Why higher taxes benefit the wealthy

The economic landscape seems pretty clear. The great divide.

a. On the one hand, the wealthy citizen abhors higher taxes, even taxes which are raised to address the increasing Federal and state budget deficits. After all, they worked hard for their money. Why should they sacrifice their gains to help others.

b. On the other hand, we have representatives in the Senate and House of representatives and various other spokespersons for the common man and woman. These voices reason that the wealthy have gained the most so they should be most willing to sacrifice some of their wealth for the common good. Who can better afford these sacrifices than the wealthy?

But what is a sustainable solution to this socio-economic puzzle? Certainly we can all agree that the annual budget deficits of $1 trillion dollars ($1,000 billion dollars) cannot continue indefinitely.

I would propose that diminishing this annual deficit, even if achieved by increased taxes will benefit both those of considerable wealth as well as those of modest income. And here is why.

The mere idea that this annual deficit will diminish is likely to have a massive, positive impact on the economy and the financial markets that reflect economic well-being.  And the wealthy stand to benefit significantly from the growth in both the economy and the markets.

I submit that the benefit of increased income of the wealthy will outweigh the sacrifice that they endure through increased taxes. Consider the following example: Row

Row

 Year 1

 Year 2

 Year 3

1

Annual income

 $ 250,000

 $ 300,000

 $ 400,000

2

Incremental tax on investment gains from year 1

 $ 10,000

 $ 30,000

3

Annual taxes

 $ 74,500

 $ 84,500

 $ 104,500

4

Tax as a % of total income

 0.30

 0.28

 0.26

 

5

Gain over year 1

 $ 50,000

 $ 100,000

6

Tax increase over year 1

 $ 10,000

 $ 30,000

 

7

Net change over year 1

 $ 40,000

 $ 70,000

In this example, in row 1, the wealthy taxpayer experiences a significant increase in capital gains from investments as a result of the lower budget deficit.

In row 2 we see that the taxes increase as well, but not nearly as much as the gains.

But as rows 5, 6, and 7 show, the increase in taxes is far less than the increase in income resulting in a substantial net benefit to the wealthy taxpayer.

This example illustrates that if the increase in taxes will result in a lower Federal deficit, then the wealthy taxpayer actually derives a net benefit from higher taxes.

This puts the wealthy taxpayer and the modest taxpayer on the same side of the increased tax argument.

A reduced Federal deficit, even at the expense of higher taxes,  benefits the wealthy earner and the moderate earner alike.

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When the price of oil decreases, what happens to the price of gasoline?

We turn on the morning news and learn that the price of a barrel of oil has reached a 6 month high, or a 6 month low, or has not changed at all.

But what is the impact of these oil price changes on the price of gasoline at our local Exxon station?  One would think that the two prices should move in parallel.  But is that really the case?

The table below illustrates how the price of a barrel oil has changed over the past 8 years.  Alongside the change in oil prices, we see the change in gasoline prices.

Year

 (A)

 

 Gal of gas (B)

Barrel

of oil (C )

Ratio (D)

 

Price of  gas

should be (E)

we overpaid (underpaid) (F)

2005

 2.75

66

  24

   2.54

    0.21

2006

 2.76

43

  16

   1.65

    1.11

2007

 2.76

89

  32

   3.42

    (0.66)

2008

 3.91

146

  37

   5.62

    (1.71)

2009

 2.70

66

  24

   2.54

    0.16

2010

 2.76

78

  28

   3.00

    (0.24)

2011

 3.33

80

  24

   3.08

    0.25

2012

 3.34

77

  23

   2.96

    0.38

Column B above indicates the price of a gallon of gas.

Column C indicates the price of a barrel of oil.

Column D shows the ratio between the two.  In 2006, a barrel of oil was 16 times that of a gallon of gasoline.  Two years later, this ratio was 37.

Based on an average ratio of 26, column E shows what a price of a gallon of gasoline should have cost, if the relationship between oil and gasoline were constant.

Finally, in column F, we see how much we overpaid or underpaid at the gas pump.  At the moment, we are being overcharged by 38 cents for each gallon of gas that we buy.

The levers of politics : Fear and Greed

Many of us are shocked by the degree of polarization that prevails in contemporary politics.

We are excoriated from the right about our moral turpitude and our profligate spending.  We are harangued from the left about our insensitivity to the plight of the disadvantaged and the inordinate benefits that accrue to the wealthy.

But while those on the extreme right and extreme left make the most noise, these are not the groups that will ultimately determine our political future.  Rather, our political future will be actualized by those who reside in the middle, the fat part of the bell curve. We are speaking, of course, about the vast undecided majority that occupies the middle of our political spectrum.

And which way will this middle of the spectrum decide?

We have suffered and continue to suffer from a faltering economy.  Business seems to course through the veins of our economy as does blood through the veins of a patient suffering from chronic low blood pressure.  There is economic activity, but with little or no conviction.

