Living in California, this issue has been particularly pressing to myself and my closest associates in recent months.  Our state, one of the biggest economies in the world, is on the verge of bankruptcy because of this basic self-defeating desire to have our cake and eat it too.

It’s very easy to be a snide armchair politician (I should know).  What’s much more difficult is to actually overcome this essential problem of living in a capitalist democracy; that we will ultimately get the government and the industry that we deserve.

It’s worth noting here that I’m an ardent proponent of capitalism.  Those who are confused by my recent defenses of socialism need to do some homework.  I would suggest starting with The Wealth of Nations, considered by many to be the first modern work on economics, written by Adam Smith, considered by many to be the father of modern capitalism, and an advocate of progressive taxation, estate taxes (”death tax”, if you’re one of those easily-propagandized types) and many other “liberal” and “socialist” causes.

But the basic problem referred to above, that we want it both ways, is an undeniable pitfall associated with both capitalism and democracy.   Because both are rooted in the advancement of liberty, they rely heavily on the essential goodness of people, and their willingness to take responsibility for their actions.

We as a society, and as a fiscal collective, are failing because we have lost sight of the fact that rights and responsibilities go hand in hand.  You do not get to demand total health care coverage while demanding the liberty to do whatever you please to your body, while whining about the nanny-state.  You cannot assert your absolute right to gun ownership while complaining that there aren’t enough police and policies to protect us, and then chafe against gun control laws.  If you believe that national security is of utmost importance, do not be surprised when you have to take your shoes off at the airport and the government becomes increasingly opaque in its machinations.

So before you go talking to anyone about a balanced budget again, it’s your turn to try your hand at the National Budget Simulator.  The numbers are a few years off now, but it gives you an excellent idea of just how difficult it really is to make your ideologies fit into the cold hard matrix of reality.

For more on the necessity of reconciling the problem of rights and responsibilities, check out Why People Hate Capitalism, a great article which could serve as an excellent wake-up call to all the posers wearing t-shirts with Che Guevara on them that were made in a Guatemalan sweat-shop and sold at Walmart.

What will be the consequences of this necessary increase in the government’s take of economic surplus – and what should they be? Should tax increases be limited to what is necessary to put public finances back in order, and be cut back once the fiscal hole has been plugged? Or should this be taken as an opportunity to permanently increase the state’s control of the economy?

Some answers to this question must depend on what one thinks is the appropriate role of the state. If one thinks its role in the economy should be minimal, taxes should be reduced as soon as the deficits are eliminated. If one thinks the state should be more actively involved in shaping the economy, one may take the need for higher taxes as an opportunity for permanent reform.

The idea that taxes are such a simple thing that they are merely increased or decreased, and the notion that an active role of the state in the economy necessarily implies tax increases and big government, both overlook some of the bigger and trickier aspects of taxation that don’t get enough discussion.

To begin with, a completely laissez faire market devoid of government control and a totally state-run economy are equally absurd ideologies, if only for slightly different reasons.  Looking beyond the minutiae, both place entirely too much faith in the assured harmony and righteousness of a philosophical construct, while ignoring the essential reality of humanity.  Just because it looks great on paper doesn’t mean it’s going to pan out in the real world.

Sandbu, and devotees of the “Free Market,” are wise to choose verbiage like “[government's] role in the economy should be minimal.”  No one is foolish enough to advocate a completely unregulated marketplace and expect to be taken seriously – the question is not whether government should regulate commerce, but how it should do so.

Article 1, Section 8 of the United States Constitution grants Congress the power to “lay and collect Taxes,” to “regulate Commerce” and to “coin Money, [and] regulate the Value thereof.”  A stable currency is a basic necessity which must, by law, be controlled and regulated by the government.  The idea of a completely free market is refuted by our nation’s founding document.  Those who argue that government regulation is in itself a hindrance to liberty fail to understand the concept of “negative liberty” – that is freedom from oppression.  As our Constitution sets out limits for the power of government, so has trust-busting set limits on the power of private enterprise – both in order to preserve the basic freedoms of the common man.

