of the above steps:
a. The federal budget deficit would disappear
b. Economic growth would take off
c. Investment capital will be flowing into the US from more restrictively taxed countries
d. The stock market would skyrocket
e. Millions of jobs would be created
f. All Americans would be better off
g. Wealth inequality would decrease
h. Huge unproductive, economic drags would be removed from the system including i. Eliminated trusts and foundations, an enormous economic drag that is totally unnecessary, and a costly burden for the wealthy; ii. Tax accountancy costs would be reduced; iii. Political contributions by corporations and individuals can be redirected to more productive uses; and iv. Pork project spending can be eliminated.
This is a general outline. It is not meant to cover all areas or required actions (e.g. corporate tax rates, dividends, payroll, specific entitlement and spending policies, etc.), just what I believe are the most important. However, here is an interactive tool that allows you to observe the impact of various policy decisions on the deficit.
Below are a few topics that support this outline for optimal fiscal reform:
Wealth Tax
A wealth tax is better than an estate tax, capital gains tax, and helps the US economy.
A net wealth tax improves the stability and amount of revenue inflows it is a larger less volatile tax revenue base (the base effect is key). Estate tax is a one-time severe hit, and capital gains tax can spike (during the stock market boom of Clinton' second term) and then drop sharply (during the 2000 -2003 period). The receipts from a 1% wealth tax could raise $0.6 trillion annually based on $64.8 trillion in American Household Net Worth reported in the Federal Reserve Flow of Funds report released earlier this month.
A net wealth tax promotes investment and the more productive use of latent resources. Ultra-high net worth individuals will be mildly incentivized to invest their capital over time, to overcome the 1% annual hurdle.
A net wealth tax is the most efficient way to address this over-politicized income redistribution argument. Raising personal income tax rates does not really effect the wealthy, as their income levels are not necessarily high. Raising capital gains taxes does not effectively target the wealthy that may or may not be underpaying taxes, nor does it sustainably move the revenue needle up.
A net wealth tax is fairer, but only with the following caveats.
- First, it must be used as a small percentage of net wealth of 1% or less that has to be constitutionally enforced. Otherwise, no wealth tax should be implemented, as it would set a precedent for even higher wealth taxes in the future. This is a precedent that we must avoid to avert harmful economic, moral, and social consequences.
- Secondly, a net wealth tax should not replace a federal income tax. In a recent New York Times article by Daniel Altman, Dr. Altman suggested having a wealth tax replace all taxes including federal income taxes. Federal income taxes should remain in my opinion. First of all, why re-invent the wheel? All other countries that have wealth taxes also have a federal income tax (and their average wealth tax rate is 1%). Also, certain individuals with low incomes and illiquid assets would be unfairly penalized. Apart from these details, Dr. Altman presented some compelling arguments for a wealth tax.
- Third, a net wealth tax should at least replace estate/inheritance/gift tax and capital gains tax, due to high double-taxation issues. Exceptionally, there should also be a federal wealth tax deduction for state property taxes (with a cap on state property tax rates). The wealth tax also removes the inequities of the estate tax system.
o Double taxation - a person works hard all his life and if successful pays high taxes all his life. If that person is a family person, he works hard so that his kids and grandkids can enjoy the fruits of his labor. But then the government steps in and taxes all that money again at 55% (excluding $1M under pending fiscal revisions), including non-liquid assets, wiping out the liquidity of certain heirs in some cases.
o Misdirected - the ultra-rich avoid estate taxes by setting up family foundations and paying their children a salary, and through complex trusts. Only the less rich pay the estate tax, and they are the ones that can least afford it (even if there is a $1M, or even higher deduction).
o Economic waste - all these trusts and foundations (which equates to a loss-of-control to trust lawyers and accountants to avoid estate tax consequences, who then siphon an inordinate amount of money from clients), are a multi-billion dollar business for lawyers and accountants that is totally unnecessary. These smart professionals should make a more productive contribution to our society. By eliminating this waste, the wealthy will actually profit from a 1% wealth tax as they pay more than 1% of their assets per year to trust lawyers and accountants.
