The Inflation Threat to Capital Formation

By

Michael T. Darda

Updated April 10, 2008 12:01 a.m. ET

The Federal Reserve'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.

History has not been kind to such episodes. 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. This period also witnessed a stock market crash and a recession. Bringing inflation and marginal tax rates down created a major pro-growth inflection point in the early 1980s. But this progress could be substantially undone if we allow easy money to once again collide with sharply higher tax rates on capital.

 

Capital gains are not indexed to account for inflation, which means that in times of rising inflation, the effective tax rate on capital can rise significantly above the statutory rate. If inflation is high enough, effective tax rates on capital can rise above 100%. This was the story of the 1970s.

The current effective tax rate on capital is around 30%, down sharply from the 60% rates seen as recently as the early 1990s. This drop has been occasioned by a long period of falling inflation and the reductions in the top tax rate on capital gains in 1997 and 2003. The result has been an extended period of economic growth, strong advances in productivity, falling unemployment and rising real wages and incomes for most Americans.

But this positive trend may not last. The statutory capital gains will automatically jump to 20% from 15% in 2011 unless legislative action is taken to extend the current rate. Democratic presidential front-runner Barack Obama has stated a preference to raise the top rate on capital gains to as high as 28%, a near doubling of the current rate. Even more worrisome is that the collision of a 28% tax rate on capital gains combined with inflation above 3% would raise the effective tax wedge on capital to nearly 60% – the highest in 17 years.

From the late 1960s to the early 1980s, effective tax rates on capital averaged more than 100%. Perhaps it is no coincidence that real equity values collapsed by nearly two-thirds from 1968 to 1982. This period saw sputtering productivity, rising inflation, high unemployment, and an American economy in general decline.

Work by my firm suggests that the combination of a 28% tax rate on capital with a sustained inflation rate of 3.25% would knock trend productivity growth down by 0.5% per year. But it could be even worse. A return to 5% inflation would raise the effective tax rate on capital to 70%, pulling trend productivity growth down by 0.7 percentage points or more – a direct threat to U.S. living standards.

Eliminating the tax on inflated gains, especially at a time when the inflation expectations have been on the rise, would help to boost asset values and whet the appetite for risk. This would complement Fed and Treasury efforts to reflate the financial system and stabilize the housing and credit markets. It may also reduce the potential for an inflationary flare up by putting some of the Fed's excess liquidity to work in the real economy.

One cannot achieve a capital gain unless after-tax income is placed at risk. The higher the real, after-tax reward to successful risk taking, the more willing individuals will be to make bets on long shots. This increases the efficiency of capital and spurs innovation and entrepreneurship. Output and employment are enhanced.

Maximizing noninflationary 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. Allowing effective tax rates on capital to spike will restrain productivity and make fiscal integrity more difficult to achieve. It is the wrong way to try to raise revenues.

While indexing the capital gains tax for inflation would bring many benefits, the same cannot be said about the popular rebates and credits that currently pollute the U.S. tax code. This includes the bipartisan $168 billion stimulus package that recently sailed through Congress.

Consumer-based rebates in 1975 and 2001 proved largely ineffective. Rebates shift spending from one place to another without altering the incentive structure or adding new money to the financial system. Unless the Fed is running the printing press to finance the rebate checks, the spending by the recipient of the rebates is offset by a bond holder or taxpayer saving to finance it. In the global sink of dollar liquidity, only the Fed controls the faucet and the drain.

To the extent that rebates shift valuable resources away from more productive uses, they probably result in a net reduction in long-term growth. In other words, after a one- or two-quarter fillip, the rebate checks set to arrive in taxpayer mailboxes this summer likely will result in slower growth.

It would be helpful to increase the real, after-tax return to successful risk bearing. This could be done by indexing the capital-gains tax for inflation, as is currently done with the income tax brackets. This would also help head off a potentially destabilizing tax increase, preserve productivity gains, and restore the economy to a sustainable, noninflationary growth track.

