Capital Gains

A few days ago, I looked at the conservatives’ claim that reducing tax rates produces more revenue.  We saw that the gains in revenue were largely from increased Social Security and Medicare taxes.  A secondary component of that increase was capital gains taxes.

The chart below shows the relationship in the percentage of capital gains taxes to individual income taxes collected as one series and the second series is the amount of corporate and individual dollars collected (in 2000 constant dollars).  We can see the close relationship that an increase in capital gains taxes has on total income tax collections. (Click image to enlarge)

I have long advocated abolishing capital gains taxes for a number of reasons.  The chart above shows just how unpredictable this tax is as a source of income for the federal government, making it difficult for any government to adequately budget for it.  The lost revenue could be made up with a small surcharge on investment transactions, as I have suggested previously.

Revenue Sources

Continuing my study of the shell game that our elected representatives are playing, today we’ll look at the revenue sources of the federal government minus Social Security taxes. (Click image to enlarge)

During the Nixon era in the late sixties and early seventies, excise and other taxes decreased.  As inflation ran rampant during the seventies, taxes on individuals made an increasing contribution to the federal pot.  As a share of the pot, corporate taxes decreased so that in the last three decades, individual taxes and Social Security and Medicare taxes on individuals made up about 3/4 of federal revenue.

As I have noted before, this country practically invites imports.  We have the lowest import duties of any developed country yet we scratch our heads and wonder why our trade balance is so far in the red, why we have a deficit, and where have the jobs gone?

Some will say that government needs to get leaner but most large organizations, both private and public, do not run lean.  Any of us who have worked for a large corporation can attest to that fact.  We can continue to campaign for leaner government but the fact is that the federal government is not raising enough money.  Like a giant Ponzi scheme, our elected representatives have been collecting Social Security taxes and treating the excess taxes as “income”.

In this coming decade, the boomers will start asking for their Social Security pensions.  The largest influx of retirees won’t occur for another 10 years and the demand for Social Security pensions will overwhelm the receipts collected sometime in the middle of the 2020s.

Just as Bernie Madoff swindled most of his investors by not investing the money entrusted to him,  politicians will be in the uncomfortable position of admitting that they spent rather than invested the Social Security excess taxes and there aren’t enough new taxpayers to get the money from.

It’s going to be a bloody battle then – not as bloody as a battle scene in the movie “Braveheart” but you get the idea.  Retired people get the majority of their income from Social Security.  Inevitably, politicians will have to find some way to tell boomers that their pension payments are going to be reduced.  The coming furor will make a Tea Party rally look rather sedate.

Taxes And GDP

Yesterday I looked at the increasing share of Federal revenue that comes from Social Security and Medicare taxes.  The chart below shows total Federal revenues broken into two components, Social Security/Medicare taxes and all other taxes, most of which are personal and corporate income taxes. (Click graph for larger image)

Today I’ll look at taxes and GDP, or Gross Domestic Product.  The chart below shows Federal revenues less Social Security and Medicare taxes as a percentage of GDP. (Click graph for larger image)

In 1980, Ronald Reagan led a campaign to reduce the 1980 17% tax bite.  In each year in the late 70s, the Social Security trust fund had run a deficit, which prompted a series of Congressional increases in Social Security taxes.  From 1977 to 1987, the social security tax increased 23% while the Medicare tax increased a whopping 62%. 

In 1986, the first of the baby boomers turned 40, entering their peak earning years.  As the income of boomers grew, so too did Social Security and Medicare revenues.

The chart below shows federal revenues as a percentage of GDP. (Click graph for larger image)

Note again the increasing percentage of taxes that comes from Social Security and Medicare.  Instead of investing Social Security taxes to pay the future benefits of the boomer generation, politicians of both parties used the taxes to offset declining income tax revenues.  Conservative politicians campaigned on lowering taxes while liberal politicians campaigned on offering more programs.

To this day, conservative politicians repeat their mantra that lowering tax rates produces greater tax revenues.  The data simply does not support that contention.

Liberal politicians continue to dream up new programs to fix another of society’s needs.  To this day, liberal politicians avoid the fact that the only way to fund more programs is to increase taxes on some segment of the population.  President Obama ran for office promising to increase taxes on a relatively small segment of the population, the “fat cats” making more than $250K per year.  Eventually he – and we – will find that there aren’t enough fat cats in the country to pay enough additional taxes for his proposed programs.

As the chart above shows, we cannot run a country by collecting only 10% of GDP in income and miscellaneous taxes without running ever larger deficits.  Several weeks ago, the rating agency Moody’s anticipated the possibility of downgrading U.S. Treasury bonds from AAA status by the end of the coming decade unless we make some changes in our deficit.  Such a downgrade would increase the cost of borrowing, adding significantly to the interest we pay each year on our national debt.

Income Tax Revenues

Conservatives have repeatedly argued that even though tax rates were cut during the Reagan administration, federal tax revenues have increased in almost every year.  Is this true?  YES.  The Tax Policy Center presents a history of federal tax revenues from the Office Of Management and Budget (OMB).

BUT, what conservatives don’t acknowledge is the effect that Social Security revenues have had on total tax revenues. Combining a history of Social Security revenues with the history of total Federal tax revenues, I created a chart to show the effect that increasing Social Security revenues have had on total federal tax revenues.

