Tax Rhetoric Hides Real Issue

Media Noise on Tax Reform

Talk about tax reform is everywhere in the news these days. The media tells us that the proposed changes are bad for us. Understandably, those proposing the changes disagree. So what does all the noise mean to you and your business?

The problem with the subject of taxation is that it poses special difficulties to those attempting to forecast outcomes. It's possible for diametrically opposed tax plans to promise the same positive outcome, for example. Therefore, the subject lends itself to manipulation by unethical politicians and news people alike. The natural complexity also serves to hide what's really important to all of us. So, let's understand the effects of tax changes. Then, let's consider the real threat to the wellbeing of our nation; a subject no one is talking about.

To understand why tax reform outcomes are so difficult to interpret we need to look at how complex systems work. Complex systems act in a seemingly random fashion as participants within the system change their behavior in response to other participants.

Let me explain with the following scenario. Assume that we get together a thousand of the smartest PhD's in the country. We'll call them the Federal Reserve or FED for short.

Federal Reserve Board, 1917

This FED has the responsibility to ensure a better economic future for all of us. The FED will study the economic market; a flexible group of players following their self interest. Then, when it sees trouble ahead, the FED will intervene to prevent any negative outcomes. Ironically, the FED will thus become the largest player in the system.

This game really begun in December of 1913. So far, the super smart people at the FED have never anticipated a single economic downturn. In fact, the FED now accepts that they are 'data dependant'; they admit to being myopic. Without visibility past their nose, they utterly 'depend' on where 'data' is right now. To make matters more confusing, other players follow every action by the FED as a sign of what's to come. It's a real case of the blind leading the blind.

At times, complex systems follow a single general direction. For example, we know that more people in a market will make the number of transactions grow. While the relationship between number of players and number of transactions is not precise, the general correlation is positive. As population has continued to grow, the number of transactions has done the same in what looks like limitless duration.  

Complex System

But then there are times when these systems periodically return to their base or mean. Market risk is a good example. The risk faced by market players alters direction because it can't continue to increase or decrease indefinitely.

The problem with complex systems is that they represent the total combination of many of these two types of movements. At times, linear movements dominate only to suddenly give in to reversion to the mean.

Think about it. It's even possible for the same participants to act differently when faced with the same circumstances. Their actions could be altered by their memory of recent success or failure, for example.

All these facts make it impossible to establish rigid expectations. So don't be surprised when the smartest scientist can't guess the path of a hurricane a few days before it makes land or when the Federal Reserve makes a catastrophic mistake with the economy. Both, the economy and the weather are complex systems. Likewise, do you really expect the TV host to be able to correctly determine what will happen after a new tax structure is implemented? No chance.

Here, please pardon the fact that I took way too long to elaborate my point; I really wanted to make it very clear. News people are as clueless as any of us. Don't waste your time listening to their opinion disguised as a news fact. For a more productive outcome, read a fiction novel instead.

Still, the media will try to convince you. And since most of the media has a left bias, they'll generally argue that paying more taxes and a bigger government are better.

Government Skeptics

Now that if you see big government with skepticism, don't distress. You are not alone. In fact, you are in great company. Our nation's forefathers shared the same skepticism. This is why our constitution was written to limit government power.

Our constitution has served us well for close to 230 years; resulting in the most successful nation in history. Our system is in fact so great that countries all around the world voluntarily adopt many of its characteristics. Subsequently, billions of people have left poverty behind.

Yes, before Europeans started to brag about their young and relatively untested socialist system of big government and heavy taxation, they needed our help rebuilding after their past mistakes. So, when the left leaning media tries to tell you that European's pay more taxes and manage to live better than we do, remember that their opinion isn't so correct.

Look at Holland. To get all the extra goodies dished out by their government, the land of public sex displays has severely mortgaged their future. To revert path, Holland will have to cut national expenditures by 10% and then endure 10 years of doubling tax rates to 100%. Their debt is so humongous that it can only be solved with 10 years of complete slavery to the government. Now you see why their politicians are so happy. There is more than cannabis behind their smirk.

Historic Tax Rates

Another strong argument the media exploits to defend their position is that higher post-WWII taxes resulted in a better economy for the US. Here again, they are missing about half of the complex system's picture. Yes, the US had tremendously high taxes in paper after WWII. But no, people didn't actually pay them.

Does anyone recall that business schools were nonexistent until much after the big war? Before universities found a way to educate future business leaders most CEO's were attorneys. Back then, being a lawyer was essential for guiding a company around government regulation.

Tax rates down; tax revenue up.

When looking at government tax receipts on a per capita basis and adjusted to inflation, it's sad to see that we pay much higher taxes today than we did after WWII despite having a lower rate. The chart clearly shows how tax rates have gone down while tax collections have gone up.

Reagan found that tax evasion eased when taxes were seen as reasonable. The inverse of this fact is why Greece collects no taxes at all. When taxes are unbelievably high, people will do anything not to pay.

In the economic complex system, players will be more willing to increase their activity in an environment of fair taxation. Then, higher player activity will conceivably result in tax receipts sufficient enough to compensate for the loss by rate reductions. This is when politicians use the term "revenue neutral". Nonetheless, don't believe them when they use it. Both sides can easily claim revenue neutrality from clearly opposing plans.

Yet, tax receipts won't be enough for our present government expenditures. Right now, our government borrows an additional 48 cents for every dollar in taxes we pay them. It's clear we can't afford our present government. We would need to cut government spending by 32%¹ to get back to break even. This will do nothing about paying off our debt. We would simply stop the bleeding.

US Total Budget, 2016

Look at the pie chart here and tell me what part of government would you cut to get the 32% reduction? I bet you can't. We are accustomed to the good stuff even when clearly insolvent.

Then, to compound our challenges, we spend the equivalent to little less than half of our massive military budget on interest payments alone. We are buried under a pile of debt.

Do you want to experience real fear? Consider the fact that our debt pays close to zero percent in interests. Think of it, if interest rates go to their 4% long term average, we will be spending double the current military budget on interests alone.

Let me make my opinion clear. Talking about taxes is important. But the real conversation to have is about debt. We are broke. We have to tighten the belt and figure how to get us back to balance sheet health. We can argue the best way to solve it. But there is no escaping the subject. Your business' future and that of your family are at risk. Let's redirect the conversation as soon as possible.

¹ Take one dollar plus 48 cents. Then calculate it's inverse. Then subtract 1 to come up with the 32 cents or 32% needed in lower government expenditures to bring us back to a point where we are not borrowing any more money.