Given this environment, the health and strength of the economy will surely influence the election.  And as with all things economic, our political leaders turn to those reliable levers of control — fear and greed.

Those on top of the economic heap strive to convince the vast middle that they aspire to be wealthier.  That we are all alike in this regard.  Stick with us and you will be wealthy too.  This group, in effect, appeals to the greed in each of us.

Then there are those who claim to represent our fellow citizens on the bottom of the economic heap.  These leaders send out a different message altogether.  They caution that the real danger in our economic future lies in the failure of the economy to sustain the old, the sick and the less well-educated.  We are all alike in this regard, they admonish.  Our neighbor has become the victim of economic indifference.  The next victim will be one of us. The appeal of  this group is directed to the intrinsic fear in each of us.

From a distance, it appears that we are engaged in  a gigantic game of tug-of-war, with 350 million participants.  Which of our fundamental impulses will hold sway.

Do we associate   with the upper class, driven by Greed to better our lot.

Or do we associate with the underclass, governed by fear that the wheels will fall off our listless  economy and we all wind up in the underclass.

In politics, like economics,  fear and greed are the master controls.

Why government savings are just pennies on the dollar

Our federal budget deficit is $1,000 billion dollars each year, year in and year out, as far as the eye can see.  This is an annuity in reverse, every year, on into the future.  After five years, we will have accumulated $5,000 billion of debt.  After 10 years, $10,000 billion of debt.  You get the picture.

So what is the federal government doing about this?  They are looking for ways to reduce spending.  But here is the curious part.  When they find a suitable candidate for expense reduction, they always multiply the savings by 10 and call it a savings over 10 years.  As in a $250 billion reduction in educational expenses over 10 years.  And when we hear of their accomplishment, we are so excited about the $250 billion number that we fail to pay attention.  We never see or hear the part about over 10 years.

And it sounds like a pretty good effort. After all, we are saving $250 billon compared to a deficit of $1,000 billion.  It feels like we are taking a solid chunk out of our annual deficit.

But are we really?   Closer reading, and listening, reveals a painful truth.  The $250 billion in savings is spread over10 years.  In actuality, we are saving only $25 billion each year. 

In other words we are not reducing our annual deficit by 25%.  No, we are reducing it by a mere 2.5%.

And this, after all, is just pennies on the dollar.

We are in budget star wars when budget talk becomes budget hyper talk

I  have not been the most loyal star wars viewer.   I saw the first movie, then maybe the second.  After that I confess that I lost interest.

But for me,    the most vivid memory of my star wars experience was the moment when the space ship’s captain clicked on the hyper speed switch and the craft instantly lurched ahead at a speed that was larger by a factor of 10 or100.   The millions of stars that populated the surrounding galaxy rushed past in a blur of streaking white shapes.

For today’s economic discussion, the notable issue is not the stars speeding past.  It is the instantaneous increase of speed by a factor of 100.   So it is with the economic discussions of our day.  We talk about dollar amounts that approach $500 billion, $600 billion, $900 billion.  And then, all of a sudden, we are back at 1.  Not 1 billion, but 1 trillion.

To maintain context and continuity of the economic narrative, we should not let our political or economic leaders refer to $1 trillion.  Rather we should insist that they call it like it is $1,000 billion.

After all, which sounds larger, 800 or 1?  If someone were to tell you we were incurring a budget deficit of 1 something, or 800 something, which would sound smaller?  If you were to say the 1, you would not be alone.  And that is the problem.

We should not permit our politicians to hypershift from billions to trillions.  It lulls the vast majority of the public into a sense of comfort and complacency.   If our deficit is larger than $900 billion and is approaching $1,000 billion, let’s call it like it is.  Do not let our political leaders downshift to trillions to make us feel more comfortable with what is fundamentally a very large budget indeed.

When I think back to my childhood, my father would frequently ask which is heavier. a pound of lead or a pound of feathers.

I ask you the budgetary equivalent.  Which is larger?  A budget of $3,800 billion or a budget of $3.8 trillion?

Economics 101 — How did we have a Federal Budget surplus in the year 2000

Who among us can remember the most controversial economic topic of the Presidential Campaign of the year 2000?

As unimaginable as it sounds today, the topic was  “what to do with the federal budget Surplus“.  That’s right, Surplus !!

Without arguing about what individuals or events were responsible for growth of the budget deficit during the intervening years, let’s simply take a look at what happened to the dollar expenditures during the 11 year period from 2000 to 2011.

Total Federal expenditures in $Billions

  Federal budget item

Year 2000

Year 2011

Largest budget items

a Social Security

$449

$775

3

b Health care

352

858

2

c Education

60

113

d Defense

358

878

1

e Welfare

176

472

4

f Protection

28

56

g Transportation

47

93

h General govt

15

29

i Other spending

80

96

j Interest

223

230

5

k Total Spending

1,788

3,600

l Surplus (Deficit)

$236

($1,299)

As we can see, the total expenditures (as shown in row k) have more than doubled in these 11 years from $1,788 billion to $3,600 billion dollars.

