Simple Economic Solutions to Big Problems

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“My business, Miss Taggart?” said Midas Mulligan. “My business is blood transfusion—and I’m still doing it. My job is to feed a life-fuel into the plants that are capable of growing. But ask Dr. Hendricks whether any amount of blood will save a body that refuses to function, a rotten hulk that expects to exist without effort. My blood bank is gold. Gold is a fuel that will perform wonders, but no fuel can work where there is no motor. . . . No, I haven’t given up. I merely got fed up with the job of running a slaughter house, where one drains blood out of healthy living beings and pumps it into gutless half-corpses.” – Ayn Rand, Atlas Shrugged

In my last post, I discussed what I thought were some of the fundamental problems with America today, giving an egregiously oversimplified explanation of why we are heading toward oligarchy. For an actual explanation of why we are heading toward oligarchy, read this review of Thomas Piketty’s Capitalism in the 21st Century, titled “Why We’re in a New Gilded Age” by Paul Krugman, or, better yet, read the actual book itself.

Given that a financial magazine for investors released it’s annual “Rich List” of the top 25 highest-paid hedge-fund managers (whom, combined, earned more last year than all of the kindergarten teachers in the U.S. combined – two times over), today felt like a good day for the second post in my series about how to get the U.S. back on track. In this post, I cover a few basic financial and economy policy proposals that are steps in the right direction.

Raise the capital gains tax

There are two primary sources of income: earned income (wages) and capital gains (returns on investments). Earned income is based on your salary. If you earn more than $100k per year, you are taxed at a higher rate than if you earn $30k. This is called a progressive tax system, because higher earners pay a disproportionate amount in taxes. People debate the nuances of this tax system, and, though it is among the lowest of any high-income countries, it is not so low as to be egregious.

In contrast, capital gains are taxed at a lower rate. There are two types: short-term capital gains and long-term capital gains. Short-term capital gains are investments that are held for less than one year, and are taxed at 35%. Buying and selling a stock or flipping a house in 6 months are examples of short-term capital gains. Long-term capital gains are investments held for longer than one year, and taxed at 15%, regardless of income level. This is effectively an implicit government subsidy for those wealthy enough to invest, and is, in effect, a regressive tax.

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During Mitt Romney’s presidential race in 2011, the subject of his taxes were a hot topic on the campaign trail. The founder of Bain Capital, a private equity firm (perhaps the most excessive beneficiaries of capital gains largesse), Romney tried hard to connect with the common people, yet refused to release his tax statements. When he finally did, it showed that he had an effective tax rate of 15% on incomes of $50 million. That is because of capital gains. Capital gains are the reason that Warren Buffett has a lower tax rate than his secretary.

This is how investors make money. Financial services has experienced the most rapid growth of any sector in the modern post-industrial economy. There is no reason that individuals who earn a living trading financial products – stocks, bonds, etc. – should be taxed at a lower rate than everyone else. Ignoring the fact that, for the most part, bankers and traders are effectively rent-seekers that add no value to society and siphon money from the system, functioning more as a parasite than anything else, these individuals need to be taxed at a higher rate.

Defenders will say that lower taxes on capital gains create incentives for people to invest for the future, hold stocks for longer, and encourage long-term thinking at companies where pressure from quarterly earnings statements engender poor decision-making. Raising the capital gains tax will hardly negatively affect any of those things. People will still invest, because, what else are they going to do? Companies that think long-term will outlast their competitors.

The only people who will be hurt bby this are career investors – the bankers, the short-sellers, the hedge funds – that have a disproportionate amount of influence in government. Raising the capital gains tax will not only generate big revenue for the federal government, it will reduce the oligarchic power that that financiers currently hold in America.

Simplify the tax code

Michael Bloomberg said that when you want people to do less of something, you tax it. The opposite is also true. The U.S. tax code is a leviathan, bloated from years of deductions and exceptions designed to incentivize specific behaviors deemed good for the economy or society as a whole. The most obvious example is the tax deduction on charitable contributions. The reason your donation to the United Way is tax-deductible is because the government wants to incentivize you to give money to charity. The tax code is filled to the brim with similar deductions, which, with the help of a savvy accountant, can turn a progressive tax system into one that rewards those who can pay for a guide to navigate the murky waters for them.

