Taxes

Herman Cain’s 9-9-9 Sham

/ L. M. Walker / 4 Comments

More Questions than Answers –

By: Larry Walker, Jr. –

Herman Cain argues that the reason we need his 999-Plan is because the tax law is too complicated. But is it really? I’ve worked with the tax law for 30 years, and I don’t think it’s all that complicated. It may have some complex calculations, mainly related to a few special write-offs and credits, but the basic bedrock of the Internal Revenue Code isn’t at all complex. Following Cain’s logic, if the tax law is so complicated that it needs to be “thrown out” and replaced, then isn’t our entire legal system similarly complex? If you answered yes, then why not just throw out the entire United States Code, shut down all courts including the U.S. Supreme Court, and just substitute the 10-Commandments. Would that work for you? If not, then why would you be in favor of Herman’s Cain’s overly simplistic 9-9-9 Tax Gimmick?

Business Taxes

Under present tax law, business expenses that are ordinary and necessary for the production of income are deductible for income tax purposes. The reason such expenses are deductible is because they represent taxable income to the recipient. There’s nothing really complicated about this. Expenses such as wages, advertising, office supplies, vehicle expenses, postage, legal and professional fees, commissions, rental payments, utilities, uniforms, travel, meals and entertainment, telephone usage, insurance, licenses, interest expense, benefits costs, retirement plan contributions and others, which are incurred for the production of income, are deductible for federal tax purposes. Although state and local governments are exempt from federal income tax, a deduction for state and local taxes is also allowed, under the theory that taxpayers should not be taxed at the federal level on taxes paid locally. All such expenses are likewise deductible in determining an entity’s profitability under general accounting principles. Where the law gets complicated, as far as business taxes are concerned, is when it comes to accelerated depreciation and general business credits.

Accelerated Depreciation

The reason fixed assets are depreciable is that each has a limited useful life, so the cost is spread over the life of the asset. For example, a computer has a useful life of 3 years, such that at the end of three years it generally needs to be replaced, so a business is allowed to write-off the cost over a three-year period. However, special gimmicks have been instituted over the years to accelerate the write-off of assets, such as the Section 179 deduction, and 50% or 100% bonus depreciation, whereby at least half or the entire cost may be written off in the year of purchase. If society wants to get rid of the accelerated depreciation loophole, then all that’s required is for the legislature to change the law back to regular straight-line depreciation. It doesn’t take a genius to figure that out, nor does it require throwing out the entire tax code.

General Business Credits

The other place that the law departs from reality is when it comes to tax credits. General business credits are special privileges which allow a company to receive direct tax credits over-and-above the normal deduction. For example, under the new Small Business Health Care Credit, where a business would normally be able to deduct the costs incurred for its portion of employee’s health insurance, a tax credit may now be taken over and above the regular deduction. Where it gets complicated is in determining which businesses qualify for the credit. In order to qualify a business can have no more than 24 full-time equivalent employees, and the average amount of wages paid per employee cannot exceed $49,999 per year. To obtain the maximum credit, a business can have no more than 10 full-time equivalent employees who are paid an average of less than $25,000 per year.

To determine whether one qualifies for the Health Care Credit, a business must be able to calculate the number of full-time equivalent employees and the average amount of wages paid based on complex formulas. Further complicating matters, the business must include and exclude certain types of employees and certain wages. Finally, if the business does qualify, it must subtract the amount of the tax credit from the amount of the normal deduction. For more on this, see Obamacare’s Effect on Small Business. If Americans wish to get rid of the smorgasbord of general business tax credits, it could be accomplished through legislation. It doesn’t take an Occupy Wall Street protest, or a 999-Plan to make this change. All that’s required is leadership.

Getting rid of accelerated depreciation and general business credits would go a long way toward tax simplification. Once accomplished, tax rates may be reduced to more tolerable levels. It doesn’t take a genius or a 999-Plan to accomplish this.

Problems with Cain’s 9% Business Flat Tax

The most egregious problem with Herman Cain’s plan involves wages. Under current tax theory, when a business pays wages, the employee bears the tax responsibility, not the business. But under Cain’s upside-down theory, businesses will not be allowed to deduct wages from gross income, unless they reside in empowerment zones. So in effect businesses will bear a 9% tax burden on the wages and salaries that they pay, and in addition employees will incur a 9% tax on the same. The double taxation of wages in the 999-Plan represents not only a huge departure from basic income tax theory, but from common sense.

Interest expense is currently deductible for income tax purposes as it represents taxable income to the recipient. But under Cain’s theory, interest will no longer be deductible by the borrower, yet it remains taxable to the lender. This is also an extreme departure from common sense. Under Cain’s theory, a corporate officer who loans money to a majority owned company would be taxed on the interest income received, while his company would incur a 9% tax on the same. Who wants to pay a 9% tax on the interest paid to banks and other lenders? It’s not personal, it’s the principle…

Contributions to employee retirement plans are currently deductible for income tax purposes, because they represent future taxable income to the recipient. But under Cain’s plan, company contributions to retirement plans are apparently not deductible for tax purposes. In effect businesses will bear a 9% tax on such contributions and the recipient will bear another 9% tax upon the withdrawal. Again, this form of double taxation represents an extreme departure from basic income tax theory.

Employer paid health insurance premiums are currently deductible for income tax purposes, and not counted as income to employees, although theoretically it should be taxable to employees. But under the Cain plan, employer paid health insurance premiums will apparently not be deductible. In effect, employers will pay a 9% tax on top of the amount paid towards employee’s health insurance benefits. So an employer will be taxed whether or not it provides health benefits. Since there won’t be any incentive for providing health care coverage under the 999-Plan, what will occur? Will companies continue to pay for health benefits plus 9%, or will they just keep the money and pay the 9%? Absent any other requirements, what would you do?

9% Business Flat Tax

“Gross income less all purchases from other U.S. located businesses, all capital investment, and net exports.”

Since Cain doesn’t define the term, “purchases”, what exactly does the above statement mean? Volumes could be written to define this simple statement. For example, does the term “purchases” include services or is it limited to products? If a company buys supplies such as paper and toner, from other U.S. based businesses, are these items deductible, or does deductibility only apply to purchases of goods for resale? If a company employs the services of another business, are such services deductible as purchases? I only ask because if that’s all there is to the proposed tax code, then it’s not clear whether this statement applies to the purchase of services, goods at retail, goods at wholesale or all of the above.

Retail businesses presently buy goods at wholesale, paying no sales tax upon the purchase, but then charge sales tax upon resale. However, service companies buy their supplies at retail; as such products are for internal use and not for resale. Services are not subject to sales tax at the State level, but will they be under the 999-Plan? Will both retailers and service businesses have to pay the 9% national sales tax on U.S. purchases, or are retailers exempt, or are both exempt? If both types of businesses have to pay the national sales tax, then even if such purchases are deductible for income tax purposes, they will have already been subject to a 9% national sales tax upon purchase. The point is that the first half-sentence of Cain’s proposal, by itself, necessitates a myriad of rules, regulations and definitions.

“For if the trumpet gives an uncertain sound, who shall prepare himself for the battle?” ~1 Corinthians 14:8

Next, according to Cain, the amounts spent on capital investments will be deductible under his 999-plan. But Cain doesn’t define what he means by the term, “capital investments”. Although he has publicly referred to this passage as meaning the purchase of equipment, he hasn’t defined any limitations. Does this apply to new or used equipment, or both? Capital assets include all tangible property which cannot easily be converted into cash and which is usually held for a long period, including real estate, equipment, etc. Under current law, buildings and other commercial real estate are generally depreciable over a 39 year lifespan, while land is never depreciable. But since Cain doesn’t go into detail, and because he wants to “throw out” the current tax code, we have to ask, will a business be able to write-off the purchase of real estate including land, in full, in the year of purchase? Are there no limitations? Here are some more questions:

  • If the purchase of capital equipment causes a company to have a net operating loss, can the loss be carried backwards and forward like under current law?

  • Is the purchase of stock in another business considered to be a tax deductible capital investment under the 999-Plan? The purchase of stock would be treated as an asset and not as a deductible expense under current law, but would it be treated simply as a deductible expense under the Cain plan? He doesn’t say.

  • Will there even be such a thing as a balance sheet under the new 999-plan, or will businesses simply need to account for gross income, purchases from U.S. businesses, capital investments, imports and exports?

  • Under the 999-Plan, purchases from non-U.S. located businesses are discouraged. So does the term “purchases” include the purchase of capital equipment? If capital assets are purchased from overseas companies, will they be deductible because they are capital investments, or will they not be deductible due to the “purchases from other U.S. located businesses” clause? Again, it’s not clear.

Net exports are also excluded from the proposed 9% business tax. So it would follow that a U.S. based business, which sells more of its goods overseas than in the U.S., would be exempt from taxes. Thus businesses are encouraged to export their goods and services, which might be beneficial to large manufacturers or retailers, but not to small service based businesses which make up the bulk of the American economy. Does a U.S. company have to be based in the U.S., where it would employ American workers, in order to receive the exemption, or can it open an operation in Mexico, sell its goods there and escape the 9% tax? Cain doesn’t provide any details on the exemption for net exporters either.

“Empowerment Zones will offer deductions for the payroll of those employed in the zone”

Under the 999-Plan, labor intensive companies would not receive a deduction for wages, unless located in empowerment zones. With wages being the bulk of gross income for many service sector businesses, under Cain’s 999-Plan it is possible for a business to have zero or negative income, according to generally accepted accounting principles, and still owe taxes. Also, in spite of the proposed repeal of Social Security, Medicare, and (I guess) Federal Unemployment, since these taxes were previously deductible for income tax purposes, the full effect of their elimination is somewhat mitigated. In other words a business can breakeven, and still wind up having to borrow money at the end of the year in order to pay a tax bill. So will more businesses simply relocate to empowerment zones under Cain’s plan, or will some just get the short end of the stick while others receive a big fat special interest type government subsidy?

“That dog won’t hunt.” ~Herman Cain

Non-Deductible Business Expenses under the 999-Plan

  • Wages paid outside of empowerment zones
  • State and local taxes
  • Federal and State and Local Licenses
  • Purchases from foreign based companies
  • Mortgage Interest Expense?
  • Business Interest Expense?
  • Retirement Plan Contributions?
  • Health Insurance Premiums?

Example 1

The following small business corporation has a single-owner, is labor intensive, and is not located within an empowerment zone. As you can see, in the example below, the company has net income of -0- under current law, and net income of 8,088.50 under the 999-Plan. This is attributable to the elimination of payroll taxes which were also deductible for income tax purposes. The company has taxable income of -0- under current law, but would have taxable income of $128,318 under the 999-Plan. This is attributable to its deductions being limited to capital investments and purchases from other businesses, versus all ordinary and necessary expenses.

Thus, where Federal, State, and National Sales taxes are all -0- under current law, they would be $21,199.08 (11,548.62 + 7,999.08 + 1,951.38) under the 999-Plan. When the total business taxes are subtracted from net income, after-tax income is -0- under current law, but would be negative (-13,110.58) under the 999-Plan. So the owner will either need to borrow money to pay the taxes, or add money from personal accounts to shore up the company. Let’s hope that the 9% Individual Flat Tax leaves the owner with enough to cover the company’s shortfall.

9% Individual Flat Tax

“Gross income less charitable deductions”

Most of us know what the term “gross income” means, but what does it mean under the 999-Plan. If an individual has a sole proprietorship, will they be taxed on gross income and not be allowed to deduct ordinary and necessary business expenses? Will those who own rental properties pay a 9% tax on gross rental income without the benefit of deductions for mortgage interest, real estate taxes, insurance, repairs and depreciation? Will employees who incur substantial unreimbursed employee expenses be denied the benefit of deducting such costs?

  • Since there won’t be a deduction for state and local taxes, including real estate taxes, one will in effect pay a 9% tax on the amount of State taxes paid.

  • Since there will no longer be a deduction for mortgage interest, there won’t be any incentive to payoff an existing mortgage. Homeowners will in effect be paying a 9% tax on the amount of mortgage interest paid. Won’t this cause more families to simply abandon their houses for rentals? Will the plan push us from a private ownership to a public or corporate ownership society?

  • Since there is no deduction for the amount of national sales taxes paid, taxpayers will in effect pay a 9% tax on the 9% national sales tax as well.

  • Since there is no deduction for retirement plan contributions, taxpayers will pay a 9% tax on contributions and another 9% on the same money when the funds are withdrawn. If one currently owns a ROTH retirement plan will they receive an exclusion from the 9% tax when the funds are withdrawn?

  • Will life and disability insurance proceeds, which are currently exempt, be subject to the new tax?

  • Since the 9% Individual Flat Tax doesn’t distinguish between being married, single, widow, widower, or having one child or ten, what will our society look like after this plan is implemented? Will the population decline, as the cost of raising children is penalized? Will there be fewer marriages?

“Empowerment Zones will offer additional deductions for those living and/or working in the zone”

In other words, it’s not a flat tax after all; it’s a flat tax with exceptions for certain special interest groups. If businesses and citizens race to occupy today’s empowerment zones, will they eventually cease to be empowerment zones? And if no one takes the bait, and the masses instead flee from empowerment zones, what then? Will the government start issuing refundable tax credits, like it does today? Will the plan then become known as the +9, -9, +9, +9 Plan? That’s a 9% flat business tax, a 9% refundable tax credit, a 9% flat individual tax, and a 9% national sales tax.

Example 2

In the example below, individual income taxes are calculated on the owner of the small business corporation in Example 1. The owner is married with two dependents and the only income is wages paid by the company. The taxpayer pays mortgage interest, real estate taxes, state income taxes, and makes charitable contributions as shown in the table below. Under current law, taxable income is $59,355 versus $94,500 under the 999-Plan. That’s because the only item deductible for tax purposes under the 999-Plan is charitable contributions. Thus Federal income tax under current law would be $6,053.10 (8,053.10 minus a child tax credit of 2,000), and $8,505 with the 999-Plan. Although the taxpayer saves $8,032.50 under the 999-Plan by not having to pay Social Security and Medicare taxes, State income taxes would be higher, unless all states with an income tax rewrite their revenue codes, simultaneously.

Thus, after-tax income would be $60,446.65 under current law, and $64,270.00 under the 999-Plan, but that’s before paying the 9% national sales tax. If we subtract out 15% of after-tax income as savings and principal repayments on loans, that leaves the taxpayer with disposable income of $51,379.65 under current law, and $54,629.50 under the 999-Plan. Disposable income is the amount that a taxpayer will spend on items subject to the 9% national sales tax. After allowing for the national sales tax of $5,784.30, the taxpayer will wind up paying $1,960.95 more in taxes under the 999-Plan than under current law. So unfortunately, this small business taxpayer will not save enough on personal taxes under the 999-Plan to compensate for the businesses shortfall of $13,110.58. But how many people own small businesses anyway? More than you can imagine. Does it get better for companies with more than one employee? No. It would only get better if the business and its owner relocated to an empowerment zone.

9% National Sales Tax

“Unlike a state sales tax, which is an add-on tax that increases the price of goods and services, this is a replacement tax. It replaces taxes that are already embedded in selling prices. By replacing higher marginal rates in the production process with lower marginal rates, marginal production costs actually decline, which will lead to prices being the same or lower, not higher.”

Once again, volumes could be written to define this overly simplistic statement. Cain has stated publicly that the national sales tax will be levied on the purchase of new houses, cars and other goods, but not on used items. When we were discussing this, someone in my office fired off, “So should I just start buying my clothes from Goodwill?” Why would anyone want to buy a new house if it will cost 9% more? A new $200,000 home would cost $218,000 under Cain’s plan. On face value, that doesn’t mesh with prices “being the same or lower” to me. This means that where a 10% down payment is required, that instead of looking at $20,000, a buyer will now have to come up with $21,800. And since the interest expense will no longer be deductible, what’s the point anyway? One wonders if there will even be any homebuilders left if this plan were to somehow pass.

A brand new $40,000 vehicle would cost $43,600 under Cain’s law, and that’s not including state and local tax, tag, and title. Most Americans can’t afford the former, so why would the latter be an improvement? So even if underlying prices remain the same under the 999-Plan, prices will, at the minimum, rise by 9%. The 999-Plan would only lead to an increase in used car sales, and a decline in automobile production.

Marginal production costs might decline for businesses that are not labor intensive, make all their purchases from U.S. suppliers, or are located in empowermnet zones; but what about labor intensive businesses, those dependent on foreign suppliers, and those located outside of empowerment zones? Under the 999-Plan, it is possible for a business to have a net loss and still owe taxes. As shown in Example 1, if a business spends 70% of its gross income on wages, and the rest on tax deductible expenses, even though it has no profit, it would still owe a 9% tax on the amount of wages paid. Thus where a business would have owed no taxes under present law, it may owe under the 999-Plan, which will drive up, not lower its production costs.

