Hillary Clinton’s Tax Reform Proposal Falls Short

Hillary Clinton is promoting a tax reform plan that will not achieve her objectives.

Clinton would like to increase long term business investment, since it would stimulate innovation, productivity and economic growth for the masses. A laudable goal, indeed; however, the remedy she prescribes will not cure this patient.

Clinton correctly states that corporate stock repurchases and dividend payments have benefited the corporate boardrooms, C-suite executives and shareholder class at the expense of the working class, since it lowered the level of retained earnings for investment in labor, plant and equipment for many years.

Stock repurchases and dividend payments have equaled, on average, 85 percent of earnings since 1998, excluding two years of recession in 2001 and 2008. In 2014, this figure was about $914 billion, or roughly 95 percent of earnings, with about $565 billion in buybacks and $349 billion in dividends, according to Bloomberg and S&P Dow Jones Indices.

Since March 2009, repurchases total nearly $2 trillion, a prime catalyst for the 191 percent increase in the S&P 500 Index in 5½ years, while stocks with the most repurchases saw a 300 percent return, according to Forbes. During the past two years, sales growth rose 2.6 percent each quarter for these firms, while per-share-earnings more than doubled to a whopping 6.1 percent, according to Bloomberg.

The share of cash flow allocated to buybacks rose to more than 30 percent, nearly double what it was in 2002, while the share for capital spending declined, from more than 50 percent to roughly 40 percent during the same time period, according to Barclays. Low levels of investment have resulted in the highest average age of fixed assets since 1956, reaching 22 years in 2013, according to the U.S. Commerce Department.

Carl Icahn believes the major proponents of quarterly-capitalism are the corporate board members and the chief executive officers, who promote the stock to enhance the value of their equity option plans.

Clinton proposes an increase in the capital gains rate on the wealthiest 0.5 percent to solve the problem.

She envisions doubling the rate to 40 percent for the first two years, and scaling it back gradually to 20 percent over the next four. Currently, the top 40 percent rate applies to assets held less than a year and reverts to 20 percent afterward. These figures exclude the 3.8 percent healthcare surcharge on net investment income.

Recently, BlackRock CEO Larry Fink proposed something similar: a 40 percent rate that applies to the first 3 years, then gradually falls to zero over the next seven.

In an interview several years ago, Larry Fink, whose firm manages $4.7 trillion, suggested he let the country down, since the financial industry became much too large over the previous three decades and the return on capital relative to labor was excessive. Bill Gross, the former founder of Pacific Investment Management Company and a current portfolio manager at Janus Capital, has expressed a similar view and expects these yields to plummet 50 percent.

The problem with Clinton’s proposal is four-fold:

* Approximately two-thirds of stock trading is conducted on behalf of tax-exempt organizations, such as pension funds and 401(k) plans, which are completely immune from any tax implications and already trade with a long-term view.

* Her proposal does not encourage 99.5 percent of the population to engage in a long-term investment perspective.

* Modifying the capital gains rate will not incentivize the corporate board and C-suite executives to focus on the long-term instead of seeking short-term profits to promote the stock price of their firm.

* Financial trading is based primarily on short-term arbitrage opportunities and speculation that do not promote long-term direct investment in labor and capital.

The key to increasing long-term capital investment is to make it more attractive for businesses to do so.

My tax proposal would achieve this objective by permitting an income tax deduction for all capital expenditures in the year they are made. Currently, these expenses are deducted over the entire life of an asset, which can range between two and fifty years.

In addition, my tax plan will replace all federal taxes with a low tax rate on consumption and savings that would balance the budget at current spending levels; save scores of billions of dollars each year in tax compliance expenditures; increase investment, employment and income; and maintain strong purchasing power.

Clinton’s capital gains scheme will not achieve these objectives.

© 2015 Newsmax Finance. All rights reserved.

Nobel Laureate Tirole Says Financial Regulation Is Inadequate

My article below, first published on October 17, 2014, is further validated by Paul Krugman’s op-ed piece in the New York Times on July 24, 2015.

Krugman, an MIT-trained Nobel Laureate in Economics, suggests as I did: the MIT-inspired model is more empirically accurate than the one promoted by scholars at the University of Chicago.

MIT economists recommended pragmatic and tailored financial regulations.  Chicago on the other hand – Nobel Laureate Milton Friedman in particular – subscribed to a more laissez-faire, less regulated construct.

Krugman writes:

“The coming of stagflation was a big win for Milton Friedman, who had predicted exactly that outcome if the government tried to keep unemployment too low for too long; it was widely seen, rightly or (mostly) wrongly, as proof that markets get it right and the government should just stay out of the way.

