Inflation is not going away. The taxing authorities love inflation because it
allows them to pay back borrowed money with cheaper dollars. It is built
into the budgets of most sovereign nations as a feature, not a bug. Per
Wikipedia, one of the earliest documented inflationary periods occurred
following Alexander the Great’s victory over the Persian Empire in 330
BCE.
The form taken was to collect the silver coins then in use, melt them down
and mix the molten silver with less valuable metals such as copper or
lead. The debased coins were then reissued at the former nominal value.
This practice increased the money supply while lowering the intrinsic value
of each coin. Consumers would need to offer more coins in exchange for
the same goods and services as previously. Those goods and services
would experience a “price” increase as the value of each adulterated coin
is reduced.
Secondarily, currency debasement benefited the government by providing
additional liquidity without the immediate raising of taxes.
The Waring States Period of ancient China, loosely dated to about the
time of Alexander the Great, saw the introduction of paper money. The
convenience of paper money meant it was no longer necessary to collect
and melt silver coins before debasing the currency.
Since war is an expensive undertaking, the national actors were
incentivized to increase the money supply, regardless of the inflation that
might come after. And inflation followed the increased money supply as
night follows day.
It wasn’t until the second half of the 1900’s that serious efforts were made
to expand the collection of taxes without unduly increasing the money
supply. One of the early attempts was Arthur Laffer’s.
Laffer’s Curve (1974) Arthur Laffer’s eponymous curve (1974) was
predicated on tax rates, which have oscillated between 28% and 91% since
WWII. He observed that there are two points in the graphing of tax-receipts which
result in the taxing authority collecting zero income.
The first point is if all earnings were taxed at a zero rate, in which case there
would be no income to the government: infinite dollars taxed at zero percent
generates zero tax receipts.
On the other hand, if all income were taxed at 100% the government would
receive zero income because the personal incentive to work and to receive
income would be lost.
Laffer’s conclusion was that the government’s tax receipts rise as rates climb
above zero . . . but beyond some uncertain inflection point, increasing the
marginal tax rate actually decreases the individual’s incentive to produce.
The classic bell-shaped curve would suggest that the point of maximum
government income should be within one standard deviation of the mean, and
most likely the total tax burden would be close to the 50% level. All that sounds
very reasonable, but it turns out not to be quite as accurate as Dr. Laffer might
have hoped.
Hauser’s Law
Hauser’s Law (1993) William Hauser, father of Hauser’s Law (1993), noted
that regardless of maximum Federal income tax rates, the taxes actually received
have pretty consistently remained at about 19.5% of GDP (plus or minus a point
or so). That’s because higher income folks, the ones actually bearing the tax
burden, often have meaningful control over when and how they get paid. And
they didn’t get rich by being stupid: they (or their advisors) can and do arrange
the receipt of income in a way that minimizes total taxes paid.
Ronald Reagan (President, 1981-1989) famously explained that the reason he
accepted working in only one motion picture a year during the high tax years of
WWII and following, was that personal income tax brackets rose to the 90%+
levels, and he had no incentive to work for money he would retain only briefly.
John Kerry, member of the Forbes family, sometime democratic presidential
nominee, Massachusetts senator, and later secretary of state, ordered a new
yacht to be built in New Zealand. As delivery approached, he was reminded that
he would be liable for $437,500 in taxes imposed by his home state of
Massachusetts if he berthed the vessel in that state within six months of the
boat’s purchase.
Thus, Kerry kept his yacht in the adjoining state of Rhode Island.
This was widely reported by the people who talk about such things. When
political pressures increased enough, John Kerry re-thought and subsequently
informed us all that he would voluntarily pay the Massachusetts taxes on his
yacht.
But regardless of who pays what taxes, William Hauser found in 1993 that total
tax receipts over a 60+ year period (i.e., since the Great Depression) were
remarkably stable at 19.5% of GDP regardless of income tax rates.
That was important. Tax rates meant little. Everything being the same, tax
receipts revolve around a nation’s Gross National Product, not its tax rates.
The implications of Hauser’s Law are stunning. Said another way, if it’s true that
tax revenues are pretty consistent at 19.5% of GDP, then raising tax rates has no
meaningful effect on federal tax revenues unless the Gross Domestic Product
(GDP) also increases.
To put this into perspective, if one wishes to increase government tax revenue,
it is easier to do so when GDP is growing. Laffer based his argument on tax
rates, Hauser based his on national production. Simply raising tax rates while
GDP is fixed is counterproductive.
Administrations cycle in and out of power. A commonality is that they nearly
always seek to increase taxes in a way unlikely to be immediately noticed. New
administrations also try to accomplish grand reorganizations, and, its been
hinted, sometimes get involved in extorting quasi-legal “donations” from
supervised industries. In the grand scheme of things, extorting “donations” may
be morally reprehensible, but it has little significant direct impact on the economy.
However, increasing taxes and the imposing of additional regulations (i.e.,
“agency costs” like rent controls) which increase the friction of doing business,
often reduce GDP and consequently – as Hauser concludes – result in lower
government revenues.
Well, so what? We’ve seen the tax rate fluctuate widely (as noted above,
between 28% and 91% since WWII) and we’re still here, so what’s the problem?
The conflict is that the money going out is expected to exceed the money coming
- It doesn’t and it won’t. The Congressional Budget Office (CBO) projects a FY
2024 deficit in excess of $6.5 trillion, increasing about 5% annually. The deficit is
estimated to constitute 24% of GDP. Income: 19.5% of GDP; outgo: 24%. The
Federal budget carries a structural 5% deficit.
That means that our income taxes just barely pay for the mandated costs of
social security, interest on the national debt, etc. We borrow almost all the money
that pays for discretionary items like the military, Health; Human Services, and
the Departments of Transportation, VA, State, Housing and Urban Development,
and Education.
Thus, the national debt balloons.
The problem happens when the lines cross, when increasing debt impacted by
rising interest rates intersects with fixed receipts of 19.5% of a falling GDP? What
happens when we can no longer pay even the interest on the national debt?
We are not, as a nation, going bankrupt. After all, we own the printing presses.
We’ll just print more money. But that has intrinsic difficulties: a higher money
supply generates greater inflation. This feeds upon itself.
There is no obvious limit on how high inflation might go. Argentina, between 1983
and 1992, is only one of many possible examples. A single Argentinian peso in
1983 had by 1992 ballooned to 100,000,000,000 pesos. That is one hundred
trillion pesos. Suddenly your gal pal will brag over her latte and custard éclair that
“You should have invested with me! Ten years ago, I was broke and now I’m
worth over 50 trillion pesos!”
You and I know she’ll have to struggle to pay for her coffee and pastry, but she’s
happy: 50 trillion of anything sounds like a lot.
At some point defaulting on our public debt becomes an option. It would be
unwise to dismiss the possibility out of hand. According to Standard; Poor’s,
there were 84 sovereign defaults between 1975 and 2002. The largest recent
sovereign default was Argentina in 2001 ($82 billion). Our default, if it happens,
would certainly shatter that figure.
This article is for informational purposes only and is not intended as professional advice. Klarise Yahya is not a financial planner. Nothing in this article is presented as investment guidance. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya
is a Commercial Mortgage Broker specializing in difficult-to-place mortgages for any kind of property. If you are thinking of refinancing or purchasing real estate, perhaps Klarise Yahya can help. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email