Eliminates double taxation of dividends –

If I heard Cain correctly, corporations would be able to deduct the amount of dividends paid, before computing taxes, so that dividends are only taxed once at the individual level. That’s a good thing, but if the current tax code is simply “thrown out”, and the IRS is shut down, what’s to prevent corporate officer’s from taking all, or most, of their compensation in the form of dividends instead of wages? Since wages won’t be deductible at the corporate level and dividends will, you can bank on this loophole being blown wide open.

Features zero tax on capital gains and repatriated profits –

No tax on capital gains? That reminds me of that old Better Business Bureau film entitled, “Too good to be true.” Yeah, if it sounds too good to be true, it probably is. Just like with dividends, if there is no longer an IRS, and if the current tax code is “thrown out”, what’s to prevent corporate officers and employees from being paid in stock, rather than wages, and then cashing in on tax-free capital gains later?

Also, since charitable contributions are the only deduction allowed under the 9% Individual Flat Tax, what happens with capital losses? Will capital losses be deductible against ordinary income, only against capital gains, or not deductible at all? He doesn’t say. So when Cain “throws out” the current tax code, and shuts down the IRS, who will write the new code? Will there be some kind of 999 Super Committee, charged with coming up with new tax theories, while barred from referencing the previous code?

Not taxing repatriated profits sounds good, but it also provides an incentive for companies to relocate overseas. So it’s either Mexico, or an empowerment zone, eh? Flip a coin. Although some have advocated for such a measure in lieu of another stimulus, no one was saying that it should be a permanent pillar of U.S. tax policy. Cain has merely picked up on a popular topic and wrapped it into what I would call basically a sham.

“Let’s get real.” ~Herman Cain

Okay, let’s get real. Cain is light on specifics, so one is resigned more to asking questions than analyzing data. It all sounds good on television, but the plan appears to be constructed mainly out of neat little sound bites designed to appeal to weak-kneed conservatives, rather than out of substance. Yes I am an accountant, and I am for simplifying the tax code, but I can’t go along with a plan that lacks common sense. In my opinion, we shouldn’t throw out our current tax code in favor of a poorly constructed plan, instigated by someone who knows nothing about income taxes. Herman Cain may know how to turnaround a pizza parlor, and he was a great local talk show host, but an accountant or economist he’s not.

Anyone serious about simplifying the tax code should be talking about the following:

  1. Eliminating accelerated depreciation
  2. Eliminating general business tax credits
  3. Eliminating personal tax credits
  4. Eliminating the alternative minimum tax
  5. Lowering marginal income tax rates

That would be a good start. If you don’t think that eliminating the above and lowering tax rates would greatly simplify the income tax code, then you don’t know anything about income taxes.

If the 999-Plan were to somehow miraculously survive a left-wing insurrection, how would the 43 States that have an income tax calculate their taxes? Since most of the States begin with federal adjusted gross income and allow federal itemized deductions, and since under the 999-Plan federal adjusted gross income is simply gross income, and itemized deductions are limited to charitable contributions, then won’t all States have to rewrite their tax codes as well? States will have to decide whether they want to allow deductions for mortgage interest, property taxes, and other expenses which are currently deductible, and if they don’t, then the burden of State taxes will rise, further diminishing the effect of the 999-Plan.

Finally, since the 999-Plan interferes with or supplants other federal laws, it will necessitate repeal of the Federal Insurance Contributions Act, and involve drastic changes to how Social Security and Medicare benefits are calculated. Will Social Security benefits be based on gross income, whether earned or unearned? Will future benefits simply come out of the general fund? If so, then will paying social insurance benefits out of the general fund put a strain on the rest of the federal budget, leading to tax hikes in the future? Will the Federal Unemployment Act also be repealed, since it is part of the payroll taxes employers pay?

There’s more to 9-9-9 than 9-9-9. As far as I’m concerned, the 999-Plan is a total sham, and because Herman Cain has staked his entire campaign on it, he’s not fit to be President of the United States. What America lacks is leadership. Offering to lead the nation down an unproven, untested, and unsound path is no different than what we have today. What most of us want to hear from prospective presidential candidates is what will replace Obamacare, which regulations will be repealed, how the size of government will be reduced, and how the federal budget will be balanced. Herman Cain’s 999-Plan is nothing more than a diversion, designed to win a primary and lose an election. If you want four more years of Obama, then vote for Cain.

“WHEN THE FOLLOWERS ARE READY, THE LEADER WILL APPEAR.”

References:

http://www.hermancain.com/docs/999-for-web-10-12.pdf

Obamacare’s Deadweight Loss

/ L. M. Walker / 1 Comment

Why you should repeal it right away! –

By: Larry Walker, Jr.-

“The most important single central fact about a free market is that no exchange takes place unless both parties benefit.” ~Milton Friedman –

Failure to repeal Obamacare by January of 2013 will result in deadweight losses in the American economy. Although static revenue believers contend that the federal government will be able to line its pockets through a new source of revenue, inefficiency will occur in the private sector causing the loss of existing and future jobs, a decline in income tax revenues, less private sector health insurance coverage, and fewer business expansions. In fact, many small businesses will be left with lower revenues, after paying the so called shared responsibility penalty, causing them to either price themselves out of the market, downsize, or shutter, depending on market conditions.

What is Deadweight Loss? – It’s an economic term which represents the costs to society created by market inefficiency. Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources. Price ceilings (such as price controls and rent controls), price floors (such as minimum wage and living wage laws) and taxation are all said to create deadweight losses. Deadweight loss occurs when supply and demand are not in equilibrium. To see how deadweight loss occurs with Obamacare, let’s use an expanded real world example.

TEA, Inc. is a small Georgia based parts assembly plant with 50 full-time employees, not including its single owner. The company doesn’t provide health insurance for its employees due to a low profit margin, as doing so would impair its ability to continue as a going concern. However, the owner wants to expand in order to increase profits through horizontal integration. The company’s pre-tax net profit is projected to be $150,000 for each plant it operates, and each plant is expected to employ 50 full-time employees. Prior to the passage of Obamacare, TEA Inc.’s owner had planned on opening a second plant in 2012 and a third in 2013 creating an additional 100 jobs, but this misguided legislation has pretty much killed that dream. How’s that?

Well, since TEA, Inc. already has 50 full-time employees, it will be required by Obamacare to either provide and pay for at least half the cost of health insurance for its employees in 2014, or pay a penalty of $2,000 on each (excluding the first 30). In analyzing the financial impact, TEA, Inc. determines that 25 of its employees will require family plans, and 25 will require self-only plans. TEA, Inc. expects the ratio of family versus self-only plans to remain about the same as it expands. In examining the average cost of small group premiums within the Georgia market, it is known that self-only plans cost an average of $4,612, and family plans cost $10,598 (see Obamacare’s Effect on Small Business).

Single Plant Option

Prior to Obamacare, with its one existing plant, TEA, Inc. would have net income of $150,000, would pay federal income taxes of $41,750, and would be left with after-tax income of $108,250 (see table below). Assuming all things are equal, by 2014 when TEA, Inc. is mandated to provide health insurance at its existing plant, its health care expense will be $190,125 leaving it with a $(40,125) net operating loss, and no federal income tax liability. Since this is out of the question TEA, Inc. will be forced to either reduce its number of full-time employees to below 50, or pay a shared responsibility penalty (i.e. Health Care Tax).

Since TEA, Inc. cannot afford to comply with the play portion of the “play or pay rules”, if it does not reduce its workforce before 01/01/2013, then by 2014 it will be forced to pay a shared responsibility penalty of $40,000 ($2,000 per person on 20 of its 50 employees). Since the shared responsibility penalty is not deductible for tax purposes, TEA, Inc. will still have taxable income of $150,000, will pay federal income taxes of $41,750, and will have after-tax income of $108,250. However, after paying the shared responsibility penalty, the company will be left with just $68,250 or $40,000 less than it would have had before Obamacare (see table below). What will TEA, Inc. do? Its owner only has 14 months to decide, because the penalty will apply in 2014 if TEA, Inc. still has 50 or more full-time employees in the year 2013 (see Obamacare’s Effect on Small Business).

Options: If TEA, Inc. reduces its current workforce by one full-time equivalent employee, it can avoid paying the $40,000 penalty in 2014, but it must eliminate that position before the end of 2012, due to the twelve month look-back rule contained in Obamacare’s fine print. By doing so, TEA, Inc. will save the amount of one employee’s wages, less the increase in applicable federal taxes, and will avoid paying the $40,000 shared responsibility penalty, making the company better off. Unfortunately, this might be the best option available under the circumstances. So far, the deadweight loss is one full-time job.

Two Plant Option

If TEA, Inc. opts to push ahead and open the second plant, prior to Obamacare it would have net income of $300,000, would pay federal income taxes of $100,250, and would be left with after-tax income of $199,750. Assuming all things are equal, in 2014 when TEA, Inc. is mandated to provide health insurance at its old and new plant, its health care expense will be $380,250 leaving it with a net operating loss of $(80,250), and no federal income tax liability (see table below). Since this is out of the question TEA, Inc. will be forced to either forgo its expansion plans and not provide the additional 50 jobs, or pay the shared responsibility penalty (i.e. Health Care Tax).

Since TEA, Inc. cannot afford to comply with the play part of the “play or pay rules”, if it proceeds with the expansion, then by 2014 it will be forced to pay a shared responsibility penalty of $140,000 ($2,000 per person on 70 of its 100 employees). Since the shared responsibility penalty is not deductible for tax purposes, TEA, Inc. will still have taxable income of $300,000, will pay federal income taxes of $100,250, and will have after-tax income of $199,750. However, after paying the penalty, the company will be left with just $59,750 or $140,000 less than it would have had before Obamacare (see table below).

It’s worth noting that even after doubling its profits, TEA, Inc. would be left with less money — $59,750, than it would have had with just the one plant — $68,250. Again, what will TEA, Inc. do? Its owner only has 14 months to decide, because the penalty will apply in 2014 if TEA, Inc. has 50 or more full-time employees in the year 2013 (see Obamacare’s Effect on Small Business). The best option appears to be to not open the second plant, and to reduce the number of full-time employees at the initial plant by one. Thus, the deadweight loss has increased to 51 full-time jobs.

Three Plant Option

If TEA, Inc. decides to trust in “hope and change” and moves ahead with adding yet a third plant, pre-Obamacare it would have net income of $450,000, would pay federal income taxes of $153,000, and would be left with after-tax income of $297,000 (see table below). Assuming all things are equal, in 2014 as TEA, Inc. is mandated to provide health insurance at all three plants, its health care expense will be $570,375 leaving it with a $(120,375) net operating loss, and no federal income tax liability. Since this is impossible, TEA, Inc. will be forced to either forgo its expansion plans and not provide the additional 100 jobs, or pay the shared responsibility penalty (i.e. Health Care Tax).

Since TEA, Inc. cannot afford to comply with the play aspect of the “play or pay rules”, if it proceeds with its expansion plans, then by 2014 it will be forced to pay a shared responsibility penalty of $240,000 ($2,000 per person on 120 of its 150 employees). Since the shared responsibility penalty is not deductible for tax purposes, TEA, Inc. will still have taxable income of $450,000, will pay income taxes of $153,000, and will have after-tax income of $297,000. However, after paying the shared responsibility penalty, the company will be left with just $57,000 (see table below).

It’s notable that even after tripling in size, TEA, Inc. would be left with less money –- $57,000, than it would have had with just two plants –- $59,750, and even less than it would have had with just the one plant –- $68,250. Again, what will TEA, Inc. do? Its owner only has 14 months to decide, because the penalty will apply in 2014 if TEA, Inc. has 50 or more full-time employees in the year 2013 (see Obamacare’s Effect on Small Business).

The best option for TEA, Inc. appears to be to forget about opening a second and third plant, and to reduce the number of employees at its existing plant. By doing so, TEA, Inc. will be able to maintain its present after-tax net income of $108,250, plus the savings achieved by eliminating a job, which yields the optimal result. Thus, in this real-life scenario, the deadweight loss created by Obamacare is 101 full-time jobs. In addition, 49 full-time employees are left without health insurance, and by 2014 will be forced to either pay a tax or secure their own health insurance coverage. Failure to repeal Obamacare means that this entrepreneur’s dreams of expansion will be destroyed, and 101 potential employees will be left on the sidelines. Obamacare will impose unnecessary deadweight losses upon the American economy, which will be multiplied many times over.

Forcing the free-market to accept and live with market inefficiency just doesn’t work out so well in a free market society. Any so called Jobs Bill which doesn’t immediately repeal this irresponsibly enacted, job killing, legislation isn’t a jobs bill at all. In my humble opinion, the Patient Protection and Affordable Care Act (PPACA) should be repealed right away. You should repeal it, right now! Be sure to sign the White House Petition to Repeal Obamacare. You must sign by 10/22/11. “Live free or die.”

Obamacare’s Effect on Small Business

/ L. M. Walker / 3 Comments

Unaffordable Care Act | Jobless, Unshared, and Irresponsible –

By: Larry Walker, Jr. –

“An unlimited power to tax involves, necessarily, a power to destroy; because there is a limit beyond which no institution and no property can bear taxation.” ~ Daniel Webster in M’CULLOCH v. STATE, 17 U.S. 316 (1819) –

Although Barack Obama boasts of having implemented 17 tax cuts for small business during his one-term proposition, as I pointed out in Why Congress Shouldn’t Just Pass Obama’s Jobs Bill, Again, not one item on the list actually meets the definition of a tax cut. #1 on the list was the Small Employer Health Insurance Tax Credit, which is found in Internal Revenue Code Section 45R. The goals of the Section 45R credit are supposedly as follows: (1) to help offset the cost to small businesses that offer employee health insurance coverage, and (2) to encourage small businesses not providing health insurance to start offering coverage.

But unfortunately, the overall effect of the Patient Protection and Affordable Care Act, will be to encourage large employers, those with 50 or more full-time employees, to drop health insurance coverage, reduce the number of employees, or cut weekly work hours to less than 30 in order to avoid paying the so-called shared responsibility penalty. Neither will the new legislation encourage smaller companies, those with fewer than 50 full-time employees, to offer health insurance, as it merely provides a six-year subsidy for those with fewer than 25 employees, encouraging them to limit their growth to 24 or fewer full-time employees, and it does absolutely nothing for companies with between 25 and 49 full-time equivalent employees.

Code Section 45R – Small Employer Health Insurance Tax Credit

The tax credit is available from 2010 through 2015. For 2010 – 2013 the maximum credit is 35% of qualified premium costs paid by for-profit companies, and 25% for non-profits. The maximum credit is only available to employers with no more than 10 full-time equivalent employees (FTE’s), who are paid average annual wages of $25,000 or less. A reduced credit is available on a phase-out basis for employers with between 10 and 25 FTE’s, who are paid average wages of $25,000 to $50,000. In effect, the credit is reduced by 6.667% for each FTE in excess of 10, and by 4% for each $1,000 in average annual wages paid above $25,000. For example, an employer with 13 full-time equivalent employees who are paid average annual wages of $45,000 will not receive a tax credit. No tax credit is available for employers with 25 or more FTE’s, or who pay average annual wages of $50,000 or more.

From Unaffordable Care Act

In 2014 through 2015, the credit increases to 50% of the amount of qualified premium costs paid by for-profits, and 35% for non-profits, however by then, the employer must participate in a state insurance exchange in order to obtain the credit. [Note: Each state is required to create an insurance exchange by January 1, 2014 which must include an American Health Benefit Exchange, as well as a Small Business Health Options Program (SHOP) Exchange.]

Full-Time Equivalent Employees (FTE’s) – For purposes of the Code Section 45R Credit, the number of FTE’s is determined by dividing the total number of hours worked by each employee (but not more than 2,080 per employee) by 2,080. This is based on a 40 hour work-week for all 52 weeks of a calendar year. The result is rounded down to the nearest whole number. An employer with 25 or more employees may still qualify for the credit if it employs part-time or seasonal workers. Seasonal workers are disregarded in determining the number of FTE’s as long as they work for less than 120 days during the tax year, however the amount of health insurance premiums paid on their behalf is still counted in determining the amount of the Section 45R credit. The number of FTE’s is calculated by totaling all hours worked by each full-time employee, each part-time employee, and each seasonal employee (working more than 120 days) and then dividing the total hours worked by 2,080.

Example: TEA Corporation has 7 employees who worked 2,000 hours each, and 5 who worked 1,500 hours each, during the tax year. The number of FTE’s is calculated by totaling all the hours worked, and dividing the result by 2,080. In this case, TEA Corporation has 10 full-time equivalent employees.

Average Annual Wages – Average annual wages is calculated by dividing the total amount of wages paid for the year by the number of FTE’s. However, certain employees are excluded from both the FTE and average annual wage calculations as follows: sole proprietors, partners in partnerships, greater than 2% owners of S-Corporations, greater than 5% owners of C-Corporations or other entities, and most family members (including children, step-children, siblings, step-siblings, parents, step-parents, nieces or nephews, aunts or uncles, and in-laws).

Example: TEA Corporation paid total annual wages of $250,000, not including the wages paid to its owner. Since TEA Corporation has 10 FTE’s, its average annual wages are $25,000 ($250,000 / 10).