Ideally, we could start over. Get rid of the entire tax code and start over from the beginning. Make it simpler, easier to understand, and, above all else, more transparent.

For years, politicians have talked about simplifying the tax code. For an issue that receives as much bipartisan support as it does, the tax code is arguably the most difficult thing to reform, short of the prison system. There are simply too many powerful stakeholders who have a lot to lose when their deductions go away.

End farm subsidies

Farm subsidies are another egregious boon for the rich. Originally designed to make American agriculture more competitive on a global scale, the oft-debated Farm Bill contains huge subsidies for largely corporate farmers – Archer Daniels Midland, Cargill, and other conglomerates – which was hardly the intention when the legislation was originally passed.

Aside from the fact that it undermines the agriculture sectors in developing countries through a combination of cheap crops and tied aid, farm subsidies take money out of the pockets of the American people and put them in the hands of corporate farmers, without providing any real benefit to the country. The reason they still exist is because the agriculture lobby controls enough politicians in the House of Representatives and Senate that dislodging them would require a degree of political gamesmanship and backbone that this or any other congress lacks.

Tax carbon

This one is not directly related to the current issue of the hollowing out of the middle class and America’s march toward oligarchy, but I thought I would put it in here because it is both essential to our survival as a species and a fantastic source of revenue for the government. In economics, carbon emissions are what is known as a “negative externality” – a byproduct of something else that is not factored into the cost. Car emissions are a good example. A hybrid car costs more than regular gas-powered one. That is partly because the technology is newer, and partly because it is paid off over time through lower gasoline expenditures. But it also has lower emissions than gas-powered cars. Emissions from normal cars pollute the environment – a reality that isn’t factored into the cost.

That Bloomberg quote was actually a reference to his advocacy for a carbon tax. If you want people to do less of something, tax it. By taxing carbon, we could both reduce emissions and replace other taxes. Elizabeth Kolbert describes the options in The New Yorker:

In the United States, a carbon tax could replace other levies – for example, the payroll tax – or, alternatively, the money could be used to reduce the deficit. Within a decade, according to a recent study by the Congressional Budget Office, a relatively modest tax of $25 per metric ton of carbon would reduce affected emissions by about 10%, while increasing federal revenues by a trillion dollars. If other countries failed to follow suit, the U.S. could, in effect, extend its own tax by levying it on goods imported from those countries.

Normally, I wouldn’t advocate for protectionist trade policies, because, as I will explain in the next section, they are generally counterproductive and damaging to an economy. But, unfortunately, climate change, man-made or not, is a real threat. And this is an externality that is currently untaxed.

What’s next

In my next post, I’ll present a hodgepodge of other policy recommendations.


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"Josh Weinstein is a visionary. I read his blog every day." - Bono
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2 Responses to Simple Economic Solutions to Big Problems

  1. am says:

    1. is fine.
    2. is needed but I don’t think you mean a flat tax which is very simple.
    3. will result in an increase in the international price of corn and also a decrease in the international production of corn. I assume that the farmers will stop growing corn if it is no longer subsidised. I also assume that moving from tied to cash aid will result in the US no longer exporting corn as food aid and the people will have to get it from somewhere else. That is fair enough but where. Certainly not in Africa so it will have to come from somewhere like Brazil et al. It will also be more expensive. The American subsidy on corn actually keeps the price of corn down. Remove it and it will goup substantially.
    4. will make the US uncompetitive, I think.
    All of above proposals will increase revenue and I assume you will post on how to spend that revenue.

  2. John Galt says:

    Love the opening paragraph.
    Very controversial. Who would administer the carbon tax. Isn’t this just another way for the financial institutions (Goldman, Morgan Stanley) to just make more money by administering and betting on the carbon tax.

    Also, you didn’t mention the high frequency traders who are just stealing money from everyone (except Goldman who seem to make money off everything and do nothing). note: Flash Boys by Michael Lewis.

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