Dominoes

Artificially low interest rates make Federal debt obligations unattractive to investors.

Higher interest rates increase the annual deficits and the total debt outstanding.

Uncontrolled entitlements like Social Security, Medicare, Medicaid and Federal retirement programs add to the deficit and debt.

Increased funding of Federal debt by the Federal Reserve (Fed) is more likely than higher taxes or annual surpluses.

Deficits that are not funded by investors (domestic or foreign) are funded by the Federal Reserve.

The purchase of Federal debt by the Fed increases the money supply.

Increases in the money supply filter into higher prices for assets and investments or consumer goods and services.

Increases in prices result in larger deficits and financial hardship for consumers.

The government usually tries to curtail inflation with price controls. (Like capping health insurance premiums.)

Price controls motivate residents to invest in hard assets or to move money outside the country.

An outflow of U.S. dollars into passive assets or overseas leads to currency controls.

Higher prices also lead to a decrease in the value of the U.S. dollar vis-a-vis other currencies.

An eventual inability to meet current debt obligations without increased expansion of the money supply leads to a devaluation of the dollar vis-a-vis other currencies.

An inability to stop the inflation spiral leads to hyper-inflation and further devaluation and price controls.

Meanwhile, investors and entrepreneurs begin to move abroad and many give up their citizenship to avoid being subject to laws that are created out of desperation.

It has happened in many other countries.

It can happen here unless those currently in control of the Federal Government and the Federal Reserve are replaced by leaders who understand that unrestrained spending does not create prosperity and abundance.

Vern

Medicare Tax on Investment Income

In case you missed it, the new health care bill has fundamentally changed the nature of the Medicare tax and might lead to similar changes in the Social Security tax.

Presently, employers and employees pay a Medicare tax of 1.45% each on wages of up to $106,800. Self employed taxpayers pay both the employee and employer portion which represents a 2.9% tax on earnings up to $106,800. This amount is indexed for inflation and tends to increase each year.

The new health care bill will impose a Medicare tax on investment income above a certain level, as well as on earned income. Single individuals who earn more than $200,000 and couples over $250,000 would be subject to the higher rate. In addition, the employee tax rate for the Medicare tax would increase from 1.45% to 2.35%. The employer rate would remain at 1.45% of any covered wages. An employee would pay 2.35% of covered wages and would separately pay 2.35% of unearned income.

If the $200k/$250k thresh-hold is reached, the tax would apply to unearned income in excess of the thresh-hold amount.

The Medicare tax would apply to unearned income from interest, dividends, annuities, royalties, rents and capital gains. Apparently, income from retirement plans and Roth IRAs would not be treated as investment income. Most likely, investment income would include the portion of an annuity payment that is not a return of the initial investment in the contract.

The change in the Medicare tax would not take effect until Jan. 1, 2013.

We can only wonder if or when the Social Security tax will also be imposed on investment income and if it will only be imposed on taxpayers with an income of more than $200k/$250k. We also wonder how long it will take for the thresh-hold limit to be reduced to something like $100,000 a year or even $50,000 per year. It's extremely hard to believe the claims that the health care bill will somehow reduce the cost of health care even while it is costing at least $900 billion over the next ten years. If this bill results in more deficits than projected, there will be pressure to find more sources of tax revenue.

If inflation returns and pushes average incomes up, more and more people will be subjected to the assorted new taxes on those who make more than $200,000 (single) or $250,000 (joint) each year.

For more see http://money.cnn.com/2010/03/10/news/economy/medicare_tax.fortune/

and http://www.msnbc.msn.com/id/35844649/ns/health-health_care/

Vern

Fallacy of the Progressive Ideal

Those who adhere to a Progressive/Liberal/Socialist philosophy appear to believe that government is both benevolent and omnipotent. (Even the leaders of the movement who don't really believe it, promote that message to the masses.)

But this belief in the benevolent power of government to regulate every human activity for the benefit of all is predicated on a serious logical fallacy.

The Liberal or Progressive presumes that whatever the government commands will and can be done. The problem is that there are two sides to the equation. For every right or benefit, there is an obligation or burden on someone. For every form of property that is confiscated to be re-distributed, there is someone who has lost that property by force or the threat of force. Thus, the premise of a benevolent government is destroyed.

The majority of people living in a totalitarian system will comply with the demands of the government but only to the minimum extent required to avoid punitive treatment. A few members of the society will strive and aspire to become one of the leaders who always manage to enjoy a much better life style than everyone else. But the nature of their effort is to be a loyal member of the system rather than to be a productive member of society. Those who are the most productive are expected to be even more productive but are rarely rewarded for their effort. So in time, those are able to be productive give up and produce the minimum that is required to survive.