Premiums – Only health insurance premiums paid by the employer under a qualifying arrangement are counted in calculating the Code Section 45R tax credit. For 2010, employers were allowed to count the total amount of premiums paid for the entire year, even though the health reform plan wasn’t passed until March 23, 2010. However, in order to qualify, the employer must pay at least 50% of the total premium costs. Employers are only allowed to count the amount the company pays and not the amounts paid by employees. Health insurance coverage also includes amounts employers pay for dental, vision, long-term care, nursing home care, home health care, community based care or any combination thereof.

The amount of an employer’s premium payments that counts is capped by the amount of average premiums for the small group market in the state (or an area within a state) in which the employer offers coverage. The average premium for the small group market in a state or area is determined by the Department of Health and Human Services (HHS). The IRS released the average premium for the small group market in each state for 2010 in Revenue Rule 2010-13 (table at left-hand). For example, in 2010, the limits in Georgia were $4,612 for self-only coverage, and $10,598 for family coverage.

Carry Back and Carry Forward – The Section 45R credit is not refundable to for-profit companies. Any unused portion may be carried back 1 year and carried forward for 20 years, however a credit earned in 2010 may only be carried forward. Note: Companies with no tax liability will not receive any immediate assistance from the Section 45R credit. So for example, a company taking advantage of the 100% bonus depreciation provision, or other tax benefits, and the Section 45R credit in the same year may not gain any immediate benefit from the health care credit.

Health Insurance Deduction and Tax Credit – Under Internal Revenue Code Section 162, long before health care reform, employers have generally been allowed to deduct the cost of providing health insurance coverage for employees. However, going forward the IRS has interpreted that the amount that may be deducted must now be reduced by the amount of any Code Section 45R credit.

Example: A Georgia Based Small Business

TEA Corporation is a Georgia based company with a single owner and 10 full-time equivalent employees, average annual wages of $25,000 per year, and it provides self-only health insurance coverage. TEA Corporation pays 50% of the total premium for each employee. These figures were chosen specifically; since in order to qualify for the maximum Section 45R credit an employer can have no more than 10 FTE’s, average wages of no more than $25,000, and must pay at least 50% of its employee’s insurance premiums.

Because the total amount of premiums cannot exceed $4,612 for self-only coverage within the State of Georgia, the total amount of premiums paid by TEA Corporation, for purposes of the tax credit, is limited to be $23,060 (2,306 X 10). Assuming the company is in a 34% income tax bracket (i.e. taxable income is between $75,000 and $100,000 per the table below); the Section 162 deduction would normally save the company $7,840 (23,060 X 34%) in taxes.

Now, since the company qualifies for the maximum Section 45R credit of 35%, it will receive a tax credit of $8,071 (23,060 X 35%), however it will only be allowed to deduct health insurance expenses under Section 162 of $14,989 (23,060 – 8,071). So the Section 162 deduction of $14,989 saves the company $5,096 (14,989 X 34%), in addition to the Section 45R credit of $8,071, for total tax savings of $13,167 (5,096 + 8,071). So in effect, the new tax credit benefits the company by an additional $5,327 (13,167 – 7,840), or by $532 per employee, because the company would have already saved $7,840 (23,060 X 34%) prior to Obamacare.

From Unaffordable Care Act

If in the example above, TEA Corporation was not able to afford health insurance prior to Obamacare, then how does the Section 45R credit change things? Won’t the company still have to shell out an additional $23,060 to cover the employer’s share of health insurance costs? Yes. And although it will be eligible for the Section 45R credit, it won’t realize the $13,167 in tax savings until its tax return is filed in the subsequent year. So in effect, the company’s cost per employee will have risen by $2,306. Adding to the dilemma is the fact that the amount each employee must contribute also increases by $2,306. So both the company and its employees will be poorer at the end of the year, although the employer may have a chance to recoup about 57% (13,167 / 23,060) of its costs through subsequent year tax savings, and its employees will receive health insurance.

Problems: (1) In tax years 2010 through 2013, the federal government is going to somehow magically come up with $13,167 to cover 57% of TEA Corporation’s health insurance premiums, and do the same for potentially thousands of other similar small businesses, but who’s going to pay for this? Won’t the tab simply be added to the seemingly unlimited national debt balance? (2) And since employees will have to pay for potentially half of their own health insurance costs, each one who wasn’t previously covered by health insurance, and more specifically those making less than $25,000 per year, will have to figure out how to live off of approximately $2,306 less in disposable income. Does this sound like a good deal for those making under $25,000 per year, or even $50,000?

More Problems: (1) Of course, if any of the 10 employees in this example require family coverage, the costs for both the employer and employee will go up dramatically, as will the government’s cost of the subsidized tax credit. In the example above, the employer and employee obligation rises from $2,306 to $5,299 per year, or half of the average premium for small group family plans of $10,598. (2) Then in 2014 and 2015, as the Section 45R Credit increases to a maximum of 50%, the federal government’s (i.e. taxpayers) share increases by even more. This additional federal spending, though tax expenditures, will only add to the federal government’s current national debt balance of $14.7 trillion and ticking, until the tax credit well runs dry in 2016. (3) If small companies can’t afford it now, how will those who employ fewer than 25 workers be able to afford health insurance after 2015?

Exempt Organizations – Meanwhile, tax-exempt organizations will receive a “refundable tax credit” of up to 25% of the amount of health insurance premiums paid between 2010 and 2013, and 35% in 2014 and 2015. This refundable tax credit is limited to the amount of federal tax withheld from employees’ paychecks, the amount of Medicare tax withheld from employees, and the amount of Medicare tax matched by the employer.

Problem: Since exempt organizations don’t pay income taxes, the cost of the refundable Section 45R tax credit will never be recovered. In effect, individual and for-profit business taxpayers are subsidizing the tax credits granted to small non-profit organizations. Non-profit organizations, which are not even subject to the income tax, are being allowed to receive refundable income tax credits based on the amount of payroll taxes paid essentially by their employees. So in this respect, all Obamacare does is to giveaway more tax expenditures to folks who don’t pay any federal income tax. Wasn’t this already a major problem prior to Obamacare?

Large Employers – “Play or Pay”

Although Obamacare doesn’t mandate small employers to offer health insurance coverage to their employees, it does include play or pay rules which apply after 2013. The provision is intended to encourage employers to offer coverage or to pay a shared responsibility penalty. The play or pay rules only apply to large employers, those with 50 or more full-time employees. [Note: Employers who offer free choice vouchers to qualified employees were supposed to have been exempt from the penalty, but this provision was repealed in 2011.]

Problem: Employers who employ 25 or fewer employees are given an incentive to begin or to continue health insurance coverage, but are not required to provide it; while those with 25 to 49 employees are given no incentive, and are not required to provide insurance; and those with 50 or more employees are given no incentive, but face penalties for not offering adequate and affordable coverage by 2014.

Shared Responsibility Penalty – The shared responsibility penalty will apply to two groups of employers after 2013: (1) Large employers that do not offer health insurance coverage. (2) Large employers that offer coverage but have one or more employees receiving premium assistance tax credits or cost-sharing because the coverage is deemed unaffordable. If even one employee receives premium assistance tax credits through a state insurance exchange, then the penalty will be $2,000 per full-time employee (not including the first 30 workers). And if the employer offers what is deemed to be unaffordable coverage, then the penalty will be $3,000 for any employee who receives premium assistance tax credits through a state insurance exchange up to a cap of $2,000 for every full-time employee.

[Note: Unaffordable coverage is defined as when the premium required to be paid by the employee is more than 9.5% of the employees’ household income. In such cases the employee is eligible for a premium assistance tax credit and cost-sharing reductions, but only if the employee declines to enroll in the employer’s coverage and purchases coverage through a state insurance exchange.]

Large Employer Problems:

(1) Large employers need to know how much household income each employee has including all working adults within their households.

(2) For purposes of the shared responsibility penalty, a Large Employer is an employer which employed an average of at least 50 full-time employees during the preceding calendar year. In other words, those with an average of 50 or more full-time equivalent employees in 2013 will be subject to the penalty in 2014, even if they have reduced the number of employees by that time.

(3) Full-Time Equivalent Employees for Large Employers – Unlike the definition of full-time equivalent employee for small employers, for purposes of the shared responsibility penalty, a full-time employee is defined as one who works an average of 30 hours per week. Employers who think they won’t be affected by the penalty or the employer mandate need to read the fine print.

Conclusions

  1. By offering incentives to micro-sized businesses, those with 25 or fewer full-time employees with average wages of less than $50,000, and no incentives to larger companies, Obamacare discriminates against job creators.

  2. Since employers with fewer than 25 employees are not required to provide health insurance coverage, and are not penalized for not providing coverage, most employers who qualify for the tax credit are not taking the bait. Let’s face it, health insurance plans drive up business costs even with a generous tax credit. And since the tax credit expires at the end of 2015, what is the catalyst which will make health insurance more affordable in the future? Will businesses and their customers have more money in their pockets as a result of Obamacare?

  3. Employers with more than 25 full-time employees and fewer than 50 fall between the cracks. For them, there is no incentive to provide health insurance coverage and no penalty for failing to provide it. It’s as if they don’t exist, which clearly displays the discriminatory aspect which Obamacare casts upon job creators.

  4. Meanwhile, large employers, those with 50 or more employees working at least 30 hours per week, receive no incentive to provide coverage, yet will be punished for not providing it. In the end, some large employers are encouraged to reduce the number of full-time equivalent employees to below 50 before 2013, to reduce the number of hours worked for some employees to below 30 per week, or to simply pay the shared responsibility penalty of $2,000 on each employee (excluding the first 30), rather than commit to even more costly health insurance contracts.

If TEA Corporation, in the example above, had 100 employees requiring self-only coverage, and paid 50% of the premiums, then its health insurance expense would be roughly $230,600. However, if TEA Corporation simply opted to pay the shared responsibility penalty of $2,000, on the 70 applicable employees, it would have to pay the IRS a penalty of just $140,000, in lieu of the $230,600 cost of insurance. But, if TEA Corporation is not able to afford $230,600, to pay for health insurance on its employees, it is compelled by the rule of law to hand over $140,000, money that it may or may not have, to the federal government under the play or pay rules. Is this fair?

The way things stand today, if by the year 2014 a large employer can’t afford health insurance, in spite of Obamacare – which does nothing to make it more affordable, or if providing health insurance would jeopardize its ability to continue as a going concern – in the Obama economy, then it still must pay the shared responsibility penalty, even if it means laying off workers, shuttering operations, or filing for bankruptcy. In other words, America’s job creators will either play, pay or be destroyed. If this job killing law is not repealed by 12/31/2012, the unemployment rate will continue to soar, because the companies which will be most affected are compelled to take action before then. In fact, in order to ensure that they are not blindsided by the one year look-back rule which begins on 01/01/2013, many companies are already taking action.

In my humble opinion, the Patient Protection and Affordable Care Act cannot be repealed fast enough. Be sure to sign the White House Petition to Repeal Obamacare. You must cast your Vote by 10/22/11.

Obama’s Economic Reduction Plan

/ L. M. Walker / Leave a comment

Private Equity vs. Government Redistribution

– By: Larry Walker, Jr. –

“A farmer went out to sow his seed. As he was scattering the seed, some fell along the path, and the birds came and ate it up. Some fell on rocky places, where it did not have much soil. It sprang up quickly, because the soil was shallow. But when the sun came up, the plants were scorched, and they withered because they had no root. Other seed fell among thorns, which grew up and choked the plants. Still other seed fell on good soil, where it produced a crop—a hundred, sixty or thirty times what was sown. He who has ears, let him hear.” ~ Matthew 13:3-9

For many, the American Dream consists of the hope of freeloading off of the good fortune of others for their entire lives. Yet for some, the dream is comprised of one day saving enough capital to invest in a business of their own. And for a few, the dream is to one day save enough to invest through a private equity group. For those aspiring towards business ownership, sometimes a little help is needed, and that help, in many instances comes though private equity firms.

So why would anyone dream of investing in a private equity firm? Well one big reason is that under current law, around 58% of the profits realized by private equity firms are taxed as long-term capital gains rather than as ordinary income. Long-term capital gains are currently taxed at the maximum rate of 15%, while ordinary income is taxed as high as 35%. The lower tax rate on long-term capital gains helps to compensate for the opportunity cost of investing for the long haul, and also enables a greater portion of the profits to be reinvested into the next venture, which can ultimately lead to the accumulation of a great deal of wealth.

Another reason many dream of investing in private equity groups is because they feel a calling to help fellow Americans reach their dreams. Unlike bloated, deficit-financed, short-sighted, big government wealth redistribution schemes, private equity is good for America. However, if the carried interest (the long-term capital gains earned through investing in private equity) were to suddenly be taxed at the same rates as ordinary income, then there would no longer be an incentive to invest in long-term private business endeavors.

Private equity firms fund and co-manage thousands of private businesses in the United States, employing millions of American workers, and these businesses are dependent upon stable long-term investments. If big government takes away the incentive to save and invest in long-term endeavors, then there will be no long-term investment. It simply won’t be worth the risk. And without long-term private equity investment, thousands of businesses, millions of jobs and the American Dream will be choked out of existence.

Carried Interest vs. Ordinary Income

Ordinary income is mostly comprised of net business income, fixed compensation, interest, dividends, rents, royalties, and short-term (less than a year) capital gains. Unlike ordinary income, there is greater risk involved with long-term (more than a year) capital investments. Private equity firms typically make investments over a 3 to 7 year term. The risk of tying up capital savings for many years is that the investment might be lost entirely, or may not return any profit at all. So is carried interest the same as ordinary income? Centuries of sound and settled tax policies say no. But Barack Obama, a novice, with no business experience, and a track record of failed economic policies; and Warren Buffett, a retiring billionaire, who has profited from lower taxes on carried interest during his lifetime, say yes. So who’s right, centuries of proven economic science, or 32 months of butt kissing and B.S.?

The Obama-Buffett Rule presumes that carried interest is the same as ordinary income and should be taxed at ordinary income tax rates of up to 35%, instead of at capital gains rates of up to 15%. The contention that the profits earned through long-term capital investment, which involves placing previously taxed income at risk through investing in risky business ventures, which employ hundreds of thousands of American workers, and which help drive the American economy, should be taxed at the same rate as fixed compensation, such as wages earned from labor, is quite a leap. The problem with Obama’s latest Socialist twist is that unlike fixed compensation, which is properly taxed as ordinary income, carried interest, garnered through private equity investments, only rewards general partners if, at the end of the term, the fund actually results in a net gain.

To break this down further, you have on the one hand wage earners, who work 40 hours per week, get paid weekly (or semi-monthly), consume most of their pay, and have taxes withheld from each paycheck. And on the other hand, you have private equity partners who work on a project for 3 to 7 years, expending capital and sweat equity, aiding in the employment of thousands of tax paying workers, helping make tax paying businesses profitable, and ultimately hoping to, at the end of the term, regain their investment along with a handsome profit. So is carried interest the same as ordinary income? Is all income created equal? Is Capitalism the same as Socialism? Do words still have meaning?

Private Equity in Action

Within the State of Georgia there are approximately 30 private equity firms, which have invested an estimated $26 billion in Georgia-based companies, which back approximately 340 private companies, which employ more than 175,000 U.S. workers. If more capital is diverted away from private equity investments, through errant tax policies, and instead invested in tax-free securities or some other jurisdiction, then where will the capital to fund these Georgia businesses come from? It’s not likely to come from banks, which are currently paying investors taxable interest of between .01% and 1.0% on savings. And it’s not likely to come from the federal government which is currently $14.7 trillion in debt. Thus, when private equity capital is finally taxed out of existence, there will be no capital, and most of these 340 companies will cease to exist, along with 175,000 jobs.

In the State of Illinois there are approximately 137 private equity firms, which have invested an estimated $72.9 billion in Illinois companies, which back approximately 450 private companies, which employ more than 350,000 workers in the U.S. The State Employees’ Retirement System of Illinois had nearly $525 million invested in private equity as of June 30, 2008, about 5 percent of the System’s total pension fund portfolio of more than $11.4 billion. And as of June 30, 2009, the Illinois’ Teachers Retirement System had $2.34 billion invested in private equity, about 8.2 percent of TRS’ total portfolio of nearly $29 billion. Are the billions of dollars that Illinois pension funds invest in private equity firms any more or less important than any other American citizen’s savings? I think not. If the government takes away the incentive of private equity partners, then where will this capital go? If you say, “To the Banks”, again you err. If you say, “Directly into businesses”, then who will oversee and manage these investments, the government? Yeah, right, just like Solyndra.

It’s Math!