It is a curious bit of cognitive dissidence that many social conservatives are disciples of free-market theory.  The apparent belief is that human behavior must be legislated and policed strictly, except when commerce is involved; people can’t be trusted to make the right decisions when it comes to family planning, intoxicants, or social interaction, but as soon as we start a business we become saints.  America’s experiments with laissez faire capitalism have been utterly disastrous, because they did not account for the human tendency towards greed and exploitation.

The communist ideology topples in the opposite direction.  When equality is enforced, the lowest common denominator becomes the cream of the crop.  Even worse, when the means of production and distribution are owned and operated by the same entity which is charged with their maintenance and health, there is no competition, no choice, no real oversight, and no higher power to appeal to when the system becomes corrupt.

In the real world, walking the middle way between competing extremist ideologies, we see a legitimate need for taxation.  The private sector generally handles resources much better than government, but there are certain things that need to be done that can’t or won’t be done by individuals or businesses.  Anyone who tithes as a part of their faith or belongs to a dues-paying organization understands this basic principle.  No one really likes paying this money, but it is an essential part of our duty as citizens to contribute to the big picture.

Taxation must necessarily be about much more than raising the funds to operate a government and provide for the common defense and general welfare – to say otherwise is to deny that tax policies have any effect on the tax-payer.  So we must ask ourselves, beyond raising revenue, what should tax policy accomplish?

• It should be simple, and deter avoidance – Currently, our tax code is just complicated enough to frustrate the common man and leave him feeling robbed blind, while allowing the savvy to exploit countless loopholes and benefit greatly.  Surely one of the most pressing needs with our tax policy is a sweeping overhaul and massive simplification.  Many so-called “fair tax” and “flat tax” proposals have been made, but they often still overlook the inherent inequalities of our economic system, and can place an undue burden on one group of tax-payers.
• Promote economic development - There are several factors to address here.  Most will agree it is unfair to heavily tax the poor, just as quickly as they will agree that it is unfair to create a tax policy which punishes success.  Tax laws relating to individuals should motivate upward mobility, savings and continuing education.  Corporate taxes should encourage job creation and reinvestment over inflating stock prices.
• Reward good behavior – Beyond the tax credits and refunds that can be used to stimulate the economy, they can also provide incentives for volunteer work,  charitable donations, healthy lifestyles, adoption and family planning, living “green,” etc.  There is no end to the list of positive behaviors which benefit both the individual and society that can be profitably subsidized through tax credits.
• Punish bad behavior – This is admittedly a tough line to draw sometimes.  “Sin tax” is a poor name, as it implies the enforcement of morality via the tax code.  But there are undeniable social costs to things like drugs, alcohol, tobacco, junk foods, etc.  These things are luxuries, and should be treated as such.  The soaring cost of healthy food in the face of cheaper and cheaper junk food is a damning failure of tax policy.  In the bigger picture, problems like pollution and waste, unsafe working environments, shoddy workmanship and improper inspections can be reduced by imposing heavy taxes and fines, or at the very least cover the cost of the damage done to society and the environment.
• Corporate tax policy should act as a trust-buster – With a very progressive corporate tax, the chance of companies becoming “too big to fail” can be nearly eliminated.  If a behemoth conglomerate like GE were to be taxed at an incredibly high rate, the likelihood of divisions spinning off into smaller, independent companies will increase, and the likelihood of mergers that leave tens of thousands unemployed while raising the stock price a few points will decrease.  Monopolies will be reduced, and the consumer will enjoy more competition in the marketplace and greater choice. Higher corporate taxes on profits encourage reinvestment in the company in the form of more efficient technologies, higher wages and benefits – all with the added bonus of reasonable CEO compensation and a more risk-averse corporate environment.

I personally believe we need to abolish the income tax, and look at better primary methods for generating revenue.  Henry George’s genius “Single Tax” is worth bringing back into the contemporary debate in this regard.  Even Milton Friedman describes George’s concept of the land value tax as the “least worst” tax possible.