o A wealth tax is a much more attractive alternative than a capital gains tax. Removal of the capital gains tax would benefit savings and investment among all Americans. Studies exist that show low correlations between capital gains tax levels and economic growth. But these studies avoid deductive reasoning and take the data out of context. As these studies admit, there are several other variables - wars, economic cycles, etc. that skew the data. Deductive reasoning proves that lowering capital gains tax rates incentivizes individuals to invest more. The ultra-rich may be less sensitive to a removal of capital gains tax, as their disposable income levels can only go so high. But the fact remains that all Americans would invest more in varying degrees (ceteris paribus) if their net expected returns were higher. It would also draw in a lot more foreign capital from higher-taxed countries. Greater investment leads to rising economic growth. The timing of that growth may be hard to capture, but it does happen. One can site China, Chile, and a host of other countries with high savings and investment rates, with stronger and steadier economic growth versus its neighbors.
- Finally, a wealth tax must be part of comprehensive fiscal reform that reduces spending and waste. It is unfair to ask the wealthy to help an overly indebted government, while the government and the bulk of Americans do not contribute. Furthermore, a net wealth tax alone will not solve our federal debt and budget quagmire.
o As a side note, the top 10% income earners already account for the bulk of US federal tax revenues today, and including local taxes, pay a slightly higher tax rate than the remaining 90% of Americans, according to the Citizens for Tax Justice 2010 tax study below (these figures exclude charitable contributions which would boost the top 1% substantially, and the top 10% moderately). The two conclusions are 1) there is room to make all-in tax rates slightly more progressive, and that 2) the wealthy are already paying a higher all-in tax rate despite media claims to the contrary.
The main argument against a wealth tax is capital flight risk. Certain European countries like Sweden dropped the wealth tax due to capital flight. The US tax system based on global income and wealth reduces, but does not eliminate, this risk. The only way to eliminate capital flight risk is to constitutionally promise to this wealthy American minority that the bulk of their personal wealth will never be taken away (e.g. the 1% cap).
A complication to enforcing a federal wealth tax is that the US constitution prohibits any "direct tax" on personal holdings (as opposed to income or capital gains) unless the revenue collected is apportioned among the states on the basis of their population. Thus, the wealth tax requires additional steps to be legally binding.
A floor of $500k or $1M could be used for the wealth tax. The caveat is that we need to keep the tax code as simple as possible to avoid loopholes and tax avoidance schemes. The higher the floor to start the wealth tax, the more maneuvering will be done to arrange/distribute family assets below the wealth tax bar.
The US should learn from the mistakes of its European neighbors. Welfare states that overtax the wealthy failed miserably. Sweden adapted, as did Germany, with positive results. Greece did not adapt, and is bankrupt with a non-competitive economy. The US should stay true to its roots of self-reliance and entrepreneurship.
Making Government More Efficient
"Making government more efficient" is more challenging to implement because of vested interests within the status quo. As opposed to the fiscal reform outline and wealth tax discussion which was more straightforward, I would like to instead create a rationale for more efficient government. This rationale would then serve as a foundation from which experts can then implement reforms to improve our government and fiscal dilemma.
Our political representatives are generally honest, hard-working people. The issue is that they are a prisoner of an increasingly ineffective political ecosystem. As a first step to gain a broader perspective, each US politician should read the following two books: American Gridlock by Woody Brock, and Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb (or at least this recent Wall Street Journal article).
A sample of conclusions from the combined wisdom of the two books by Messieurs Brock and Taleb:
· Too much power and money is centralized in Washington DC - this creates 1) an inefficient government and self-serving ecosystem that is in conflict with the public good, and 2) a highly fragile structure that puts the whole nation at risk (which currently is the case with our dysfunctional bipartisan politics).
o The richest metropolitan area in the US is now Washington DC due mainly to a concentration of well-paid lawyers, politicians, lobbyists and federal workers (see this recent article for more details). The average household income in the Washington area was $85k compared to the national average of $50k, creating aggregate household income of $221B in 2010. Does the benefit produced by these lawyers, lobbyists and federal workers exceed their high cost?
· A standard measurement tool is needed to perform a cost-benefit analysis on government spending projects and initiatives. Benefits must be broadly defined as the public good (not just profits made). For example, federal infrastructure investments on roads and highways could improve productivity, reduce accidents, etc. that could justify at least part of the $50B investment being proposed by President Obama. But only those projects whose broadly-defined benefits exceed costs should be implemented. Certainly, we have some federal and state programs today that cost more than they are worth. But special interest groups and horse-trading of different pork projects pushes them through to the detriment of a large majority of Americans. All projects should be analyzed in the same light regardless of political backing.
