classical economics
for analysis,  forecasting
and policy design

Tax Rates, Fed Fantasies

Fans of High Tax Rates, and Other Fakers
By Wayne Jett © December 8, 2010
    Federal income taxes target the middle class, who accumulate capital by working for earned income. The federal tax system is designed to give great advantages to the super-rich – Warren E. Buffett, Bill Gates, George Soros, Ted Turner and others well known and anonymous. The top income tax rate President Barack Obama and top Democrats wanted to raise (from 35% to 39.6% - a 13.1% increase) actually hits the upper-middle class, not the super-rich.
Time to Unmask Buffett
    When tax rates are at issue, a few billionaires usually step out and publicly plead “tax-me-more,” urging higher rates should be applicable to earned income and to estate assets upon death. Buffett, who as chairman and CEO of financial conglomerate Berkshire Hathaway has the appearance of a nice grandfather, frequently plays this role. Bill Gates Sr., father of Microsoft’s founder, weighs in for higher estate taxes whenever asked.
    Buffett doesn’t actually say “I pay lots of income taxes at the highest rate and love it,” but he leads the public to believe this is so. The fact is Buffett avoids federal income taxes so effectively he would be unaffected whether Obama’s increased tax rate applied to earnings above $100,000, much less $250,000 or $1 million yearly.
    Here is why. During the most recent seven years reported by Forbes magazine, Buffett accepted only $100,000 annually as salary for his corporate duties. In those same seven years, Buffett’s shares in Berkshire Hathaway gained in value more than $3 billion annually. But Buffett paid no taxes on the billions in gains because he never sold the shares.
    When Buffett gives his shares to the tax-exempt, charitable Bill and Melinda Gates Foundation, as he said he will do, he will never pay income taxes on the many billions of gain in value over his cost. To the contrary, he will be entitled to deduct the shares’ market value from the amount of his $100,000 salary before paying income taxes on it.
     Once Buffett’s BRK shares are in the Gates Foundation, the shares may be sold and the funds reinvested again and again without ever paying income taxes. The Gates Foundation is given this tax-free status merely for spending or giving five percent of its assets for approved uses. The same is true of Bill Gates and his MSFT shares, of course, and any other gifts to the foundation. Middle class giving to charity matches or exceeds this threshold, but only the gifts are deductible from all taxable earnings and gains.
    *With such fantastic tax treatment awaiting assets placed in charitable foundations, why would anyone wait until death to claim it? Indeed, the super-rich do not wait. For example, 26-year-old multi-billionaire Mark Zuckerberg is among many super-rich "re-energized" by Buffett to put assets in charitable foundations sooner rather than later.
     The great fortunes of Gates and Buffett will continue to own, buy, sell, merge, manage and manipulate companies, media, land, minerals and other assets in the economy in perpetuity without ever paying income taxes or estate taxes. By this design, the federal tax system serves as a tool which aids the super-rich in dominating the American economy and government.
Bernanke’s 60 Minutes
    Federal Reserve chairman Ben Bernanke took to the friendly airwaves of CBS’ “60 Minutes” Sunday evening to persuade the public the Fed should spend $600 billion for new Treasury securities. Had he been straight-forward, he would surely have failed, so he engaged in jaw-dropping prevarications.
    Thanks to Bernanke and CBS, the public was told:
(1)    Inflation is very, very low – so low the economy is close to the range where prices actually start falling. This dangerous condition is called deflation, which happened in the Great Depression.
(2)    The Fed’s plan to spend $600 billion or more for Treasury debt securities fights deflation by keeping interest rates low to stimulate the economy for faster growth.
(3)    To pay for the Treasury securities, the Fed is not printing money. Currency in circulation will not increase, and money supply will not increase in any significant way.
(4)    The Fed’s purchase of Treasury securities will not increase federal debt. The Fed will provide the money from its own reserves.
(5)    China hurts itself by pegging its currency to the dollar. China could have its own monetary policy, but instead tracks the dollar. As a result, China’s economy suffers high inflation. By separating from the dollar, China’s central bank could increase and stabilize the value of its currency.
(6)    Bernanke is 100% confident of the Fed’s ability to stop inflation, which can be accomplished in 15 minutes by increasing interest rates.
(7)    The Fed must remain independent of political influences in order to fashion monetary policy and conduct operations in the best interests of the national economy.
Assessing these representations without recalling the old slap-down sop “you know he is lying if his lips are moving” is, sadly, impossible.
Washing Ben’s Mouth Out (With Soap)
    After decades of Keynesians destroying economic literacy, perhaps even this “jump the shark” Fed episode must be analyzed with a straight face. Although doing so risks stating the obvious, here goes.
    Is it possible that the Fed’s management of the dollar produces dangerously low inflation in the U. S. – so low that prices risk falling off a ledge into a deflationary abyss – but China produces virulent inflation in its economy by keeping its currency pegged to the dollar? No, it is impossible. With the yuan pegged to the dollar, China’s PBOC devalues the yuan as the Fed devalues the dollar by injecting excess currency. This produces inflation in both economies. The Fed and federal government conceal inflation here by disguising it as price movements and by manipulating the CPI. Despite high inflation as signaled by the gold price and as reflected in most spot prices of necessities, demand for non-necessities remains weak and contracting.
