Saturday, April 12, 2008
Inflation and Taxation
"The [Fed's] efforts to reflate the financial system with negative real short-term interest rates may have a dire consequence: sharply higher effective tax rates on capital. ... The combination of a rise in the statutory tax rate on capital and rising inflation nearly doubled the effective tax rate on capital between 1986 and 1991. ... Bringing inflation and marginal tax rates down created a major pro-growth inflection point in the early 1980s. But this process could be substantially undone if we allow easy money to once again collide with sharply higher tax rates on capital. ... If inflation is high enough, effective tax rates on capital can rise abouve 100%. This was the story of the 1970s. ... Even more worrisome is that the collision of a 27% tax on capital gains combined with inflation about 3% would raise the effective tax wedge on capital to nearly 60%--the highest in 17 years. ... One cannot achieve a capital gain unless after-tax income is placed at risk. ... Maximizing non-inflationary growth with sound tax policy--while restraining the growth of entitlement spending--is the only way to deal with long-term structural deficits, without a crushing tax burden. ... To the extent that rebates shift valuable resources away from more productive uses, they probably result in a net reduction in long-term growth", my emphasis, Michael Darda (MD) at the WSJ, 10 April 2008.
I only disagree with one thing MD wrote. Only restraining spending can balance the budget. No tax increase will ever balance the budget as it will be spent away. I agree with MD about the "rebate" plan. It will only redirect spending to less productive uses and consume capital.