Or to put it another way, many economists responded to stagflation by turning their backs on Keynesian economics and its call for government action to fight recessions.

At M.I.T., however, Keynes never went away. To be sure, stagflation showed that there were limits to what policy can do. But students continued to learn about the imperfections of markets and the role that monetary and fiscal policy can play in boosting a depressed economy.”

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Nobel Laureate Tirole Says Financial Regulation Is Inadequate
By Barry Elias
Friday, October 17, 2014

Jean Tirole, the 2014 recipient of the Nobel Prize in Economic Sciences, believes the financial industry is not properly regulated.

The selection of Tirole, a professor at the Toulouse School of Economics in France, comes on the heels of the 2008 financial crisis that unveiled the serious shortcomings in the regulation of banks and other financial firms, and the extraordinary market power of technology companies, such as Google and Apple.

Tirole, an MIT-trained economist, was mentored by Eric Maskin, another MIT economist and Nobel Laureate. His area of expertise is industrial organization, regulation and competition. The underlying premise of his work, which has been substantially validated empirically, suggests markets are inefficient, reflect choices based on behavioral psychology and require some level of regulation. This is in strong contrast to the long-held view by theorists from the University of Chicago that markets are efficient and require little, if any, regulation.

George Stigler, the 1982 Nobel Laureate in Economic Sciences from the University of Chicago for his work on regulation, acknowledged in his memoirs that he was very surprised by the confidence he had when he recommended the breakup of the U.S. Steel monopoly in the 1950s, despite having little knowledge of how the industry operated. He said this belief was driven by consensus more than evidence.

Tirole demonstrated that game theory and contract theory can be applied to regulatory paradigm, especially between strong market participants under oligopolistic and monopolistic conditions, where the quality, quantity and prices of goods and services are controlled by very few actors. In essence, he says firms factor into their strategic decision making how rivals will react when they vary prices or product offerings. The University of Chicago school recognized this, but did not follow the implications.

In addition, information asymmetries exist, since the regulated tend to have much more knowledge than the regulators regarding the successful operation of their business, specifically in terms of costs and strategic options. Additionally, there is incentive for firms to be opaque and hide knowledge, thereby “playing games” with other firms and those who regulate them.

A clever regulator can offset these asymmetries by permitting the firm to select from a series of contracts. The firms choice will hint at their cost structure and how much flexibility they have to lower prices.

Tirole believes each industry is unique in how the regulations need to be applied, and it is crucial that they not stymie long-term investment in innovation and productivity. He also suggests that regulation needs to apply to vertical industries that control many aspects of the production process, from simple raw materials to multiple end uses.

His research has been applied successfully in many industries, such as communications, technology and banking. In the 1980s, he helped European governments divest state monopolies. His recommended paradigm encouraged investment and innovation, curbed excess windfall profits and enabled consumers to experience lower prices and better service. In many industries, the United States has not adopted these regulatory measures.

In the late 1990s, Tirole stressed the importance of liquidity in the banking system, where assets can be readily converted to cash to meet financial obligations. He now recognizes the importance of systemic risk where regulated banks interact with unregulated financial entities. This was not addressed prior to the crisis, said Tirole.

Recently, he has been focusing more on banking and finance. He has teamed up with Emmanuel Farhi, another MIT-trained economist and now a Harvard professor of economics, to study the optimal bank bailout policy by the federal government in times of crisis. Tirole is also examining how central banks can enhance liquidity to commercial banks when the demand and supply of their assets are low.

Finally, regulators across the globe are requiring banks to hold more liquid assets.
Tirole also stresses, once you devise and implement an effective regulation strategy, it must be enforced efficiently by the state. To her credit, Federal Reserve Chair Janet Yellen is committed to reigning in the excessive risks taken by the financial community in recent decades.

The financial industry needs strong minds to tackle this issue before another cataclysm rears its ugly head.

© 2015 Newsmax Finance. All rights reserved.

First published on October 17, 2014.

Economic Growth Will Be Restored With Reforms to Protect Dollar

Fifty years ago, the United States began actively debasing the dollar, and the results are now readily apparent: low price-adjusted productivity and total compensation growth, extraordinary wealth and income disparities, and a more treacherous employment environment.

From the beginning of our republic, in 1792, the U.S. dollar was able to purchase 0.77 ounces of silver on a relatively consistent basis, until 1965. That year, President Lyndon Johnson signed the Coinage Act, which permitted the circulation of coins made from less valuable metal alloys instead of the original silver composition.

Since 1965, the dollar’s purchasing power has been in free fall – reaching a nadir of 0.02 ounces of silver in 1980, and recovering minimally to 0.06 ounces of silver today.