· Smaller is better. The larger the government project or ecosystem, the larger the cost overruns.
· Eradicating special interest influence (including deep political finance reform), and when possible, emphasize smaller, merit-based projects, could help create a cleaner and more efficient government. The question becomes what politician has the courage to risk his political career to stand-up to the AARP, in order to implement much needed entitlement reform? The answers are don't make politics your lifetime job, political finance reform, or have the courage to stand-up for what is right.
· Ironically, both Messieurs Brock and Taleb independently agree that financial leverage should be removed from the banking system, in order to reduce the risk of (fragility to) a systemic financial meltdown.
The book Zen and the Art of Motorcycle Maintenance by Robert Pirsig brings out some interesting parallels. In particular, the section on the concept of quality when the author speaks of all-arounders who served as political leaders in Ancient Greece without ego as fellow-participants (farmers, merchants, etc.) in the community, and then returned to their professions after their civil service. These all-arounders were followed centuries later by professional lifetime politicians who were more narrow specialists that developed a different lifestyle and consciousness from their fellow citizens. A similar comparison can be made today between many of our current politicians and our country's founders over 200 years ago. While it may be hard to turn back the clock to a smaller, more homogeneous society of the late 1700's, certain prerequisites such as 1) doing a minimum amount of time working in the real world and/or going through boot camp and technical school in the military, and 2) having strict term limits without entering lobbying or politically-related jobs after service could better align our politicians awareness and incentives with the US citizenry.
The lack of political courage to address entitlement rationalization is a missed opportunity. Entitlements like social security are the big elephants in the room that need to be streamlined to put our fiscal house in order. Instead, congress is taking the politically convenient path of broadly cutting government services, including essential ones that have greater benefits than costs. For example, cutting Pell Grants for educational scholarships strikes at the heart of closing the US opportunity gap (which is at least as important as closing the income gap). Congress should lead by example and start with their own pension plan (see here and here) - which while not as bad as rumored by some, could still be cut back in these hard times.
The reason most politicians avoid entitlement reform is fear of not being re-elected, which also means loss of/ lowering of pension benefits, and an inability to survive outside of the political ecosystem. This goes back to the need for underlying political reform, that incentivizes politicians to be more independent and not succumb to special interests. While you may or may not like their viewpoints, ethical, self-made men like Michael Bloomberg and Gary Johnson have had a net positive effect on their New York City and New Mexico constituencies, and are not bad role models for other politicians to follow.
Resolving Political Gridlock
Below are a few random thoughts to help resolve the current political gridlock in Washington DC:
It's simple. All they have to do is agree on the facts - Gil Elbaz, CEO of Factual, when asked how to solve the Israeli-Palestinian conflict. So for example, we need to collectively decide what is the role of the federal government. Once we agree on that, then these vague divisive arguments of big government versus small government will disappear.
Woody Brock adds that deductive reasoning based on irrefutable assumptions that subsequently can be supported by real-world data (as opposed to twisting information to fit personal biases) is the way to obtain factual agreement, whether in Israel or Washington DC.
A decision is better than no decision - Magnus Ryde, Chairman of Gemfire, when discussing how a well-supported decision without delay is key to a successful post-merger restructuring (even if it was the wrong decision, you at least started the trial-and-error process so that it can be improved later). Also, the longer you wait, the harder it is to make any changes, as vested interests become entrenched, and the merger fails.
Eliminate Political Action Committees and other special interest groups that incentivize political gridlock due to their own special agendas.
A December 21, 2012 New York Times article headlines
Speaker John A. Boehner abruptly halted efforts to pass fallback legislation to prevent a fiscal crisis after conservative Republicans refused to allow taxes to rise even on the most affluent
The solution to remove this political gridlock is easy. Implement a limited wealth tax and lower income taxes for all Americans, as part of a broader fiscal reform. Then everybody can claim a victory.
Conclusion
This optimal fiscal reform outline is a win-win for nearly all Americans including the wealthy. The only losers may be certain lawyers, accountants, and lobbyists. Now how hard is it to agree on that!
I would like to thank Rob Kalman, Steve McAllister, and Jim Hogan for their contribution to this article.
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