Category Archives: politics

We Can End Federal Taxation as We Know It

By Barry Elias | Friday, 18 Dec 2015 06:56 AM

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The way we tax is obsolete.

More than a century has passed since the inception of the federal income tax. It’s safe to say, this system has completely broken down. The complex, voluminous tax code — included in the 70,000-plus page CCH Standard Federal Tax Reporter — needs a revolutionary overhaul.

The current system doesn’t raise nearly enough money, social security is nearing insolvency, the administrative cost is exorbitant, and economic growth is actually impeded.

We need tax reform that will increase investment, productivity, employment, income, purchasing power, and economic growth, while keeping inflation and tax compliance costs low. I believe my tax plan will achieve all of these objectives.

The purpose of the federal tax is to collect enough revenues to pay for the government’s annual expenditures. We spent nearly $3.7 trillion in this fiscal year 2015, but only collected about $3.2 trillion, leaving a shortfall of nearly $500 billion, which must be borrowed, and we pay interest on this debt.

Furthermore, we forgo tax revenue due to deductions, exclusions and other preferential tax treatments. Last year alone, that amounted to roughly $1.2 trillion. New types of transactions have spawned an underground economy that is valued at close to $2 trillion per annum, which goes completely unreported. Included in this figure are transactions that occur on eBay and Airbnb; Bitcoin trading; illegal drug trafficking and distribution; domestic assistance; babysitter services; and lemonade stand revenue: The list is endless.

Due to the underground economy, the U. S. Treasury loses nearly $400 billion of tax revenue every year. In addition, social security taxes are only collected on the first $118,500 of earned income. The professional athlete earning $10 million, for example, pays no social security tax on nearly 99% of his pay.

To make matters worse, complying with the current arcane system – one that looms large as a nuisance on our calendars in the months leading up to April 15 – has a hidden cost totaling hundreds of billions of dollars each year. This expense includes tax preparation professionals, financial advisers, estate planners, attorneys, lobbyists, Internal Revenue

Service agents, and the time spent by all parties involved. Nearly 6 billion hours are invested in this activity each year.

Tax compliance actually impedes economic growth. We can use the savings and 6 billion hours of time more productively to grow the economy. Our focus should shift towards making value-added goods and services at more competitive prices, rather than complying with an ineffective and inefficient tax code. The environment has also been harmed as we destroy forests to accommodate the massive printing of forms, manuals and instruction booklets.

Lost revenue and the cost to comply with the current federal tax system probably exceed $2 trillion. This is an extraordinary problem that yearns for a substantial solution.

Huge issues have been tackled at other times in our history. At the dawn of the 20th century, when the NY Central Railroad was forced to convert from steam locomotive to electric trains, the $70 million cost nearly matched their $80 million of annual revenues.

Nevertheless, management figured out a way to lay new tracks underground, while the railroad continued to operate. Incidentally, this investment created a huge, unexpected economic boom. As it turned out, Park Avenue was built over the tracks, permitting air rights to be leased to developers.

Herculean problems call for out-of-the-box measures.

My solution to the current tax conundrum is streamlined and elegant. Instead of taxing monetary inflows, such as income, I propose assessing what is done with the money: it is either saved or spent, and we can derive revenue from both to balance our annual budget.

This plan will minimize tax rates and administrative costs, while maximizing the tax base and transparency. It will also increase investment, productivity, employment, income, purchasing power, and economic growth over the long term for the general population, while keeping a lid on inflation.

My proposal will eliminate all current forms of federal taxation. These taxes include the following: income, social security, Medicare, disability, interest, dividends, capital gains, gifts, inheritances, and corporate profits.

They would be replaced by a tax on savings and consumption. Savings will be assessed at a lower rate than consumption, since a dollar saved generates significantly more jobs and income for society than a dollar spent.

The savings that are assessed would include only liquid financial assets, such as stocks, bonds and cash. These products typically involve the trading of existing assets or the restructuring or retirement of existing debt, instead of the creation of new assets. Too often, financial assets are a method for transferring wealth rather than creating value.

Hence, these savings need to be subject to tax, albeit at a much lower rate than that for consumption.

Excluded from these savings would be direct capital investment, since this activity generates strong employment and income gains. Physical land and buildings would also be excluded due to strong productivity potential, and a low level of liquidity, which might cause extreme market volatility in the event of strong selling pressure to meet tax obligations.

This proposal would balance the federal budget at current spending levels, preserving key social programs like social security, Medicare, disability, Medicaid, food stamps, other welfare programs, and the earned income tax credit, while maintaining a strong defense and homeland security apparatus.

Savings in the form of equities, bonds and cash for individuals, corporations and tax-exempt organizations total nearly $189 trillion, according to the Federal Reserve.