Finally, I find it interesting that the concept of progressive taxation has been pigeonholed as a liberal or “socialist” concept.  Teddy Roosevelt was a fierce advocate of a progressive tax, and saw it as a direct counterpoint to the values of socialism.  What’s more, to hear the modern right ideologues explain it, Reagan must have been a socialist, Nixon a communist, and Eisenhower… oh don’t even get them started on Eisenhower’s 91% top marginal rate.

Time Magazine has compiled this great top ten list of tax-related tips for tough economic times:

1. Contribute to Your IRA
2. Fund Your Health-Savings Account
3. Claim a Refundable Tax Credit for a New Home
4. Collect a Stimulus Rebate
5. Claim a Natural-Disaster Deduction
6. Claim Property Tax Deductions
7. Beware of Hidden Costs
8. Claim a Job-Search Deduction
9. Take Advantage of Tax Breaks on New Cars
10. Put Old Tax Returns to Use

Check out the full article for more details.

Unfortunately, like all too many Americans, I find myself scrambling to get my taxes squared away just a few days before April 15th.  If you’re like me, you know these are all great ideas as far as next year’s taxes are concerned… but right now we need relief from the last-minute headaches of trying to get everything in order before the deadline!

Here’s a great list of the top 10 last-minute tax tips to supplement those aspirins you just took.

Good luck, and get some rest!  You deserve it.  Happy Tax Freedom Day!

A report from the U.S. Treasury entitled “Income Mobility in the U.S. from 1996 to 2005” has been touted by some as proof that the Horatio Alger myth is alive and well.

From the report:

“Economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. In addition, the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups.”

The data does seem to show that a majority of Americans have moved up, but what of those who see no improvement in their lives, or who fall through the cracks?  Are they merely the collateral damage of a thriving capitalist economy, the lazy bums who just didn’t try hard enough?

Looking at the bottom quintile, we see that 55% remained within that same income bracket, the lowest level of mobility of any group on the chart besides the top 20%.  More people in the middle class moved down into the lower income brackets (34.2%) than moved upward (31.7%), even slightly more than remained in the middle (34.1%).  While according to this data, many Americans’ lives improved in those ten years, many others saw stagnant or declining incomes.  Is it still the American Dream if it’s only accessible to a fraction of the population, and one that is disproportionately white?

More importantly, we have to look at the findings of the report with a critical eye.  The Bush Treasury fudges the numbers to imply that poor people did generally better than rich people during this decade.  On November 17, 2004, Berkshire Hathaway CEO Warren Buffett explained that in reality the richest 400 Americans have seen an increase in collective wealth of 700% from 1987-2007, while the increase in wages for the average American barely kept pace with the increase in the core CPI (Consumer Price Index) – an index that does not include costs of food and energy.

The conservative think-tank known as the Heritage Foundation, attempting to prove that “a rising tide lifts all boats,” points out that the current definition of “poverty” in America includes many comforts unknown in the third world, or even in the United States just a few generations ago.  It’s true that we have made a great deal of progress with poverty in America, and even a person making only $15,000/year is in the top 12.25% of the richest people in the world.  But there’s an important point worth noting in that same article:

“Today, the expenditures per person of the lowest-income one-fifth (or quintile) of households equal those of the median American household in the early 1970s, after adjusting for inflation.”

The implication is that the bottom 20% today are doing as well as the middle-class of the 1970’s, but what’s being discussed is expenditures.  What they don’t mention is that these expenditures are outpacing income, and therefore are increasingly paid for with money borrowed – often at usurious rates.

“Credit is a dual-edged sword.  Access to credit gives low income families a private safety net when something goes wrong. It means they can put groceries on the table even when they don’t have a paycheck this week. But that safety net comes at an extraordinary cost. The credit itself can end up sinking them financially.” – Harvard law professor Elizabeth Warren

As debt piles up, low income families find themselves in a downward spiral.  The poor and working class pay more in interest and late fees, payday loans, overdraft and NSF bank charges, and are even more likely to be audited by the IRS.  We’ve allowed both the public and private financial sector to create a new form of indentured servitude, a wage slavery.

