According to the “Wall Street Journal,” Washington is teeing up “the rich” for a big tax hike next year, as a way to make them “pay their fair share.”  Well, the latest IRS data have arrived on who paid what share of income taxes in 2006, and it’s going to be hard for the rich to pay any more than they already do.  The data show that the 2003 Bush tax cuts caused what may be the biggest increase in tax payments by the rich in American history.

The nearby chart shows that the top 1% of taxpayers, those who earn above $388,806, paid 40% of all income taxes in 2006, the highest share in at least 40 years.  The top 10% in income, those earning more than $108,904, paid 71%.  Barack Obama says he’s going to cut taxes for those at the bottom, but that’s also going to be a challenge because Americans with an income below the median paid a record low 2.9% of all income taxes, while the top 50% paid 97.1%.  Perhaps he thinks half the country should pay all the taxes to support the other half.   

Aha, we are told: The rich paid more taxes because they made a greater share of the money.  That is true.  The top 1% earned 22% of all reported income.  But they also paid a share of taxes not far from double their share of income.  In other words, the tax code is already steeply progressive. 

My Thoughts:  The average American today works from January 1 to July 16 just to pay for government before they begin working for themselves.  Isn’t it ironic that just a few weeks ago we celebrated the Fourth of July, a national holiday that honors early Americans who rejected an oppressive tax system?

 Giving a whole new meaning to the number 1776 . . .

 From Chris Edwards at the Cato-at-liberty blog. 

Karl Rove had some interesting remarks in last Thursday’s WSJ about McCain and Obama’s economics.  Here are a few selected comments: 

• In Raleigh, N.C. last week, Sen. Obama promised, “I’ll make oil companies like Exxon pay a tax on their windfall profits, and we’ll use the money to help families pay for their skyrocketing energy costs and other bills.”
• Set aside for a minute that Jimmy Carter passed a “windfall profits tax” to devastating effect, putting American oil companies at a competitive disadvantage to foreign competitors, virtually ending domestic energy exploration, and making the U.S. more dependent on foreign sources of oil and gas.
• Sen. McCain doesn’t support the windfall profits tax, but he can be as hostile to profits as Mr. Obama.  “[W]e should look at any incentives that we are giving,” Mr. McCain said in May, even as he talked up a gas tax “holiday” that would give drivers incentives to burn more gasoline.
• This past Thursday, Mr. McCain came close to advocating a form of industrial policy, saying, “I’m very angry, frankly, at the oil companies not only because of the obscene profits they’ve made, but their failure to invest in alternate energy.”

Our Thoughts:  Free markets rule!  Washington needs to stay away from business.  Profit motive drives creativity and solutions for our future.  In 1986, Ronald Reagan said, “Government’s view of the economy could be summed up in a few short phrases:  If it moves, tax it.  It it keeps moving, regulate it.  And if it stops moving, subsidize it.”

Thanks to Aron Huddleston for this article.

Update:  Not sure where you stand on the political spectrum?  Then you might like The World’s Smallest Political Quiz. 

We once had a Democrat President who understood economics and the relationship between tax rates and tax revenue.  Can you imagine the liberal loons of today using similar rhetoric?

(HT: http://www.cato-at-liberty.org/) 

The infusion of what is called “loose money” is always a stimulating consequence for the economy in the short term.  The analogy I often use is pumping oxygenated blood into your body.

The downside is the Federal Reserve’s ability to create money without limit does create malinvestment of capital.

But the growth of the money supply is, in my opinion, very healthy for the economy.

Long-term, the creation of money out of nothing always causes inflation, which is a problem, especially for those investors whose portfolios are filled with dollar-based investments.  The reason we haven’t seen major waves of inflation despite mass creation of money is because the U.S. and global economy does not have a shortage of goods and services.  This is acting like a sponge soaking up the new money.

Remember the real definition of inflation:  It’s the increase in the supply of money which causes prices to rise when not enough goods and services are available to absorb the new money. 

The difference between today and the Jimmy Carter days of the 1970s was that back then there was a major structural problem with the economy.  Simply put, there weren’t enough factories to produce enough stuff to soak up the money being created. 

If you double the money supply without doubling the amount of goods and services, prices will eventually double.

In our current go-round, the Fed has doubled the money supply but the supply of goods and services has also doubled so it’s nearly a wash.

I say “nearly” because in reality, there is actually a lot more inflation than what the government-published statistics indicate.  In the long-term, inflation is like the tide coming in pushing up the prices of assets, including stock prices.

Investors who are concerned about the money supply growth creating inflation are certainly thinking correctly but they also have to take in to account what is happening with that money. 

All too often when listening to a group of people casually discussing the topic of taxation, I’m reminded of the old saying, “All the world’s insane but thee and me, and sometimes I’m not so sure about thee.”

That’s because those who follow a statist agenda tell me that to soak the rich, we must cut their taxes.

