Wait… Nearly 14 Million from a Blind Trust!?

A lot has been made about Mitt Romney’s recently released 2011 tax returns.  Most of his income comes from investments made in a ‘blind trust’.  Some take issue with whether or not the trust is truly ‘blind’.  Others have taken issue with his effective tax rate(it’s lower than what many wage earners pay).  I want to discuss, what I see as a much larger problem.  Let us assume for a moment that Mitt Romney’s blind trust really is ‘blind’.  How is it that a man makes nearly 14 million dollars by doing absolutely no work?

A blind trust is supposed to be where a wealthy politician puts all his financial assets and then has no say in how it is managed.  The people who manage it for him earn a small(maybe a large) fee for managing it on Romney’s behalf.  By putting money into a blind trust one doesn’t have to do anything with it.  They aren’t consulted, bothered, cajoled, nothing.  Just a big ol’ check at the end.  This means Mitt Romney contributed absolutely zero work to the economy, but still managed to pull nearly 14 million dollars out of the economy for himself.  If this Forbes article on Mitt Romney’s Wealth is to be believed, that comes out to a 6% or 7% return on investment.

Let’s review the idealized role that investors play in a capitalist society.  Investors serve a very useful function in society.  They choose how and where to invest new resources.  If they choose wisely, society in general gets richer, and the investor makes money – possibly a lot of money.  A win-win.  The risk of course is that they choose poorly and lose some or all their money.  The money made by an investor is the reward for doing their homework and investing wisely in new enterprises.  Losing their money is the punishment for speculating or just investing foolishly.

The problem is, Mitt Romney did none of those things.  Did he really do anything worthwhile to earn a 6% return?  Six percent is pretty high considering that the average savings account is below half a percent.  The only decision he had to make as an “investor” was who to put in charge of his blind trust.  Is that one decision really worth 14 million dollars and a six percent return?  Maybe it is, but I think it would certainly warrant a review of the current rules of the system.

I am not suggesting as a solution anything radical like a 100% tax on financial income, or a ban on private investment.  What I am suggesting is to look at the ways this money is made.  The eco-system of laws and institutions behind it.  What government rules or agencies may be perpetuating it?  Does someone have to be a 200+ millionaire to earn a 6% return by doing nothing?  If so, why?  And is there a good reason why it is so?

Why is it that a person can state that they made nearly 14 million dollars last year without lifting a finger, and no one in the corporate so much as raises an eyebrow?

The Purpose of Taxes

The story of taxation usually goes like this:  You earn your dollars, then give some portion of it to the government.  The government then takes your money and buys tanks, builds roads, and gives food to the poor.  For local and state governments, that is a true story.  However, for the federal government, which creates the currency, this story remains just that: A story.  Despite what most people in Washington believe, the government doesn’t need your tax dollars to fund it’s activities.  Since the federal government can create money at will, then how does it make sense to say that it needs your taxes to fund all the things that it does?  Obviously, it doesn’t.  So what is the purpose of taxation? The purpose is two-fold:  To control inflation and maintain demand for the currency.

Taxes are needed to regulate inflation.

Since you already know that government spending is constrained by inflation, not revenue, then this should make sense.  If everything else were to remain equal, then taxes would always have to rise with spending to regulate inflation.  If the government kept injecting large amounts of spending without taxation you would eventually see inflation.  However, there are several reasons that inflation and budget deficits don’t always correlate.

There are many reasons that they do not always correlate.  A high savings rate is a good example.  If people are saving dollars instead of buying items it can cause deflation.   Another is fluctuations in foreign exchange markets.  In fact, we are currently living in an age of astronomical budget deficits, and yet we are still seeing very low inflation.

The other reason for federal taxes is to maintain demand for the currency.

Once a currency has already been established, this reason isn’t as obvious.  To understand this concept you we must go back to the launch of a brand new currency.  Let’s say Ireland decided to dump the Euro and create a new currency called ‘quid’.  The Irish government would make a bunch of quid and then try to use it hire someone to sweep the streets of Dublin.  What they would find is that no one was willing to word for quids, no matter how many were offered because everyone would still be using Euros.

Ireland finds that it must artificially create a demand for quid.  They do this by declaring that all taxes must be paid in quid.  Suddenly, people need quid.  People are now willing to work for the government in exchange for quid.  They can make the quid they need to pay their taxes and then sell their excess quid to people who don’t work for the government, but must still pay their taxes in quid.  In exchange for their quid, the workers could get Euro’s(an example of a foreign exchange market) or goods and services(a plain old money transaction).  The amount of Euro’s and goods they get for their quid is negotiated by the market.  After a time the currency will take hold and the Irish government will find it can pay for anything it wants in quid.  As long as people MUST pay their taxes using quid, there will be a demand for quid.

Upon reading this I hope that you come away with a better idea of what taxes are really used for.  Most people believe that the federal government must tax people to fund itself.  When you point out that’s silly because the government can create money at will, many people will start to think you’re suggesting doing away with all taxation(which would be equally silly).  That’s why it’s important to know and to explain to others the purpose of taxes:  Regulate inflation, and maintain the currency.