What if there was only one person on a remote island who knew how to obtain food? If the other residents on that island confiscate what has been obtained, the one who knew how would have little incentive to secure more food than he could eat while out hunting. And he might have a lot of incentive to move to some part of the island away from the others.

Little by little, the level of productivity throughout the entire economy begins to diminish and everyone must cope with fewer of the essentials and comforts of life.

To forestall this decline in productivity, the government begins to impose more and more harsh regulations and punishments for non-compliance. In time, workers are hard to distinguish from slaves who toil for a bare minimum of what is needed for them to continue working.

Those who believe that government can solve problems that have not been solved by free citizens will soon learn that government can only issue laws and regulations that can be enforced at the point of a gun. Force is not an incentive to do well. It is an incentive to become obscure.

Vern

How Much Do You Hate Paying Taxes?

Many decades ago when I was the accounting manager for an insurance company, another manager was constantly complaining about the company and its administrative policies. After a couple of years of being a sympathetic ear, I asked, "If you really dislike working here, why aren't you looking for a job somewhere else?" A few months later, he had moved on to apparently greener pastures.

For those who are seriously unhappy about the taxes they must pay to any high tax state, they are free to move to a number of states that have much lower taxes. Florida, Texas and Alaska are fairly high on that list. Moving from one state to another is rarely perceived as being unpatriotic or otherwise immoral.

When people move to the U.S. from countries that have even higher taxes than we do, no one here calls them disparaging names because they left their country of birth. We actually applaud them for coming to our land of liberty. (That's assuming they came through legal channels, of course.)

But somehow the idea of leaving the USA because of high taxes is perceived by many of us as a dastardly act of betrayal that is close to treason. But why?

I suspect that part of the reason is that we have been conditioned to think of our country a lot like the way we think of our religion. Or, as a minister once told me, "If you don't believe as I do, then you haven't prayed enough." Clearly, he was convinced his religion was the only right religion. And many Americans feel the same way about our country.

This feeling is reinforced by our empathy for the men and women in the military who are risking and often losing their life or limbs in defense of our country.

But the children of the Third Reich were conditioned to feel the same way about their country. The youngsters of Communist Russia believed their country was best. The Japanese during the Second World War believed their country was superior to all others. And so it goes from country to country, religion to religion and even from school to school.

Different people have different priorities and values. Some value personal freedom. Some value economic freedom and freedom from what is perceived to be excessive taxes. If we are to encourage immigrants who wish to live here, we should also encourage emigrants to find what they value the most, wherever they can.

Charles Adams, author of "For Good and Evil: The Impact of Taxes on the Course of Civilization" contends that "The list of notables who have fled their homeland to avoid heavy taxation would read like an international Who's Who. Flight is the number one device used by wealthy people to avoid heavy taxation."

If we value freedom, then we must accept the right of anyone to be free to search elsewhere for lower taxes, fewer regulations or more opportunity.

For those who are truly unhappy with the current burden of U.S. taxes, expatriation may be the best way for them to find happiness. From a tax perspective, expatriating eliminates most of the need for "tax engineering", also known as tax planning. It can also eliminate nearly all of the time consuming and frustrating tax forms and other disclosures that are required by the U.S. government. Of course, there are other countries in the world that impose higher taxes and that are more intrusive than the U.S., but there are also many countries that are like some of our states. They do not impose an income tax and they do not intrude into the financial affairs of their residents.

Vern

Time for Truth About the Social Security Trust Fund

For about 30 years, the Social Security taxes collected from employees, employers and the self-employed have exceeded the benefits that were paid to retirees and the disabled. What did the government do with the excess taxes it collected?

The excess taxes were invested. But where? Surely they had to be invested in the safest possible investment. And what would that investment be? Oh Yes; Of Course. What could be safer than U.S. Treasury Bonds?

But now, USA Today tells us that in 2010 " the (Social Security) retirement program is projected to pay out more in benefits than it collects in taxes — nearly $29 billion more." But why worry about that? After all, there are trillions of dollars sitting safely in the Social Security Trust Fund. (http://news.yahoo.com/s/ap/us_social_security_ious)

But how does the S.S. Administration get that money out of the trust fund? Well, U.S. Treasury bills and bonds are debts of the U.S. Government. In the vernacular, they are I.O.U.s. In order to pay off any of those I.O.U.s, the Treasury Department has three choices.

