Hello from Europe!

Middle class workers generally spend most of their earnings on consumption while the rich, who can't spend it all, look for investment opportunities.

A GREAT reason for why they shouldn't have that much wealth to begin with and that it should be rolled over into the general funds for the betterment of society rather than wasted on nothing. They CAN'T use that much money so...don't have it.

Middle class workers generally spend most of their earnings on consumption while the rich, who can't spend it all, look for investment opportunities.

A GREAT reason for why they shouldn't have that much wealth to begin with and that it should be rolled over into the general funds for the betterment of society rather than wasted on nothing. They CAN'T use that much money so...don't have it.

With all of excitement of Abu this week did anyone notice that?

Maybe they've been investing in this:

Outsourcing Intelligence:

http://www.thenation.com/doc/20070730/hillhouse

But perhaps most important is the role of the central banks, and the Fed's responsibility in making easy credit available for too long (remember "irrational exuberance," way back in 1996?). The Fed never let the stock bubble deflate, it just converted it into a real estate bubble. It's axiomatic that the longer you put off the pain, the more it's going to hurt.

I have to laugh when I hear complaints from libertoonians about farm subsidies, because the biggest subsidy in the U.S. is when the Federal Reserve lowers the prime interest rate to help out the the uber-rich when their precious credit gets tight. Let's face it folks - we have a government of the money, by the money, and for the money now. The reason getting rid of estate taxes is currently a political issue isn't because there's a groundswell of popular opinion on the matter, but because campaign contributions speak loud and clear to politicians and lobbyists who are bought and paid for.

One of the Things-Which-Must-Not-Be-Said is that the U.S economy has been rigged to the benefit of investment and capital, at the expense of just about everything else. That is going to HAVE to change because conservatives blew their big shot at driving Social Security money into stocks. As the Baby Boom retires, they'll become more concerned about protecting their nest egg and will suck buttloads of money out of the market. It's one thing to prioritize stocks when they're going up and up and up. But you can't make them the center of your financial universe if they're stagnant or declining over a long period of time.

Mike

A tax code that supports free and easy capital formation is a good thing

Such a thing might or might not be good, if it existed. However, I think you are mistaking a tax code (and a more general set of government policies) that support concentration of capital with supporting the formation of capital. For the most part, capital formation is protected just by the basic defense of property rights independent of the distributive properties of the tax code; a tax structure that favorably treats the returns on existing capital compared to other income guarantees that those who already hold capital will get more, while those who do not already hold capital will (compared to their prospects under a more equitable tax scheme) have less opportunity to do so in the future. I don't see that it necessarily favors the formation of capital, though.

Isn't a credit bubble just the latest stage of the asset inflation that's been going on for 10 years or so? When you've got too much money chasing too few goods, the prices of those goods go up. Stocks, houses, mortgage-back securities, corn, whatever. And then, splat.

The terribly sad thing about all this is that there are plenty of sectors desperately calling for investment where that excess money could be doing some good. Human and social capital of all kinds, alternative energy sources, mitigation of climate change... But since the entire defining characteristic of modern markets is to be short-sighted (because there's always someone else to sell to) we buy assets that can vanish in the turn of an electron.

A credit bubble develops when there's too much money to lend and too few places to lend it.
How is that, again? Besides being the nonsense one expects from a WaPo "journalist", the article conflates 2 issues (at least) into 1. There's the consumer side which includes the sub-prime market and then there's the commercial lending piece of the pie.
As commercial banks were driven out of the decent spreads from lending to companies, they looked to consumers to drive earnings. Thus the home equity loans that were helped by reduced rates and rising house values.
Quite a few of those same banks looked to manage the wealthy customer's money for good, steady fee income.
The principally NY investment banks which had taken over the commercial lending market were also able to help the wealthy find places to earn higher returns. The sub-prime market was created for yield based on mortgage repayment models.

A tax code that supports free and easy capital formation is a good thing, but when does it become too much of a good thing?
The Piketty-Saez data show that income inequality also grew during the 90s when Clinton raised taxes on the rich. So, based on that data, this is a dumb question since there must be something deeper that explains income inequality than the tax code.

But wait, if there's a credit bubble, why don't we see a corresponding devaluation of our currency? And if there's a devaluation of our currency, why don't the inflation statistics reflect that?

I'm really curious, because if those indicators can't inform us or warn us about these things, then gosh, somebody's got to be lying or fudging numbers somewhere. . .

For those who tirelessly advance the Big Lie that there is no difference between Democrats on Capitol Hill or Republicans, the just-passed homeland security bill should put an end to it.