Putting an End to Taxes

It’s Monday, so not ease back into the work week with some humor.  From Allgov:

Nobody likes taxes. The problem is that the United States government needs money—lots of it—to do all the things we want it to do. So we tend to think of taxes as unpleasant necessities. I believe we can eliminate taxes completely. We just need to be more aggressive about creating new sources of revenue. Here are a few suggestions:

Here’s a couple of my favorite suggestions, but you should really go and read the whole article.

Sell Advertising on Paper Money
Take a look at a dollar bill. See that blank border that surrounds the designs on the front and back? There are dozens of companies that would pay huge sums of money to insert their logos and slogans into that space.
*snip*
Sell Invasion Insurance to Dictatorships
The United States spends almost as much money on our military as all the other nations of the world combined. This is an enormous drain on our national budget and we don’t get much in return for all the money we spend. Currently, the U.S. tries to intimidate other nations, such as Iran, by threatening to invade them. Instead, let’s just charge each dictatorship in the world an annual fee in exchange for the promise to not bomb them.
I came up with a couple of my own ideas to add to the list:
  • Create a national lottery, but rig it so that nobody ever wins.  I think this would be great.  People would keep playing this lottery, but our government could just pocket all that money every week.  If people get suspicious because nobody ever wins, they can just hire an actor and pretend that person won.
  • Piracy.  Hey, if it’s profitable for Somalia, surely our navy could do it.
  • Sell the moon. Hey! we were there first and if I learned anything in grade school it was “finders, keepers”.  If the rest of the world wants any moon real estate, they better” buy  now at our low low sell out prices!”
  • Hire out CIA agents as bounty hunters. Need someone whacked?  Let the government do it for you.  If you got enough money, no target is off-limits.
  • Borrow Recklessly, then change our phone number.  All right, we all got that one deadbeat relative who never pays his bills.  Our government should take a lesson from them.  Step 1, they run up a bunch of bills.  Step 2, change their phone number.  Step 3, move out and crash on someone’s couch until the bill collectors give up.  Step 4.  They start going by a new nickname on legal documents.   Here’s how I think this would play out on the international level.  Step 1, borrow a bunch of money from China.  Step 2, the Whitehouse and congress change their phone numbers so when China calls, they get a busy signal.  Of course, eventually they’ll send their collectors to the United States to collect their money – that’s when we go to step 3.  We all move to Canada for a few years until things “settle down”.  Step 4, we re-emerge as the Combined States of America.

Well, that’s all I got.  Do you have a*ahem* creative suggestion to get rid of taxes.

What is a Good Tax?

One of my favorite, and most frequent commenters, Robinson, asked a question this week.  How does the “fair tax” hold up against modern taxes? What are the problems and benefits? That’s a small question with a big answer.  First, let’s figure out how to judge a tax  and then next week, I’ll discuss how the Fair Tax holds up against those criteria.

Here are the criteria of how I judge a tax.

  1. So what is the purpose of a tax?  The textbook answer for taxation is of course, “To provide revenue to government for its operation and programs.”  Most government entities must collect taxes before they can spend anything.  Hopefully this is obvious and needs no further explanation.  So the first criteria is “How much revenue will it bring in?”
  2. A problem with taxation is that it can discourage productive behavior and hurt the economy.  For instance, if a city has too high of property taxes, people might move out.  Not something the city wants.  So the second criteria is “how much does it discourage productive behavior?”
  3. Another purpose of a tax might be to reduce undesired behavior.  This is known as a sin tax.  Also, the revenue from the sales can be used to deal with increased government expenses.  For instance, the tax on cigarettes would be a sin tax.  The higher prices is meant to discourage people from using them, and the revenue from the tax can be used to pay for increased medical costs.  So, does a tax discourage undesirable behavior.
  4. How much does it cost to collect a tax?  If the purpose of a tax is collect revenue, then you don’t want to spend more money collecting it than you actually get.  For instance, a toll can be an expensive tax because you have to pay someone to sit in a booth all day, every day, collecting tolls.
  5. The fifth criteria is, how easy is it to enforce?  Kind of a related issue to number 4.  Will it be possible and practical to enforce the tax.  For instance, you could try and tax people every time they charge a rechargeable battery, but how would you enforce it?  Also, if a tax is too high it can encourage more and more people to try and skirt around a tax.
  6. The sixth criteria, if it’s a service tax, “does it pay for what it’s intended to pay for?”  This applies mostly to excise taxes and tolls.   Examples are tolls you might pay for bridge or particular highway.  Another example would be the tax on gasoline.  The money raised by that tax is put into building new roads and maintaining the old ones.  For these taxes you have to judge if it’s raising enough revenue to pay for what it’s intended to pay for.
  7. Is a tax fair or does it unfairly target certain groups of people?  This is a hard category to judge.  For instance, you might say that property taxes unfairly target homeowners, to benefit renters.  You might also say that the gasoline tax that pays for our highways isn’t fair because electric cars don’t pay into it, but still use the roads.   A tax can be unfair if it tries to collect money from those who don’t have or earn enough to pay the tax.

So those are the criteria I will use when judging a tax.  What do you think?  Am I missing a category?