    The U. S. economy is nowhere near deflationary. It is contracting, meaning real GDP is declining, due to poisonous, mercantilist federal policies (the tax system, the Federal Reserve, environmental policy, energy policy and aid to financial fraud by the Securities & Exchange Commission, the Commodities Futures Trading Commission, the Food & Drug Administration, etc.). Contraction is characterized by weak demand and declining prices, which signal the need to cut production further.
    The Fed will monetize new federal debt, not to fight deflation, but to make it easy for Treasury to borrow money to spend. After the government spends the money, making it impossible to undo the borrowing, interest rates will rise, particularly if the Fed sells the debt into the market in order to drain liquidity from the monetary base.
    The monetary base in the U. S. economy ($840 billion in August, 2008) will increase  dollar-for-dollar as the Fed purchases $600 billion-plus Treasury securities during the next six months.  The Fed cannot hold this new money out of the economy as was done with funds paid for bank assets because Treasury will spend the borrowed funds. Inflation is already apt to reach double-digits in near term years, and this will make it much worse.
    The Fed will create $600 billion-plus electronically by wiring purchase funds to buy Treasury securities. True, printing presses will not make new dollars until old dollars in circulation wear out, and currency in circulation (if by that you mean number of dollars in wallets and purses) doesn’t change much. But the chairman’s statements were disingenuous.
    The $600 billion-plus does not come from “reserves” of the Federal Reserve. The Fed has no reserves such as gold or other hard assets not already monetized to back the value of this new currency to be created. Value for the proposed new currency comes only by transfer from dollars already accepted in exchange for labor and production, thereby causing deterioration called inflation.
    Eliminating inflation by manipulating interest rates is not merely uncertain – it is mathematically impossible. Never has the Fed done so in 15 minutes or in 40 years. Indeed, the last time the Fed "jumped the shark" was when Bernanke explained how psychological "expectations" made inflation so intractable. The Fed sets the overnight funds rate target to assist big banks in setting lending rates non-competitively. Liquidity management is handled separately, as is presently obvious.
    The Federal Reserve is heavily influenced by pecuniary interests of big banks which own and dominate it. The Fed is a privately owned central bank given extraordinary powers to create currency which is the only legal tender for assets goods and services. Pecuniary and political influences determine Fed actions, even with an intellectual as its chairman.
Anti-democratic Central Bank
    The Federal Reserve is destroying the dollar as the international reserve currency. China and Russia have decided to do their mutual commerce in their own currencies. This has political implications, but it is a financial decision. If the dollar’s value were more dependable than their currencies, the dollar would continue to be used. Other economies will be forced to the same decision in due course.
    Recent disclosures of Fed purchases of commercial paper issued by General Electric, Ford and other major companies are unsurprising. After all, the private commercial paper market was demolished by policies and actions previously chronicled here. Worth reiterating, however, are the effects of Fed actions in advancing monopolies and concentration of capital at the expense of competitive business. Fed loans to international banks and other firms, while U. S. small businesses are allowed to go without financing, evidence the same mercantilist mindset.
    The Fed’s agreement to finance sovereign debts of beleaguered governments in the European Monetary Union is ominous for more reasons than one. Having financed foreign governments which have overspent their budgets, how likely is the Fed to decline to bail out state governments like California, Illinois, Michigan and New York? This is the outcome sought by the dominant elite, which will lead to the fall of the U. S. Constitution’s protection for middle class political rights.
DOJ Dragnet – Really?
    About ten day ago, the Wall Street Journal and New York Times told the public of subpoenas served by FBI on hedge funds and other financial firms in an investigation of major insider trading cases by the U. S. Attorney for the Southern District of New York. Subsequent reports indicate widespread use of “consultants” with inside contacts at publicly traded companies to gain non-public information.
    Some close observers of financial fraud in U. S. markets, whose views deserve considerable weight, consider this move by the Justice Department to be the real thing – a move to bring to justice the ring of hedge funds and enabling investment bankers which have robbed other investors for decades. Whether this optimism is warranted, or the long overdue federal probe turns into early campaign fund raising, remains to be seen.
    The point is worth making that even former Fed chairman Alan Greenspan recently remarked (in public) that effective enforcement of existing criminal fraud statutes is one of two most fundamental reforms necessary for economic recovery. Financial fraud was identified here as the principal economic macro-force plaguing U. S. markets well before the collapse of 2008. For anyone interested, the other reform needed, per Greenspan, is more capital in banks.

     As with the Department of Justice dragnet on Wall Street, the deal between the president and Congress on tax rates outlined so far is not a reality until it is written and enacted. The dominant elite prefer the higher rates of existing law effective January 1. ~