As you can see, it has been dramatic.  When we subtract Social Security revenues from total federal tax revenues, we see that, contrary to what conservatives maintain, income tax revenues in constant 2000 dollars have not increased almost every year since the Reagan era tax cuts.

The larger income tax revenues of the 1990s was due not to a decrease in tax rates but to an increase in tax rates on the upper income brackets.  As the stock market experienced the “irrational exuberance” of the 1990s, capital gains taxes increased dramatically. 

Have the Bush tax cuts of 2003 contributed to more tax revenues?  Yes, BUT most of the revenue gains were again from capital gains taxes.  As the stock market dramatically declined in the latter part of 2008, capital gains and the taxes on those gains evaporated.

The decrease of income tax revenues accelerated in 2009 and although the chart does not show it, the constant dollar income tax revenue in 2009 was about the same level as 1980.

Federal Deficit Solution

This year’s federal deficit will be about 10% of GDP.  Let’s put that figure in perspective.  Since World War 2, there have only been three or four years that the deficit has exceeded 5% of GDP.  Former Vice-President Dick Cheney famously said that “deficits don’t matter” but they do – for governments, for companies, for individuals. 

States have employed lotteries to fund a number of programs, including education and state parks.  The federal government should have a lottery to help pay off the deficit.  The prize?  A 10 year holiday from federal income taxes for 50,000 winners.  High income earners would buy a lot of lottery tickets, paying back the $2 trillion in tax cuts that they were awarded in 2003.  If 146 million U.S. taxpayers bought just one $99 ticket, that would raise $14 billion less expenses. How many tickets would you buy to get a 10 year reprieve from federal income taxes?  The federal government could “kick the can down the road”, forsaking some future tax revenues for some instant revenue. 

Although high income earners would benefit the most by winning, the lottery would generate sales among those of all income classes.  Lottery tickets would have to be tied to an individual’s social security number to prevent a secondary market of buying and selling of tickets.

The federal government could sell broadcast rights to the prime time night of the lottery drawing , thus earning additional revenue.  The number of viewers would probably exceed that of any Super Bowl, presenting a bonanza opportunity for networks to sell premium advertising time. 

If we are going to have big government, let’s have smart government.  Let’s have fun government.

Health Summit

This past week, President Obama met with leaders of both parties in a televised summit designed to enable each party to publicly state their positions on health care reform.  Ostensibly, the summit’s purpose was to find common ground between the parties but the only common ground was the line drawn in the sand between the two parties.

The summit did make clear each party’s fundamental view of the role of the federal government.  This debate has continued for two centuries and, as I noted in an earlier post, James Madison crafted the debate into this country’s Constitution as the only solution to keep the confederation of states unified into a single country.

During the seven hour summit, Mr. Obama probably put the core issue most succinctly.  After saying that the public could see the difference in each party’s position, he said “that’s what elections are for.”  He could have been referring to the past election, which gave the Democratic Party a clear mandate for change.  In a subtle way, he may have been referring to the upcoming November elections – let the voters decide which position they prefer.

What muddies the political waters are the independents and the “in-betweeners”, those who think that a limited role for federal government should not be as limited as Republican ideologues argue for.  On the other hand, these “middle-of-the-roaders” may see the large role of the federal government espoused by Democrats as too intrusive.

Politicians are prone to explain things in nutty sports metaphors, as though the general public had only a 4th grade education.  So, in case you have only a 4th grade education or are a lover of stupid metaphors, let me explain it this way:  it’s like there’s cows on one side of the fence and sheep on the other side of the fence.  The sheep believe in eating the grass all the way down to the ground.  The cows believe that they should leave a bit more of the grass blade showing so that the grass can regenerate. A bunch of people sit on the fence trying to figure out which side of the fence they’re going to jump on.


Oil Calvary To the Rescue

Many states are struggling with large budget deficits.  It surprised me to learn that the oil industry pays for almost 90% of Alaska’s state general fund.  By state law, the state sets aside 25 – 50% of certain oil and mineral tax revenues into a reserve fund.  Over the past twenty years the state has borrowed almost $4B from the reserve fund to balance their budget, repaying the loan during the past three years as oil prices increased. The state’s 2009 Fall Forecast shows a balance of over $8B remaining in the reserve fund.

Further south, California is struggling with a $6B budget shortfall for this year and over $14B for 2010- 2011.  Because the state relies so heavily on income taxes, a downturn in incomes, especially capital gains, has a severe impact on the state’s budget.  Like many states, California closed their budget imbalance with Federal stimulus funds.  California has been the largest recipient of these funds, totalling almost $7B by the end of 2009, with an additional $15 billion in awards to be paid to the state.  New York and Texas are the runner-ups in the stimulus contest but their awards total a bit more than half of what California has marked up.

Barring any further stimulus packages, the federal spigot to the states is scheduled to shut off this year, leaving state legislatures already battered by difficult choices to make even more unpopular choices.  California’s only choice may be to mount an army headed by a cigar chomping Gov. Schwarzenegger, invade Alaska and take over their oil fields and tax revenue.