Further insult occurred when the dollar lost its backing by gold in 1973 under President Richard Nixon. As the value of the dollar slid, so did productivity. From 1947 through 1973, productivity expanded at an average annual rate of 2.8 percent. However, since 1973, this figure plummeted to a paltry 1.8 percent, according to the Bureau of Labor Statistics.

As productivity declined, many households required more than one earner to maintain comparable living standards.

The civilian labor participation rate for prime-age workers, from 25 to 54 years, was 64 percent in 1948, and by 1965, it reached 70 percent, according to the Federal Reserve. However, following the dollar debasement that year, this figure reached a zenith of 84.6 percent in January 1999 — a staggering rise given the relatively small improvement in living standards for many.

The labor participation rate has since retreated to 81 percent, not because we are experiencing an economic renaissance, rather because many workers in this age group are unable to get absorbed into the labor market due to poor business conditions or less than adequate skill levels.

How can we improve productivity?

Private currency creation is a critical way. Money creation predicated on a creative and innovative use of resources will provide the foundation for stable productivity and income growth.

Effective currency creation will stimulate more prudent long term investment in real goods and services, generating strong economic growth and a more consistent relationship between the money supply and the quantity of goods and services produced. In this scenario, labor productivity will rise, business cycle volatility will fall, and income and purchasing power will increase.

This is the premise behind the virtual currency movement.

Recently, Representative Paul Brown, R-Georgia, reintroduced the Free Competition in Currency Act, an idea originally promoted by Ron Paul, the former Texas Congressman, and based on the work of Friedrick Hayek, a Nobel laureate in economics.

This bill would end legal tender laws, permit private coinage and eliminate capital gains taxation on gold and silver. Also reintroduced recently was the proposal for the Centennial Monetary Commission by Representative Kevin Brady, R- Texas, chairman of the House-Senate Joint Economic Committee, to examine United States monetary policy, evaluate alternative monetary regimes and recommend a course of monetary policy going forward.

In addition to monetary reform, fiscal changes are essential to resuscitate labor productivity and economic growth. Principal among the possible initiatives is the simplification of the tax code.

My proposal, in collaboration with my wife Billie, can balance the budget at current spending levels with lower rates, fewer deductions and smaller compliance costs. We have work to do America – let’s get started!

© 2015 Newsmax Finance. All rights reserved.

The End of Government Bailouts As We Know It

We may be witnessing the end of government bailouts as we know it.

The American International Group became a metaphor for the excesses of Wall Street. The global insurance giant found itself in this dire predicament by producing and marketing ill-conceived financial derivative products that were not properly regulated by federal authorities. The intricate and systemically fragile nature of these complex and opaque financial products metastasized throughout the global economic landscape.

The ensuing financial crisis devastated the world, severing more than $34.4 trillion of wealth off global equity markets valuations from the end of the third quarter of 2007 through the end of the first quarter of 2009 — a 54.6 percent decline to $28.6 trillion from $63 trillion, according to the Roosevelt Institute, a non-profit organization.

During this period, U.S. household wealth plummeted $13 trillion, or 19 percent — from $68 trillion to $55 trillion, according to the Federal Reserve Bank. In addition, nominal GDP contacted $500 billion, or 3 percent — from $14.8 trillion in the third quarter of 2008 to $14.3 trillion in the second quarter of 2009.

The Federal Reserve essentially took control of AIG by providing $182 billion in rescue funds, acquiring a 79.9 percent stake in the company, and replacing the chief executive officer. Despite this taxpayer support, the company issued executive bonuses of approximately $165 million and a bonus package for the entire firm of as much as $1 billion.

By the end of 2012, the U.S. government divested itself from AIG, receiving approximately $205 billion, generating a profit of nearly $22 billion.

In a recent class action lawsuit, plaintiff shareholders claimed the federal government intervention was illegal and sought $40 billion in damages. A recent ruling validated the unlawful nature of the governmental action, but the court awarded no damages. This plaintiffs plan an appeal.

Judge Thomas C. Wheeler of the United States Court of Federal Claims said the Federal Reserve did not have the legal authority to take executive control of the firm, since the Fed does not have jurisdiction over insurance firms. The repeal of Glass-Steagall in 1999 — which permitted insurance companies to engage the creation and marketing of financial products — created a regulatory vacuum for the financial business at AIG.

However, Judge Wheeler suggested this illegal activity actually added value to the firm, since the firm would have declared bankruptcy without any intervention. He therefore stipulated that the plaintiffs are not entitled to any monetary damages.