And then there’s this hogwash about wealthy people paying lower tax rates than middle income earners. Does anyone really believe this? All you have to do is glance over at one of our “progressive” tax rate schedules, to know that’s not the case. Since our tax rate structure is “progressive”, the rates increase along with income. One’s combined tax rate is never the same as their bracket rate. In other words, you may be in a 25% bracket, but that doesn’t mean you’ll fork over 25% of your taxable income. As you can see below, married couples with ‘ordinary taxable income’ of $25,000 pay a tax of 11.6%, those with $50,000 pay 13.3%, and those with $100,000 pay 17.2%; while married couples with ‘ordinary taxable income’ of $250,000 pay a tax of 24.0%, those with $1,000,000 pay 32.0%, and those with $10,000,000 pay 34.7%.

In terms of dollar amounts, on the low-end, 11.6% of $25,000 translates into $2,900, while on the high-end, 34.7% of $10 million works out to around $3.5 million. So is paying $2,900 in taxes greater than or equal to paying $3.5 million? It’s math! One must also consider that five times out of ten, that $2,900 liability gets magically turned into a tax refund of up to $8,000, as nearly half of all American workers are either not liable for any income tax whatsoever, or fall into the negative category. So perhaps the words “fair share” could be more appropriately expressed as “unfair and not-shared”.

From Taxing the Rich
From Taxing the Rich

Although it may seem fair for Obama and Buffett to compare a private equity partner with $10,000,000 of carried interest, to a married couple with taxable wages of $100,000, it’s really not. It’s like comparing oranges to apples. Although the wage earning couple will pay federal taxes of 17.2% versus the carried interest earners 15.0%, in the end, the couple will have paid a total of $17,250 in taxes, versus $1,500,000 for the private equity partner. So is $17,250 greater than $1,500,000? “It’s math!”

The real difference is that a private equity partner may then turn around and reinvest most or all of the remaining $8,500,000 into the same company that the married couple works for, thus enabling them to continue their very employment. In terms of economics, the multiplier effect on private equity investment generates many times the tax revenue paid by the partner himself. Just add up the taxes collected on all the additional wages, salaries and business profits he helps to generate. But if that capital be muzzled, the result will be less free-enterprise and even higher levels of unemployment. Thus, while earning a salary is productive, it’s nowhere near as productive as carried interest. Perhaps there’s a reason why some of our tax policies are the way they are! “It’s math!”

If Obama and Buffett really wanted to compare apples to apples, then they would be comparing a married couple with carried interest income of $10,000,000, to a couple with long-term capital gains income of $10,000,000. Each will pay $1,500,000 in taxes. So is fairness still an issue? The truth is that no American is prevented from saving his or her own money and investing in activities generating similar capital gains. Anyone can do it, and will reap an equal reward — a maximum 15% long-term capital gains tax. But if the government ever takes away this incentive, or begins to discriminate against certain forms of long-term gains, then you can kiss the American Dream goodbye.

Government Subsidies vs. Private Equity

If the government steps in and confiscates a larger chunk of the profits earned by private equity firms, then there will be that much less capital to reinvest in new acquisitions. And what will the government do to make up the shortfall? Will the government invest in and manage new enterprises? Perhaps, the federal government will subsidize more companies like Solyndra, but then who gets the ‘return on subsidy’ (ROS), if and when the government is successful? Will every taxpayer get an equal slice of the pie? That’s highly doubtful. More than likely, the money will simply be absorbed into the federal government’s irresponsible $1.3 trillion per year budget deficits, or into its $14.7 trillion national debt, or used to pay unemployment compensation, or to dole out more food stamps, neither of which will create new jobs. In other words, the money will be pilfered and consumed rather than invested in viable job creating enterprises. And we all know that America needs more jobs, not more debt, unemployment compensation and food stamps.

Private equity investors fund American businesses which employ millions of American workers. By investing in non-public companies they typically hold their investments with the intent of realizing a return within 3 to 7 years. Shouldn’t there be some reward for committing previously taxed income for 3 to 7 years, in order to help businesses grow, and to enable employment for millions of workers, with no guarantee of a profit let alone return of the original investment? I say, yes. Obama and Buffett say, no. Where they err in their quest for “fairness” is in that 42% of the profits earned by private equity investors are already taxed at ordinary tax rates, while just 58% represents carried interest. They also fail to realize that such profits are typically reinvested back into the cash account to fund the next acquisition. You would think that at least Buffett would understand this concept, since most of his earnings have been likewise reinvested.

Hell No!

With Obama’s brand of math, one would surmise that if the government could just confiscate the $1.4 trillion in annual private savings, and use it to pay the $1.4 trillion of annual government deficits this would somehow bring about “balance”. But all it would really bring about is a permanent state of depression, mass government dependency, and even greater deficits once the government runs out of other people’s money. And considering that the best the federal government could possibly do, by confiscating additional tax revenue, is to immediately absorb it into its irresponsibly amassed $14.7 trillion in accumulated deficits, over $4 trillion of which was squandered by Obama himself, the answer to the request for more revenue is still, “Hell No”. Cut spending, stop squandering the tax dollars we’re already paying, and stop regurgitating the same old lies over and over again.

Although the federal government does employ a couple of million workers, about 59% of the money used to pay them is already confiscated from taxpayers, while the other 41% is merely borrowed from the Federal Reserve Bank and from countries like China. Every dime taken away from private investors and spent by the government is a dime taken away from private businesses and private sector workers. Once the point of no return was breached, back in 2010, there was no longer enough personal income to cover the amount of federal debt, on a per capita basis, and if this is not corrected soon, it will lead to the death of the American Dream. If there is already not enough income to pay the government’s debt, then why is Obama begging for higher taxes? When there is nothing left but government, then what? Will the government pay everyone a subsidy of say $50,000, and then proceed to levy a 100% tax on everyone in order to fund itself into infinity? Isn’t this exactly where Obama’s plan leads?

The failure of Obamanomics can be summed up in a few short phrases: If it produces jobs, tax it. If it keeps producing jobs, regulate it. And when it stops producing jobs, subsidize it. Thus Obama’s plan for deficit reduction, like his Jobs Act, is just another gimmick leading to economic reduction, job destruction, government dependence, poverty and the end of the American Dream. Obama gave it his best, but his best just wasn’t good enough for America. Hey Obama, “Hell no, and good riddance.”

*** BTW – Raising the tax rate on carried interest from 15% to 35% would result in a 133.33% tax hike, or to 39.6% would equal a 164.0% hike, just in case anyone is still considering this madness. ***

“There is a limit to the taxing power of a State beyond which increased rates produce decreased revenue. If that be exceeded intangible securities and other personal property become driven out of its jurisdiction, industry cannot meet its less burdened competitors, and no capital will be found for enlarging old or starting new enterprises. Such a condition means first stagnation, then decay and dissolution. There is before us a danger that our resources may be taxed out of existence and our prosperity destroyed.” ~Calvin Coolidge (Address to the General Court beginning the 2nd year as Governor of Massachusetts January 8, 1920)

References:

Private Equity Info

Private Equity Growth Capital Council

Related:

The Problems with Raising Taxes on Carried Interest, Part II

Why Congress Shouldn’t Just Pass Obama’s Jobs Bill, Again

/ L. M. Walker / 2 Comments

– 6 Temporary Stimuli, 17 Tax “Cuts”, and Zero Results

– By: Larry Walker, Jr. –

As I carefully chronicled in, “Obama: The Era of Flimflam Economics, Part II – Untimely and Proven to Fail”, the policy theory, known as economic stimulus, was designed by economists as a tool for implementation at the onset of a recession, with the goal of either softening its effects, or averting a downturn altogether. However, in the real economy, economic stimulus has yet to be proven successful at doing either. In February of 2009, partisan windbag, Barack Obama declared, “What do you think a stimulus is?“, implying that the idea was for the government to borrow and spend near a trillion dollars on anything, but then later at a Jobs Council, after the money had been squandered, he admitted that, “Shovel-Ready Was Not as Shovel-Ready as We Expected”.

Short-Term Stimulus vs. Long-Term Policy

To summarize, it was near the end of 2007, when prominent economists began advising the federal government that the economy was heading into a recession, and that it could be avoided if the government would implement an economic stimulus program. They proffered that in order to work successfully, such a stimulus needed to be targeted, timely, and temporary. As far as timeliness was concerned, tax refund checks needed to reach taxpayers in a matter of weeks not months. But economists must have forgotten that they were dealing with the federal government. How in the world would the federal government be able to: (1) agree on and pass legislation, (2) send it on to the IRS for interpretation and implementation, and (3) expect for tax refund checks to start rolling out in a couple of weeks, especially in the middle of the tax filing season?

The first economic stimulus package of the Great Recession was proposed in January of 2008. Even though a similar stimulus plan was attempted and failed in 2001, nevertheless, Congress was suckered in through panic mode once again. This time they would fling $150 billion to the wind, but by the time the checks reached taxpayers, in April of 2008, it was too late, the recession had commenced. Looking back, it turns out that the recession officially commenced in December of 2007 and didn’t end until June of 2009. So why is it that millions of job losses, millions of home foreclosures, hundreds of bank failures and trillions of dollars in government debt later, politicians still seem to be hell bent on the premise that temporary stimulus policies work?

In February of 2009, a year after the first failed tactic, Barack Obama enacted a second stimulus plan. The American Recovery and Reinvestment Act of 2009 turned out to be nothing more than a gigantic, nearly $1 trillion, spending program. Although his borrow-and-spend policy was designed to be temporary, it was neither targeted nor timely. So the questions then and now are: Why was the federal government still trying to implement a stimulus program 14 months after the recession began, when every honest economist knows that the idea is to inject stimulus either prior to or just as a recession commences? By February of 2009, was it possible for a stimulus plan to prevent something which had already occurred? And lastly, why is the federal government still toying with the idea today, some 27 months after the recession has ended?

It should be rather obvious by now that economic stimulus programs don’t work in the real world. Although the theory may look impressive on a chalk board, the federal government is not an efficient institution for implementing a positive jolt to the economy, let alone much of anything else. It should also be clear that there are economic recovery policies which have been proven to work, time immemorial, once a recession has passed. For example, The Tax Reduction Act of 1964, The Economic Recovery Tax Act of 1981, The Tax Reform Act of 1986, The Deficit Reduction Act of 1993, and the Jobs and Growth Tax Relief Reconciliation Act of 2003 were all long-term plans which stabilized and grew the economy following recessions.

What’s lacking today is a long-term tax policy which would inject a sense of stability and predictability to the economy at large. Small businesses don’t make plans based on hope and change, what we need is to know what our income tax rates and incentives will be for the next 8 to 10 years. Yet, Obama has wasted nearly 3 years already, passing one temporary measure after another, and now it’s more of the same. As far as I’m concerned, it’s over for Obama. With the knowledge that long-term tax policies have been used as effective recovery tools following recessions, and that short-term stimulus programs have never been successful, why in the world is Obama trying to subject the nation to another stimulus prototype now, some 3 years and 9 months after the Great Recession began? Is it because we’re on the verge of another recession? And if we are on the verge of a double-dip, knowing that temporary stimulus programs don’t work in the real world, why would we ever allow Obama and Congress to waste more time, and money that we don’t have, with yet another futile stab?

From Main Street to Washington, DC

Having been an accountant and tax advisor for many small businesses, including my own, through at least the last two recessions, I know first hand which tax policies have worked and haven’t, and which have been important to small businesses versus the completely useless. For example, after passage of the Jobs and Growth Tax Relief Reconciliation Act of 2003, there was a sense of stability, and future plans could be implemented without the lingering fear that something would change or be taken away the following year. Its key policies which helped small businesses, within my orbit, were as follows:

  1. Stable and well defined Personal and Corporate Income Tax Rates and Brackets.

  2. Accelerated Depreciation through Section 179 and Bonus Depreciation within clearly defined limits and timeframes.

  3. Increasing and well defined limits on IRA and Qualified Retirement Plan contributions.

  4. Stable and declining tax rates on capital gains, and qualified dividends.

  5. Defined and stable tax credits such as the energy efficiency credit, child tax credit, education credit, and the life-time learning credit.

  6. Stable, declining and well defined Estate tax rates and brackets.

In contrast, the policies I have witnessed since February of 2009, have made planning next to impossible and pretty much pointless. For example, we knew that the tax rates and most of the policies implemented by #43 would expire at the end of 2010, so that was pretty much the end of the planning cycle, however the recession cut many plans short well before 2010. In fact, many small businesses didn’t make it through 2008, and some went under in 2009. As for the survivors, well what we’ve all been waiting for are the permanent policies which will carry us through the next decade. But thus far, all we’ve seen is a series of temporary tax measures, many with erratic nonsensical start and end dates, and most of which have been completely useless at a time when gross business income has for the most part been depressed.

Obama’s 17 Phantom Tax Cuts for Small Business

Obama has implemented 17, so called, tax cuts for small business. For the complete list, see the Feb. 25, 2011, posting on the official White House blog entitled, “Seventeen Small Business Tax Cuts and Counting.” The post is touted as enumerating 17 small business tax cuts and credits created or extended through legislation signed by Obama, since February of 2009. But what is important to remember is that it’s not how many tax cuts have been implemented, but rather, whether or not they have been effective. Overall, I would have to give the Obama policies a grade of “D”. Obama’s 17 small business tax policies (or as he calls them “cuts”), and their effectiveness from my point of view follows, but first, here’s a short summary:

  • Eight of them were included in American Recovery and Reinvestment Act (aka the economic stimulus), the Affordable Care Act (aka the health care law), and the Hiring Incentives to Restore Employment Act (aka the Hire Act). Among the cuts: the exclusion of up to 75 percent of capital gains on key small business investments; a tax credit for the cost of health insurance for small business employees, and new tax credits for hiring Americans out of work for at least two months.

  • Another eight came via the Small Business Jobs Act, signed by President Obama in September of 2010. These included: adding deductions for business cell phone use; creating a new deduction for health care costs for the self-employed; allowing greater deductions for business start-up expenses; eliminating taxes on all capital gains from key small business investments, and raising the small business expense limit to $500,000.

  • Three months later, he signed a tax bill that raised the expense limit to 100 percent of small business new investments until the end of 2011. It also extended the elimination of capital gains taxes for small business investments through the end of 2012.

From the Recovery Act, HIRE Acts, and Affordable Care Act

1. A new small business health care tax credit

We didn’t have any businesses qualify for this credit. The calculation was very complex, so it wasn’t readily known whether any businesses would qualify until after the end of the tax year. It’s kind of difficult to shoot for something when even your accountant says, “I don’t know. I’ll let you know as soon as the IRS puts out some regulations showing us how it will be calculated.” And then well into the following year, “I’ll get back to you as soon as the IRS releases the appropriate tax forms.” One business came close to qualifying, but the employees’ salaries turned out to be too high. Who knew?

The small businesses I deal with don’t normally determine what their employees salaries and benefits will be based on temporary government policies. And they don’t sit around waiting on the IRS to publish forms and regulations when a decision is needed right away. In other words, when a business needs 4 more engineers, due to demand, negotiations don’t center on keeping salaries below a certain threshold in order to qualify for a one-year, one-time tax credit. And negotiations for health care plans center more on the affordability of monthly payments, and are not recklessly entered into with the hope of receiving a one-time tax credit, to be realized in some subsequent year.

Most small businesses in my sphere don’t offer health insurance, simply because it’s cost prohibitive, so the idea of a one-time tax credit, to offset the cost of something unaffordable to begin with, turned out to be pretty much a waste of orating skills, paper and ink. It sounded good though, and I guess that’s what counts with Obama and his cronies.

2. A new tax credit for hiring unemployed workers

I would say three businesses may have qualified for this credit, and mostly by luck. Others thought they would qualify, but it turned out that the new hires had not been unemployed for at least 60 days which disqualified them. I got lucky by hiring someone who had been unemployed for more than 60 days, and was luckily hired a few days after the law went into effect. But it wasn’t like I was hunting for someone who would qualify, and didn’t even know about the credit at the time because the details were not readily available. Again, I don’t know of any small businesses that hire people based on temporary tax credits, most hire people when they are needed to meet the objectives of the organization.

Also, since our payroll tax software wasn’t set up to account for the credit, because it was implemented after the start of the tax year, and since IRS Form 941 was not updated when the credit went into effect, it turned out to be more of an accounting nightmare than anything else. Personally, I would have gladly forgone the credit in exchange for not having to figure out how to account for it. Thank God that’s over with. Can we please just have some stability so we can run our businesses without something changing every few months?

3. Bonus depreciation tax incentives to support new investment

Section 179 depreciation has generally been sufficient. Although, bonus depreciation is advantageous at times, it’s more advantageous when a business has a loss, which is generally not the goal. If net income is high enough to write-off all equipment purchases, why would anyone choose to write-off half? Like I said, there is an application, but it mostly applies when net income equals zero, and one wishes to accelerate a loss. There were a few takers, but come to think of it, most of those went out of business due to the losses already incurred.

Uncertainty – From a planning standpoint, the other looming question was that, if the Bush tax cuts were going to expire at the end of 2010, might the depreciation expense perhaps be better utilized in the year rates were set to increase rather than while rates were low? Thus it may have made more sense to just delay any purchases until 2011, or 2012 rather than accelerate the write-offs while tax rates were still relatively low. Again, a stable long-term tax policy trumps temporary measures any day.

