How to Improve the Economy and Reduce the Deficit…

When I write my articles I try to keep as positive as possible.  I hope some of my other articles like and have shown you that I strongly believe in the power of positive thinking to improve one’s business and personal life.  Since I like to write positively – I stay as far away from political pieces as I can since many people have a negative attitude towards politics or one party.  However, on the minimum wage and I was sucked into commenting on his article and Ben urged me to write an article in regards to my comments and views.

Ben’s article argued that the minimum wage needs to be raised in order for lower income families to make enough to afford the basic necessities of life.  I hold a completely different view – that we should have a free market and the government should not force business to pay their employees a higher minimum wage.  I think a higher minimum wage will cause business to hire less people, charge more for products, cut back on services, and ultimately hurt the economy.  This article is not about the minimum wage, but other national policies that I think will improve the economy and reduce the deficit.

When I write this article, I am not writing as a Democrat or Republican. I am writing about what I think can improve the economy and reduce the deficit with a mix of liberal and conservative ideas.  If you must know, I consider myself an independent and although I am a registered republican, I stopped voting along party lines years ago.  I now vote for the best person, not a party.

Taxing the Wealthy

My entire theory is based on the United States tax policy and how it affects the rich, poor and investments.   I used to be a strong believer that the lower taxes are, the better the economy will be.  I have recently completely changed my philosophy and I now believe raising taxes on the wealthy may increase our economic production.

The Clinton Era

Before many of you roll your eyes and stop reading, let me explain a few things.  Taxes were raised under Clinton, but he also did many other things with the monetary policy  that were not exactly liberal.  I also know that Clinton didn’t do it all, he had help from Congress, the Senate and not all the changes may have been his idea.  You can argue whether it was Clinton or the Republicans made the changes, but I am going to refer to it all as Clintons doing just to make the article easier to write.

• He raised top two tax brackets to 36 and 39.6 percent.
• He lowered the tax rate on the poor significantly by revamping the welfare system.
• He lowered the capital gains tax rate from 28 to 20 percent.
• Spending was cut from 22% of GDP to 18% of GDP.

These policies made huge changes in the economy and were a huge change from where we are now.  They were other factors that affected the economy like the .COM boom, but I think the Clinton policy changes made a huge difference in economic production.  The policy changes coupled with an economic boom also produced a surplus in the federal budget.  It’s hard to believe now with our current deficit, but there was a 198 billion dollar surplus in 2000.  Other economic indicators also showed a very healthy economy: unemployment was 4% and the economy was growing at 4.2%.  There were plenty of jobs for everyone and minimum wage was not a hot topic, because most people could find jobs paying above minimum wage.

Promote Investment

There are so many variables that go into the US economy that no one can know or sure what works and what doesn’t.  Republicans will say it was the things they believe in that worked and Democrats will say it was the things they believe in that worked.  I personally think it was a combination of both liberal and conservative ideas.

I believe the federal governments policies at the time promoted business investment and consumer spending big time.  I’ll go after the hottest button first; raising taxes on the wealthy.   Clinton raised taxes to 39.6 and 36 on the top two tax brackets, but the economy still went crazy.  There are many factors that could have pushed the economy up, but I will explain why I think the higher taxes actually helped the economy.

The biggest thing that changed my mind from taxes needing to be lower for the wealthy to taxes needing to be higher was a discussion I had with my banker.  I was asking her about 1031 exchanges and if she was seeing an increase or decrease in the number she was seeing.  She said she is seeing very few exchanges, because taxes are so low investors aren’t exchanging their properties, they are taking profits.  The investors figure taxes will never be this low again so the smart move is to take profits now and pay taxes instead of reinvest in more property.

I started thinking, if the little investor is using this strategy, I bet the big boys are too.  Economically it makes sense to defer taxes as long as possible when taxes are high and take profit and pay taxes either when they are low.   We have seen a struggling economy for years, even with taxes on the rich at some of the lowest rates in history.  I know taxes aren’t the only thing that affect the economy, but they do affects business owners investment strategies.  Personally I don’t think low tax rates promote investment, they promote profit taking.