Supporting this notion, Wheeler cited John Studzinski, vice chairman of the Blackstone Group and an advisor to AIG, who advised the board of directors to accept the government’s offer of 20 percent equity in the company, since “20 percent of something [is] better than 100 percent of nothing.”

It seems the real victims of the AIG debacle are not the AIG shareholders: they are the world that suffered tens of trillions of dollars in lost wealth.

Judge Wheeler believes the banks were treated more favorably than AIG In fact, the Fed may have had more legal authority to intervene more forcefully with them.

While the Dodd-Frank financial overhaul legislation prohibits the Fed from assisting a single institution with capital injections, the new laws are ambiguous regarding equity stakes.

Notwithstanding this ambiguity, the future climate now favors less governmental intervention, since specific terms associated with tax payer subsidies may generate litigation.

As a result, untethered tax payer assistance of financial and non-financial corporations may be on the wane.

The real test is forthcoming, as hedge funds Pershing Square, Fairholme Funds and Perry Capital along with other investors await their day in court regarding government treatment of the Fannie Mae and Freddie Mac — mortgage companies that are now operated under the conservatorship of the Federal Housing Financial Agency.

These government sponsored entities received a federal cash infusion of over $200 billion after the financial crisis erupted, with a stipulation of a 10 percent dividend. In 2012, the terms of the agreement were amended: in lieu of dividend payments, the government would receive all the profits indefinitely. By the end of June, this figure may approach $230 billion.

These investors are staking a similar claim as that sought by the AIG shareholders.

We may be witnessing the failing of too big to fail.

© 2015 Newsmax Finance. All rights reserved.

Compensation Closely Tracks Productivity: And Both Are Weak

Data suggest that wage-based workers have been severely under-compensated when considering how productive they have been.

A careful analysis of this seems to reflect the opposite.

The claims are based on an apparently flawed interpretation of the data, which suggests inflation-adjusted wages have declined 0.7 percent since 1973, while inflation-adjusted productivity rose 100 percent.

Much of this difference is the result of an under-reporting of total compensation (35 percent), a higher level of inflation applied to this compensation (44 percent), and an over-reporting of employee productivity (21 percent), according to The Heritage Foundation.

Wages measure hourly earnings of production workers and non-supervisory personnel: it excludes salaried workers and fringe benefits, such as healthcare, pensions, bonuses, all commissions, exercise stock options, education and transportation stipends, and other unusual forms of payment.

The Bureau of Labor Statistics estimates that these benefits comprise nearly 30 percent of wage-based compensation. As a share of total compensation, the figure may be approximately 20 percent, according to the Heritage Foundation. In fact, since 2001, benefits grew roughly 60 percent, while wages and salaries increased about 37 percent, says the BLS. Greater compensation accounts for 35 percent of the apparent differential.

The consumer price index — the inflation rate applied to total compensation for the purchase of consumer products — is much higher than the implicit price deflator — the price level applied to employee productivity for goods and services sold to consumers, businesses and foreign entities.

This is due to consumer recall bias of high ticket purchases — such as housing, gas and utilities — hedonic quality improvements, substitution for goods and services of comparable quality, and more accurate business reporting of input and output expenditures. Different inflation rates applied to compensation and productivity are responsible for 44 percent of the differential.

Labor productivity has also been overstated, since depreciation has not been taken into account.

As technological development has progressed in recent decades, so has product obsolesce: this requires replacement with no addition to income or productivity. Net domestic product per hour worked — which subtracts depreciation from gross domestic product (GDP) per hour of labor — has only risen 58 percent in the last 40 years, 11 percentage points lower than the 69 percentage rise in GDP per hour worked.

Also, overstatements of import prices suggest lower input quantities, and this artificially inflates productivity.

This dynamic has been exacerbated in recent decades as imports as a share of GDP rose significantly, from an average of 10 percent in the 1980s and early 1990s to 17.5 percent today.

These factors account for 21 percent of the differential.

All told, since 1973, average annual total compensation rose 1.5 percent, while annual productivity increased 1.8 percent.

In agreement with these results are Harvard Professor Martin Feldstein, the former President of the National Bureau of Economic Research; Dean Baker, director of the Center for Economic Policy Research and staff member of the Federal Reserve Bank of St. Louis; and Georgetown Professor Stephen Rose.

During the 25 years from 1948 through 1973, labor productivity rose 3.5 percent each year.

However, since then productivity increased a paltry 1.5 percent annually for 36 of those 42 years, according to the San Francisco Federal Reserve, the Bureau of Economic Analysis and the Bureau of Labor Statistics. Spanning the seven outlier years, from 1996 to 2003, productivity grew at a 3.5 percent clip during the internet boom.

