Categories

Pragmatic Capitalism

Practical Views on Money, Finance & Life

After 90 Years Of Boom/Bust Cycles, We Should Know How To Help Prevent The Big Booms From Turning Into A Bad Bust

« Back to Previous Page
0

Economists and politicians want to take the volatility out of the economy. But perhaps we need to just remember that the boom and the bust is part of the way human emotions will always play out across time. It doesn’t mean we can’t add guard rails to the roads in case our driver nods off, but it also doesn’t mean we should strap him to the seat with his eye lids stapled to his forehead….

I believe we can do a better job of guiding people’s emotions with something that is very personal with every person and business. I am talking about taxes. We don’t utilize tax policy to dampen the boom cycle. We wait until the boom burst, and then we clean up the mess. If we rely on monetary policy to either stimulate the economy, or dampen a boom, we end up creating a recession, or misguided stimulation. The stimulation is mainly directed at the financial and real estate sectors, creating higher housing cost, and more leveraging.
I remember the 1970’s and 1980. In the 1970’s we had annual inflation rates of up to 12%. In 1979 Paul Volcker was appointed by President Carter as Chairman of the Federal Reserve. To lower inflation rates, and inflation expectation, he used monetary policies to increase interest for mortgages to 18%. Even with interest rates that high, inflation psychology and high inflation was still in the economy. Not until long term capital gains was taxed at the same rate as ordinary income did annual inflation rates start to come down. If the federal government had made the tax rate on long term capital gains the same tax rate as interest income, either by lowering the tax rate on interest earned, or raising the tax rate on long term capital gains, the Fed would not have had to raise interest rates as high, which disrupted our economy and the other economies around the world.

Relying primarily on the Fed to stimulate the economy and dampen the boom is very inefficient. It is similar to taking a sledge hammer to drive in a tack. A huge amount of collateral damage is done to the economy.

I explained how the 2% Appreciation/Inflation Taxation Policy would operate to stimulate the economy, and dampen a boom. I was disappointed that you didn’t respond, since you had asked me how the 2% Policy would function during the business cycle.

Hi HH. I still don’t understand your proposal. Can you explain it in 3-5 sentences? What is the 2% inflation rule and how will it actually work during the business cycle?

Cullen Sorry the question should have been:

Can Pre Bust “Automatic Stabilizers” Help Maintain Employment & Reduce Bubble Formation?

How would the 2% Appreciation/Inflation Tax Policy would operate during the cycles of the economy?

If real estate prices and other asset prices were increasing more than 2% annually , the tax on savings and money investments (bonds and other debt investments) would automatically decrease based on the appreciation/inflation annual percentage rate, and at the same time the interest deduction would automatically decrease based on the annual appreciation/inflation rate. This automatic adjustment in our tax code would slow the economy down without raising cost of production, and consumption.

This change would maintain employment, and also allow production the time it needs to balance supply with normal demand. Employment would be maintained, as the economy balances itself, therefore normal consumption would continue with the 2% Policy enacted. Small imbalances in the economy would not increase into major bubbles, busting, and then creating financial crisis as the primary housing bubble did.

The transfer of purchasing power to the hard asset investor from the debt investor would be reduced annually during the high appreciation/inflation cycle at the end of the year as each party filed their taxes due this change in tax policy. Interest rates would remain in a narrower range, which would be beneficial to our capitalist economy.

Leonard

Posted by Happyashell
Answered on 05/03/2016 4:32 PM
Leonard,

I must be missing something because I still don’t get it. Lowering taxes into an economic boom would exacerbate the boom. If tech stocks are booming and you lower the taxes on investing in tech stocks then that should increase the demand for this sector. This would cause bigger booms and busts….

– Cullen

Cullen Roche Posted by Cullen Roche
Answered on 05/03/2016 4:41 PM
Cullen

I am not lowering the tax rate on long term capital gains, nor am I raising the tax rate on long term capital gains.

Only after the appreciation/inflation rate increases to 2% does the tax rate on interest earned on debt decrease, to improve return on investment, and to encourage people to stay in their debt investment. This would be very similar to automatically increasing the interest rate.
What is different is that cost to producers and consumers has not increased, and debt that is earning a lower rate of interest does not lose value when the tax rate changes.

To discourage excessive credit use after the appreciation/inflation rate increases to 2% the interest deduction would be reduced from 100% deductible to a lower percentage rate based on the annual appreciation/inflation rate. This change in the tax code would increase the cost of debt without raising the percentage rate of the interest paid.