From this amount, the following liquid financial assets would be excluded from taxation:

  • wages and salaries, or $7.9 trillion;
  • $100,000 for a family of three, or $10 trillion;
  • retirement funds, or $25.7 trillion;
  • education IRAs and 529 plans, or $250 billion;
  • direct investment for capital expenditures, or $3.6 trillion (20 percent of GDP);
  • and tax-exempt organizations, or $4 trillion, for a total $50 trillion.

The net taxable amount after exclusions would approach $139 trillion. A savings tax rate of 2 percent on this figure would raise approximately $2.8 trillion.

Instead of reporting dividends, interest and capital gains, financial institutions would report an average daily balance of liquid financial assets on hand over the course of the year — to minimize or eliminate tax arbitrage opportunities — and send the tax directly to the federal government, another cost saver for the American people. I assume most people will not stash much cash under a mattress, since they would forgo a return on their money, and it’s not a safe methodology.

Americans consume about $12.4 trillion annually in goods and services, according to the Bureau of Economic Analysis. Taxing consumption at 10 percent would raise about $1.2 trillion. An annual tax refund of $3,000 would be provided to each family of three to offset the first $30,000 of essential consumption expenditures, costing $300 billion each year.

Therefore, the total revenue raised would be around $4 trillion: $2.8 trillion from savings and $1.2 trillion from consumption. These revenues would offset the current $3.7 trillion annual budget plus the $300 billion yearly consumption refund.

To generate these tax rates, we divide the tax revenue by the pre-tax amounts for both savings and consumption. That is, a 10 percent consumption tax on a $1 (pre-tax) retail item would generate 10 cents of tax revenue, resulting in a post-tax amount of $1.10 ($1 plus 10 cents).

The Fair Tax proposal, which was presented to Congress in the late 1990s, would divide the 10 cent tax revenue by the post-tax amount of $1.10, to arrive at a consumption tax rate of 9.1 percent. By using the post-tax amounts, as used in the Fair Tax model, the tax rates for my plan would be less than what I have stated: 1.96 percent for savings (instead 2 percent) and 9.1 percent for consumption (instead of 10 percent).

The fair tax proposal would subject consumption to a pre-tax rate of 30 percent (10 percent in my plan) and a post-tax rate of 23 percent (9.1 percent in my plan). The Fair Tax plan does not include a savings tax, but does eliminate all existing federal taxes.

In my view, the Fair Tax plan is far too regressive. It hits the poor and middle class hardest, since they consume a much greater percentage of their income and wealth, as compared with those in the upper economic strata.

I believe my plan is fairer in this regard, and will have mass appeal.

The poorest would no longer pay 15 percent for social security and Medicare as they do today; they would likely pay no other federal taxes; and they would still have access to Medicaid, food stamps, other welfare programs, and the earned income tax credit.

The wealthy would no longer pay any of the current federal taxes, including those on income, payroll, interest, dividends, capital gains, gifts, and inheritance. Expenditures on estate planning would be negligible, and wealth will be preserved, since the average annual return on investment will most likely exceed 2 percent.

The middle class would benefit from all of these proposals, including the participation in the earned income tax credit program and a reduction in tax compliance expenditures.

These benefits and savings can then be directed toward the consumption of essential goods and services, such as food, housing, clothing, healthcare, and education.

Corporations will experience tax-free profits and dividends; lower costs of production, including tax-free labor and capital; and severely reduced tax compliance expenditures. As a result, there would be downward pressure on the price of goods and services produced, which would increase purchasing power for the masses.

On the government side, the strategy would virtually balance the federal budget at current spending levels and make social security and Medicare more solvent.

This simple method would assess the most money at the lowest rate with the least cost and most visibility. This transparency would ensure that virtually all individuals would feel the impact of any tax rate increase immediately, resulting in a call for justification or reform. This check and balance would likely keep the rates low and stable over the long term.

Today, special interest tax benefits are visible to a very select few, resulting in higher tax rates and tax bases for others to offset the lost revenue to the government. This system would also allow us to focus more on the creation of value-added products and services instead of on minimizing the tax liability.

By excluding labor and capital from taxation, employment, investment and productivity will rise, generating greater income, stronger purchasing power, and more robust and sustainable economic growth, while keeping inflation in check.

Low tax rates will likely increase net capital inflows from overseas, including some of the more than $22 trillion of U.S. financial assets that reside abroad, as well as new foreign assets. If these net inflows materialize, tax rates can be lowered while maintaining a balanced federal budget. Moreover, reductions in government spending would allow rates to fall further.

My tax proposal is seen as fair, effective and elegant in its simplicity by a large swath of the political spectrum, including liberals and conservatives. The time has come to end federal taxation as we know it.

My wife, Billie Elias, contributed significantly to this article.

Barry Elias is an economic policy analyst. To read more from him, CLICK HERE NOW.

© 2015 Newsmax Finance. All rights reserved.

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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.

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.

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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 II

The asset management business may never be the same, despite record levels of assets under management and annual profits.

In 2014, global assets under management totaled $74 trillion and annual profits reached $102 billion, according to the Boston Consulting Group. However, lurking beneath these seemingly rosy figures are disruptive economic and technological forces that may upend this industry.