This is not a very good record of achievement.

Making matters worse, median compensation rose less than average productivity, since productivity has increased less for lower-skilled labor than those in high-skilled technologically driven professions.

Since 2000, the Pew Charitable Trust estimates inflation-adjusted wages and salaries have fallen 3.7 percent among workers in the lowest tenth of the earnings distribution and 3 percent for those in the lowest quarter, while those near the zenith have seen a 9.7 percent rise.

How do we increase both compensation and productivity?

Lower the cost of education by implementing new technologies for effective content delivery and instruction geared toward global demand in the marketplace. Total cost of attendance at selective universities for one individual — including tuition, fees, housing and food — now exceed median household income by as much as 20 percent. This cost structure is stifling access to opportunity and innovation.

Reduce healthcare expenditures by implementing a payment system based on positive quality assessments — such as outcome benefits — instead of one driven by the quantity of product and services delivered. Healthcare purchases as a share of GDP rose from 5 percent in 1960 to nearly 20 percent today — a fourfold rise. This too undermines future robust economic growth.

Implement my tax plan, which will lower the cost of employment and capital to generate higher business investment, stronger productivity and greater income growth for the many.

There is a better way.

© 2015 Newsmax Finance. All rights reserved.

Piketty’s Tax Reform Recommendations Miss the Mark

While Thomas Piketty has identified serious shortcomings in the global economic landscape, his policy prescriptions may be disastrous.

Thomas Piketty is a professor at the Paris School of Economics and author of the best-selling book Capital in the Twenty-First Century, which illustrates the unsustainable degree of global income and wealth inequality that has developed during the past several decades.

Piketty’s tax reform proposals would reduce income inequality to some degree, but unfortunately, it would be at the expense of all income groups, including the lower and middle classes.

He recommends a wealth tax of approximately 0.5 percent beginning at incomes of $260,000, 1 percent starting at $1.3 million and 2 percent from $6.5 million or higher. This tax would be applied to all forms of wealth, including nonfinancial assets such as real estate. In the U.S., net worth from real estate is approximately $13.9 trillion, or 17 percent of the $82.9 trillion total, according to the Federal Reserve.

In addition, Piketty proposes income tax rates of 50 percent starting at incomes of $200,000, which would gradually rise to as high as 80 percent at $500,000 or $1 million. While he has not been specific, he suggested these rates might apply to unearned income (interest, dividends and capital gains) as well as ordinary earned income (wages and salaries).

These proposed taxes are in addition to the existing federal taxes.

Typically, higher tax rates provide less incentive for individuals to work and invest. This tends to reduce wages, income and economic growth. Economists refer to this as dynamic scoring in their projections.

Using dynamic analysis, the wealth tax would lower capital formation by 16.5 percent, reduce wages by 5.2 percent, eliminate 1.1 million jobs and lower GDP by 6.1 percent ($1 trillion), while adding only $62.6 billion in tax revenue during a 10-year period. The after-tax income loss to the top 20 percent of the population would exceed 10 percent, while that for the remaining quintiles would be in the 7 to 9 percent range, according to the Tax Foundation.

The higher income tax rate on earned income would lower capital stock by 7.4 percent, cut 2.1 million jobs and reduce GDP by 3.5 percent ($575 billion), while increasing tax revenue by approximately $150 billion over 10 years. The bottom 90 percent would experience a 3 percent decline in after-tax income, while that for the top 1 percent would fall 21 percent. Including this tax rate on unearned income would magnify the damage by reducing capital stock by 42.3 percent, striking 4.9 million jobs and chopping GDP by 18.1 percent ($3 trillion), while reducing government revenue. This scenario implies a plummet of 16.8 percent in post-tax income for the lowest 90 percent and a 43.3 percent drop for the highest 1 percent, the Tax Foundation notes.

The combined effect of the wealth tax and higher income tax rates would be quite harmful to the economy. In addition, Piketty’s plan would further complicate the labyrinth we have for a tax code, thereby increasing the cost of compliance.

My tax proposal  would eliminate all existing federal taxes and replace them with: 1) a consumption tax of 10 percent on all purchases above the federal poverty level, and 2) a 2 percent tax on liquid financial assets, such as equities, bonds and cash deposits, that excludes retirement, educational and philanthropic accounts.This would promote employment, investment and economic growth; lower income and wealth disparities; preserve the social safety net and purchasing power; balance the budget at current spending levels; significantly reduce compliance costs; and capture much of the underground economy where income goes unreported.