The tax that the lender would not pay when the appreciation/inflation rate was more than 2% annually would be paid by the debtor, because of the reduction of the interest deduction.

Since debt is money, in our economy, if the government, or the private sector introduced too much money into the economy, the money’s (debt) purchasing value would be maintained on an annual basis without raising interest rates. The Federal Reserve also would not find it necessary to move interest rates excessively up or down to maintain full employment and stable prices, as they did in 1979 and 2008.

Posted by Happyashell
Answered on 05/03/2016 5:40 PM
« Back to Previous Page
Post your Response

Leonard

Closed
Marked as spam
Posted by Happyashell
Posted on 05/09/2016 7:24 PM
170 views
Private answer

Hi HH,

I just don’t see how your proposal works. Reducing taxes into a boom will exacerbate the boom. I just don’t think we see things the same way. I don’t know what else to say. Sorry!

Cullen

Marked as spam
Cullen Roche Posted by Cullen Roche
Answered on 05/09/2016 11:05 PM
    Private answer

    Cullen

    We arrive at a place I want to arrive at also by dampening a boom with the tax code by rising the long term capital gains tax rate until it is at the same tax rate as the tax on earned interest. People would be encouraged to remain in their debt investment, and enter the market that already has too many buyers in it, because prices are rising too fast. The interest deduction would be reduced as the boom progresses to discourage excessive leveraging. Under this policy interest income would become more favorable as the tax on long term capital gains increases. The boom would not turn into a bubble and then burst. People would remain employed, thus retaining their wealth, and in less need of government automatic stabilizer benefits.

    Marked as spam
    Posted by Happyashell
    Answered on 05/10/2016 1:05 AM
      Private answer

      HH, in the other thread you said:

      “If real estate prices and other asset prices were increasing more than 2% annually , the tax on savings and money investments (bonds and other debt investments) would automatically decrease based on the appreciation/inflation annual percentage rate”

      Now you’re saying you’d increase taxes on long-term cap gains?

      I don’t understand your proposal to be honest and it seems to me that you can’t explain it in less than 10,000 words. I don’t think tax policy needs to be that complex. An automatic rule that raises tax rates on capital gains would be enough to dampen booms. Why make it more complex than that? I think I agree with your basic thinking, but I think you need to do a more concise job explaining it. If I can’t grasp it in 10 minutes then Congress won’t grasp it in 10 years….

      Best,

      Cullen

      Marked as spam
      Cullen Roche Posted by Cullen Roche
      Answered on 05/10/2016 1:33 AM
        Private answer

        Cullen I correct a sentence

        OK,lets try the rising of taxes, and the cost of debt to tone down a boom.

        We arrive at a place I want to arrive at by raising the long term capital gains tax rate until it is at the same tax rate as the tax on earned interest. People would be encouraged to remain in their debt investment, and not enter the market that already has too many buyers in it. We know that there is too many buyers, because prices are rising too fast. The interest deduction would be reduced as the boom progresses, raising the cost of the loan, to discourage excessive leveraging. Under this policy interest income would become more favorable than long term capital gains as the tax on long term capital gains increases. The tax code would help eliminate the “heard effect, and quiet people’s animal spirits” The boom would not turn into a bubble, and then burst. People would remain employed, thus retaining their wealth, and be in less need of government automatic stabilizer benefits.

        Leonard Cullen please delete the previous us response, dated 5/10/2016 1:05 am

        Marked as spam
        Posted by Happyashell
        Answered on 05/10/2016 1:38 AM
          Private answer

          Automatically raising and lowering of the long term capital gains tax rate, if real estate, or other asset prices are increasing or decreasing above or below the 2% appreciation/inflation rate, will work for what needs to happen to dampen a boom, or to stimulate the economy. The reduction of the interest deduction strengthens the proposal.
          My concern has always been, that the two different tax rates are left enforce for too long, during the boom. When the Fed decides to dampen the boom it must move interest rates much higher to overcome the return on investment factor, of the two types of income. The reverse occurres when the Fed wants to stimulate the economy. My point is that the stimuli Congress enacts to help the economy to recover from a recession, expressly the lowering of the long term capital gains tax rate, needs to be eliminated before the Fed uses monetary policies, to increase the efficiency of the Fed’s monetary polices, and lessen the collateral damage when interest are raised or lowered excessively.

          Marked as spam
          Posted by Happyashell
          Answered on 05/10/2016 10:24 AM
            Private answer

            HH,

            I am a big fan of using tax rates as a countercyclical measure! So your proposal makes sense to me. Thanks for clarifying.