1. It can borrow the money from someone else -- like the Japanese or Chinese.

2. It can raise taxes.

3. It can borrow the money from the Federal Reserve.

The Chinese have already begun to diversify where they invest their foreign exchange reserves -- away from the dollar. Other countries like Japan are as broke as the U.S. And some of the recent policies of the U.S. Treasury and the IRS are likely to drive a LOT of foreign investment away. So borrowing from foreign investors isn't as easy as it used to be.

President Obama has already told us he wants to raise taxes on the folks who make more than $250,000 a year and he wants to eliminate some alleged loopholes in the tax rules for U.S. based multi-national corporations. But he has promised not to raise taxes on the "middle class" -- which presumably means everyone making less than 250k per year. As I've indicated in other articles, the folks and companies that are targets of these tax policies won't be cooperative lame ducks. They will be doing everything the law allows to avoid or to postpone having to pay more taxes.

So that leaves the third choice. The Fed is always the lender of last resort for the U.S. government. But when the Fed buys debt obligations from the Treasury, it pays for the debt with newly created money. It isn't really necessary to physically print the money. The Fed just makes a bookkeeping entry and more money is magically created.

But -- for those like myself who agree with the Austrian school of economics, when the Fed creates new money it filters through the economy and increases prices. Sometimes the new money increases the price of consumer goods. Sometimes it gets invested in stocks or real estate or things like gold and silver bullion. And in today's economic environment, a lot of the new money is likely to be used to pay off some consumer debts or business debts. But over time, it will add to the total amount of money in the economy which will result in inflation. (See http://en.wikipedia.org/wiki/Austrian_School)

Those are the choices available to the Treasury Dept. to deal with existing obligations.

The Congress and the President have a fourth choice. They can renege on some of the promises of previous politicians who transformed Social Security from a reasonably sensible program for those who lived far beyond their productive years into a program that provides benefits for the low income beneficiaries far in excess of what a real insurance program would provide in exchange for the same contributions or premiums. Those who earned the maximum income during the past 40 years and therefore paid the maximum amount of taxes won't get as generous a return. They could have done better if they were allowed to invest the taxes they paid in a conservative mix of investments. But Social Security benefits are highly regressive -- meaning they provide proportionately more benefits to the lower income participants.

So, we can reasonably expect the Government to borrow as much as they can, to raise taxes as much as they can and to reduce benefits as much as they can (without extreme push-back from the retired and near retired). Once those sources have been tapped out, they will borrow the money from the Fed and we will pay for the benefits with funny money that will reduce the real value of our investments and will increase prices on the goods and services we need.

Vern

For more see http://money.cnn.com/2009/07/29/news/economy/fixing_social_security.fortune/

The Inflation Tax

When I started my first newsletter on legal methods of tax avoidance, my focus was on income taxes. But a few years later, the U.S. economy was experiencing double digit inflation. Somewhere during that period I discovered what I chose to call the "inflation tax".

While I agree with those who argue that inflation is a tax, I don't agree that it is a hidden tax. When inflation rates get into the double digits, everyone is acutely aware of how inflation is hurting their purchasing power.

But there is an aspect of inflation that is hidden and few people are aware of it.

First, let me make it clear that I agree with the economists who argue that inflation is a function of an expansion of the money supply when the Federal Reserve buys government debt by issuing new money. There are other elements in the equation -- such as the so-called multiplier effect and the velocity of money -- but the driving force is new money created by the Fed.

The new money drives up the price of both assets and the price of nearly all products and services.

The assets and products and services aren't worth more. it just requires more dollars to buy something.

With respect to assets like stocks, real estate, natural resources, foreign currencies, collectibles, precious metals and most tangible assets, the increase in the dollar price of those assets is deemed to be a gain by the tax law. If the asset is sold, the increase in the price from when it was acquired and when it was sold is taxable. Under current law the tax might be 15% of the gain, plus state income taxes of up to 10%. Some types of assets like collectibles are taxed at a 28% federal rate and a state tax rate of up to 10%.

Suppose you bought some stocks in a company that produces oil. The stock cost $100 per share. With 6% inflation, it would double in about 12 years assuming that there is no change in the profitability of the company. Although the price has doubled, the original $100 will only buy half as many goods or services. This is like a 50% tax on the stock shares. Then, when the stock is sold, the tax law treats the increase in the dollar price as a gain and subjects that $100 to an income tax of up to 15% federal and up to 10% for some states.

So that's a tax on a tax. And it's what I call the "inflation tax".

Vern

The "Secret" U.S. National Sales Tax

A lot of people who don't like the income tax believe the U.S. should adopt a national sales tax or value added tax. But those on the left of the political spectrum denounce a sales tax as being regressive -- meaning that it hurts the poor more than the well-to-do.