Further, the poor are more likely to rent or take out ballooning adjustable-rate mortgages, pay more in “sin taxes” on things like tobacco and alcohol, and are less likely to be able to acquire health care or higher education at affordable rates.

If you’re utterly devoid of compassion, consider the cost to you.  All of society pays for poverty, not just in the sense of being taxed to provide a public safety net.  The costs of increased crime, drug addiction, poor nutrition and lack of education in low-income communities affect even the most affluent, if only in higher taxes for police, prisons, and entitlements.

The prevailing theory for too long has been that more wealth at the top necessarily means more wealth at the bottom.  It is true that the economy is not a finite pie, wealth is created, but what we need to understand is that in the same way that rich people’s wealth can create jobs, wealth among the poor, working and middle class drives the engine of demand and consumer spending.  Supply-side economics is a nothing but a Trojan Horse for a massive upward redistribution of wealth – without enough demand, everything stops.

There’s a lot we can still do.  A few simple suggestions:

• Balance food production subsidies to improve nutrition. Corn subsidies have helped the price of soda fall 30% over the last 25 years, while the price of fruit has risen 50% – there’s no way that can be good for the poorest Americans’ health.
• Provide financial education to increase savings and investment. All children  should be required to have a basic competency of budgeting and financial planning by the time they are old enough to enter the workforce (16 or so).
• Return to community banking, restoring the focus of wealth from corporations to individuals and small businesses.
• Modernize banking regulations. In the age of “exotic options,” we can’t still rely on Depression-era regulation to keep the markets in check.
• Invest more money into a social safety net; health care, education and the kind of temporary assistance that is excellent short-term economic stimulus to boot.
• Person-to-person lending and micro-lending are rapidly proving to be the wave of the future, and deserve greater public awareness.

Most important of all, get involved, and prove you love your country and your fellow man with blood, sweat and tears – not just lip-service.

The 1933 Glass-Steagall Act was a response to the stock market crash of 1929 and the ensuing Great Depression, and it accomplished two very important things.  The first was the establishment of the Federal Deposit Insurance Corporation (FDIC), protecting bank deposits up to a certain limit in order to prevent bank runs and maintain a modicum of consumer confidence in their banks.  The other important piece, the part that is germane to this discussion, was the prohibition against bank holding companies owning other financial companies like securities and insurance firms.

Glass-Steagall was the bane of the banking industry for decades.  As far as they were concerned, these were outdated and unnecessary regulations which prevented them from making the kind of gangster-money that was their birthright.  Since the early 1980’s, the financial sector had been lobbying to remove these restrictions.

From the 1987 Congressional Research Service report on preserving Glass-Steagall:

The argument for preserving Glass-Steagall:

1. Conflicts of interest characterize the granting of credit – lending – and the use of credit – investing – by the same entity, which led to abuses that originally produced the Act.

2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

The argument against preserving the Act:

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.

2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.

3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.

4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation.

So essentially the arguments for preserving the Act were “we’ve been down this road before, we know where it goes, and that’s why this law exists.”

As for the arguments against; number 1 seems a stronger argument for increased regulation of securities firms and foreign institutions operating within the U.S. rather than an argument for further deregulating consumer banks.  Numbers 2 and 3 just seem naive, but perhaps only because hindsight is 20/20.  Number 4 is only partially true; most notably China maintains a wall between commercial and investment banking, and intends to continue to do so in the wake of the current crisis.

G7 member nations have not historically done so, but the legal and regulatory frameworks in these countries for financial firms are different than ours, by virtue of the fact that they have not had such a separation.  This goes back to argument number 2; repealing Glass-Steagall would be fine, as long as strong regulation was in place to prevent conflicts of interest and firms becoming “too big to fail.”