            Cullen

            Marked as spam
            Cullen Roche Posted by Cullen Roche
            Answered on 05/10/2016 5:04 PM
              Private answer

              Another smart aleck who thinks he has the final absolute explanation of how markets work ….

              Marked as spam
              Posted by Machine Learning
              Answered on 05/10/2016 9:21 PM
                Private answer

                Inflation dropped back to normal in 1983 after the Mexican (or was it Brady Bonds?) default increased demand for liquidity after Volcker caused a deflation. LT capital gains rate only went up a little bit under Clinton only later in 1992. So I think your analysis may be flawed.

                Marked as spam
                Posted by MachineGhost
                Answered on 05/10/2016 10:32 PM
                  Private answer

                  And you may be greatly overestimating the wealth effect that jiggling tax rates has, nevermind central banks jiggling inter-member bank loan rates. Reminds me of the quantity theory of money…

                  Automatic stabilizers seems like a good idea if it is quantitative. But it needs to be evidence based, not theoretical.

                  Marked as spam
                  Posted by MachineGhost
                  Answered on 05/10/2016 10:35 PM
                    Private answer

                    What is important to note about the Clinton tax changes is that before the changes both types of income were taxed at the rate. Clinton agreed to an increase in the top tax rate to 39.9%. The long term capital gains tax rate (LTCGs)remained at 28%. The lower rate for LTCGs was enough to encourage people to invest to obtain LTCGs rather than interest or dividend income. Also in Clinton’s Presidentcy LTCGs, on up to $500,000.00, on the sale of a person’ primary home was taxed at 0% and the financial and real estate sectors deregulated. We ended up with the dot com bubble and primary housing bubble. Don’t take my word for it, that tax rate changes influences people’s financial decisions. Read “What Started The Dot Com Bubble And What Caused It To Burst. Go to http://www.taxpolicyusa.wordpress.com Two economist wrote the article.

                    Marked as spam
                    Posted by Happyashell
                    Answered on 05/11/2016 12:32 AM
                      Private answer

                      What is important to note about the Clinton tax changes is that before the changes both types of income were taxed at the rate. Clinton agreed to an increase in the top tax rate to 39.9%. The long term capital gains tax rate (LTCGs)remained at 28%. The lower rate for LTCGs was enough to encourage people to invest to obtain LTCGs rather than interest or dividend income. Also in Clinton’s Presidentcy LTCGs, on up to $500,000.00, on the sale of a person’ primary home was taxed at 0% and the financial and real estate sectors deregulated. We ended up with the dot com bubble and primary housing bubble. Don’t take my word for it, that tax rate changes influences people’s financial decisions. Read “What Started The Dot Com Bubble And What Caused It To Burst. Go to http://www.taxpolicyusa.wordpress.com Two economist wrote the article.

                      Marked as spam
                      Posted by Happyashell
                      Answered on 05/11/2016 12:33 AM
                        Private answer

                        Well you seem to have a fetish for income and gains to be exactly the same rate, but you seme to be overfocused on stocks as I’m mentioned in another thread. Stocks are not the real economy. So what you do to reign in the former will have negative effects on the latter. We care about the real economy here, not frothy speculative financial markets.

                        Marked as spam
                        Posted by MachineGhost
                        Answered on 05/11/2016 1:11 AM
                          Private answer

                          I am concerned about the Main St. economy, and creating policy that helps to prevents bubbles from forming in single family homes, food, and commodities that affect the Main St. economy. I am concerned about keeping people employed so they are able to provide for themselves and their families.

                          What is important to note about the Clinton tax changes is that, before the changes, both types of income were taxed at the same rate. Clinton agreed to an increase in the top tax rate to 39.9%. in 1993 The long term capital gains tax rate (LTCGs) remained at 28% until 1997 when it was lowered to 20%. The lower rate for LTCGs was enough to encourage people to “invest”, to obtain LTCGs, in real estate, commodities, and other assets. rather than collect interest, or dividend income. Also in Clinton’s Presidency the tax LTCGs, was reduced to 0%, on up to $500,000.00, on the sale of a person’ primary home. Also the financial and real estate sectors became more deregulated. We ended up with the dot com bubble, primary housing bubble, and higher commodity prices. And more leveraged credit, and speculation. Ending in the financial crisis of 2008, which created untold amounts of misery in the world wide Main St. economy.

                          Don’t take my word for it, that tax rate changes can influence people’s financial decisions, even the purchased of an overpriced/unaffordable primary home. Read “What Started The Dot Com Bubble And What Caused It To Pop. Go to http://www.taxpolicyusa.wordpress.com and then stroll down. The article summarizes a white paper written by three Professors.

