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The Fiscal Cliff Part 2Posted Thursday, November 29, 2012, at 12:45 PM
I suspect that most people have had financial problems at some point in their life. Having hopefully gained wisdom from the experience, imagine a younger person coming to you for financial advice. Knowing nothing else about the facts and circumstances, what suggestions come to mind?
How many of you would advise that the key to solving financial problems is to borrow more money?
Would you suggest that the person find a way to increase his or her income? You might. But what if the querant advises that they are already working so much that it is interfering with his or her domestic tranquility?
Would you suggest that the person find a way to reduce spending and pay down debt? You might. But what if the querant advises that his or her spouse and children will riot if their lifestyle is scaled back?
Would you suggest that the person file for bankruptcy? You might. But what if the querant advises that bankruptcy would mean defaulting on both family and strangers who may be provoked into doing you harm?
As a nation, that is exactly where we are. We are presently over $16 Trillion in current debt and are obligated to an additional $100+ Trillion in the future that we do not have the ability to pay.
One of the few virtually undisputed principals in economics is that the more something costs, the less of it people will buy.
So, what happens if we raise corporate tax rates? The truth is that corporations can only pay the taxes that they collect in the form of revenue from consumers. Simply put, they have to raise the price of their goods and services to collect the money to pay the tax. If prices go up, consumers will buy less.
So what happens if we raise capital gains tax rates? After all, that is the way that rich people make their money and pay those preferred low tax rates.
For an investment to qualify as a capital gain, the investor must have a risk of losing his investment. At what point do you decide that the potential net profit is not worth the risk and stop investing?
So, what happens if we raise income tax rates? A person living in Indiana today pays the following taxes: Federal income tax - 10 to 35%, Social Security & Medicaid tax - 16.5%, State income tax - 3.4%, County income tax - 1.5%, State sales tax - 7% for a total of 38.4% to 63.4%. Needless to say, there are many other taxes not included. At what point do you decide that time spent with your family, or pursuing other interests, is more valuable than pursuing additional income?
Tax rates and the resulting revenues are not a static calculation. A tax rate of 0% will collect $0.00 in revenue. A tax rate of 100% will collect $0.00 in revenue. Everything between comprises a curve where different rates bring different revenue. A higher rate does not necessarily mean more revenue.
History shows that the maximum revenue is generated when tax rates are between 15 to 20 percent. Therefore, if our problem is that we need more revenue, the answer, ironically, is that we should raise taxes on the poor and reduce taxes on the middle class and the rich.
The bottom line is that raising taxes won't fix the problem.
That leaves spending cuts or bankruptcy. So long as the cuts are real, not the kind Washington always seems to agree on, that could work. Bankruptcy, so long as it is a true repudiation of the current debt and future obligations, could work.
Which choice to make?
If defaulting on our debt would provoke war, or possibly civil war, that may not be a good choice.
The only reasonable solution left is to make genuine cuts in spending and deal with all of the wailing and gnashing of teeth.
It will never happen.
Instead, Congress will try to fool us into thinking that they have done something until it all falls apart. I have no idea when the fall will happen. Greece has hung in more than twice as long as the "experts" and I guessed. But planning your retirement, in my case, or the future for young folks accordingly is probably a good idea.
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