Mr. Darda is the chief economist of MKM Partners.

original 

The Intimidation Game (excerpts)

The Intimidation Game: How the Left Is Silencing Free Speech  by Kimberley Strassel

January 21, 2010, is when the Supreme Court ruled on a case known as Citizens United. To listen to President Barack Obama, or Senator Harry Reid, or any number of self-proclaimed “good government” organizations, this decision mattered because it marked a new tidal wave of “dark” money and “shadowy” organizations into elections. It supposedly gave powerful special interests new control over democracy. Citizens United didn’t do any of that. But it did unleash a new era. It set off a new campaign of retribution and threats against conservatives. Citizens United launched the modern intimidation game.

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They encouraged, explicitly and implicitly, the IRS to target and freeze conservative groups during election years. They called out conservative donors by name, making them the targets of a vast and threatening federal bureaucracy.

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They also cleverly cloaked all this behind a claim of good government. Citizens United, they said, threatened to put powerful and nefarious forces in charge of democracy. And therefore all of their actions and tactics were justified in the name of the people.

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Nearly sixty years ago, the Supreme Court issued a groundbreaking decision, NAACP v. Alabama, that protected the rights of Americans to engage in politics with some degree of anonymity. This was the civil rights era, and blacks were being targeted, firebombed, and shot at for daring to speak out. The high court understood how corrosive this was to democracy, and declared that the Constitution provided some measure of refuge to citizens at risk of political retribution.

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Political memories are short, and Watergate had helped politicians to forget the way government had abused disclosure during the McCarthy and civil rights eras.

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Political operatives weren’t just using disclosure to punish citizens for their donations, but were wielding it to close off speech before it even happened. As Thomas wrote, the “success of such intimidation tactics has apparently spawned a cottage industry that uses forcibly disclosed donor information to pre-empt citizens’ exercise of their First Amendment rights.” He made special note of the Matzzie letter warning off donors in the 2008 election. Thomas then predicted another problem. It was bad enough, he noted, that citizens were using disclosure to threaten and retaliate against each other. But his colleagues needed to consider that transparency might ultimately prove a weapon in the hands of a more menacing power—government.

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As Thomas rang out in closing, “I cannot endorse a view of the First Amendment that subjects citizens of this Nation to death threats, ruined careers, damaged or defaced property, or pre-emptive and threatening warning letters as the price for engaging in ‘core political speech, the primary object of First Amendment protection.’”

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Few people outside of Clarence Thomas remembered the ugly history of the NAACP, or McIntyre, or the risk of exposing Americans to retribution. Citizens had instead refocused Americans on the threat of “dark money” (undisclosed money)—and Democrats intended to use that to their favor.

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In the 2012 election year, U.S. political actors spent about $7 billion attempting to get their favored candidates elected. It sounds like a lot, but then again, Americans spend roughly $7 billion every year on Halloween. National elections happen only every two years, which means that the U.S population spends twice as much every cycle buying Supergirl costumes and Milk Duds than they do electing the people who will govern their country. Of that $7 billion spent in 2012 to form a government, about $320 million of it was “dark money.” Do the math, and 96 percent of the money spent in elections is disclosed. Only 3 to 4 percent (it varies by cycle) is done anonymously, and even then, most of it is hardly anonymous.

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In short, the IRS had been warned. It knew its own history. It knew the law. But it also had its boss, the president of the United States, sending it very clear signals every day about “shadowy” conservative “front” groups “posing” as tax-exempt entities and illegally controlled by “foreign” players, engaged in “unsupervised” spending that was a “threat” to democracy. It had formal complaints. It had some of the nation’s most influential Democratic senators demanding an investigation. It heard the call. And it acted.

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Democrats also shouldn’t have been surprised by the news. They’d inspired the targeting. They knew that a Democratic administration and Democratic Senate and Democratic House members had called on an IRS staffed with Democratic appointees to go after conservative groups. They now knew that the IRS had done just that.