The bill, which was initiated by Democrats and which finally won Republican votes, enacts into law (assuming President Bush signs it) recommendations by the 9/11 Commission that were ignored by the Bush Administration and the Republican Congress and that took a Democratic victory last Fall in congressional races to get done.

That and the important minimum wage bill which Republicans had blocked for years before Democrats gained majorities in the Congress are examples of the difference between the two political parties not only in the Congress but fundamentally.

That opponents (wake up Lou Dobbs) are branding this Congress a Do-Nothing Congress mainly because its efforts thus far in putting a stop to the Iraq War have yet to gain success -- these folks are the worst sorts of partisans. They ignore substantial successes and jump all over a struggle that is continuing on many fronts despite initial setbacks (wake up Republican Party bloggers). And, by the by, Defense Secretary Gates letter this week to Mrs. Clinton on withdrawal planning respresents quite a success on this issue in and of itself for her and Democrats such as John Kerry.

This Congress also has had numerous successes in the interests of the people in blocking measures advanced by Republican Party big business interests such as the GOP assault on net neutrality, which undoubtedly would have been successful had not the Democrats taken control of the Congress. The GOP was all set to go with turning the net over to big business at the expense of the public -- but were blocked when Democrats came to power. Net neutrality is a fact of life and no longer is an issue and won't be so long as Democrats remain in power.

There are many other successes of this Congress to offset the Big Lie, so much so that it would make a good topic for discussion in and of itself.

QUOTE:

HOUSE MAY PASS SECURITY BILL TODAY

by THE ASSOCIATED PRESS
Published: July 27, 2007
Filed at 2:31 p.m. ET

WASHINGTON (AP) -- The House is expected to pass a homeland security bill and send it to President Bush as early as today. Last night, the Senate approved the package of security measures recommended by the 9/11 Commission, shifting more federal money to high-risk states and cities and requiring more stringent screening of air and sea cargo.

The measure passed by a 85-8 vote.

House passage would give Democrats a much-needed legislative victory just a week before Congress adjourns for its August recess.

Along with a boost in the minimum wage, which went into effect on Tuesday, the 9/11 Commission bill would be at the top of the Democratic majority's achievement list if President Bush signs it into law.

UNQUOTE

This also drives a nail into the coffin of the Big Lie that Democrats are soft on security. (Attention Rudy).

It seems like we Boomers could be asking the intermediaries who invest our collective retirement savings for us to hedge our bets by investing in actual, tangible goods and services that we'll want and need in retirement, and not just in schemes designed to throw off cash. What's a retiree gonna buy with piles of mere cash if all there is on the shelf is a skateboard, for example. How 'bout if we slightly overinvest in nice retirement housing, with beautiful gardens to walk through, and plenty of trained physical and medical helpers, etc.? A glut of physicians might be cheaper to hire in retirement, and so on.

Is it realistic to think that the fact of middle class workers generally spending most of their earnings on consumption is a direct product of one or more specific changes of government policy or (at the other extreme) an inevitable fact of life?

Perhaps a more immediately useful question would be directed at the meaning of "most." Spending 75-80% of one's income on consumption leaves a healty remainder to invest for the future. 95-99% of income spent on consumption doesn't, and if middle income individuals are spending that much then an increase in wealth inequality is inevitable barring very high enforced rates of taxation.

Look at this issue more closely and we quickly see a problem with Kevin's assignment of responsibility for the credit bubble to "conservative economics." You can count spending on housing as consumption or as investment; most people think of it as both, since increases in property values over time is a key element in their retirement planning. It's pretty clear that before you get to capital gains tax rates and dodgy loan practices as explanations of why so much money is floating around you have to consider the impact of the tax deduction for mortgage interest. This is for sure a product of conservative economics, also liberal economics and every other kind practiced in this country. Everyone is for the mortgage interest deduction.

Should they be?

How 'bout if we slightly overinvest in nice retirement housing

What do you think has been going on in FL, NV, AZ for the last five years? You're going to be able to get a really nice place there for dimes on the dollar in a year or two.

The biggest driving force behind both this bubble and income disparity has been the Fed, not the tax code (though the tax code has certainly helped). Every time it's looked like the investor class might be hurt, say during the Asian crisis in 1998 or the stock market decline in 2000, the Fed has aggressively stepped in to prop up the market while every time wages for workers have started to rise too much, the Fed has stepped in to slow down the economy. At some point this inbalance has got to blow. The question is whether we're seeing it now or whether it will emerge somewhere down the road.