Since 2007, asset management costs have skyrocketed 44 percent, according to the McKinsey consultancy firm. These extraordinary expenses are due to the technological infrastructure that is required to support the sales, marketing, and distribution of highly complex financial products. The cost increases have outpaced revenue and asset growth, slenderizing profit margins in North America, western Europe and the emerging markets. Further, the growing cost structure may not subside any time soon.

While new asset flow has reached its highs, much of the asset level growth has been due price rises in stocks and bonds. These markets exploded when the Federal Reserve expanded the monetary base four-fold and lowered the discount rate to near zero. In addition, much of the new money streamed into passive products, such as exchange-traded funds that track indices: these require less active management and have lower profit margins.

Also looming on the horizon is the likely prospect of higher interest rates: as interest rates increase prices of stocks and bonds fall to maintain competitive asset yields. Profit margins may fall 16 percent with an interest rate rise of 1 percentage point, according to McKinsey.

These asset managers have begun to diversify into debt products, such as leveraged loans, since they escape the regulatory burdens faced by banks. This is of concern, since these firms have the potential to become systemically important financial institutions that would require the maintenance of adequate capital reserves, especially since banks are unavailable as market makers to maintain market liquidity for any buyer and seller.

Another danger is the rapidly accelerating industry consolidation. In 2013, the top 10 US asset managers experiencing positive net inflows, such as Vanguard, BlackRock and State Street Capital, received 53 percent of the total. By 2014, this figure grew to 68 percent, since much of the flow was in the form of passive products — a segment dominated by a few firms, including Vanguard.

Perhaps more dire than the underlying economic fundamentals, the asset management model is under heavy attack by the technology industry.

Since the financial market is based mainly on short-term, speculative and arbitrageur trading methods, algorithmic portfolio managers have been moving into this space at a rapid pace, catering to the retail market.

A new threat recently came in the form of a Google alert. This technology behemoth is seriously considering a move into the industry after commissioning a project feasibility study. Coupled with virtual currencies, technology may be the new normal in finance.

Given this trajectory, the financial industry may be unrecognizable in the decades to come.

© 2015 Newsmax Finance. All rights reserved.

Financial Disruption Begins to Take Root

The financial industry is feeling the effects of technological disruption, competition and regulation. This portends well for the investing public and a financial sector that has grown to unsustainable proportions.

In recent years, the U.K. increased financial transparency by unbundling the fee for investment advice and asset management. A decade ago, a fund manager might not have known the fees and a commission-based adviser might have been evasive.

As expected, with more transparency, the cost of these services has begun to fall.

Fund manager fees have fallen below 1 percent of assets, down from 2 or 3 percent several decades ago. Online stockbroker platforms are beginning to charge less than ½ of 1 percent on four-figure balances, and a new fund recently introduced a performance fee-only product. Peer-to-peer lending and crowdfunding provide additional technological alternatives that further competition and place downward pressure on the cost of investing.

Unfortunately, this type of unbundling has not yet occurred in the U.S. and might take several more years.

Mutual funds typically do not advertise the transaction costs associated with fund trading, which the client is responsible for paying. These costs can average 1.44 percent annually, more than the management fees and operational expenses combined, according to Roger Edelen of the University of California, Davis; Richard Evans of the University of Virginia; and Gregory Kadlec of Virginia Tech. Small-cap funds fared much worse, with trading costs of 3.17 percent.

Some passive index funds, which do not trade shares often, offer expense ratios that are 1/10 of those for actively managed mutual funds, which can range from 1.5 percent to 2.0 percent annually.

The research indicates that the greater the trading, the lower the net return to the investor. The annual return for mutual funds with trading in the top 20 percent lagged those in the bottom 20 percent by 1.78 percent.

The average investor might pay a total of 3 percent in management and trading expenses, nearly 1/3 of the annual return of 9.6 percent for the S&P 500 during the past 86 years.

Mutual fund investors and fund advisors pay broker-dealers $8.88 billion annually for account maintenance, shareholder servicing and revenue-sharing, according to a letter from Niels Holch, executive director at the Coalition of Mutual Fund Investors, to Mary Miller, undersecretary of domestic finance at the U.S. Treasury Department, dated Nov. 14, 2014.

Holch claims these payments are not warranted based on Section 120 of the Dodd-Frank Act, which would require the Financial Stability Oversight Council to issue recommendations to the Securities and Exchange Commission that would heighten standards that lower systemic risk to the financial system.

Notwithstanding this legislative requirement, technological disruption and competition could undermine demand for these investment vehicles and encourage more transparent reporting of the true transaction costs associated with their purchase, thereby lowering investor expense.

Technology might inspire greater competition, transparency and responsible regulation that levels the financial playing field for the many.
© 2015 Newsmax Finance. All rights reserved.

Elias Economics

Elias Economics provides an objective analysis of economics, public policy and politics with a global perspective.

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