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Once the IRS scandal was exposed, a lot of investigators began wondering just how much unsanctioned, two-way cooperation between Obama agencies was taking place in opposition to conservatives. If the FEC staff was funneling tips to Justice, was Justice influencing FEC staff reports? Was Lerner influencing FEC staff? McGahn explains that what makes the situation even murkier is the basic character of FEC staff. They are naturally biased. “The place in its early days was staffed by followers of Ralph Nader—Naderites who believed that all politicians are corrupt, and that both parties are awash in too much money,” he says. A younger generation is now in town, but the ghosts still linger.

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The pressure on Democratic legislators in ALEC has become even more wild and nasty.

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The left uses this information to hassle legislators, even going so far as to employ it in campaigns against them. “This is the part that I hate the most,” says Nelson. She acknowledges that some of the Democratic drop in ALEC membership is due to bigger forces. The Democratic Party has shifted to the left, and many of its pro-business Democrats were ousted in primaries, beaten by Republicans, or switched parties. “But those who are left are viewed and attacked as pariahs, just for deigning to work with the other side,” says Nelson. “These activists don’t want bipartisanship, they don’t want solutions. They want anyone who doesn’t agree with them shut down.” Nelson has even struggled in recent years to get a Democrat to serve in the rotating top ALEC leadership position. ALEC has even dealt with Democratic saboteurs.

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But the most sinister part of the subpoena was this: “This John Doe search warrant is issued subject to a secrecy order. By order of the court pursuant to a secrecy order that applies to this proceeding, you are hereby commanded and ordered not to disclose to anyone, other than your own attorney, the contents of the search warrant and or the fact that you have received this search warrant. Violation of the secrecy order is punishable as contempt of court.” It was almost Orwellian.

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It was a revenge attack for the success his side had had in defeating the recent recalls.

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O’Keefe’s view is that direct participation by these organizations—nonprofits, think tanks, 527s, the like—is the only way to keep politicians and government responsive. He just as fervently believes that money is a foundational aspect of that. “It always bugs me, this obsession with political spending,” he says. “Campaign spending as a percentage of the federal budget is a flat line—and it is all of 0.02 percent. The left, they act like there is too much money in politics. Really?

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The outrage over the tactics, and public concern over government abuse, did at least give Republicans an opening to right a few wrongs. In October 2015, Walker signed a bill gutting the John Doe as a tool for political persecution. The new law outlaws John Doe investigations for allegations of political misconduct. Prosecutors can henceforth only use them for grave and specific lawbreaking—namely violent felonies and some drug crimes—and also must obtain permission from a majority of the state’s chief judges to extend probes beyond six months. Secrecy orders now only apply to prosecutors, court officials, judges, and investigators. There are no more gags on suspects or witnesses. Every Democrat in the Wisconsin Assembly and Senate voted against the measure. Which is another way of saying that Wisconsin liberals went on record in favor of gag orders, predawn raids, limitless warrants into e-mail, phone, and bank records, and the targeting of Americans for their ideology.

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Nixon’s private “enemies list” was bad. Barack Obama’s public “enemies list” was arguably worse. Obama had used 2010 to alert and sic the IRS on Tea Party groups. But by calling out private citizens by name on his website, he was alerting and siccing every part of his government on Republican donors. The message from the man who controls the Justice Department (which can indict people), the SEC (which can fine people), and the IRS (which can audit people) was clear: Donate money to Romney, and you are fair government game. The posting was also an APB to every liberal group and activist in the country to target those donors.

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In some ways, it shouldn’t have come as a surprise. The left started its intimidation campaign by trying to silence a nonprofit here, a company there, a big donor here, a trade association there. But along the way it wrapped in small donors, and scholars, and scientists, and petition signers, and shareholders, and free-market professors, and grassroots groups. It was only a matter of time before it came to the obvious conclusion: Everybody has too much speech. And so on September 11, 2014, fifty-four members of the Senate Democratic caucus voted to do something that had never been attempted in the history of this glorious country: They voted to alter the First Amendment. Henceforth, “Congress and the states may regulate and set reasonable limits on the raising and spending of money by candidates and others to influence elections,” and may outright “prohibit” corporations and nonprofits from spending any money “to influence elections.” The amendment gave incumbent legislators and state officials near-total power to suppress undesirable political speech. Why were Democrats proposing a change to the Constitution, rather than just legislation? Because such legislation is unconstitutional.