It is not only the level of taxes that causes businesses to invest or take profits, but the anticipation of what future tax rates will do.  If businesses assume tax rates are going to rise soon, I think that promotes profit taking even more.  They want to pay the lower rate on as much as possible before the rates increase.  Once the tax rates increase the businesses will go into tax deferment mode until taxes go down again.  It is very clear the federal governments tax system promotes investment in the economy.  There are huge tax breaks for investing in your own business, investing in your retirement or buying Real Estate.  When taxes go up, I don’t think businesses will cut back since they pay taxes on profit.  The more expenses you have the less profit and less taxes you pay.  It reminds me of my accountant’s advice when I started to make good money and I saw my first big tax bill to the IRS.  I asked him what I could do to pay less taxes.  He said, “a big tax bill means you are doing good, you made a lot of money and didn’t spend very much either.”

He is no longer my accountant, because I was looking for real advice on how to lower my taxes.  The point of the story is that people and business pay less in taxes the more money they spend on deductible items: entertainment, real estate, infrastructure, staff, etc.  The government tax policy makes sure those deductible items help our economy.  I think businesses will increase investment, increase hiring, increase infrastructure if tax rate go up so they can pay less taxes.

Lower Taxes on Lower Income

Here is another hot topic that I will share my views on.  The lower the income, the lower tax rates are and many people feel this is unfair.  I happen to think that the lower tax rates are on low income earners – the better it is for our economy.  My reasoning is that the low income earner historically saves less money than the high income earner.  If tax rates are lowered on the top 1%, the top 1% are probably not going to go on a spending spree and buy a bunch of consumer goods.  The top 1% became the top 1% by saving money, investing wisely, or building a business.  Most of the low income earners are living month to month with a long list of items they would love to have if they could afford them.  Many low income earners will immediately spend any raise or tax break they receive, which will boost the economy.  This is why many people think the Clinton tax break on the poor was a huge boost to the economy, just as many others think the tax increase on the rich was a boost tot he economy.  I think both worked.

Right now, I don’t think we need to lower taxes on the low income earners, because they are extremely low to begin with, but I don’t think they should be raised any either.

Spending

Clinton was able to reduce spending dramatically while in office.  Right now the federal budget is about 25% of GDP compared to 18% when Clinton was in office.  A huge worry in the US and world economy is budget deficits and increasing government debt.   No matter what is done,   spending has to be reduced.  I won’t talk much about this because I am not an accountant who can decide where to cut spending.  I don’t know the right answers, because I don’t know enough about the situation to know where to make cuts. However,  I do know it is much easier to give people money, than it is to take away money you are already giving them.  Any time an increase in the budget is proposed it needs to be scrutinized, because it is going to be very hard to reverse any increases.

Possible Derailments

My theory is based largely on tax deductions and I have a major concern with a few things I have been hearing on tax reform.  One item I have heard is the removing of many deductions for businesses and individuals.  I think eliminating deductions would be a huge mistake, because that would decrease  incentives to invest and spend money.

I also think increasing the capital gains tax would be a mistake, because a low capital gains rate promotes quick buys and quick sales.  Buying and purchasing are one thing that drives the growth rate and creates jobs.  Increasing the capital gains rate may cause there to be more holding and less selling.  To drive the economy we need a lot of selling and a lot of buying.

Conclusion

I believe by raising taxes on the wealthy – it will promote investment and economic growth as well as provide more revenue to the federal government to reduce the deficit.  I think cutting spending is a huge part of reducing the deficit, but I don’t know if enough can be cut to make a real difference in our economic environment.  We can’t remove deductions and other incentives to invest in the economy, that would counteract the entire point of the tax system.

As far as Ben’s article about raising the minimum wage: I think raising minimum wage will hurt the economy and be a temporary fix for the low income earners.  To best help the low income earners, we need higher paying jobs, not a higher minimum wage.  Improve the economy, decrease the deficit and higher paying jobs will help low income earners not care about the minimum wage.

The minimum wage will become what it was meant to be, a starting point for those entering the workforce.

Thoughts? Join the discussion below in the comments! Let me know if you agree or disagree- and why.

Photo: David Pearson