What seems to be lost in this argument is that we already have a tax that works just like a national sales tax.

For 2008, income taxes, employment taxes and excise taxes paid by corporations equaled about 30% of total tax revenues. And this did not count the same kind of taxes paid by the owners of pass-through businesses like S corporations, partnerships and limited liability companies. These pass-through entities tend to be smaller but there are a lot more of them. Conservatively, I estimate that at least 40% of the government's total revenue comes from taxes imposed on businesses.

But here's the catch. A business doesn't really pay any taxes. They merely collect the taxes.

When all businesses are faced with the same cost, that cost will be included in the price of their products and the consumers will bear the real burden of the tax. One could argue that the taxes on employers for social security, Medicare and unemployment benefits have the effect of reducing the wages that could be paid to the employees. But the result is the same as imposing the tax on the consumers.

The far left will argue that it is the evil owners (capitalists) of businesses who bear the burden of the taxes imposed on businesses. That argument falls apart when you consider that owners will shut down a business (or sell their stock) if they are unable to earn a competitive return on their investment. Without an adequate return in relation to risk, investors will put their savings under the mattress or in a low yield but safer savings deposit.

However, when the government imposes more taxes on businesses than other countries do, a lot of the U.S. business owners will move to more hospitable countries. Or they may begin to hire more self-employed independent contractors instead of hiring more employees. Or they may even outsource work to cheaper labor in other countries.

Vern

www.vernonjacobs.com

Life without Big Brother

A growing number of Americans are becoming vocal about reducing the size of government, cutting federal spending and cutting taxes. As April 15 approaches, the number of taxpayers who want to change the system will increase dramatically.

But have you contemplated what life would be like without "big brother"?

First of all, if the federal government were to comply with the limitations embodied in the Constitution, it would be limited to providing for the national defense, maintaining a judicial system, setting rules for immigration and eliminating restrictions on interstate commerce by the states. Everything else would be within the authority of the states.

There would be no federal income tax and the IRS would be limited to collecting excise taxes. The Federal Reserve would not have the ability to inflate the currency if the federal government was not issuing more debt. The federal government would not be involved in education, space exploration, Social Security, Medicare, Medicaid, farm subsidies, corporate subsidies, highway construction, environmental protection and many, many other activities. Our interference in the affairs of other countries would be minimal. There would be no federal food and drug administration and the legality of using drugs would vary from state to state.

Some states would have an income tax and would provide a high level of government services in addition to a social safety net. Other states would rely on a sales tax or property taxes and would not provide many benefits.

A lot of the social safety net that is provided by the federal government would either be provided by some of the states or by private charity. The cost of government would be dramatically lower -- by a lot more than 50%. With less regulation, businesses would not have to spend a lot of time and money on regulatory compliance and paperwork. The federal government would not be able to confer special privileges on unions. There would be fewer lawsuits because there would be fewer laws and regulations that govern behavior unless the behavior is harmful to others.

The U.S. would become even more of a magnet for entrepreneurs and capital from around the world. Consumer prices would decrease due to productivity gains without the offsetting cost of inflation. The IRS would not be terrorizing the citizens.

But many people who are now dependent on the federal government for most of their income would become dependent on the states, on relatives or on private charity. Businesses that derive most of their revenue from selling goods and services to the federal government would need to adjust to a marketplace without the government.

For some this would be good news. But for others it would be financially painful.

Vern

Are You a Conservative or a Liberal?

I received the following comparison of a conservative and a liberal via mail from an unknown source. However, the lack of a specific source doesn't detract from the message. (Vern)

Listed below are very obvious issues that have sprung up in the past two decades. It is an attack on life in America .

If you ever wondered what side of the fence you sit on, this is a great test!

If a conservative doesn't like guns, he doesn`t buy one. If a liberal doesn't like guns, he wants all guns outlawed.

If a conservative is a vegetarian , he doesn't eat meat. If a liberal is a vegetarian, he wants all meat products banned for everyone.

If a conservative is homosexual, he quietly leads his life. If a liberal is homosexual, he demands legislated respect.

If a conservative is down-and-out, he thinks about how to better his situation. A liberal wonders who is going to take care of him.

If a conservative doesn't like a talk show host , he switches channels. Liberals demand that those they don't like be shut down.

If a conservative is a non-believer, he doesn't go to church. A liberal non-believer wants any mention of God and religion silenced. (Unless it's a foreign religion, of course!)

If a conservative decides he needs health care, he goes about shopping for it, or may choose a job that provides it. A liberal demands that the rest of us pay for his.

If a conservative reads this, he'll forward it so his friends can have a good laugh. A liberal will delete it because he's "offended".