If we look further, we can see that the top 5 expense items are

Social security,
Healthcare,
Defense,
Welfare  and
Interest

In fact, these five items accounted for 87% of the total budget in 2000.  By 2011, they accounted for 89% of the budget.  Arguably, these are commitments and entitlements with no flexibility whatsoever.

I am not trying to justify this growth in expenditures, nor am I trying to argue for a reduction in these expenditures.  I am simply attempting to establish a common understanding of where the money is going.

Now let’s look at these same Federal expenditures from a different angle.  What percentage of the total do we spend on defense, or social security, or healthcare?  And how has this percentage changed from 2000 to 2011?

Federal line item expenditures as a percent of the total budget


Year 2000

 
Year 2011

Change in Pct of total Change
in Pct of total
a Social Security

25.11

21.53

(3.58)

b Health care

19.69

23.83

4.15

c Education

3.36

3.14

(0.22)

d Defense

20.02

24.39

4.37

e Welfare

9.84

13.11

3.27

f Protection

1.57

1.56

(0.01)

g Transportation

2.63

2.58

(0.05)

h General govt

0.84

0.81

(0.03)

i Other spending

4.47

2.67

(1.81)

j Interest

12.47

6.39

(6.08)

As you can see, healthcare, defense, and welfare have risen dramatically as a percentage of total expenditures.  Social security and interest expense have fallen as a percentage of the total.  The other budget items have changed negligibly.

Perhaps the most interesting item is social security.  In total dollars, this item has risen 72%.  Even so, it has become a dramatically smaller part of the total budget in 2011 than it was in 2000.

And watch out for that interest expense item on row j.  If rates were to increase the windfall that the Federal Government has been receiving will disappear.

We now have a sound basis for understanding the trend in Federal spending.  This common understanding will be a foundation for future discussions.

Why do we call it news?

The speed of news

I often wonder, in colonial times, how news traveled from Virginia to Boston or New York to Philadelphia.  How many days did it take to learn that events of political importance took place?

Over time with the advent of the telegraph, the telephone, radio, and TV, the railroad, automobile, and airplane, news can  travel in hours and minutes, not days.

Today, with the advent of the internet, cell phone cameras, and social networking, news can and does travel in seconds.

When news and life can change in an instant

I am an avid newspaper reader.  In fact, on weekends and vacations, I read old newspapers that I didn’t get to when they were freshly published.  These old newspapers are not as relevant as they were when first published, but there are still insights to be gained and information to be gleaned.  But I can tell you that there are times when the news is so startling, so shocking, and so irrevocably new and different, that one immediately recognizes that the world will never be the same.  Under these circumstances, all future events and news will be viewed through a totally different lens and and the old newspapers are rendered  worthless.  These papers, less than a day old,  were describing a world that operated under old and outdated  rules.

The tragic events of 9/11/2001 are the most vivid and visceral recent reminder of one such event.  The financial maelstrom of 2008, though it took longer to develop, is another such event.  Both personal and institutional finance will never be the same.

If it happens over and over again, is it still news?

Fast forward to 2012 and let’s try an experiment.  Have a friend of loved one give you a newspaper article of any of the major topics of the day.  And remove any references to the date.

Greece is about to default on its financial obligations to the European banks. Is this story from Jan 2010 or Jan 2011 or January 2012?

Hold the presses.  Greece has reached an agreement with its Euro zone partners.  What date would you give this article?

Suicide bombs or IED’s have taken dozens of lives in Iraq, Afghanistan or Pakistan.  Is this news event from before, during, or after the US involvement in these countries?  Is it from 2003 or 2012?  This is a period of almost 10 years.  And events of this type occur so frequently, that we see them on the internet, we read about them in the newspaper the next day.  Often, we don’t know if we are looking at two different events or the same one.

And lives are being sacrificed or eliminated in Libya (old news?) and Syria (new news?) in the name of democracy.  Once again, date these events.

Meanwhile, here in the United States, our elected representatives, supposedly acting on our behalf, routinely engage one another in what can best be described as a total lack of cooperation or civility.  Evidence of this governmental intransigence appears over and over again in the newspapers, media, and the internet.  I defy you to date any news article related to the political events (non-events) or actions (inaction)  in Washington DC.

Like a speeding train, news rushes past

This is not to say that the news of the day is unimportant.  There are intensely important events occurring and recurring all over the world.  Iranian nuclear ambitions, revolutions and self-government in the Arab world, United States financial growth, Euro Zone financial solvency and  Chinese economic growth and dominance to name a few.

Lurking somewhere in the numbing and repetitive nature of today’s news is the next world changing and life changing event.  The looming tragedy is that, even with today’s blazing speed of information, we are only equipped to learn about it faster.  We are not equipped to anticipate the event.  Nor, it seems, are we equipped to  prevent it from happening.

If and when the next 9/11 occurs, we will all say to one another, “Do you know what just happened?”

By then, it is no longer news.