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Rumination on Taxation

By       Message Siegfried Othmer       (Page 1 of 3 pages)     Permalink    (# of views)   1 comment

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What has been happening in California may be a harbinger for what's in store at the national level. For some years now, Republicans have taken advantage of a two-thirds vote requirement for the budget and all new taxes to impose an effective no-new-taxes policy on majority Democrats. California's financial situation has grown increasingly desperate. No matter how high the misery quotient rises, there shall be no more taxes by Republican edict.

Privately, Republican legislators even admitted that California's financial problems could not be resolved through cuts alone. But they were just not going to be party to a tax increase. This is likely to happen at the national level as well, with Senate Republicans opposing any tax increase for social spending. For this reason, the Administration should take the opportunity to increase taxes to pay for the war in Afghanistan and Iraq, because it may represent the only viable opportunity they have.

There are very few opportunities in this politically divisive era to get both parties on board with any proposition, least of all on taxation. By asking for a tax increase to support the war effort, President Obama would serve the dual purpose of securing Congressional support for his Afghanistan policy while also easing his budgetary concerns. This may be the only chance in his term of office, unless filibuster rules are changed.

Even though opportunities of working on a bipartisan basis are diminishing, the ideal should still be kept in mind. Beyond the "no-new-taxes" inclination of Republicans, now that they no longer have their own guy in the White House, they have contributed two key ideas to the tax debate over the years: the flat tax, and the consumption tax. The flat tax has the ostensible advantage of simplicity in administration, and the consumption tax is deemed preferable to a tax on productive labor. The proposals at least need to be considered.

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Whither the Flat Tax?

If tax flatness is a virtue, presumably the principle should be applied first to the tax that is least flat. That just happens to be the Social Security tax. Now when it comes to Social Security, Republicans argue that this is not really a tax, but rather a premium for an insurance program. If benefits are limited according to income, then the fees to support it should be also. But about thirty percent of Social Security payments are made to widows, widowers, and minor dependents. This is a welfare burden, which should be borne by everyone in the society, not just by those who make a family income of around $110K or less. Fairness would argue that at least the welfare portion of the Social Security tax burden should be applied to all incomes.

If as little as 2% of higher income brackets are committed to Social Security, fairness in this basic sense would be essentially achieved. Moreover, the financial future of Social Security would be assured indefinitely. We will have made the Social Security tax a little more flat, so the flat taxers should be pleased. If we moved to a totally flat Social Security tax, on the basis that a secure retirement income is a broad societal interest, then the base rate could even go down substantially, which would be a boon to hiring at the lower income levels.

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Taxing Consumption

Now when it comes to taxing consumption, the first item of business should be to remove tax deductions that promote consumption. If consumption taxes are an absolute good, then negative income taxes on consumption must be a detriment. And so they are. The best case in point is the deduction for mortgage interest payments. The British Economist Magazine calls such deductions "daft." And these are dyed-in-the-wool capitalists speaking. Even if there is a political argument in favor of promoting home ownership, there is surely no reason to extend the tax deduction beyond a family's first mortgage. There should be no extension to home equity loans and to second homes.

The fairness argument, however, goes against any such deduction at all. Why should the renter subsidize the homeowner? There is no good reason. It would be yet another case of the relatively less well-off Americans supporting the better-off. As a practical matter, however, it is difficult to cut off any government 'benefit,' so the right approach may simply be to cap the benefit, and to phase it out over time.

Wealth as Consumption

The larger argument may come as a bit of a shock, but it needs to be put on the table: We need to tax wealth as consumption. Even Alan Greenspan shares this perspective: wealth represents the ability to consume. Wealth is also the beneficiary of vast government expenditures; hence the holders of wealth are 'consumers' of government services, both directly and indirectly; hence there should be taxes due for services rendered. The entire effort by the Federal Reserve Board and of the Treasury Department to rescue our economy was based on preservation of wealth as the driving principle. More correctly, they acted to preserve asset values, the valuation we place on the actual wealth in our economy. Wealth was deemed to be the source of investment to fund development. Hence it had to be preserved at all costs. More broadly, the Fed sought to prevent deflation overall, which would sharply constrain its policy options.

Let there be no doubt that our whole financial system sat at the edge of the precipice last year, and that only government intervention saved it from the abyss. At Goldman Sachs it was said that if Morgan Stanley went south, the life expectancy of Goldman was about thirty seconds. No one was safe from what was engulfing us. Our government staked literally trillions of dollars on the rescue effort, and thus managed to pull the bacon out of the fire. It's true that they salvaged the whole economy thereby, but in first order they preserved wealth all around. In justice, then, holders of wealth now need to pay the tab. They benefited from an insurance policy on which they had not paid any premiums.

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The rhetoric in which capitalism shrouds itself is invariably self-serving. Malcolm Forbes famously claimed that no one is so innocently employed as when he is making money. A more realistic view is that capitalism never pays its bills. The externalities never appear on its books. That was never as clear as in the run-up to our financial catastrophe. The heart of the matter was that financial risk was assumed to be managed. It was managed by being out-boarded to others. In this manner, micro-scale risk was indeed managed at every step. Macro-risk, however, was no one's problem in particular.

Macro-risk was effectively out-boarded to the society at large by default. If the whole system crashes, then no one in particular can be blamed. It would be a matter of 'systemic risk.' It was not part of anyone's computer models. It was not, however, unexpected. A code was operative on Wall Street during the halcyon days: "IBG,YBG." "I'll be gone; you'll be gone." You and I will be the first to know when the punch bowl runs low, said the fast-money guys to each other, and we'll be out the door before the collapse. This is why the collapse happened so extraordinarily fast once it got under way. The whole fraudulent enterprise was momentum-driven. Once momentum flagged, the end was sure to be nigh. Once confidence in the institutions was called seriously into question, it was all over.

The econometric models on which investment strategies were based explicitly assumed that markets were 'well-behaved.' There was no way to predict large excursions, so they were not in the models. The strategy has been described as a matter of 'picking up dimes in front of a steamroller.' This strategy is defensible only if the chance of getting run over by the steamroller does not have to be factored in. The financial wizards trusted their own alacrity to protect their hides from the steamroller. The threat that the steamroller would flatten not only a particular institution but rather the whole world of finance was not in their calculations.

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Siegfried Othmer is a physicist who over the last 33 years has been engaged with neurofeedback as a technique for the rehabilitation and enhancement of brain function. He is Chief Scientist at the EEG Institute in Los Angeles. Coming to (more...)

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