Never underestimate the venality of politicians. In 1998, regulators allowed Citicorp to acquire Traveler’s Group, a move that was technically still illegal under Glass-Steagall.  So the obvious solution was to simply undo the law.  In 1999, the banking industry got its way with Gramm-Leach-Bliley.

In fairness, while the bill derives its common name from 3 Republican congressman who sponsored it, it was signed by a Democratic president and received bipartisan support in the House.  Doing favors for campaign contributors is a bipartisan issue.

The apologists for GLB point out, rightly, that it was not responsible for the mortgage crisis.  But let’s not conflate the sub-prime crisis with the current economic problems we’re facing.  Reading the proponents (even FactCheck.org’s refutation of claims that GLB is responsible for our current economic woes) is oddly quaint at this point in the game.  In the early fall of last year, the statement that “Bank of America, Citigroup, Wells Fargo and J.P. Morgan Chase have weathered the financial crisis in reasonably good shape” seemed sound when the Dow was still above 10,000 – now they are patently absurd.

The meme that says that Fannie and Freddie were the problem, that subprime mortgage holders are at fault, is the classic “blame the victim” routine.  Risky mortgages are only a problem when they’re over-leveraged – when debt is treated as if it were wealth.

The problem is really quite simple.  What the  repealing of Glass-Steagall has ultimately done is allow the financial sector to balloon to a  ridiculous size, with derivatives now accounting for $1.114 quadrillion (that’s $1,114,000,000,000!) – 22 times the GDP of the entire world.  Too much of our economy is based on people pushing around numbers on paper, and it’s being concentrated in fewer and fewer hands.

Given the fact that banking and investment firms have been allowed to merge into behemoths like AIG and CitiGroup, we can be held hostage by a small handful of “too big to fail” firms – “bail us out with no strings attached, or the economy will crash.”

Too big to fail means too big to exist.  Otherwise, we set the stage for forced corporate welfare – we socialize the losses, and privatize the profits.  If we don’t break these companies up and restore a financial sector that can absorb individual firms going under, we will be bailing them out for decades to come.

The entire Bush administration was one “stimulus” package after another.  You see, we’ve known recession was coming for a long, long time now.  More importantly, the 2008 stimulus wasn’t concerned with stopping a recession, but merely slowing its advance until it was someone else’s problem.

“This stimulus,” said Moody’s writer Mark Zandi in January of 2008, “will not prevent a recession if one is already on its way, as its benefits will not be realized until summer; however, it could substantially mitigate the severity of any downturn,”

Zandi continues:

“Why stimulus? With a presidential election fast approaching, policymakers have come to a quick consensus regarding the risks of recession and the need for fiscal stimulus. The economy is indeed struggling. Real GDP likely grew near 1% in the fourth quarter of 2007, and the economy appears to be contracting in early 2008. The job market has stalled, Christmas sales were soft, and industrial production has gone flat.

The threat of recession is evident in the recent substantial increase in unemployment. The jobless rate has risen 0.6 percentage points from its 4.4% cyclical low last March to 5% in December. Recessions are always preceded by such a rise, and one has never occurred without a recession ensuing.”

So, why did the Bush administration favor tax cuts?  We were told that giving more money back to the wealthiest Americans was the best method for stimulating the economy. 

In the face of stale rhetoric about trickle-down economics and welfare queens, one of the biggest economic power-houses in the world lays out the truth.  The only government spending which stimulates more than increased infrastructure spending is a temporary increase in food stamps, and extending unemployment insurance benefits.

Among the worst methods for stimulus?  The Bush tax cuts, reducing the corporate tax rate, and cutting dividend and capital gains tax rates.

The numbers don’t lie, but politicians sure do.

“When I hear the constant vilification of corporate America, I personally don’t understand it. I would ask a lot of our folks in government to stop doing it because I think it’s hurting our country.”

Now, cheap populism is easy, and its getting a bit tired.  But let’s look at this rationally.

First of all, what Mr. Dimon means is “it’s hurting the stock market,” and it’s arguable whether he has a point or not.  As discussed in my last money article, it appears we’re on the inevitable downside of a massive bubble, and losses in the market probably have almost nothing to do with current government action.