4. 75 percent exclusion of small business capital gains

This was of no use whatsoever from my vantage point. One would have to purchase qualified small business stock after February 17, 2009 and before January 1, 2011, and then hold it for five years in order to take advantage. None of our small businesses make a living through buying and selling small company stock. The only practical use I could see was for owners planning to sell their stake in a company, but they would have had to acquire that stake between the dates above, so it wasn’t much use to existing business owners. My first impression was that it was a policy designed for those looking to make a quick exit and perhaps relocate overseas, but the five year hold time destroyed that dream. If you’re interested in how convoluted this provision turned out to be, there’s an interesting article here.

5. Expansion of limits on small business expensing

Did anybody in Washington, DC get the memo that surviving small businesses just got hammered for two years straight, and thus had no money left, and no desire to go out on credit for new equipment, if credit could even be obtained? All I can say is that the old limit of $25K seemed to be more than sufficient to cover replacement items. I haven’t witnessed any considerable expansion plans since 2006.

Uncertainty – From a planning standpoint, the other looming question was that, if the Bush tax cuts were going to expire at the end of 2010, might the depreciation expense perhaps be better utilized in the year rates were set to increase rather than while rates were low? Thus it may have made more sense to just delay any purchases until 2011, or 2012 rather than accelerate the write-offs while tax rates were still relatively low. Again, a stable long-term tax policy trumps temporary measures any day.

6. Five-year carryback of net operating losses

This was yet another policy more useful for those who lost money and were on their way out of business, than for those fighting but keeping their heads above water. I took this as more of a policy of defeat than future success. I guess the government figured that a small tax refund from five years ago would encourage small businesses to keep hiring while losing money in the meantime. I had a couple of businesses utilize the five-year carryback, but unfortunately they are no longer in business.

7. Reduction of the built-in gains holding period for small businesses from 10 to 7 years to allow small business greater flexibility in their investments

This was another waste of paper and ink. This policy only helped out S-Corporations who were formerly taxed as C-Corporations, and had built in gains at the time of conversion. A built in gain is the difference between the fair market value of an asset and its tax basis at the time of the conversion. I’m sure some businesses out there took advantage, but really, how many C-Corporations switched to S-Corporation status? I think I advised one to do it maybe 10 years ago, but other than that it hasn’t always been the best move due to built-in gains, undistributed net profits, the number of shareholders, or the owner’s personal tax situation. The majority of the small businesses in my neck of the woods have been S-Corporations from inception, generally based on my advice. So did anyone actually benefit from this provision? I have serious doubts.

8. Temporary small business estimated tax payment relief to allow small businesses to keep needed cash on hand

Since estimated tax payments are made throughout the year in order to reduce or eliminate the amount owed when the tax return is due, the full amount being due by March 15th, why would I advise any small business to skimp? I had no takers here either. Most small business owners who make estimated tax payments want their taxes covered by tax time, and don’t want to skimp on estimated tax payments during the year, and then get stuck with a gigantic tax bill later. If a business took advantage of this and then didn’t have funds to pay on March 15th it would only snowball into perpetual tax debt. ‘Once you get behind, you never catch up.’ So this was another waste of paper and ink. Hey, do we look stupid or what? Why not just cut the doggone tax rates, and stop playing games?

From the Small Business Jobs Act

9. Zero capital gains taxes on key investments in small businesses

Zero is right! Like I said in number 4 (above), it was of no use whatsoever when 75% of the gain was excluded, from my vantage point. To slip through this loophole, one would have had to purchase qualified small business stock after September 27, 2010 and before January 1, 2011. Since there were only three month’s to gear up, and it was the holiday season, I’m pretty sure no one took advantage, but if you did, please shout it from the rooftops. None of our small business clients make a living through buying and selling small company stock. The only practical use I could see was for an owner planning to sell their stake in the company, but to gain any benefit, they would have to acquire that stake between the dates above, and so it wasn’t much use to existing small business owners. My first impression was that it was a policy designed for those looking to make a quick exit and perhaps relocate overseas, but the five year hold time once again destroys that dream. This was another waste of paper and ink. If you’re interested in how convoluted this provision turned out to be there’s an interesting article here.

10. Raising the small business expensing to $500,000

I didn’t have any small business clients who were able or desired to purchase anywhere near $500K of new equipment. Since this doesn’t apply to real property, it’s generally well beyond the needs of most of the small businesses in my area. Thus, I had no takers. This might be a great policy for well capitalized startup businesses, but the number of startups has been on the decline, and most that I know of haven’t had that much capital. Since the write-off is limited to a businesses net income, $500K is generally beyond the earnings of most first year enterprises. This is generally a good policy to implement in the middle of a recovery in order to maintain growth, but not in the midst of a weak economy. Thus to me, it amounted to another waste of paper and ink.

11. An extension of 50 percent bonus depreciation

Hey, didn’t we try this already? See number 3 (above).

12. A new deduction for health care [insurance] expenses for the self-employed

This is actually a bit misleading. It should read ‘deduction for health “insurance” expenses’, not ‘health “care” expenses’. Since most of the small businesses we advise are S-Corporations, owner-employees with company paid health insurance, were already allowed a 100% deduction for health insurance long before this Act. The amount paid is included in their wages, but not subject to Social Security and Medicare taxes, and is allowed to be written off in full on their personal returns. This results in a total offset on the personal return, and a higher wage deduction on the S-Corporation return. I suppose it helped some sole-proprietors, Schedule C filers who have health insurance, but it didn’t affect anyone within my practice. Why walk when you can fly?

13. Tax relief and simplification for cell phone deductions

Most small businesses actually using cell phones for business purposes were already deducting the business usage portion. This provision only helped to avert a threatened crack down on the deduction which would have made it more costly to maintain records proving every call was business related, but since the crackdown never occurred, the effect upon small businesses was a sigh of relief, but no additional savings. In other words it saved us from having to spend more to comply with yet another ridiculous government regulation, but was really just a wash. Nothing was really saved, and nothing gained, in other words, it may have sounded good, but the effect was nil.

It’s akin to the government making 1099’s mandatory for all vendors, cancelling the regulation before implementation, and then claiming to have saved businesses money. No. You didn’t save us money. What you did was give us two years of uncertainty and unneeded stress, that’s what you gave us. That’s why government should just get out of the way.

14. An increase in the deduction for entrepreneurs’ start-up expenses

Although this policy temporarily increased, in 2010, the amount of start-up expenditures entrepreneurs could deduct from their taxes from $5,000 to $10,000, most of the start-up expenses that come across my desk are in the $100’s not thousands. And in cases where there are larger amounts, but little initial year net income, taking the write-off over 60 months is sometimes more plausible, especially when one doesn’t know whether tax rates will be higher in subsequent years, which by the way, we still don’t know.

15. A five-year carryback of general business credits

This policy allowed certain small businesses to “carry back” their general business credits to offset five years of taxes. I didn’t have any business clients qualify for any of the general business credits last year, and none who were really targeting them. In fact, the last business I can remember taking advantage of one of these credits was advised to do so through a tax scam. They paid the scammer an upfront fee in same amount as the credit they were assured to get back from the IRS. But in the end, all they got was an IRS audit resulting in the disallowance of the credit, had to pay the IRS back, and then had to sue the scammer to be made whole. I’m sure there are legitimate uses for some of these credits; I just haven’t dealt with any small businesses lately where any of them would have made a difference. You may view a full list of the credits here. In my view, most are either obsolete, redundant, or serve only a narrow base of special interests. Anyone serious about tax reform has my permission to strike the entire list.

16. Limitations on penalties for errors in tax reporting that disproportionately affect small business

The bill would change the penalty for failing to report certain tax transactions from a fixed dollar amount – which was criticized for imposing a larger penalty on small businesses – to a percentage of the tax benefits from the transaction. There was a time that all tax penalties were based on a percentage of taxes owed, but that’s no longer the case. Unfortunately this new provision doesn’t limit the effect of the $195 per month penalty the IRS currently charges, per shareholder, for each part of a month that an S-Corporation or Partnership return is filed late. S-Corporations and Partnerships, which have no income tax liability, are currently assessed the penalty, even though the late filing typically affects only a limited number of owners, or sometimes just one. If the government was serious about helping small businesses, they would stick to the old percentage of tax benefit policy (i.e. no tax benefit, no penalty), and eliminate this unfair charge on small businesses immediately.

And from the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act

17. 100 percent expensing

Hey, didn’t we do this twice already? See numbers 3 and 11 (above). This provision only applies to qualified property placed in service after September 8, 2010 and before January 1, 2012. So for those who purchased qualifying equipment on or before September 7, 2010, too bad, you should have waited. This is a prime example of another wacky implementation date from Obama. It’s also the provision that allows up to 100% of the price of an SUV or Corporate Jet to be written off in the first year, a provision signed into law by Obama, who later railed against the same.

This might be a good thing for some, but so far we haven’t seen any great demand for purchasing new equipment, no matter the incentive. Most small businesses, within my scope, are trying to pay off the debt from yesteryears purchases, and not looking to expand, or to replace equipment unless it’s an emergency. In other words, it’s not just hiring that’s down, it’s the economy as a whole, and with that comes dealing with slow paying customers, managing debt, grappling with price competition, and cutting back on expenses – including the purchase of new equipment. Thus, upping bonus depreciation from 50% to 100% looks good on paper, but it’s another temporary measure which in my estimation will not provide the spark needed to boost the economy.

Conclusion

Overall, most of Obama’s so called tax “cuts”, listed above, may make good sound bites, but I haven’t found them to have much practical application in the real world. There was a time, not so long ago, that the term tax cut, meant exactly that. It meant that tax rates were reduced. None of the provisions above represent reductions to income tax rates or adjustments to tax brackets, so they are not technically tax cuts. They are merely temporary ploys, targeting special interest groups, requiring one to either borrow and spend money, or jump through unreasonable (often impossible) hoops simply to obtain an additional deduction or credit.

Meanwhile, on Main Street, a permanent reduction in personal and corporate income tax rates, from the get go, would probably have had a greater impact, even if it were done in stages, with super low rates for two years followed by modest increases over the next eight, or something. None of Obama’s 17 tax deductions, credits, or extensions have really mattered much to me or to most of my small business clients, and the stuff he’s talking about now won’t make much of a difference either. If it’s temporary, and if it requires jumping through hoops, borrowing money, or meeting time frames beginning in the middle of the year – or starting on some arbitrary date in some odd month, then just forget it. It would be a heck of a lot easier to just cut overall income tax rates for one year, and then provide fixed rate schedules for the next decade. Is that so difficult? Is it really? If JFK, Reagan, Clinton, and ‘W’ could do it, why couldn’t Obama?

It’s all over for Obama now, time to move on. He had his chance, and blew it. The era of temporary stimulus boondoggles is over. Instead of thinking targeted, timely and temporary, it’s time to move towards a plan that’s broader based, strategic and permanent. Now it’s up to Congress and the 2012 presidential candidates to outline a long-term strategy and take it to every corner of the country.

References:

DNC Chair Wasserman Schultz says Obama has signed bills with 17 small business tax cuts

Taxing the Rich – 1765 to 2011, Part III

/ L. M. Walker / 5 Comments

– War on Taxes: 1964 to 2011

– By: Larry Walker, Jr. –

“The largest single barrier to full employment of our manpower and resources and to a higher rate of economic growth is the unrealistically heavy drag of federal income taxes on private purchasing power, initiative and incentive.” ~John F. Kennedy, Jan. 24, 1963, special message to Congress on tax reduction and reform

From Taxing the Rich

Recap: 1776 to 1912

In 1765, Great Britain imposed a series of taxes upon the American Colonies, in order to pay for its lengthy French and Indian War (1754-1763). After the war, the British forced upon the Colonies, the Stamp Act of 1765, requiring the purchase of tax stamps for any printed documents including newspapers, legal documents, marriage licenses and more. This was followed by the Townshend Acts of 1767 which were passed: to raise revenue in order to pay the salaries of governors and judges so that they would be independent of colonial rule; to create a more effective means of enforcing compliance with trade regulations; to punish the province of New York for failing to comply with the 1765 Quartering Act; and to establish as precedent the British Parliament’s right to tax.

Just like the Tea Party Movement of today, our founding fathers resented insidious taxes and regulations imposed upon them without their consent. Then as now, it is simply a matter of ‘taxation without representation’, an act which early Americans likened to tyranny. By 1773, when the East India Company was granted a virtual monopoly on the importation of tea, it was the last straw. In protest, a group of Boston citizens disguised as Mohawk Indians boarded a ship and dumped 342 chests of tea into Boston harbor. The Revolutionary War ensued, and the United States of America was born. Today, the Affordable Care Act is only a symptom of the disease. The disease being: overregulation, overburdensome covert and overt taxes, unsustainable federal debt, and a small minority of ideologues, with socialist tendencies, forcing their will upon the people.

The first income tax proposed by the United States Government was intended to fund the American Civil War (1861). Prior to this, the government was funded strictly through customs duties, tariffs levied on imported goods. During the War of 1812, the government experimented briefly with excise taxes on certain goods, commodities, housing, slaves and land, but a tax on income was out of the question. What is significant is that prior to 1861, or for the first 86 years of American history, whether a citizen had an annual income of $800, $250,000, $1,000,000 or $10,000,000, every dime was considered to be private property of the individual, and not subject to any federal claim.

In 1862, the first Revenue Act was revised, before any tax was due, and the Revenue Act of 1862 launched the first progressive rate tax in U.S. history. The Act established the office of the Commissioner of Internal Revenue, and specified that the Federal income tax was a temporary measure that would terminate in the year 1866. Annual income of U.S. residents, to the extent it exceeded $600 ($13,400 in 2011 dollars), was taxed at a rate of 3.0%; those earning over $10,000 per year ($224,000 in 2011 dollars) were taxed at a 5.0% rate. Through 1912, the income tax only existed for 11 out of the first 137 years of American history, from 1862 to 1872, while no income tax was imposed upon private citizens for 126 years. The income tax was a temporary measure imposed to fund the American Civil War. During the era, the highest tax rate assessed on married couples occurred between 1865 and 1866, when those earning the equivalent of $250,000 (in 2011 dollars) paid a tax of 8.4%, those earning $1,000,000 paid 9.6%, and those earning $10,000,000 incurred a tax rate of just 10.0%.

In the midst of the Panic of 1893, an amendment to the Wilson-Gorman Tariff Act of 1894 was passed, establishing a flat 2.0% tax on all incomes above $4,000 per year (about $104,000 today). The amendment would have exempted from taxation the salaries of state and local officials, federal judges, and the president. Believing the tax to be unconstitutional, President Grover Cleveland refused to sign it. The Act became law in 1894 without his signature, but was ruled unconstitutional by the U.S. Supreme Court in the following year.

Thus America remained the land of the free, free of an income tax from 1873 through 1912. But behind the scenes, the Democrat Party was fast at work, conjuring legislation which would ultimately destroy the freedoms won by Americans in 1776. Democrats proposed a constitutional income tax amendment in their party platforms of 1896 and 1908. Theodore Roosevelt endorsed both an income tax and an inheritance tax, and in 1908, became the first President of the United States to openly propose that the political power of government be used to redistribute wealth.

In 1909, the income tax amendment passed overwhelmingly in the Congress and was sent off to the states. The last state ratified the amendment on February 13, 1913. The Sixteenth Amendment owes its existence mainly to the West and South, where individual incomes of $5,000 or more were comparatively few. Sold to the public as a tax on the rich, the income tax initially applied to less than 1.0% of the population, but that would be short lived. The aspirations of power hungry, greedy and wasteful politicians would soon change the federal government into the conundrum it is today.

From Taxing the Rich

Recap: 1913 to 1963

In April of 1913, President Woodrow Wilson summoned a special session of Congress to confront the perennial tariff question. He was the first president since John Adams to make an appeal directly to Congress. Under the guise of reducing tariffs, the Act turned out to be nothing more than a means of reinstituting a federal income tax. The argument followed that since a reduction in tariff duties would lead to lost revenue, an income tax would be required to makeup the shortfall. We should be mindful of this deception as Barack Obama attempts to twist arms during his upcoming special session.

World War I commenced on July 28, 1914 and lasted until November 11, 1918. Since the income tax was initially imposed as a means of funding war (1861), its original intent now combined with an element of wealth redistribution, lead to one of the most convoluted tax rate schedules of all time. The War Revenue Act of 1917 expanded the tax rate schedule from 7 to 56 tiers. Rates were hiked to a range of 6.0% to 77.0% in 1918. The 1918 tax rate schedule was so convoluted that taxpayers were thrown into a higher bracket with every $1,000 to $2,000 of additional income.

Although the war ended in 1918, income taxes were not significantly reduced until 1924. In 1919 the top rate was gradually lowered to 73.0%, then to 58.0% in 1922, and to 46.0% under the Mellon Tax Bill of 1924. By 1924, the tax rate schedule contained just 43 tiers compared to 56 in 1918. The bottom rate also gradually declined from 6.0% in 1918 to 2.0% in 1924. Then in 1925, under the leadership of President Calvin Coolidge, the bottom rate was reduced to 1.5%, the top rate slashed to 25.0% with a reduced top bracket, and the tax rate schedule was simplified to 23 tiers from 43.