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The Democratic Party as a whole is now adopting this proposal to overthrow the First Amendment. It won’t happen anytime soon—passing an amendment to the Constitution is hard. But the fact that Democrats are trying to marks a radical shift in the political culture. The left is done with debate.

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Then again, there’s a good case to be made the left isn’t planning on there ever being another moment when the other side is in power. Their intention is to make sure they forever own the debate. That’s the point of shutting down speech. That’s the point of the intimidation game.

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Instead, the laws that were designed to keep the political class in check are being used to keep the American people in check.

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The entire concept of disclosure has in fact been flipped on its head. The American people know almost nothing about the working of government. Instead, disclosure is trained on the electorate, allowing the government to know everything about the political activities of Americans.

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At the very least, it’s time to rethink the levels at which citizens are required to disclose contributions. They need to be dramatically raised. If the left’s argument is that democracy is at risk from “powerful” players, then it can have nothing to fear from the donor who gives $5,000 or $10,000 or even $20,000 to a candidate or party. That is peanuts compared to the more than $70 million that billionaire environmental activist Tom Steyer spent in the 2014 elections to (unsuccessfully) retain a Democratic Senate. It’s a simple fact that in today’s big-money political arena, no politician can be “bought” with a mere $10,000. The current disclosure requirement of $200 is primarily designed to ensure that every citizen’s political activity is known to the federal government.

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That’s why it is also time to rethink the Federal Records Act and the Freedom of Information Act. Both need to be overhauled, to include provisions that ease and streamline the ability of outside groups to obtain records, and to impose severe penalties on agencies and federal employees who fail to comply.

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It’s time to rethink campaign finance laws, at both the federal and state level.

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Corporate actors have an enormous stake in the political debates that shape regulations and the tax system and trade policy. They have a right to speak.

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It’s time for the courts to wake up—and to recognize Clarence Thomas’s prescient observations about where today’s disclosure and speech law regime has left the country. It’s time for the courts to recognize that we are once again in an environment in which average citizens are afraid to speak.

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Mostly, it’s time for Americans to speak up. The intimidation game only works if its targets let it. When citizens blow the whistle on abuse and stand up to it, they are by definition rejecting intimidation. They inspire others to come to their defense and to speak out themselves.

Government Controlled Healthcare

Macra: The Quiet Health-Care Takeover

A 962-page rule puts the federal government between doctors and patients.

ENLARGE 
Photo: Getty Images

By

James C. Capretta and

Lanhee J. Chen

May 31, 2016 6:33 p.m. ET

82 COMMENTS

The American people have become familiar with ObamaCare’s failings: higher premiums, fewer choices and a more powerful federal health bureaucracy. Yet another important piece of health-care legislation, signed into law last year, has gone almost unnoticed.

The Medicare Access and CHIP Reauthorization Act, known simply as Macra, was enacted to replace the outdated and dysfunctional system for paying doctors under Medicare. The old system, based on the universally despised sustainable-growth rate formula, perennially threatened to impose unsustainable cuts in physicians’ fees. Macra passed Congress with bipartisan support and President Obama quickly signed it. Unfortunately, the law empowers the federal bureaucracy at the expense of the doctor-patient relationship, putting the quality of American health care at risk.

In an effort to secure broad support, Congress wrote into the law general guidance but left important details of implementation to the executive branch. What happened next was predictable: In April the administration presented a 962-page regulatory behemoth. This new set of rules uses the power of Medicare to put the federal government in charge of almost every aspect of physician care in the U.S.