                          Marked as spam
                          Posted by Happyashell
                          Answered on 05/11/2016 2:28 AM
                            Private answer

                            It’s a nice theory, but I doubt it’s going to hold up after riogorous scrutiny. The economy bottomed in early 1994 and the Internet bubble was in full spring by 1997 since Netscape IPOed in late 1994. And despite income and LTCG being the same after 2003, it didn’t prevent the sub-prime real estate bubble that followed thereafter.

                            Logically, the conclusion here is to get rid of both dividend and LTCG taxes. The former punishes corporations (double/triple taxation) and savers and the latter punishes Main Street businesses (the vast majority which are pass-through entities) to supposedly reign in financial speculation. All in the name of “fairness”. It’s almost as if you’re proposing a financial profits speculation tax…

                            Rather than Soviet-Style Command and Control, there’s got to be a better way to implement automatic stabilizers without creating winners and losers.

                            Marked as spam
                            Posted by MachineGhost
                            Answered on 05/11/2016 2:36 PM
                              Private answer

                              Machine, I think you are missing the point. It isn’t important what date the dot com bubble started, or ended. It is how the dot com, and the primary home bubble ended that is important.

                              You state that the internet bubble was in full spring. (I think you meant “full swing.) The lowering of the LTCGs tax rate from 28% to 20%, when the top tax rate was 39.6%, threw gas on a roaring fire, increasing the inflating rate of the bubble. If the LTCGs tax rate had been raised to a top rate of 39.6%, or the tax rate on interest earned had been lowered to the rate of the LTCGs income, less people would have participated in the creation of a bigger dot com bubble. The interest deduction increased the use of credit leveraging. To reduce the credit leveraging we could have reduced the interest deduction. A deregulated financial sector was more than willing to provide credit for the speculation, because of the money that could be had.

                              The primary home bubble was created in the same manner. We already had many incentives in the tax code to buy a primary home. When the, $500,000.00 LTCGs exclusion was enacted it threw gasoline on the primary home market. Homeowner who had a lot of equity, had a very good reason to sell their home. The buyer had a very good reason to purchase the home. In two years they believed that they could cash in also, gaining tax free money. The longer the the demand imbalance existed, the more primary home prices increased. More and more people didn’t want to be left out, bidding wars started heating up. Credit standards were decreasing as the greed and fraud increased in the real estate market.

                              The financial and real estate sector lobbied congress for its further deregulation, and the exclusion of LTCGs on the sale of primary homes. It was the real estate, and the financial sectors that benefited the most from the mania. They are the people that got the “gold mine”, mortgage investors, and taxpayers got the “shaft.”

                              Again, if the LTCGs exclusion had been eliminated, and the capital gains tax had been raised to the tax rate of ordinary income, or the tax rate on earned interest had been lowered to the LTCGs rate of 20%, after primary home prices were increasing more than 2% annually, less buyers would have participated in the mania, reducing demand. Primary home builders would have been able to satisfy normal demand.

                              Our economy is dynamic our tax code is static. Our economy is continually changing, because of different circumstances, creating different economic cycles. The economy cannot wait for a 535 political divided committee to change policies. Policies that stimulate the economy, when it is in the recession cycle, can be over stimulating in the high appreciation/ inflation cycle. Tax rate changes concerning long term capital gains, interest income, and dividend must change automatically as the economic cycles change, to help prevent bubbles, and to maintain employment.

                              Relying primarily on the Fed’s monetary policies is not the best way to maintain a strong economy, full employment,and stable prices.

                              We should be using the tax code first, before the Fed must “take away the punch bowl.”

                              Marked as spam
                              Posted by Happyashell
                              Answered on 05/11/2016 8:30 PM
                                Private answer

                                Seriously, you think that being able to deduct investment interest expense which is only allowed when you have enough expenses itemize (i.e. the top 50% or so taxpayers), exacerbated the dot.com bubble? You may not realize this, but the Fed sets the allowed level of credit margin under Regulation T and that did not change at all during the dot.com bubble. It’s been at 50% (or 2:1) for decades. So I don’t think you can compare the dot.com bubble to the subprime bubble at all. The former is a case where people simply ignored stock valuations; the latter was a case where everyone in the food chain engaged in “don’t ask, don’t tell” fraud to emit credit.

                                Like you say, the tax jiggling just poured fuel on the fire, but it was not the fire. The fire was going to continue to exist until it flamed out regardless of any tax policies. So I should not let the perfect be the enemy of good?