In the midst of the Great Depression, President Herbert Hoover relapsed, imposing higher tax rates and expanding the number of tax brackets from 23 to 55. In 1932, the bottom rate was increased from 1.5% to 4.0%, and the top rate was hiked from 25.0% to 63.0%. Franklin Roosevelt would later increase the top rate to 79.0%, in 1936, where it remained through 1940. Hoover had in effect reinstated wartime tax rates during a time of peace. Errantly believing that higher taxes would increase government revenue, Hoover was the first president to prove that raising taxes during a recession only prolongs the downturn.

Thanks to Hoover, and his successor Franklin Roosevelt, the Great Depression wouldn’t end until America entered the 2nd World War. After Hoover opened the door, FDR removed the hinges, gradually raising rates from the bottom up. President Franklin Roosevelt believed and stated that, “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.” This would mark a critical turning point in American history, as the purpose of the income tax had shifted from a temporary means to fund the Civil War, to a measure reinforcing lower tariff duties, to a tool for redistributing wealth, and ultimately to the price of living under the rule of a tyrannical dictator.

Following suit, bottom tax rates were raised from 4.0% in 1932, to 10.0% in 1941, to 19.0% in 1942, and to a record high of 23.0% in 1944. His successor, Harry Truman, would continue the tradition. After initially lowering the bottom rate to 20.0% in 1949, Truman raised it to 20.4% in 1951 and to 22.2% in 1952. The bottom rate was then locked in at 20.0%, by President Dwight Eisenhower, where it remained from 1954 through 1963. The top rate was likewise increased by FDR, climbing from 63.0% in 1932, to 79.0% in 1936, 81.0% in 1941, 88.0% in 1942, and to a record high of 94.0% in 1944 — during the height of the 2nd World War. Truman later lowered the top bar to 91.0% in 1946, and then raised it yet again to 92.0% in 1952. Eisenhower would fix the top tier at 91.0%, where it would remain from 1954 through 1963.

During the first 51 years after reinstatement of the income tax (1913 – 1963), the bottom rate commenced at 1.0%, peaked at 23.0%, and settled at 20.0%. Meanwhile, the top rate was nudged in at 7.0%, peaked at 94.0%, and ended the period at 91.0%. Imagine being in the top tax bracket with an opportunity to make an extra $1 million, and facing the prospect of handing over $910,000 of it to the government, while clutching to a paltry $90,000. Was that fair? Does it sound like a plan for economic prosperity and jobs growth? As we shall see, neither John F. Kennedy nor Ronald Reagan thought so.

From Taxing the Rich

The Tax Reduction Act of 1964

“Our tax system still siphons out of the private economy too large a share of personal and business purchasing power and reduces the incentive for risk, investment and effort – thereby aborting our recoveries and stifling our national growth rate.” – John F. Kennedy, Jan. 24, 1963, message to Congress on tax reduction and reform, House Doc. 43, 88th Congress, 1st Session

Finally in 1963, President John F. Kennedy was able to restore a measure of common sense to the overburdening income tax system. However, shortly after rebuking the “tax the rich” intelligentsia, JFK was assassinated in November 1963. He was succeeded by Lyndon Johnson who signed his vision into law. Under the Tax Reduction Act of 1964, the bottom rate was lowered from 20.0% in 1963, to 16.0% in 1964, and then to 14.0% from 1965 through 1976, and then later reduced to 0.0% in 1977 where it remained until 1986. The top rate was likewise reduced from 91.0% in 1963, to 77.0% in 1964, and then cut to 70.0% in 1965 where it remained until 1981.

Note: It was also during this era, that the Earned Income Credit (EIC) was signed into law by President Gerald Ford in 1975. The function of the EIC was to offset the burden Social Security taxes placed on low-income filers with children, and to motivate them to work.

From Taxing the Rich

In 1965 married couples with taxable income equivalent to $250,000 today paid a tax of 28.6%; those earning $1,000,000 paid 50.3%; and those earning $10,000,000 forked over 67.9% of taxable income (see table below).

From Taxing the Rich

During the entire 18 year period marking JFK’s tax reform legacy, married couples with taxable income equivalent to $250,000 today would have faced an average tax rate of 31.0%; those earning $1,000,000 would have paid an average rate of 52.8%; and those earning $10,000,000 would have forked over an average of 68.6% of their taxable income.

The Economic Recovery Tax Act of 1981

“We don’t have a trillion-dollar debt because we haven’t taxed enough; we have a trillion-dollar debt because we spend too much” ~Ronald Reagan – 40th US President (1981-1989)

In 1981, President Ronald Reagan, in the Jeffersonian spirit, with the wisdom of Lincoln, and the knowledge of Coolidge, took over where Kennedy left off. Summing up the folly of big government, he declared that, “The government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” The Economic Recovery Tax Act, which went into effect in 1982, would maintain the bottom rate of 0.0%, and slash the top rate from 70.0% to 50.0%, but this was only the beginning.

In 1982 married couples with taxable income equivalent to $250,000 today paid a tax of 38.3%; those earning $1,000,000 paid 47.1%; and those earning $10,000,000 forked over 49.7% of taxable income (see table below).

From Taxing the Rich

The Tax Reform Act of 1986

The Economic Recovery Tax Act of 1981 was only a prelude to Reagan’s ultimate goal, tax reform. His objective was to simplify the income tax code, broaden the tax base and eliminate many tax shelters and other tax preferences. Under the Tax Reform Act of 1986 the bottom rate was raised from 0.0% to 11.0%, and the top rate slashed from 50.0% to 38.5%. As of 2011, the Act is the most recent major simplification of the tax code, drastically reducing the number of deductions and the number of tax brackets.

From Taxing the Rich

In 1987 a married couple with taxable income equivalent to $250,000 today paid a tax of 30.5%; those earning $1,000,000 paid 36.5%; and those earning $10,000,000 forked over 38.3% of taxable income (see table below).

From Taxing the Rich

The Tax Reform Act of 1986 culminated in the most simplified rate schedule since the days of Abraham Lincoln. Between 1988 and 1990, the tax rate schedule contained only two tiers, with a bottom rate of 15.0% for couples making under $56,504, and a top rate of 28.0% for those making $56,504 or more.

Between 1988 and 1990, married couples with taxable income equivalent to $250,000 today paid a tax of 25.1%; those earning $1,000,000 paid 27.3%; and those earning $10,000,000 had a tax liability of 27.9% of taxable income (see table below).

From Taxing the Rich

Although George H. W. Bush would ultimately raise taxes by adding a new top bracket of 31.0%, in 1991 through 1992, during the entire 11 year period, married couples with taxable income equivalent to $250,000 today would have faced an average tax rate of 30.5%; those earning $1,000,000 paid an average of 37.2%; and those earning $10,000,000 would have incurred an average tax liability of 39.3% of taxable income.

The Deficit Reduction Act of 1993

“I’ll tell you the whole story about that budget. Probably there are people in this room still mad at me at that budget because you think I raised your taxes too much. It might surprise you to know that I think I raised them too much, too” ~Bill Clinton – 1995

Bill Clinton’s Deficit Reduction Act of 1993 was nothing more than a tax hike. It was far from stellar, simply adding two new brackets above George H. W. Bush’s, but one positive aspect was that it represented a permanent change. The tax rates and brackets remained constant from 1993 through 2000, with an annual adjustment for inflation. The Act kept Reagan’s 15.0% and 28.0% brackets, and Bush’s 31.0% bracket in tact, and merely added two new brackets to the mix — 36.0% and 39.6%.

Note: Clinton is also responsible for implementing the Child Tax Credit, as part of the Taxpayer Relief Act of 1997. The credit was designed to provide tax relief to lower-income families. Initially, for tax year 1998, families with qualifying children were allowed a credit against their federal income tax of $400 for each qualifying child. For tax years after 1998, the credit increased to $500 per qualifying child, and for families with three or more children, the child tax credit was refundable.

From Taxing the Rich

During the 8 year period, 1993 through 2000, married couples with taxable income equivalent to $250,000 today enjoyed an average tax rate of 27.1%; those earning $1,000,000 incurred an average rate of 36.0%; and those earning $10,000,000 gave up an average of 39.2% of taxable income (see table below).

From Taxing the Rich

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)

“He said, tax the rich. You’ve heard that before haven’t you? You know what that means. The rich dodge and you pay.” ~George W. Bush – 2004

In 2001, George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act. The Act maintained the 15.0% bracket, and modestly reduced Reagan’s 28.0% bracket, Bush’s 31.0% bracket, and Clinton’s 36.0% and 39.6% brackets, to 27.5%, 30.5%, 35.5% and 39.1% in 2001. Then in 2002, the Act added a new 10.0% bracket (making it an authentic across the board tax cut), maintained a 15% bracket, and further reduced the remaining brackets to 27.0%, 30.0%, 35.0% and 38.6%.

Note: EGTRRA also enacted a stair-step schedule that raised the Child Tax Credit from $500 to $1,000 over a 10 year period. It also made a portion of the credit, known as the additional child tax credit, refundable.

The following year, Bush would sign the Jobs and Growth Tax Relief Reconciliation Act of 2003 which provided the rates in force today. The Act maintained the 10.0% and 15.0% brackets, and reduced the remaining brackets to 25.0%, 28.0%, 33.0%, and 35.0%. As of today, although Barack Obama has delivered numerous speeches and proposed various temporary tax relief measures, such as a 2.0% cut on the employees’ portion of Social Security taxes (which threatens to accelerate the programs demise), he has offered nothing in the order of permanent tax reductions or reforms.

From Taxing the Rich

Between 2003 and 2011, married couples with taxable income equivalent to $250,000 today are accustomed to an average rate of 24.0%; those earning $1,000,000 have incurred an average of 32.0%; and those earning $10,000,000 are accustomed to paying an average tax of 34.7% of taxable income (see table below).

From Taxing the Rich

Pressing On

“Nothing in this world can take the place of persistence. Talent will not; nothing is more common than unsuccessful people with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan ‘press on’ has solved and always will solve the problems of the human race.” ~Calvin Coolidge

When a taxpayer has enough deductions and credits to not owe any income tax, that should be the end of the matter, but that’s not the case today. No. Ever since enactment of the Earned Income Credit in 1975, followed by the Child Tax Credit in 1997, the federal income tax has become one of the government’s primary tools for the redistribution of wealth. Today, billions of dollars are transferred from one taxpayer to another before the funds ever reach federal coffers. Nowadays, a family with no tax liability at all may receive a “tax refund” of as much as $8,000 per year. This is most outrageous, and a matter which should be on the table for Congressional reform today, not tomorrow. In fact, on September 2, 2011, the Treasury Department’s Inspector General for Tax Administration reported that, in 2010, $4.2 billion in refundable credits were paid to individuals not even authorized to work in the United States. The federal government’s days of sitting around begging for more tax revenue, while recklessly giving away the dollars we currently pay are over.

When we examine the tax rates levied on upper incomes since the Revenue Act of 1913, we find that the average rate paid by married couples with taxable income equivalent to $250,000 today is 23.3%, while those earning $1,000,000 have paid an average tax of 38.6%; and those earning $10,000,000 have paid an average rate of 55.7%. The weighted averages are essentially the same, at 23.3%, 38.6%, and 55.8%, respectively (see table below).

From Taxing the Rich

But of course, if we take into account the first 137 years of American history prior to 1913, when the income tax was for the most part nonexistent, the historically weighted averages are actually significantly lower. We must never forget that out of 236 years of American history, the United States has only put up with an income tax for 110. That’s why many American’s are pressing towards a return to the low rates of Coolidge, while some long for the rates promised in 1913, and still others for repeal of the 16th Amendment.

Today we have Barack Obama, a man who seems curiously decoupled from any sense of American history. By repeatedly delivering the same broken record speech about raising taxes on millionaires and billionaires, while simultaneously proposing to apply the top tax rate to those earning $250,000, Obama has made himself the laughing stock of POTUS’. What gives? Did he miss the 1960’s, 1970’s, or 1980’s? Perhaps Obama was living outside of the country during a key decade, missing a segment of history that most Americans my age remember. I would suggest to Obama or anyone else proposing a radical change in U.S. tax policy, to first learn something about American tax history, and then proceed with caution. We must never forget that it was ‘taxation without representation’, an act of tyranny, which led to the first American Revolution.

Since 1913, the highest average tax rate assessed on taxable incomes of $250,000 has been 32.2%, during precarious times, the lowest 1.3%, and the historical weighted average 23.3%. So with that in mind, one can only imagine where Barack Obama is coming from as he delivers speech after speech hinting at raising taxes on millionaires and billionaires, a feat he portends to accomplish through ushering those making $250,000 into the top tax bracket. If we can learn anything from the past, it should be clear that tax rates on incomes of $1,000,000, $10,000,000 or more are lagging behind their historical weighted averages, while rates on those making $250,000 are within tolerance. So where’s the legislation spelling out the addition of upper brackets on those making millions and billions per year? Obama should either place a proposal in line with his rhetoric on the table, or simply step aside.

From Taxing the Rich

References / Related:

Taxing the Rich, Part I

Taxing the Rich, Part II

Spreadsheets: Historical Income Tax Data

Images: Tax Tables and Charts

Tax Foundation – Income Tax Tables: 1913 to 2011

Tax Acts of the United State, 1861 through 2010

The Origin of the Income Tax

Quick Revolutionary War Tour 1765-1777

#Taxes

CPI Adjusted Dollars:

http://www.measuringworth.com/uscompare/

http://www.dollartimes.com/calculators/inflation.htm

Taxing the Rich – 1765 to 2011, Part II

/ L. M. Walker / 5 Comments

– War and Taxes: 1873 to 1963

– By: Larry Walker, Jr. –

“A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned – this is the sum of good government.“ ~Thomas Jefferson

From Taxing the Rich

In the post-Civil War years, a booming economy produced tariff surpluses for decades. However, Democrat members of Congress, not wanting to give up on the pursuit of legalized theft, introduced sixty-eight income tax bills between the years of 1874 and 1894. It was in the midst of the Panic of 1893 that an amendment to the Wilson-Gorman Tariff Act of 1894 was passed, establishing a 2.0% tax on all incomes above $4,000 per year (about $104,000 today). The amendment would have exempted from taxation the salaries of state and local officials, federal judges, and the president.

Believing the income tax to be unconstitutional, President Grover Cleveland refused to sign it. The Act became law in 1894 without his signature, but was ruled to be unconstitutional in the following year. In 1895, the Supreme Court ruled 5-4 against the income tax, stating that its provisions amounted to a direct tax, which was prohibited by the U.S. Constitution. Prior to the 16th Amendment, a direct tax could only be levied if apportioned among the states according to the census, a concept that America could easily restore through its repeal.

Article I, Section 8: The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.

Article I, Section 9: No capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken. [This section was changed in 1913 by passage of the 16th Amendment.]

Thus America remained the land of the free, free of income taxes from 1873 through 1912. But behind the scenes, the Democrat Party was fast at work, conjuring legislation which would ultimately destroy the freedoms won by Americans in 1776. Democrats proposed a constitutional income tax amendment in their party platforms of 1896 and 1908. Theodore Roosevelt endorsed both an income tax and an inheritance tax, and in 1908, became the first President of the United States to openly propose that the political power of government be used to redistribute wealth.

In 1909, the income tax amendment passed overwhelmingly in the Congress and was sent off to the states. The last state ratified the amendment on February 13, 1913. The Sixteenth Amendment owes its existence mainly to the West and South, where individual incomes of $5,000 or more were comparatively few. Sold to the public as mainly a tax on the rich, the income tax initially applied to less than 1.0% of the population, but that would be short lived. The aspirations of power hungry, greedy and wasteful politicians would soon change the federal government into the conundrum it is today.

“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.” ~Ronald Reagan

Those hornswoggled by today’s Democrat Party, having been indoctrinated in the tired old “tax the rich” mantra of the early 20th Century, will eventually find themselves mired in an infinite array of new taxes: energy taxes, excise taxes, higher Social Security and Medicare taxes, mandated health care taxes, consumption taxes, value added taxes, and every imaginable form of regressive fine and fee. From 1776 to the present, a battle has been waged to determine the government’s fair share of a private citizen’s earnings, and it will continue until government is finally restored to its Constitutional limitations.

The Revenue Act of 1913

In April of 1913, President Woodrow Wilson summoned a special session of Congress to confront the perennial tariff question. He was the first president since John Adams to make an appeal directly to Congress. Under the guise of reducing tariffs, the Act turned out to be nothing more than a means of reinstituting a federal income tax. The argument followed that since a reduction in tariff duties would lead to lost revenue, an income tax would be required to makeup the shortfall. We should be mindful of this as Barack Obama attempts to twist arms during his upcoming special session.