Macra adopts the same theory of cost control embedded in ObamaCare. It assumes that the federal government has the knowledge and wherewithal to engineer better health care through “delivery system reforms,” forgetting the utter failure of the bureaucracy’s previous effort. ObamaCare and now Macra use Medicare’s payment regulations to force hospitals and physicians to change how they care for their patients. The administration’s regulations will force doctors to comply with scores of new reporting requirements and intrusions into their practices. Physicians who refuse to bend will see their Medicare fees cut.

Macra and the new regulations force physicians to pick between a “merit-based incentive payment system” or an “alternative-payment model.” Doctors who choose the former will get paid fee-for-service, but they will receive meager annual increases of only 0.25% starting in 2019. Some doctors could earn “bonus payments” but only if the federal bureaucracy approves of their performance.

These rules are purposely onerous because the administration wants physicians to opt into the alternative-payment model. In that system, the government shifts regulatory control from individual physicians to organizations with responsibility for managing patient care. Physicians serving patients through this system will be eligible for annual payment increases of 0.75%, plus bonuses distributed if their organizations hit the government’s spending targets.

The not-so-hidden agenda of the Obama administration is to use Macra and related regulations to force physicians into joining accountable-care organizations. ObamaCare nudged hospitals and physician groups to form these organizations to manage patient care. But they are an unproven concept in Medicare, weighed down by a mountain of rules and information systems. Early data from the administration shows that they haven’t done much to cut costs or improve quality compared with traditional Medicare.

Another major flaw is patient retention. ObamaCare stipulates that a Medicare-eligible patient be automatically put in an accountable-care organization if his doctor is affiliated with one. However, the patient remains free to see any doctor he wants, and the patient usually doesn’t even know he has been placed in such an organization. It is difficult to control costs when the patient has no knowledge of or reason to stay within the system. In 2014, only one-quarter of the 333 accountable-care organizations received bonus payments for hitting financial and quality targets.

Many hospitals, physician groups and managed-care entities have ceased participating in the program because of its excessive rules and small rewards. Macra and the administration’s regulations are simply attempts to resuscitate accountable-care organizations through coercion. Physicians fed up with the bureaucratic rules and low payments of fee-for-service will have no recourse except to join one of the organizations. And when physicians join, their patients come with them, whether they know it or not.

The administration’s rule ignores that Medicare already has a thriving alternative-payment model. Private Medicare Advantage plans, many of which are HMOs with decades of experience managing care, have developed new ways of identifying and compensating the most cost-effective physicians. Some 30% of Medicare beneficiaries have voluntarily elected to get their care through these plans without being coerced, according to the 2015 Medicare Trustees Report.

Congress understandably jettisoned the failed sustainable-growth rate formula, and it is important to reward quality health care, rather than pay more for high volume. But Macra threatens to sidetrack this movement by embracing the same bureaucratic mind-set that underlies ObamaCare. A better plan would use competition and consumer choice to reward physicians for providing high-quality care at affordable and easily ascertained prices, without coercion by the federal government. The results would be better for physicians and their patients—not to mention taxpayers.


Mr. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute. Mr. Chen is a research fellow at the Hoover Institution and director of domestic-policy studies in the Public Policy Program at Stanford University.

wsj.com

Barack Obama Checks Out

Bret Stephens

March 14, 2016 7:42 p.m. ET

Barack Obama—do you remember him?—will remain in office for another 311 days. But not really. The president has left the presidency. The commander in chief is on sabbatical. He spends his time hanging out at a festival in Austin. And with the cast of “Hamilton,” the musical. And with Justin, the tween sensation from Canada.

In his place, an exact look-alike of Mr. Obama is giving interviews to Jeffrey Goldberg of the Atlantic, interviews that are so gratuitously damaging to long-standing U.S. alliances, international security and Mr. Obama’s reputation as a serious steward of the American interest that the words could not possibly have sprung from the lips of the president himself.