Unlike Piketty’s proposal, my plan excludes the taxation of real estate. This would increase investment, development and employment. More importantly, it would enhance financial liquidity, reduce price volatility and lower the likelihood of social disruption, since owners would not need to sell large quantities of illiquid assets quickly to pay the wealth tax in times of crisis.

There may be a better way to do tax reform.

© 2015 Newsmax Finance. All rights reserved.

Why Reagan Supply-Side Economics Did Not Work: Part III

While President Reagan had excellent intentions and some good policy prescriptions, his economic platform ultimately fell far short, as I suggested in two previous columns: Part I and Part II.

The key underlying fault lines were tax reform and monetary reform.

He succeeded in lowering tax rates — the individual rate from 70 percent to 28 percent, and the corporate rate from 46 percent to 39 percent, according to the Tax Foundation. The problem: tax rates on personal income were lower than that for corporate income for all income levels.

This dynamic caused a huge increase in the formation of Subchapter S corporations, whereby proprietors transform corporate income into personal income to minimize tax liability. By 2003, nearly 62 percent of all corporations were S corps, according to the Internal Revenue Service. This environment lowered the incentive to retain earnings and reinvest in employees, equipment and infrastructure.

Investment as a share of GDP fell from 21.75 percent at the start of 1981 to 19.5 percent in the beginning of 1989, a 10 percent decline, according to the International Monetary Fund. Following the financial collapse in 2009, investment relative to GDP hovered near 15 percent, a 31 percent drop from 1981.

Concurrently, consumption as a share of GDP began to rise, from approximately 60 percent in 1981 to 64 percent in 1989. For the previous three decades, this figure held steady at 60 percent. Consumption is now approaching 70 percent of the economy.

High levels of consumption have less of an impact on overall economic growth than does investment, since the expenditure comes at the end of the production process instead of at the beginning. With investment, collateral spending takes place, which acts as an economic multiplier that sustains activity for the long term.

As consumption grew, the merchandise trade deficit as a share of GDP expanded, from close to zero to as high as 3 percent, before declining briefly when the U.S. dollar was devalued during the Plaza Accord of 1985, according to Haver Analytics. This deficit caused a drain on domestic savings, falling from 10 percent to 8 percent, according to the Federal Reserve. Lower savings reduced the quantity of funds available for investment.

Monetary velocity, or money turnover, declined 23 percent during Reagan’s presidency (33 percent in the first six years alone). While some of the decline was due to high interest rates that reduced demand and inflation, the decline was significant. Today, this figure is 61 percent below the 1981 level.

Less direct investment in the real economy was replaced with the creation of huge swaths of financial products and services, which began in earnest during the 1980s. From 1950 to 1980, financial assets were four times the size of the economy. By 2007, this figure rose to 10 times. Financial speculation and arbitrage became the order of the day, which tend to transfer income and wealth rather than create it.

Irresponsible financial deregulation was another impediment. Despite large losses for the savings & loan industry due to mismatched assets and liabilities (they received lower rates on long-term loans than what they paid for short-term deposits), S&Ls were permitted to operate with lower capital standards and received greater deposit insurance. The implicit loan guarantees provided by the government lead to a $124 billion taxpayer financed bailout of the industry in the late 1980s and 1990s, an ominous precursor of the 2008 financial and economic collapse.

As investment declined and consumption rose, income and wealth inequality began to increase after declining for the previous four or five decades, according Emmanuel Saez and Gabriel Zucman of the National Bureau of Economic Research in the graphic below.

Picture-2.png
Today, we are starting to near the disparities that existed prior to the Great Depression.

The principal reason that our economy was able to transform from a real economy to a financial one was the ability of the Fed to extend massive amounts of credit to the financial institutions, which was then transferred to their clients many times over.

When the U.S. completely abandoned the gold standard in 1971, credit and debt were created more readily, since they were no longer backed by a real resource produced with an efficient allocation of land, labor and capital.

During Reagan’s term, total debt relative to GDP rose from roughly 160 percent to 230 percent, the steepest rise since the Great Depression, according to the Bureau of Economic Analysis and the Fed.

This type of irresponsible credit and debt creation would not have been attainable if Reagan instituted an asset-backed currency that was included in both the 1980 and 1984 republican presidential platform.

Money creation that is partially backed by tangible assets, such as gold, silver and virtual currencies, provide incentive for responsible growth that maintains purchasing power.

The assets backing the money stock would serve as a capital cushion to absorb potential losses due to insufficient management or uncertain and unpredictable geopolitical and economic conditions. Embedded in the value of the currency is the production cost of these products, thereby acting as a proxy for price control through market mechanisms. This monetary mechanism would be less susceptible to manipulation by sovereign or special interests.