Everyone is for the mortgage interest deduction.
Should they be?
Posted by: Zathras on July 27, 2007 at 5:12 PM | PERMALINK

My heart says no.

But - I'd almost certainly be a renter without it, Zathras. I'm kind of fond of that government teat. And really, it's quite small compared to many others.

But wait, if there's a credit bubble, why don't we see a corresponding devaluation of our currency? And if there's a devaluation of our currency, why don't the inflation statistics reflect that?

The dollar has been trending down against foreign currency for some time now and the price of commodities have been climbing. Energy prices are way up.

As the dollar has devalued over the last 7 years we have not really seen any major reaction from the American economy.

As energy companies (oil primarily) have raked in billions one has to wonder where the money is going and how it's being placed, invested or whatever.

The world economy is changing rapidly and I suppose we're now going to see some collapse of the American economy which is paying more and more for oil.

I suppose some might argue that it doesn't matter if there's great wealth disparity because the averages look good. But, if energy companies have more and more of the wealth, then what does the rest of the economy do, except SHRINK. And, that's what the Street is now showing.

The dollar has been trending down against foreign currency for some time now and the price of commodities have been climbing. Energy prices are way up.
Posted by: Stephen on July 27, 2007 at 5:24 PM | PERMALINK

(back to sarcasm mode)
But that can't be - in fact, I saw George W Bush on TV today, talking about how great it is that our economy grew at 2.4% (while the CNN crawl was showing 3.4%) - and talking about how interesting it was that things were going so well, and how American companies were exporting more products, which meant that Americans could find more jobs in America (which is good, because, as you know, when Americans can't find jobs in America, they have to go to other countries to find them, in this free-tradin' global economy).

As the Baby Boom retires, they'll become more concerned about protecting their nest egg and will suck buttloads of money out of the market.

This is a very important point, and everyone needs to take this into account in their investment/capital preservation strategies (This is not just rich people; do you have a 401k). The baby boomers were a huge distortion on the market way up and they are going to be a bigger distortion on the way out.

Houses are already dropping in price because that bubble overshot their value. But what is going to happen when they all start selling their homes? While a reverse mortgage allows someone to get that last bit of equity out without actually selling, when people get old enough, they cannot handle a house with multiple floors. There is going to come a time when retiring boomers sell homes in mass. And there won't necessarily be all that many people to buy them.

. . . as capital gains taxes are reduced in order to spur investment; —Kevin Drum

This is crap, at least with regard to the reduction in the capital gains tax during the current Dark Ages (aka: the Bush Administration). It's just a way for the wealthy and ultra-wealthy to be even more so. We do not lack for private investment, therefore there is no pressing need to lower what was already a sop to the rich tax rate.

Unlike the crap spewed by the Rethugs about this over the last six-years, we don't have a "shareholder society." Your retirement savings in a 401-K or a portfolio of mutual funds (which is typical of 90% of "investors" in the U.S.) in no way benefits from a reduced capital gains tax rate.

Jeff;
Well, of course, a 401k is tax-deferred anyway.

Uh, JeffII,
savings in a 401-K or a portfolio of mutual funds...in no way benefits from a reduced capital gains tax rate.
If you have money in mutual funds outside a 401(k), the capital gains tax matters. If the fund realizes gains during the year but reinvests that money, you get a higher asset value (hopefully) but you pay tax on the gains w/o getting the cash. Good for the gov't, not so good for you.
That cash flow effect is also why the payroll tax is so pernicious. You pay income tax on money you never see.

To see what % of families hold stocks, bonds, etc. see the Survey of Consumer Finance. The Survey is done every 3 years, the 2007 data will be released in Dec. This data will help you with good estimates instead of the SWAG you used of 90%.

TJM,

Lower capital gains tax rates benefits high net worth individuals who are constantly pushing money around. For example, your local paper may report on the stock transactions of executives in local corporations. For example, CFO of International Widget sells 10,000 shares of company stock. He benefits from a favorable capital gains tax rate. A middle manager at the same firm selling fifteen shares is not significantly affected by the CGT rate, unless is was at a confiscatory level, which hasn't been the case in the U.S. for at least 50 years.

Again, 90% of America investing in 401-K and mutual funds are not actively selling shares in their funds to realize gains. Even if they were, the numbers are likely to be it the tens of thousands of dollars or less, and not the hundreds of thousands or even millions of dollars of shares sold by fund managers or individual investors purposely taking profits.