Second, there have been some very real villains in corporate America in recent years, and many of them have been partially involved, in deed or in spirit, in this latest bubble-and-bust economy.  If Madoff and Stanford can be prosecuted for running ponzi schemes, why not AIG, Citibank, Bear Stearns, Lehman Brothers?

I’m not claiming anyone’s guilty who hasn’t been proven so. But do we not have an obligation to root out and punish those who have broken the law?  Shouldn’t we make an example of them?

Supposing Dimon’s right about this, and the government’s pursuit of justice for criminal behavior is hurting the stock market, I still think it’s a price worth paying.

Those whose fortunes are largely in the markets will have to tighten their belts and be patient with their investments.  Meanwhile, all Americans will receive the benefits of a properly-regulated financial sector and a more secure future.  On this point, even Dimon agrees.  Read more at Bloomberg.

But here’s where I’m still at odds with Dimon:

“If we act like a dysfunctional family and we don’t finish these things and we’re forever debating them, I think this will go on for several years. It’s completely up to us at this point.”

Cheap populism and vilification of the rich are lazy and counter-productive, but let’s be clear: if we don’t put checks on greed, it will always come back to haunt us.  This notion – that if we don’t let corporate America do what it wants without questions, and if we continue to debate how to maintain and regulate a healthy market in the years to come, it will hurt the country – is just a lazy and counter-productive excuse to continue business as usual and not make the hard changes and investments our economy needs.

While there are limitations to an index based on such a small number of companies, the Dow gives a good pulse of economic health in the big picture.

I was searching around for some information on the DJI adjusted for inflation the other day, and came across this little gem.  Most striking is that the real annual return of the Dow over 80+ years have been approximately 1.64% after taking inflation into account.

Not surprisingly, 3 large bubbles are visible, poking above that 1.64%/year curve.  The first is of course the boom and bust that led to the Great Depression, a sharp spike in both directions and lasting less just a few years from about 1925-31.  In the mid 50’s, a new bubble begins to form, peaking about a decade later and sliding down as fast as it came up for another 20 years, finally hitting a bottom in the late 70’s/early 80’s that is almost as low on the scale as the Great Depression.

By around ‘95, another bubble takes off like a bat out of hell, slows a bit in the wake of the “dot-com bubble” and September 11, but promptly returns to its previous high in late 2008… which is when the bottom fell out.

It would appear, looking at this, that we’ve still got a few thousand points to shed before we hit bottom.  It remains a mystery how few people saw this crisis coming.  Looking at this chart in 1999, it should have been obvious a massive bubble was bound to burst any day – but the financial wizards saw no end in sight to rampant growth?

Not wanting to repeat the mistakes that created Japan’s “Lost Decade”, both the US and UK governments have been moving quickly, first lowering interest rates and now pushing government dollars into the economy via special projects, in the hopes of the money making its way to businesses and consumers.

The major concern with pumping government money into the economy is always inflation.  Given that we are potentially facing serious deflation in the US in the near future, this is primarily a long-term concern.  Governments appear to be counting on the economy turning around quickly, allowing a quick return to a smaller money supply to restore balance and stave off inflation.

Of particular interest to America is the fact that the Bank of England, the counterpart of our Federal Reserve, was nationalized in 1946.  Our Federal Reserve, however, is not completely state-owned.  With all the discussion of nationalizing private banks, perhaps we should be looking first at the necessity of completely nationalizing or even eliminating the Federal Reserve.

Section 8 of the United States Constitution authorizes Congress:

“To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”

When the Federal Reserve was established in 1913, it was decided that a nice little loophole there meant that a quasi-public entity could control the creation and value of paper money, and since then electronic money, since these aren’t “coin”.

Shouldn’t creating and regulating the value of paper and electronic money be just as much considered to be “coin[ing] Money” and therefore be as much under the control of Congress and the Treasury?  It might be beneficial to be able to increase the money supply in the US without having to pay interest to private banks.