Unlike the previous gold standards that had a fixed price of gold, this model would be based on a floating rate that could adjust to changing economic conditions. The Bretton Woods agreement in 1944 collapsed in the early 1970s because the U.S. dollar was not permitted to fluctuate fully relative to global currencies and the price of gold was fixed at a specific dollar value.

Foreign entities were able to purchase gold and dollars relatively cheaply. By the early 1970s, the quantity of U.S. dollars abroad exceeded the value of gold in the United States at the fixed price. In 1971, President Nixon disbanded the gold standard policy.

A strong economy is predicated on major tax and monetary reform.

© 2015 Newsmax Finance. All rights reserved.

Reagan Supply-Side Economics Did Not Work

The impediment to our economic progress is the dearth in supply of productive assets.Thirty five years after the introduction of supply-side economics by President Reagan, we are in the unenviable position being left with the trickle in a trickle down economy.The reason: low levels of direct investment in the real economy for many decades.

The Reagan revolution ushered in heavy investment in financial assets. From 1950 to 1980, financial assets were four times the entire economy, according to the Federal Reserve. By 2008, they reached an astonishing 10 times, which precipitated the financial and economic collapse.

The creation and trading of these assets manifested relatively little in terms of jobs and income for the masses, as compared with direct investment. Instead, they functioned to transfer wealth and concentrate it by promoting financial speculation and arbitrage, which tends to be a zero sum game.

From 1987 through 2008, U.S. research and development rose a mere 0.3 percent per annum, compared with 4.9 percent annually from 1953 through 1987, according to Information Technology & Innovation Foundation, a non-partisan research and educational institute. From 1980 through 2008, gross private domestic investment as a percentage of GDP fell 40 percent, resulting in a 60 percent decline in the turnover of money (monetary velocity), according to the Federal Reserve.

Diminished levels of investment in labor and capital have led to a dearth in supply and productivity. Since 1999, labor force participation has declined 5 percentage points, and labor productivity is growing at 1.3 percent per year, the lowest rate in nearly 40 years, according to the U.S. Department of Labor.

The labor force will continue to erode as the baby boomers enter retirement, which began in 2008. Since then, new retirees added to the social security system have risen 50 percent to 2.7 million per year, compared with 1.8 million in the prior decade. The labor force is projected to grow at a mere 0.5 percent rate in the coming decades, a third of the 1.5 percent rate since 1950, according to the Congressional Budget Office.

Another critical issue: there are not enough job vacancies to absorb the unemployed.

In 1999, the unemployment and job vacancy rates were both 4 percent. In an ideal setting, this would signal a perfect clearing of the labor supply by employers demanding employees. Today, unemployment is around 6 percent, while the job opening rate is 4 percent: there are not enough jobs to absorb those seeking work.

Moreover, this unemployment figure excludes the additional 5 percent of the labor market that is no longer counted as unemployed since 1999, bringing the possible supply of labor to an astonishing 11 percent.

Many of these individuals do not possess the skills required by business to compete globally. The poor education system over the past three or four decades undermined the cognitive, social and emotional skill acquisition of our population, This is evidenced by our grossly inadequate performance on standardized secondary examinations in math and english, low tertiary graduation rates, and insufficient pragmatic problem solving abilities.

Less labor and lower productivity will result in lower income and tax revenue, greater deficits and higher debt relative to income, making entitlement programs more at risk to cuts in benefits. In addition, the low supply of real goods and services will place upward pressure on prices in the real economy, which will undermine purchasing power, especially for the lower and middle classes.

Inflation has already impacted the financial economy, where stock and bond prices have increased substantially in the low interest rate environment.

Increasing the supply of productive assets is critical.

My tax plan will do this by eliminating and replacing all federal taxes with a 10 percent consumption tax on purchases above the federal poverty level and a 2 percent savings tax, which excludes retirement, educational and charitable entities. This plan would increase investment, employment and income while balancing the budget at current spending levels, providing a strong safety net to those disadvantaged, and sustaining strong purchasing power for the coming generations.

Future generations are depending on us.

© 2015 Newsmax Finance. All rights reserved.

Reaganomics Devastated the Economy

During the Reagan presidency, the individual income tax rate fell from 70 percent to 28 percent, while the corporate income tax rate fell from 46 percent to 39 percent, according to the Tax Foundation.

Since the personal rate was lower than the corporate rate, there was less incentive to invest in businesses and more incentive to accumulate personal income, especially for the proprietors.