I was a bit late in reading Mr. Goldberg’s long article, “The Obama Doctrine,” which appeared last week and is based on hours of conversation with the president, along with ancillary interviews with John Kerry, Hillary Clinton, Leon Panetta, Manuel Valls of France, Benjamin Netanyahu of Israel and other boldface names. Kudos to Mr. Goldberg for his level of access, the breadth of his reporting, the sheer volume of juicy quotes and revealing details.

Still, it’s a deep dive into a shallow mind. Mr. Obama’s recipe for Sunni-Shiite harmony in the Middle East? The two sides, says Mr. Obama, “need to find an effective way to share the neighborhood,” sounding like Mr. Rogers. The explanation for the “sh— show” (the president’s words) in Libya? “I had more faith in the Europeans,” he says, sounding like my 12-year-old blaming her 6-year-old sister for chores not done. The recipe for better global governance? “If only everyone could be like the Scandinavians, this would all be easy,” he says, sounding like—Barack Obama.

Then there’s Mr. Obama the political theorist. “Real power means you can get what you want without having to exert violence,” the president says in connection to Vladimir Putin’s gambles in Ukraine and Syria. That’s true, in a Yoda sort of way. But isn’t seizing foreign territory without anyone doing much to stop you also a form of “real power”? Is dictatorial power fake because it depends on the threat of force?

Elsewhere, Mr. Obama airily dismisses the concept of “credibility” in U.S. foreign policy, noting that Ronald Reagan’s decision to pull U.S. troops from Lebanon after the 1983 Marine barracks bombing didn’t affect U.S. credibility with China or Russia. That’s debatable. But the withdrawal affected our credibility with Iran, which was behind the bombing, and with a young Saudi named Osama bin Laden.

“Where was this false courage of yours when the explosion in Beirut took place in 1983?” bin Laden asked in his 1996 declaration of war on the U.S., which also cited Bill Clinton’s abrupt withdrawal from Somalia after the 1993 Black Hawk Down incident. “You left the area carrying disappointment, humiliation, defeat and your dead with you.”

As for current threats, Mr. Goldberg asks Mr. Obama what he would do if Mr. Putin made a move against Moldova, “another vulnerable post-Soviet state.”
 Mr. Obama’s answer—“if it’s really important to somebody, and it’s not that important to us, they know that, and we know that”—is of the April Glaspie school of diplomacy. So long, Moldova.

Mr. Goldberg also discloses that Mr. Kerry has begged the president to launch cruise missile strikes against the Assad regime in Syria, for the sake of a little leverage in negotiations. Mr. Obama has brushed the requests away. Mr. Assad can at last rest easy, if he isn’t already.

U.S. allies fare less well under Mr. Obama’s gaze. David Cameron comes in for a scolding on U.K. military spending, as well as for getting “distracted” on Libya. Nicolas Sarkozy, the former and possibly future president of France, is dismissed by Mr. Obama as a posturing braggart. Regarding the president’s commitment to Israel’s security, Mr. Goldberg reports, citing Mr. Panetta, that the president “has questioned why the U.S. should maintain Israel’s so-called qualitative military edge, which grants it access to more sophisticated weapons systems than America’s Arab allies.”

As for those allies, Mr. Obama treats the Saudis with such naked contempt that it prompted former intelligence minister Turki al-Faisal to denounce the president in an op-ed: “Could it be,” the prince asked, “that you are petulant about the Kingdom’s efforts to support the Egyptian people when they rose against the Muslim Brothers’ government and you supported it?”

Summing up the president’s worldview, Mr. Goldberg describes him as a “Hobbesian optimist”—which philosophically must be the equivalent of a Jew for Jesus. But Mr. Obama has shown that he lacks Hobbes’s understanding that Leviathan must fill the vacuums that will otherwise be filled by an ISIS or a Putin, or an optimist’s belief that American power can shape the world for the better.

The French diplomat Charles de Talleyrand once said of the (restored) Bourbon dynasty that “they had learned nothing and forgotten nothing.” Given the mix of score-settling and delusion on display in this interview, that may well be the president’s foreign-policy epitaph, too.
 
Write bstephens@wsj.com.