                                Let’s talk about the question of fairness. How do you propose to know for all individuals when their rational exhuberance crosses over into irrational exhuberance in an asset class? Is it fair to tax and penalize people desparately trying to save for retirement and/or investment goals? You seem to be basically arguing that we should all be in the bloated, superflous middle with no outliers based on individual effort. And that there should be no debate over any aspects as the punishment is always automatic. So yeah, I’m very skeptical although I am sympathetic to the ideal.

                                Marked as spam
                                Posted by MachineGhost
                                Answered on 05/11/2016 8:57 PM
                                  Private answer

                                  I will somewhat agree with the original poster as I have also proposed that fiscal policy, being the Big Hammer, is the main tool we should use, and because politicians are often not intelligent, it should be rule based (with rule adjustments based on rigorous analytical scrutiny). But treating debt and equity differently requires considerably more understanding of what is really unknown, or at least poorly understood.

                                  A simpler solution to the Great Recesion housing bust would be to have simply followed classic Eastern European wisdom and not allowed people to buy houses until they had 20% or 25% in equity (down payment) and a year of basic living expenses in cash equivalent savings. And most people who had savings and understood economics are relatively much better off today.

                                  Nothing is better for increasing wealth than boom bust cycles if you understand they are boom bust cycles.

                                  Marked as spam
                                  Posted by John Daschbach
                                  Answered on 05/11/2016 10:33 PM
                                    Private answer

                                    Machine & John

                                    The changes in the Federal tax rates for earned interest, and long term capital gains (LTCGs) would be based on an index containing real estate, commodities, labor cost, and whatever else affects national appreciation/inflation rates. Therefore no single person would have their tax rates changed based on how much money they “earned” with LTCGs, debt investment (interest income}, or money saved. Tax rates changes would be changed nationally, gradually, and annually. There would be less “winners” and “losers” than there are now, because we would be eliminating a flaw in the tax code. The flaw being that the tax code does not change, as circumstance change, encouraging people to have unbalanced portfolios of excessive debt, during the boom cycle. When the boom collapses, the economy collapses creating unemployment, which affects everyone from the top to the bottom.

                                    By using the tax code to dampen the boom, before it creates a bubble, which we know from history always ends badly, we can create an economy that provides a better standard of living for all our citizens. Sure we will have to make money “the old fashion way,” we will have to earn it by providing a service, or product that benefits the economy. Playing the game of chasing booms and bust has not made our economy stronger. We have only created higher prices, more poverty, and more busted families.

                                    Each State, that has an income tax, should also adopt the 2% Appreciation/ Inflation Taxation Policy, because most markets are local, not national. That being a problem with monetary policy. When the Fed uses monetary policy to raise, or lower interest rates it affect regions of country that are in different cycles. One region might be in a boom cycle, and another region might be in a bust cycle. The boom region is over stimulated, if the Fed lowers rates, driving it towards a bust. By using the 2% Policy in each State, it counteract this situation.

                                    Other reasons we should first use the tax code to dampen booms, and stimulate the economy.

                                    Take the current situation of extremely low interest rates. If we had used the income tax to prevent the primary home bubble from getting as large as it did, interest rates wouldn’t have decreased as much as they have, and it would have been easier to stimulate the economy.

                                    Imagine if you will, after primary home prices were increasing annually more than 2%, if the LTCGs tax would have been raised gradually to a top rate of 35%, and the interest deduction would been reduced gradually. Also the LTCGs exclusion tax rate of 0% on the sale of primary homes, would have been raised also gradually. And the tax on interest earned would have been reduced gradually. All this would have taken place automatically each year. The desire for people to participate in the mania would have been reduced. The bubble would not have grown as big. Less damage would have been done to the financial sector, and to people’s lives. To stimulate the economy after price appreciation fell below 2% annually’ every thing would be reversed automatically, gradually and annually, to maintain aggregate demand, and maintain employment. If we still needed monetary policies applied, during the damping, or stimulus pauses, then apply it as lightly as possible. With the 2% Tax Policy enacted tax policy would be working in sync with the Fed’s monetary policies, after the changes in tax rates. Tax policy would not be making monetary policy less efficient, and more difficult. With the 2% Policy enacted, interest rates might have been able to stay closer to where they were before the economy started collapsing, and the financial crisis occurred. The Fed would have more room to maneuver, if needed.

                                    For more info. go to http://www.taxpolicyusa.wordpress.com

                                    Marked as spam
                                    Posted by Happyashell
                                    Answered on 05/13/2016 6:20 PM