The 1913 Act appealed to those of the “tax the rich” mentality. Its progressive rates were similar to our modern day model, with the exception that it contained 7 tiers and a top rate of 7.0%, versus the present 6 tiers with a top rate of 35.0%. Marginal tax rates, under the 1913 Act, ranged from just 1.0% up to 7.0%. And since a married couple was allowed an exemption of $4,000, which was more than most people earned, most of the population was exempt. At the time, less than 1.0% of the population was subject to the tax, which helps to explain how the 16th Amendment achieved ratification: i.e. “It won’t affect me, so why should I care?” The largest proportion of the tax was targeted to those with incomes higher than anyone could imagine, as at the time, the top bracket of $500,000 was the equivalent of more than $10,000,000 today.

From Taxing the Rich

In 1913, a married couple with taxable income equivalent to $250,000 today would have paid a tax of just 1.0%; those earning $1,000,000 would have paid a tax of 1.6%; and those earning $10,000,000 would have incurred a tax rate of just 4.9% (see table below).

From Taxing the Rich

The War Revenue Act of 1917

World War I commenced on July 28, 1914 and lasted until November 11, 1918. Since the income tax was initially imposed as a means to fund war (1861), its original intent, now combined with an element of wealth redistribution, lead to one of the most convoluted tax rate schedules of all time. The War Revenue Act of 1917 expanded the tax rate schedule from 7 to 56 tiers. Rates were hiked to a range of 6.0% to 77.0% in 1918. The 1918 tax rate schedule was so convoluted that taxpayers were thrown into a higher bracket with every $1,000 to $2,000 of additional income.

From Taxing the Rich

Under the 1918 Act, a married couple with taxable income equivalent to $250,000 today would have paid a tax of 12.9%; those earning $1,000,000 would have paid a tax of 25.7%; and those earning $10,000,000 would have incurred a tax rate of 66.9% (see table below).

From Taxing the Rich

The Mellon Tax Bill (1924 – 1931)

Although the war ended in 1918, income taxes were not significantly reduced until 1924. In 1919 the top rate was gradually lowered to 73.0%, then to 58.0% in 1922, and to 46.0% under the Mellon Bill of 1924. By 1924, the tax rate schedule contained just 43 tiers compared to 56 in 1918. The bottom rate also gradually declined from 6.0% in 1918 to 2.0% in 1924. Then in 1925, under the leadership of President Calvin Coolidge, the bottom rate was reduced to 1.5%, the top rate slashed to 25.0% with a reduced top bracket, and the tax rate schedule was simplified to 23 tiers from 43.

Finally, common sense had returned. It was peacetime, and with taxes greatly reduced, the “Roaring Twenties” ensued. Although Coolidge didn’t cut top rates back to 7.0%, the lower rates he put in place, lasting from 1925 through 1931, have never been matched since. Coolidge had it right when he proclaimed that, “Collecting more taxes than is absolutely necessary is legalized robbery.”

From Taxing the Rich

Even before being elected President of the United States, the former Governor of Massachusetts understood and opined that, “There is a limit to the taxing power of a State beyond which increased rates produce decreased revenue. If that be exceeded intangible securities and other personal property become driven out of its jurisdiction, industry cannot meet its less burdened competitors, and no capital will be found for enlarging old or starting new enterprises. Such a condition means first stagnation, then decay and dissolution. There is before us a danger that our resources may be taxed out of existence and our prosperity destroyed.” ~Calvin Coolidge (Address to the General Court beginning the 2nd year as Governor of Massachusetts January 8, 1920)

By 1925, a married couple with taxable income equivalent to $250,000 today would have paid a tax of just 4.9%; those earning $1,000,000 would have paid a tax of 14.4%; and those earning $10,000,000 would have incurred a tax rate of 23.9% (see table below).

From Taxing the Rich

Revenue Acts of 1932 to 1940

In the midst of the Great Depression, President Herbert Hoover relapsed, imposing higher tax rates and expanding the number of tax brackets from 23 to 55. In 1932, the bottom rate was increased from 1.5% to 4.0%, and the top rate was hiked from 25.0% to 63.0%. The tax rate on upper brackets was later increased to 79.0%, by FDR, in 1936, where it would remain through 1940. Hoover had in effect reinstated wartime tax rates during a time of peace. Errantly believing that higher taxes would increase government revenue, Hoover was the first president to prove that raising taxes during a recession only prolongs the downturn. Thanks to Hoover, and his successor Franklin Roosevelt, the Great Depression wouldn’t end until America entered the 2nd World War.

From Taxing the Rich

In 1932, a married couple with taxable income equivalent to $250,000 today would have paid a tax of 8.6%; those earning $1,000,000 would have paid a tax of 21.8%; and those earning $10,000,000 would have forked over 54.8% of their taxable income (see table below).

From Taxing the Rich

Revenue Acts of 1941 to 1963

The next major tax hike would occur in 1941, with rates remaining at accelerated levels through 1963. After Hoover opened the door, FDR removed the hinges, gradually raising rates from the bottom up. President Franklin Roosevelt believed and stated that, “Taxes, after all, are dues that we pay for the privileges of membership in an organized society.” This would mark a critical turning point in American history, as the purpose of the income tax had shifted from a temporary means to fund the Civil War, to a measure reinforcing lower tariff duties, to the price of living under the rule of a tyrannical dictator.

Following suit, bottom tax rates were raised from 4.0% in 1932, to 10.0% in 1941, to 19.0% in 1942, and to a record high of 23.0% in 1944. His successor, Harry Truman, would continue the tradition. After initially lowering the bottom rate to 20.0% in 1949, Truman raised it to 20.4% in 1951 and to 22.2% in 1952. The bottom rate was then locked in at 20.0%, by President Dwight Eisenhower, where it remained from 1954 through 1963.

The top rate was likewise increased by FDR, climbing from 63.0% in 1932, to 79.0% in 1936, 81.0% in 1941, 88.0% in 1942, and to a record high of 94.0% in 1944 during the 2nd World War. Truman later lowered the top bar to 91.0% in 1946, and then raised it yet again to 92.0% in 1952. Eisenhower would fix the top tier at 91.0%, where it would remain from 1954 through 1963.

From Taxing the Rich

In 1941, a married couple with taxable income equivalent to $250,000 today would have paid a tax of 23.1%; those earning $1,000,000 would have paid 46.9%; and those earning $10,000,000 would have forked over 71.0% of their taxable income (see table below).

From Taxing the Rich

During the entire 23 year period, a married couple with taxable income equivalent to $250,000 today would have faced an average tax rate of 32.2%; those earning $1,000,000 paid an average tax of 57.6%; and those earning $10,000,000 would have forked over a whopping 85.5% of their taxable income (see table below).

Summary

“The government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the government and the buying power of consumers. By adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.” ~Abraham Lincoln, 16th US President (1809-1865)

From Taxing the Rich

During the first 51 years after reinstatement of the income tax, from 1913 to 1963, the bottom rate commenced at 1.0%, peaked at 23.0%, and settled at 20.0%. Meanwhile, the top rate was nudged in at 7.0%, peaked at 94.0%, and ended the period at 91.0%. Imagine being in the top tax bracket with an opportunity to make an extra $1 million, and facing the prospect of handing over $910,000 of it to the government, while clutching to a paltry $90,000. Was that fair? Does it sound like a plan for economic prosperity and jobs growth? As we shall see, neither John F. Kennedy nor Ronald Reagan thought so.

The average rates on the wealthy during each significant wave between 1913 and 1963 are shown above. It is important to understand that a small imposition, upon the rich, blossomed into grand theft taxation. That’s what happens when citizens allow a government to act without restraint. Those seeking to usher couples with taxable income of $250,000 into the upper echelons of taxation should recognize that the highest tax rates ever assessed at this level, when wartime taxes were at a peak, averages out to 32.2%, while pre-1941 averages were below double digits.

It’s time for America to return to her roots. We cannot and will never again allow our government to lead us, as blind men, into the abyss. To raise taxes on one is to raise them on all. Those who believed they would always be exempt from taxes, in 1913, would soon find themselves paying nearly three times the rate initially assessed on the wealthy. Today, every worker is subject to Social Security and Medicare taxes totaling 15.3% (temporarily 13.3%), a rate which is more than double that paid by the wealthiest Americans under the Revenue Act of 1913. There is no escape; you’re either for higher taxes, or lower taxes. Don’t believe the lie. Those advocating higher taxes on the rich have always and will always ultimately raise them on every soul, from the bottom up.

To be continued… Taxing the Rich – 1765 to 2011, Part III

References / Related:

Taxing the Rich – 1765 to 2011, Part I

Spreadsheets: Historical Income Tax Data

Images: Tax Tables and Charts

Tax Foundation – Income Tax Tables: 1913 to 2011

Tax Acts of the United State, 1861 through 2010

The Origin of the Income Tax

Quick Revolutionary War Tour 1765-1777

#Taxes

CPI Adjusted Dollars:

http://www.measuringworth.com/uscompare/

http://www.dollartimes.com/calculators/inflation.htm

Taxing the Rich – 1765 to 2011, Part I

/ L. M. Walker / 5 Comments

– War and Taxes: 1765 to 1872

– By: Larry Walker, Jr. –

“There is a limit to the taxing power of a State beyond which increased rates produce decreased revenue. If that be exceeded intangible securities and other personal property become driven out of its jurisdiction, industry cannot meet its less burdened competitors, and no capital will be found for enlarging old or starting new enterprises. Such a condition means first stagnation, then decay and dissolution. There is before us a danger that our resources may be taxed out of existence and our prosperity destroyed.” ~Calvin Coolidge

From Taxing the Rich

The American Revolution was the product of war and taxes. There are few topics more cantankerous, for war has oft been used as an excuse to enslave a populace through taxation, and unfair over-burdensome taxes have oft led to war. With the United States government’s passage of the quixotic Affordable Care Act of 2010, which would regulate the lives of every man, woman and child from cradle to grave, and add a new set of taxes and mandates; the Tea Party revolution was reborn. Elected officials who take the movement flippantly are likely to find themselves buried in the trash heap of human history.

In 1765, Great Britain imposed a series of taxes upon the American Colonies, in order to pay for its lengthy French and Indian War (1754-1763). After the war, the British forced upon the Colonies, the Stamp Act of 1765, requiring the purchase of tax stamps for any printed documents including newspapers, legal documents, marriage licenses and more. This was followed by the Townshend Acts of 1767 which were passed: to raise revenue in order to pay the salaries of governors and judges so that they would be independent of colonial rule; to create a more effective means of enforcing compliance with trade regulations; to punish the province of New York for failing to comply with the 1765 Quartering Act; and to establish as precedent the British Parliament’s right to tax.

Just like the Tea Party Movement of today, our founding fathers resented insidious taxes and regulations imposed upon them without their consent. Then as now, it is simply a matter of ‘taxation without representation’, an act which early Americans likened to tyranny. By 1773, when the East India Company was granted a virtual monopoly on the importation of tea, it was the last straw. In protest, a group of Boston citizens disguised as Mohawk Indians boarded a ship and dumped 342 chests of tea into Boston harbor. The Revolutionary War ensued, and the United States of America was born. Today, the Affordable Care Act is only a symptom of the disease. The disease being: over-regulation, over-burdensome covert and overt taxes, unsustainable federal debt, and a small minority of ideologues with socialist tendencies forcing its will upon the people.

“Collecting more taxes than is absolutely necessary is legalized robbery.” ~Calvin Coolidge

Far-left demagogues often speak in platitudes, but the utopian paradise they seek, through raising taxes on millionaires and billionaires, is a myth. Behind closed doors, they secretly plot to raise taxes on every soul, from the bottom up. They seem to have no recollection of American history, a history in which Americans have only been subject to an income tax for 110 out of 236 years. The United States has only endured an income tax between the years of 1862 to 1872, and 1913 through 2011. The income tax was initially spawned to fund the Civil War, errantly raised during the Great Depression, hiked to the max during both World Wars, and is today being exploited by left-wing politicians whose only goal is to reduce American exceptionalism to a failed, redistributive, collectivist state.

Ever since the income tax was introduced in the United States, the balance has tilted between having no income tax at all, to a top marginal rate of 94.0% (1944); and from a top tax bracket of $15,200 in 1867, to $79,412,681 in 1936 (in today’s dollars). In this series, we will examine the tax rate schedules in use from 1861 through 2011, and in so doing, will uncover the rates levied on incomes of $250,000, $1,000,000, and $10,000,000, throughout U.S. history. We will discover how the purpose of the income tax has shifted from a means to fund war, to an apparatus of wealth redistribution.

We will determine the average historical tax rates, and weighted average tax rates imposed upon upper incomes. We shall learn that throughout American history, an income of $250,000 has been taxed at an average historical rate of 23.6%. We shall hopefully gain some sense of what the term “fair tax” really means, as for some no income tax at all is considered fair, while for others a tax of 94.0% upon the rich is deemed just. Yet we believe as Calvin Coolidge, John F. Kennedy, Ronald Reagan, and George W. Bush believed, that ‘there is a limit to the taxing power of a State beyond which increased rates produce decreased revenue, and that if taxes are too high America’s resources may be taxed out of existence and our nation’s prosperity destroyed’.

The Revenue Act of 1861

The first income tax levied by the United States Government was imposed to fund the Civil War (1861). Prior to this, the government was funded strictly through customs duties, tariffs levied on imported goods. During the War of 1812, the government experimented briefly with excise taxes on certain goods, commodities, housing, slaves and land, but a tax on income was out of the question. What is significant is that prior to 1861, or for the first 86 years of American history, whether a citizen had an annual income of $800, $250,000, $1,000,000 or $10,000,000, every dime was considered to be private property of the individual, and not subject to any federal claim.

The Revenue Act of 1861 included the first U.S. Federal income tax statute. It introduced the federal income tax as a flat rate tax. The income tax was to be “levied, collected, and paid, upon the annual income of every person residing in the United States, whether such income is derived from any kind of property, or from any profession, trade, employment, or vocation carried on in the United States or elsewhere, or from any other source whatever”. Rates under the Act were 3.0% on income above $800 ($20,400 in 2011 inflation adjusted dollars) and 5.0% on income of individuals living outside the country.

From Taxing the Rich

Under the 1861 Act, a married couple earning the equivalent of $250,000 (in 2011 dollars) would have paid a tax of just 2.8%; those earning $1,000,000 would have paid 2.9%; and those earning $10,000,000 would have incurred a tax rate of just 3.0% (see table above).

It is important to note that: (1) America’s first income tax was a flat rate tax, (2) it was meant to be temporary, with the proceeds used solely to fund the Civil War; (3) for the preceding 86 year period, personal income of American citizens was not subject to any federal tax; and (4) that no revenue was ever raised under the 1861 Act, because it was revised (on June 30, 1862) before any tax was due.

The Revenue Act of 1862

In 1862, the initial Revenue Act was revised to reflect the first progressive rate tax in U.S. history. The office of the Commissioner of Internal Revenue was established. The Act specified that the Federal income tax was a temporary measure that would terminate in the year 1866. Annual income of U.S. residents, to the extent it exceeded $600 ($13,400 in 2011 dollars), was taxed at a rate of 3.0%; those earning over $10,000 per year ($224,000 in 2011 dollars) were taxed at a 5.0% rate. With respect to the income tax liability generated by the salaries of “officers, or payments to persons in the civil, military, naval, or other employment or service of the United States, including senators and representatives and delegates in Congress,” the law also imposed a duty on paymasters to deduct and withhold the income tax, and to send the withheld tax to the Commissioner of Internal Revenue.

Under the Revenue Act of 1862, a married couple earning the equivalent of $250,000 (in 2011 dollars) would have paid a tax of just 3.4%; those earning $1,000,000 would have paid 4.6%; and those earning $10,000,000 would have incurred a tax rate of just 5.0% (see table below).

From Taxing the Rich

The Revenue Act of 1864

Since in 1862 the Union War Debt stood at $505 million, and since the income tax only raised $2.7 million in 1862 and $20.2 million in 1863, rates were raised in 1864. The 3.0% tax on incomes above $600 ($8,590 in 2011 dollars due to devaluation) was increased to 5.0%, a new 7.5% rate was introduced on incomes over $5,000 ($71,600 in 2011 dollars), and the old rate of 5.0% on incomes above $10,000 ($143,000 in 2011 dollars) was raised to 10.0%.

Under the Revenue Act of 1864, a married couple earning the equivalent of $250,000 (in 2011 dollars) would have paid a tax of just 7.7%; those earning $1,000,000 would have paid 9.4%; and those earning $10,000,000 would have incurred a tax rate of just 9.9% (see table below).

From Taxing the Rich

Ending the Income Tax (1865 to 1872)

When the Act finally expired, the United States was again without an income tax; a condition that would last from 1873 until 1912, adding another 40 years to our tax-free heritage. By 1865, the 7.5% rate was increased to 10.0% leading to the highest tax rates for the period. By the end of 1866, when it was to have expired, the income tax was instead gradually phased out. The top rate was lowered to 5.0% between 1867 and 1869, and then to 2.5% from 1870 to 1872 (see tables below).