As a result, investment as a percentage of gross domestic product fell by a third from 22 percent in 1980 to 15 percent in 2010, according to Trading Economics. Based on data from the Federal Reserve Bank, monetary velocity (additional income per unit of spending) fell 50 percent during this time. This decline in the economic multiplier was due to a greater concentration of consumption relative to investment. Less income is generated when spending occurs at the end of the production cycle (consumption), rather than at the beginning (investment).

Since 1980, there has been an extraordinary accumulation of wealth by the top 1 percent, from 20 percent to 35 percent. Emmanuel Saez, an economist at the University of California, Berkeley, estimates the top 1 percent have received 52 percent of the economic growth from 1993 through 2010.

By contrast, real median household income (inflation adjusted) has increased by less than 1/5 of 1 percent since 1980, according to the U.S. Census Bureau.

Based on my previous article, corporate tax rates are currently higher than individual tax rates for all levels of net income.

A healthy economy requires the reverse.

When corporate tax rates are lower than individual tax rates, investment as a percentage of income will rise. This will enable productive and sustainable business development, thereby enhancing economic growth for society — one that benefits the poor, the middle class and even the upper class, since more consumers will be available to purchase products.

© 2015 Newsmax Finance. All rights reserved.

Financial Disruption: Part III

Finance is continuing down the path of technological disruption with marked acceleration.

Helping to lead the charge is the Massachusetts Institute of Technology in Cambridge, Massachusetts, known for an environment that incubates innovative intellectual ideas with pragmatic applications. (Disclosure: my son is currently an undergraduate student at MIT.)

At the forefront of this revolutionary change is the concept of the virtual currency, such as bitcoin.

As the pioneers at MIT describe it, this “currency” is much more than a currency: it represents a platform and protocol for ownership and transfer of virtually any good or service in return for any another – whether it is a carrot, a car, condominium, a contract, or a convertible bond.

The principle reason for this highly perfected barter arrangement is the infinitely divisible property of digital assets. In this model, a portion of your kitchen table can be sold and used to purchase a two-year internet connectivity contract. The title of ownership will be more secure and less susceptible to manipulation by individuals, corporations or governments, since the information is decentralized and available for the world to see. Moreover, this system removes many financial intermediary layers, thereby affording quicker and cheaper transactions.

Michael Casey, the senior advisor to the Digital Currency Initiative at the MIT Media Lab explains the real beauty of this system is that no one needs to trust anyone else in the transaction – neither the counterparty nor a neutral third-party – since the information is available to an extraordinary number of people globally. He believes this methodology will enable irrefutable, self-sovereign identity markers of property ownership, irrespective of their socioeconomic or financial status, and enable asset collateralization for exchanging of goods and services He also makes the case that these digital assets can be used to collateralize currency creation, which would be helpful to a country like Greece, so it could pledge state-owned assets to reorganize and service its debt obligations.

Brian Ford, the Director of Digital Currency at the MIT Media Lab, has spent decades at the nexus of technology, public policy and entrepreneurship. He has been leading efforts to mainstream digital currencies through research and incubation of high-impact applications of this emerging technology. In collaboration with global experts from government, nonprofits and the private sector, he is exploring how cryptography, economics, privacy, and digital systems can be used to support the commercial and social viability of this technology. . He recently served as the Senior Advisor for Mobile and Data Innovation at the White House where he led efforts to leverage emerging technologies to address the President’s most critical national priorities.

One of the goals of this initiative is to seriously engage the MIT community to test digital currency concepts that address issues surrounding security, stability, scalability, individual rights, and the economy – with an eye on high social impact. The world-at-large has been taking important note, including government and regulatory entities, central banks, the financial community, and business organizations.

Yanis Varoufakis, a former Greek finance minister, suggested a digital currency could replace the euro if it were backed by future tax revenue; the Bank of England claims the technology will have extraordinary implications; Deloitte issued a report on the potential for state-sponsored cryptocurrencies as an alternative to conventional money; the chief information officer at UBS believes it would simplify banking substantially; Nasdaq is testing bitcoin technology for use on its stock exchange; and many large corporations accept bitcoin for purchases of their products and services, including DISH TV, Dell, the Sacramento Kings, and Kmart.

In my view, the most important application of digital currencies is its use in partially backing the creation of money and credit.

Monetary creation becomes much more responsible, effective and efficient when it is partially backed by the production of goods and services, such as digital assets. This model permits more consistent monetary growth that is linked to the supply and demand of goods and services. The cost of currency production is then reflected more proportionately in the real economy with greater stability and predictability across geographic boundaries and through time. This minimizes extreme and volatile business cycles, enables a more fluid employment environment, and increases income and purchasing power for the many.

We should warmly welcome this new technological disruption.

© 2015 Newsmax Finance. All rights reserved.