I'm aware that a significantly % of Americans foolishly own individual stocks (you might have heard of the tech bubble of last century?). But middle income families aren't buying 10,000 or more shares of company X, holding it for two quarters and then selling it because it has appreciated 5% and now looks like it will be in decline.

That being said, there are financially-challenged people who do muck around in the stock market with a relative handful of shares getting in and out and, typically, making very little money. Even if they do make 5-10% on a investment of less than $10K, a favorable capital gains tax rate is not going to get them the Porsche they've been lusting after.

Your simplistic response TJM shows that you took the Rethug line on this bamboozle hook, line and sinker.

Given Zathras' proclivity for drive-by posting, is it any wonder why no one listens to him?

It was simplistic because it's clear you can't handle anything else.
You said "in no way" which is sort of an absolute, isn't it?. I pointed out you were wrong, not that there were or weren't policy issues involving size of position.
You also plainly don't understand how mutual funds or their managers work. In the (simplistic) example the owner, say like you, isn't selling the stock, the manager is selling the stock inside the mutual fund. They keep the cash, you pay the tax. Paying less is, in and of itself, better than paying more, don't you think?
significantly % of Americans foolishly own individual stocks
Good grief, jeffy,what, are you convinced that the only people with money must have been born with it?

Actually the "in no way" is true for middle class people.

Sure a middle class person with a bit invested in the stock market (say me, for example, or probably you) may pay a bit less capital gains tax under a capital gains favoring tax system than they would under one which did not favor capital gains over wage income, but they also pay MORE taxes on their wages than they would under a tax system which did not favor capital gains. Because a practical definition for middle class is a person who makes the vast majority of their income from wages, but also owns some property a capital gains favoring tax system will be a net negative for them unless the total income of the middle class + wealthy is small compared to the income of the poor, which is never true. A practical definition of a wealthy person is one who gets most of their money from investment in the form of capitol gains, interest, and dividends so a tax system favoring some or all of those income streams will always favor the wealthy. The situation is only more extreme for the poor who make all their income from wages and own very little property.

"...the vast majority of their income ..."
By that I mean lifetime income.

Capital formation and accumulation is an unadulterated good. It is the only path to greater prosperity.

Credit bubbles are not the result of increasing captital formation (in other words, not the result of too much capital), but rather, the result government manipulations to artificially suppress the rate of interest. Such manipulations change the profile of what are truly profitable uses of capital. When the resulting price inflation eventually catches up to you, the monetary inflation has to end. This always reveals the enormous malinvestments that took place during the bubble- think housing, for example, or dot coms in the late 90s. We are seeing the mother of all credit bubbles in China, as I write. Warren Buffett is quoted as saying, "It is only when the tide goes out that you find out who was swimming naked."

Should the tax code encourage saving? I think this is the wrong question. The proper question is, does it discourage saving? Any tax on savings will discourage it. Many progressives think that the tax code favors capital over labor, and I am partially sympathetic to this point of view, but I think the bias lies in areas other than the ones progressives continuously point to. To spread the benefits of capitalism, you need to encourage the lower quintiles to actually form and accumulate capital more than they do- this is the path away from poverty and towards self-empowerment. One of the reasons that the lower quintiles don't save as much as they could is because they are heavily taxed. Their common methods of capital accumulation are taxed as normal income, and most brutally, they bear a direct labor tax of over 15% at the federal level. The first step is to abolish the payroll tax. The second step is to abolish the income tax and replace it with a tax on consumption. To provide the proper progressivity, you then institute a per head rebate that will become a negative tax for those who consume the least, which should largely constitute the poorest amongst us.

These are the broad strokes, but they address almost all of the problems with the tax code other than evasion.

When there's too much of this cash floating around, you get a credit bubble.

You also get a stock market bubble. Currently there are two opposing forces working on the market: 1) an excess of available capital due to tax cuts for the rich and the increasing bimodal income distribution (ie, the middle class is shrinking and money is being redistributed up) which forces stock prices gradually up and 2) a string of worsening econ stats due to the erosion of the middle class in a consumer econ like the USA, which forces prices down in sharp spikes.

Unless the wealthy take care of the middle class which really drives their wealth accumulation, then most of their windfall from the GWB years is likely to evaporate in a flash.

A consumption tax with a per person rebate would pound the middle class more than they have been pounded already. If you want to turn the US into Mexico, that is the way to go.

Disputo, what if all components/goods which were made 100% in the US were exempt from the VAT (i.e.)? You could also have differing rates of VAT depending on the consumable. Tinkering with that would seem to be far easier and more transparent than the current Byzantine system of what determines taxable income, and the tariffs/subsidies that we currently have.