Now I consider myself a rather open-minded, rational guy but when I’m confronted by an ideology that differs from my own, I want to see evidence.  Show me the proof that back up your claims. 

MAJOR PROBLEM:  In the case of taxing productivity, there isn’t any proof.  I’m done extensive research and there is nothing that shows me that the benefits of increasing taxes on the wealthy outweigh the costs. 

No surprise there since in today’s world most people blindly follow a traditional socialist model:  our progressive tax system. 

200 years ago early Americans would have overthrown their government had they been forced to pay a tax on their production.  The only federal taxes forced on them were on tobacco, liquor, and imports. 

Present day Americans are simply lifetime tax servants to an ever-growing Master in Washington, D.C. and they love it. 

So here’s a modern history reality check:

• In the 1920s when President Calvin Coolidge cut taxes, the US economy grew faster than Nebraska corn.
• When JFK cut taxes in the 1960s, America went from having one car on every block to having one car in every garage. 
• Ronald Reagan’s tax cuts in the 80s helped move us from a demand-management, consumption-oriented society to one that stimulated capital savings, investment, and production.

Translation:  Tax cuts result in healthy wealth creation for all citizens. 

One of the most inspiring individuals I studied early in my career was free market thinker Ludwig von Mises.  If you have any interest in fiscal policies that big government thugs prefer you not understand, I recommend reading anything written by him. 

In his book, PLANNING FOR FREEDOM, von Mises writes:

If the present tax rates had been in effect from the beginning of [the 20th] century, many who are millionaires today would live under more modest circumstances.  But all those new branches of industry which supply the masses with articles unheard of before would operate, if at all, on a much smaller scale, and their products would be beyond the reach of the common man.

Fast forward to 2007.  Looking back on the tax cuts of 2003 we learn that even though the tax rates of higher income individuals were reduced by 50 percent, the amount of taxes collected on the wealthiest Americans has almost doubled. 

And one more thing, the budget deficit has fallen.

It’s precisely what history teaches us - cut taxes on the wealthy and revenues to the Treasury soar.  That’s good fiscal policy. 

So what does this all mean for investors?

Depends.  Most will continue their “government will save us” thinking and hope for the best.  You and me are better off taking an anti-statist, self-educated approach to managing our financial lives and informing as many people as we can along the way. 

Check out Part I of this brief tutorial from the Cato Institute’s Dan Mitchell explaining the relationship between tax rates, taxable income, and tax revenue:

For more, see Part II and Part III.

My personal investment portfolio is quite simple.  It’s broadly diversified among ownership positions using equity mutual funds and I hedge my portfolio against the depreciation of the dollar using a link to gold.

That allocation offers me the opportunity to do well during most economic environments while keeping the portfolio safe.

But to have a portfolio designed to offer true financial safety, that portfolio must also be able to weather any economic environment that is thrown our way.

A threat that we’ve not experienced in some time is deflation.  A deflationary environment is when there is a decrease in consumer prices and an increase in the buying power of money.  Historically, deflation has often led to a depression - such as the one America went through during the 1930s.

So what if the Federal Reserve’s monetary policy triggers another deflationary environment like it did in the late 1920s?  How would my portfolio be protected then?

If deflation is on the horizon, I would add a second hedge position to my portfolio and that would be a slice of long-term U.S. Treasury bonds.

Interest rates (the cost of renting money) and bond prices are inversely proportional so as interest rates decline in a deflationary environment, the price of long-term government bonds goes up.

Why TREASURY bonds?  As long as the federal government has the ability to create money out of nothing and holds the power of taxation, the threat of credit risk is virtually nonexistent. 

Why LONG-TERM bonds?  Simply put, the greater the length to maturity, the greater the impact interest rates will have on bond prices.  Therefore, if I see the economy heading down the path that leads me to believe the threat of deflation is probable, I want to buy some Treasuries in my portfolio as far out as I can own them.

Remember 1987?

There was a threat of a deflationary collapse due to Alan Greenspan’s tightening of the money supply.  Knowing I had to protect my portfolio, I allocated 10 percent of it to long-term U.S. Treasuries. 

Then in 1994, there was a spike in interest rates which presented an opportunity to buy more - which I did, and hung on until 1998.

Throughout the year, headlines were filled with news about the Asian crises and the Long Term Capital hedge fund fiasco.  The media was touting their usual doom and gloom so the public was buying up bonds which drove up the price of the bonds I owned.   

About that time the economy was experiencing high money supply growth and one of the iron laws of economics is you cannot have deflation when new money is created at such a rapid pace.  Inflation, yes; but not deflation.

Once I believe Greenspan had created enough money to cover the major deflationary pressures, I sold the long-term Treasury bonds for a handsome profit and have not owned any since.

In summarizing, until there is a compelling reason to argue a pending deflationary collapse in the economy, my portfolio will have nothing to do with bonds. 

Until then, diversified ownership is the way to go.