Between 1865 and 1866, a married couple earning the equivalent of $250,000 (in 2011 dollars) would have paid a tax of 8.4%; those earning $1,000,000 would have paid 9.6%; and those earning $10,000,000 would have incurred a tax rate of 10.0% (see table below).

From Taxing the Rich
From Taxing the Rich

Summary

“The freedoms won by Americans in 1776 were lost in the revolution of 1913.” ~Frank Chodorov

During the first 137 years of American history (1776 – 1912), the income tax only existed for 11 years, while no income tax was imposed upon private citizens for 126 years. The highest tax rate assessed on married couples occurred between 1865 and 1866, when those earning the equivalent of $250,000 (in 2011 dollars) paid a tax of 8.4%, those earning $1,000,000 paid 9.6%, and those earning $10,000,000 incurred a tax rate of just 10.0%. In the current tax debate, those caterwauling for higher taxes on the wealthy should, if it is within them, remember their own heritage. An understanding of the origin of the American income tax system, its original intent and early rates, is essential to any meaningful dialogue.

To be continued… Taxing the Rich – 1765 to 2011, Part II

References / Related:

Spreadsheets: Historical Income Tax Data

Images: Tax Tables and Charts

Tax Foundation – Income Tax Tables: 1913 to 2011

Tax Acts of the United States, 1861 through 2010

The Origin of the Income Tax

Quick Revolutionary War Tour 1765-1777

#Taxes

CPI Adjusted Dollars:

http://www.measuringworth.com/uscompare/

http://www.dollartimes.com/calculators/inflation.htm

Obama’s 1950s Tax Fallacy

/ L. M. Walker / 6 Comments

– Is the FICA tax a tax?

– By: Larry Walker, Jr. –

During a press conference on June 29, 2011, Barack Obama said, “The revenue we’re talking about isn’t coming out of the pockets of middle-class families that are struggling — it’s coming out of folks who are doing extraordinarily well and who are enjoying the lowest tax rates since before I was born. If you’re a — if you are a wealthy CEO or a … hedge fund manager in America right now, your taxes are lower than they have ever been. They’re lower than they’ve been since the 1950s.”

Does Obama really want to go there? Why stop at the 1950s? Why not go all the way back to 1913, or 1926, when top marginal tax rates were only 7.0% and 25.0%, respectively? And if top marginal tax rates are lower today than they’ve been since the 1950s, are they not also lower than they’ve been since 1964? For what it’s worth, I know that within my lifetime, top marginal tax rates are higher today than they were in the late 1980s, and lower than they were for most of the 1990s, but as for the 1950s, why should I care? That was before my time as well.

If I understand Obama correctly, what he’s saying is that if you were a wealthy CEO or a hedge fund manager in the 1950s, your taxes are lower today, than they were back then. But, if you were a wealthy CEO or a hedge fund manager in the 1950s, and are still breathing, you’re probably well into your 80s and could care less, like me. Enjoy forking over the paltry 35% of your earnings for your remaining years, and don’t forget the Social Security, Medicare, and State taxes. I mean, if anyone deserves a break, it’s our elders.

Now, I wasn’t born until 1960, and didn’t start working consistently until the 1980s, and I think my Mom was only 12 in 1950, so is anyone around today who can relate? The truth is that for anyone to have entered the workforce, at say the age of 18, in 1950, would make them at least 79 years old today. And anyone who entered the workforce at the end of that decade, in 1959, would be at least 70. So in order to have been in the prime earning years back then, ages 30 to 50, would make one well beyond 80 years of age today. For example, Alfred Winslow Jones (9 September 1900 – 2 June 1989), who formed the first hedge fund in 1949, would have been 111 years old by now. And, since the average age of a CEO in the United States, today, is just 56, most wouldn’t even have been born until the mid-1950s. The fact that there aren’t any CEOs or hedge fund managers around today, who were in those positions in the 1950s, leads anyone paying attention to think that Obama is out of touch with reality. And that’s putting it kindly.

The table below compares what 1950s tax rates looked like back then, against what they would look like in 2010 dollars. [Note: Tax rates were the same throughout the 1950s, and the brackets for Single and Married Filing Separate taxpayers were exactly one-half of the amounts in the following 1955 Married Filing Joint schedule.]

From 1950s Tax Fallacy

Winning The ‘50s – At least in the 1950s, everyone had skin in the game. If you had taxable income of under $32,352, in 2010 dollars, your marginal tax rate would have been 20%. If you had taxable income of $250,000, in today’s dollars, your marginal tax rate would have been 47%. And if you had taxable income of over $1,000,000, in 2010 dollars, your marginal rate would have been between 78% and 91%. So is this what Obama wants? If so, he should change his slogan from “Winning the Future” to “Winning the ‘50s”, or something.

Nobody really knows what Obama is bloviating about, but just for the heck of it, let’s analyze whether the amount of personal tax revenues collected, as a percentage of GDP, was any higher in the 1950s than it is today. The chart below was derived from statistics published by the U.S. Bureau of Economic Analysis. According to the data, personal taxes, as a percentage of GDP, averaged 7.6% in the 1950s, and 7.5% between 2001 and 2010. So in that sense, Americans are paying a whopping 1.3% less in personal taxes than our grandparents, and great-grandparents paid back in the 1950s. I included federal government spending just out of curiosity. It turns out that government spending as a percentage of GDP, while only averaging 16.4% in the 1950s, has averaged 21.3% since 2001. So it appears that the percentage decline of 1.3% in personal taxes, which we are all enjoying today, is miniscule, compared to the unsustainable 29.8% spike in federal government spending. Perhaps Obama should have picked a different decade.

From 1950s Tax Fallacy

Although it may be true that in the single year of 2010, personal taxes declined to 6.2% of GDP, versus the 7.6% average of the 1950s, or by -18.4%; at the same time, government spending has skyrocketed to 25.5% of GDP, versus 16.4% in the 1950s, or by +55.5%. So in 2010, personal taxes declined by -18.4%, while federal spending increased by +55.5%, compared to 1950s averages. So what’s wrong with this picture? Should we just adopt the 1950s tax brackets and then jack the rates up by 73.9%?

Back to the point of Obama’s tirade: Although in terms of tax brackets, it would appear on the surface that we are paying lower taxes today, than our ancestors who worked in the 1950s, there is one additional item to consider. Without getting into all the other taxes we pay today, which either were not around or at least not as burdensome in the 1950s (i.e. federal fuel taxes, airline ticket taxes, state and local taxes, and such), FICA payroll taxes were much lower in the 1950s compared to today.

Is the FICA tax a tax?

We know that the Federal Insurance Contributions Act (FICA) is codified at Title 26, Subtitle C, Chapter 21 of the United States Code. And that the FICA tax is a United States payroll (or employment) tax imposed by the federal government on both employees and employers to fund Social Security and Medicare —federal programs that provide benefits for retirees, the disabled, and children of deceased workers, etc… And we know that the amount that one pays in payroll taxes throughout one’s working career is indirectly tied to the social security benefits annuity that one receives as a retiree. Yet while some folks claim that the payroll tax is not a tax because its collection is tied to a benefit, the United States Supreme Court decided in Flemming v. Nestor (1960) that no one has an accrued property right to benefits from Social Security. Add to that the fact that the Trust Funds have been looted, and it is clear that the FICA tax is really just a tax. My basic rule of thumb is that, if it comes out of my paycheck, and goes to the federal government, it’s a tax.

In 1950, the Old-Age, Survivors, and Disability Insurance (OASDI) tax rate levied on both employees and employers was just 1.5% of the first $3,000 in wages ($3,000 in 1950 was equivalent to $27,451 in 2010). And by 1959, the rate had increased to 2.5% of the first $4,800 in wages ($35,866.96 in 2010 dollars). There wasn’t any Medicare tax in the 1950s, as it was not implemented until 1966. Historical FICA tax rates are shown below.

From 1950s Tax Fallacy

As most of us working today are aware, beginning in 1990, the OASDI tax rate was increased to 6.2% of the first $51,300 in earnings, and the wage base has increased each year since by increases in the national average wage index. Also beginning in 1990, Medicare taxes were assessed at the rate of 1.45% of the first $51,300 in wages, and the wage base was stepped up to $125,000 in 1991, $130,200 in 1992, $135,000 in 1993, and has been levied without earnings limitations since 1994. Most of today’s workforce is also aware that since 2009, the OASDI rate of 6.2% has applied to the first $108,600 in wages, while the Medicare tax of 1.45% has been levied without limit (see chart below). By the way, Medicare taxes are scheduled to increase in 2013, for those who are not paying their “fair share” today.

From 1950s Tax Fallacy

So if we add social insurance taxes, since they are a tax, to personal income taxes, and compare the total amount of taxes paid in the 1950s to the present, are taxes still lower today? Well, per the chart below, the average amount of combined social insurance and personal taxes paid in the 1950s was 9.7% of GDP, versus an average of 14.3% for the decade ending in 2010. So it turns out that the total amount of taxes the federal government collects from us today are 47.4% more than in the 1950s. This might explain why many of us feel as though we are taxed enough already. But how would we know without first checking the facts? What is clear, without question, is that taxes are a heck of a lot lower today, than they were when they reached a record 17% of GDP in the year 2000. Also of note is the fact that government spending only represented 18.8% of GDP in the year 2000, or about the same as it was in 1969, versus a disgraceful 25.5% in 2010.

From 1950s Tax Fallacy

The Point: The fact that we are paying 6.2% in Social Security taxes on the first $108,600 of earnings today, whereas the rate was only 2.5% of the first $4,800 in 1959; and that we are paying an additional 1.45% in Medicare taxes on an unlimited amount of earnings today, whereas the tax did not exist in the 1950s; means that the amount of taxes paid by individuals, as a percentage of GDP, is much greater today than it was for those living and working in the 1950s. In fact, the total amount of taxes Americans pay today is at least 47.4% greater than it was in the 1950s. It’s also interesting to note that the amount of taxes paid in 2010 was exactly the same, as a percentage of GDP, as paid by those who lived and worked in 1970 (see the chart above, data here). So what’s the bottom line?

The bottom line: If Obama wants to go back to the 1950s, let’s go. But it’s not going to work unless government spending follows suit. So cut government spending from 25.5% of GDP, back down to 16.4%, and you’ve got a deal. But I’m afraid that short of passing the Monetary Reform Act, the next step forward is another shellacking. But that’s a given. America lacks leadership. Either you’re hot, lukewarm or cold, but attempting to divert attention away from the real problem, excessive government spending, towards some make-believe injustice since the 1950s, is so far from the mark that it’s almost incomprehensible. As I see it, there are two problems with Obama’s sound bite. First of all, 51% of the current American workforce doesn’t pay any income taxes at all (i.e. not paying their fair share). Secondly, the injustice du jour lies not in the amount of taxes being collected, but rather in the amount of money the federal government is squandering. It would appear that with Obama, all roads lead to Athens, or is it Rome?

“It is a paradoxical truth that tax rates are too high and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now … Cutting taxes now is not to incur a budget deficit, but to achieve the more prosperous, expanding economy which can bring a budget surplus.” ~John F. Kennedy, Nov. 20, 1962, president’s news conference

References:

Data Tables

http://www.bea.gov/national/nipaweb/SelectTable.asp#S2

http://www.ssa.gov/OACT/ProgData/taxRates.html

http://findarticles.com/p/articles/mi_m2893/is_4_26/ai_n25340358/

http://www.taxfoundation.org/publications/show/151.html

http://www.dollartimes.com/calculators/inflation.htm

Solving the Debt Crisis | A Catch-22

/ L. M. Walker / 3 Comments

~ Pass The Monetary Reform Act ~

By: Larry Walker, Jr. ~

The Obama administration’s solution for the nation’s impending destruction, due to out-of-control deficit spending, is to increase the debt ceiling now, and worry about spending cuts later. The Obama administration is under the impression that more borrowing power will enable the nation to maintain its AAA Credit rating. The Catch-22 is that an instant increase in the debt ceiling will result in an instant downgrade to the nation’s credit rating. You see, the problem is not the level of the nation’s debt ceiling; the problem is America’s debt-to-GDP ratio. If raising the debt ceiling by $2.5 trillion would result in an equal increase in gross domestic product, then the problem would be solved. However, there is no verifiable link between government spending and economic growth.

The following passage, from Joseph Heller’s book, “Catch-22”, about sums up the whole zero-sum debt dilemma: “There was only one catch and that was Catch-22, which specified that a concern for one’s safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn’t, but if he was sane he had to fly them. If he flew them he was crazy and didn’t have to; but if he didn’t want to he was sane and had to.” The solution to Orr’s problem would be to simply end the war. Similarly, the solution to the National Debt problem is to simply end the Fed.

Obama and his supporters are basically saying, “You have to buy more government bonds, otherwise the bonds you already own will go into default.” In other words, the only way the government can continue to pay the interest on its $14.5 trillion National Debt is through incurring more debt. Like Orr in Heller’s Catch-22, Obama must be thinking: I have bankrupted the federal government and need to borrow more to keep from going broke. If we don’t raise the debt ceiling, the National Debt will be contained, but we will not be able to pay the interest on the current debt. If we raise the debt ceiling, we will increase our debt thus ensuring our demise, but if we don’t raise the debt ceiling then we must declare bankruptcy. If we raise the debt ceiling we will be bankrupt, and if we don’t raise the debt ceiling we will be bankrupt.

What AAA Rating? – While American politicians claim that their intention is to preserve the nation’s alleged AAA credit rating, Dagong Global Credit Rating Co., Ltd. (Dagong), China’s credit rating service, has already lowered its rating to A+/negative. Dagong initially assigned the United States a sovereign credit rating of AA in July 2010, but lowered this rating on November 3, 2010, when the U.S. Federal Reserve announced its QE2 monetary policy. In Dagong’s opinion, QE2 was “aimed at stimulating the U.S. economy through issuing an excessive amount of U.S. dollars”, which it saw as a sign of “the collapse of the U.S. government’s ability to repay its debt and a drastic decline of its intention to repay”. Dagong therefore downgraded the U.S.A.’s credit rating to A+/negative, and has since placed the sovereign credit rating of the United States on its Negative Watch List. But who cares about China’s credit rating service, right? After all, we only acknowledge Moody’s and S&P in the West, because we can always borrow from Europeans, right?

Unasked Questions – The questions that politicians have failed to consider in this entire futile debate are as follows:

Why is the government in debt? – The federal government is in debt because it has given its ability to create money over to the privately owned Federal Reserve, and to privately owned National Banks. Every time the government needs money, it must first borrow it from the Federal Reserve by exchanging bonds for cash. Why? If the government were to simply print its own currency, similar to Lincoln’s Greenbacks, then there would be no National Debt at all. So why not change this first? If the federal government were to pass the Monetary Reform Act, it would be able to payoff the entire National Debt within a year, and would simultaneously extinguish from its budget $400 billion per year in interest payments.

Where will the money come from? – When the Obama administration proposes to increase the National Debt by another $2.5 trillion, it’s most profound that no one is asking where the money will come from. So where will the money come from? The answer is out of thin air. That’s right. The money the government borrows is created out of thin air. But creating money out of thin air has consequences, namely inflation. When the Fed prints money and exchanges it for government bonds, the existing money supply is diluted, in other words, worth less. Who needs QE3, when you’ve got Obama-Year-3?

Dazed and Confused – Many, so called, conservatives seem to be confused on the matter of Monetary Reform. When we say, “Who cares about the banks, let them go broke”, they reply, “but banks are businesses and what you are proposing is anti-capitalism.” It’s funny that when it came to big bank bailouts, the same crowd who was chanting, “Let them go broke,” is now saying, “Don’t take away our precious banks.” I maintain that banks are not businesses. Banks produce no real goods or services; they merely buy, sell and hold debt. They also receive the largest government subsidy there is, the ability to create money out of thin air and to loan it out at interest.

Real businesses produce real products and services such as oil companies. Oil companies drill for oil and natural gas, and then refine it into tangible products sold to the public for profit. When politicians speak of taking away, so called, tax subsidies for oil companies, what they are really saying is that U.S. citizens should pay more in energy costs, not that oil companies should pay more in taxes. When we say, “End the Fed,” what we are really saying is, “End the National Debt”. When we say, “Raise bank reserve ratios from 0% to 10%, to 100%”, what we are saying is, “Take away the national banking system’s ability to create and loan out money that it doesn’t have.”

The Only Solution – Cutting taxes, reducing spending, raising taxes, and increasing spending are proposals which no matter how you structure them will not solve the real problem. Borrowing more to keep from going broke is not only absurd, it’s insane. So who’s kidding who? Passing the Monetary Reform Act will solve the National Debt problem and place America firmly on the road to recovery. In my opinion, there is no other solution.

Until there is reform, “Render unto Caesar the things which are Caesar’s, and unto The United States the things that are the Federal Reserve Bank’s.”

Photo Credit: World Crisis by Petr Kratochvil