Tuesday, March 14, 2006

The End of Deficits

Deficit spending is, in some ways, a very appealing way to fund the government. It does not, as is often claimed, mean that we will pay later for the benefits of government that we receive today. It means that other people will pay later for the benefits that we receive today--our children, mostly--or better yet, other people's children. This is especially true if we can shelter our future earnings, and our children's inheritance, from future taxes.

It is no coincidence that the same people who are leading the charge to fund the government through deficit spending (while protesting that they don't want to do it, but just can't help themselves) are also pushing to eliminate inheritance taxes, reduce or eliminate capital gains taxes and create tax shelters to shield their and their children's future earnings from the high taxes that must inevitably follow years of deficit spending.

A classic example of a tax shelter designed by and for deficit spenders is the Roth IRA. With a traditional IRA (or 401k or the like) taxes are deferred on the investment until after the investor retires--when presumably one's income, and therefore tax rate, will be lower. But with a Roth IRA, one pays taxes on the investment immediately and then pays no tax on the interest or growth of that investment. The two give the exact same result--as long as tax rates are the same at the time of investment as they are at the time of withdrawal. If tax rates go down, the traditional IRA is better. If tax rates go up, the Roth is better. But they're supposed to be retirement accounts! Why would anyone expect taxes to be higher after retirement, than it is in peak earning years? Well, if one is a Congressman, and has decided to tax much less than is needed to fund the government, then one knows that the bill will eventually come due. Roth IRA's were designed by Congressmen who did not want to pay for the government today--and did not want to be stuck with the bill after they retired.

Having identified the problem--a problem, if you're one of those people who does not want to stick our children with the bill for our spending--the solution is simple. Change the tax structure. Don't have future earners pay for today's spending--have past earners pay for it. Interest and repayment of the national debt should come from taxes on assets--rather than from taxes on earnings. In this way, the people who benefit the most from deficit spending--those who are and have been acquiring wealth, while the government is acquiring debt--are the same ones who will pay for that debt. In this way, the net effect on future generations is essentially zero. While we are burdening them trillions of dollars of debt, we are also leaving them equal trillions of dollars of assets, in the form of government bonds. And, for the most part, the same people who will receive the one will be paying the other.

By shifting a portion of the tax burden away from income and on to assets, we also shift a portion of our tax burden away from Americans and on to foreign investors in the U.S. Foreigners own about $10 Trillion in U.S. assets, out of about $50T in total private wealth. If we exempted $20T, then one third of this tax would actually be paid by foreign investors. $20T is enough to give all senior citizens a $500K personal exemption and everyone else about $200K.* With a net tax base of $30T, interest on the national debt could be covered with about a 1% tax.

One might expect that, since investors would get a slightly smaller return on their investments under this tax system, interest rates might go up. But that is unlikely. Interest rates are determined by the threat of inflation and by the profitability of alternative investments. In fact, a modest asset tax can actually encourage investment and help to bring down interest rates, as it discourages luxury purchases. And there is some evidence that asset taxes are more effective at fighting inflation than income taxes. It would likely cause a small drop in the dollar against other currencies, which is neither all good nor all bad.

An asset tax would be a far more equitable and less painful way to pay for the deficit. But perhaps more importantly, it would virtually insure that we would never run another deficit. Why? Because wealth is much more concentrated than income, and even a flat asset tax is far more progressive than our 'progressive' income tax. When the millionaires and multi-millionaires who run the U.S. government realize that they are the ones who will have to pay for the national debt, believe me, they will get religion on deficit spending. They will become budget-balancing fanatics! The richest 1% of Americans earn 13% of all income and pay 25% of national income taxes. (But only about 17% of total taxes, and as I said, they are working hard to lower that share.) By contrast, however, seventy-five percent of all private wealth in America is owned by the richest 10% of households, and 40% is owned by the richest 1%. With even a modest exemption, a national asset tax will be paid entirely by the very wealthiest American households--and foreign investors.

*Since most Americans have much less than that in net assets, I am assuming that only about half of the personal exemption would be applied.


Blogger Dingo said...

Liked your discussion of assets taxes. I very much agree that that is the way to go. It's also a harder tax to cheat on. Can't hide a house.

In case you are interested you can find comments by Dingo on the subject. Just go to google and type in: "flat assets tax" OR "flat asset tax". Last I checked I had the first 4 entries on google. You might have to scroll but you'll get to my posts. My approach is somewhat different but we have the same bottom line solution.


12:47 AM  

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