I'm all in favor of a progressive consumption tax.

Yancey's suggestion is not the way to get there.

What gets overlooked is how important government borrowing is to preventing even more asset inflation and maintaining the value of the dollar. Where would all that money go, if it wasn't being recycled through the public sector? It's the same with Social Security. There isn't enough places to invest that much money in the private markets. Wealth is like electricity, in that it is difficult to store the enormous amounts being generated and it has to be spent productively.
It wasn't a coincidence government borrowing took off around the same time the last serious bout of inflation was beaten back.
Growth is bottom up, not top down and a healthy economy needs a broad distribution of wealth. The problem with treating the economy like a game of Monopoly is that when one person controls everything, the game is over and you start again. In reality this stage is revolution.

Growth is bottom up, not top down and a healthy economy needs a broad distribution of wealth. The problem with treating the economy like a game of Monopoly is that when one person controls everything, the game is over and you start again. In reality this stage is revolution.

This cannot be repeated enough.

(Good simile, btw.)

Disputo,

So what is the way to get there? How would this hit the middle class any harder than what hits them today? The middle class pay payroll taxes and income taxes already today. A consumption tax with a standard rebate would hit those who consume the most, which would be the wealthy. And it would do it in a way that would give everyone an incentive to accumulate capital.

In any case, the rebate isn't intended to make the middle class tax negative, it is intended to make the lowest quintile tax negative. There is no way to distribute the entire tax burden to a small fraction of the population, and it is unwise to do so anyway. Under my system, everyone pays taxes, but poorest get it all and more back. Everyone sees the burden, even if they don't bear any of it.

Should the tax code encourage saving? I think this is the wrong question. The proper question is, does it discourage saving? Any tax on savings will discourage it. Posted by: Yancey Ward

No one was discussing a "tax on saving." Capital gains is not savings, it's a tax on unearned income. And in spite of everything TJM thinks, the middle-class has very little of this. The greatest capital gains the middle-class has is the investment in their real estate. Anyone making significant income on investments is not middle-class.

A consumption tax with a standard rebate would hit those who consume the most, which would be the wealthy.

Um, no: 1) relative to income (not to mention wealth), the wealthy consume the least, and 2) there is nothing progressive about a flat tax, which is precisely what you suggesting. (You don't introduce curvature into a line by shifting it down the Y axis.)

The result of your plan would be to further decrease the amount of taxes paid by the rich, while dramatically increasing the taxes that the middle class pays.

Disputo,

The tax paid depends on the absolute amount you consume. That the wealthy consume a smaller fraction of their income is irrelevant, they still consume more absolute totals, and by a significant amount. The tax paid, using a per capita rebate for progressivity, declines as a percentage of total income as you go down the income scale. The poorest would have a negative tax rate, some would have a zero tax rate, the lower middle class could have, lets say, a 10% tax rate, the middle-middle class could have a 15% tax rate, the upper middle-class could have a 20% tax rate, and on and on up the scale. This works because the rebate becomes a smaller and smaller fraction of one's income and one's tax burden. How much do you think a $10,000 rebate means to someone who makes $1,000,000 and pays $250,000 in total taxes. I propose the rebate system for simplicity. The only other ways to have a progressive consumption tax is to either tax certain goods at different rates, or have a different rate for people with different incomes- both of which are vastly more complex than simply rebating an equal amount to everybody.

The middle class today is already heavily taxed by the present system, and taxed in such a way that it discourages them from saving anything, and taxed in such a way as to lower the demand for their labor.

However, you still didn't answer my question- how would you do it if you are really in favor of a progressive consumption tax?

Capital gains, minus the inflation component, is the return on real savings. That you tax them at all reduces the incentive to save in the first place. For someone like your average Joe, a lot of his savings take the form of bank savings accounts and interest paying financial instruments, and the interest paid on them is taxed as normal income. What I am getting at is that if you want to treat labor and capital identically in the tax code, you shouldn't tax either one, you should collect the tax at consumption, but to make it progressive, simply have a standard rebate that more than elimates the tax paid by the poorest, and eliminates the tax by smaller and smaller amounts as you go up the income/consumption scale. Why some people can't see that this is progressive is beyond my reckoning.

Some interesting (actually, amazing) comments so far. For those of you who seem confused, start by reading The Case Against the Fed. Then, read Secrets of the Temple. After those, you can maybe make some intelligent comments