Herman Cain and his catchy 9-9-9 plan for tax system simplification is attracting widespread attention lately. Not to be overshadowed, Rick Perry has joined the flat tax parade on the advice of Steve Forbes, a longtime flat tax advocate.
While the desire to simplify the overly complex American tax code with its virtually impenetrable tangle of special interest generated exemptions and loopholes is a laudable objective, this recurrent flirtation with a flat tax solution is extremely misguided.
Tax policy is the single most powerful and efficient tool in the government gadget box to shape the American economy. A flat tax takes all the leverage away from this tool.
If we hope to regain a competitive presence in the new global economy, it is indeed a complete overhaul of the tax code which will achieve the most impressive results in a timely manner. Flat tax schemes as well as simplistic progressive or regressive tax code formulas all fail to target the causes of our precipitous economic decline.
Tax policy powerfully shapes the business landscape by imposing predictable costs directly into the price and profitability calculations every legitimate business must perform when providing any good or service. American tax policy should be strictly driven by one core economic objective: expanding the creation of wealth by our free enterprise private sector.
This might sound ridiculously obvious at first glance, but creating ‘wealth’ is a specific form of ‘making money’. Hedge fund default schemes and interstate cigarette smuggling operations make lots of money, but they do not create a single penny of true economic wealth.
Wealth is an economic concept employing numerous parameters which profile the overall health and competitive viability of an economy. Wealth is created and accrued principally by means of efficient investment in and utilization of plant and equipment (factories) as well as the skilled labor necessary to transform raw materials or component parts into the kinds of quality finished and semifinished goods which are desired by consumers.
While human ingenuity is the source of wealth creation, and while quality education, health care and positive social values underpin the liberation of human creative potential, the intangible economic concept of ‘wealth’ is transformed into a tangible, bankable, real-world property on the factory floor. This is where rubber meets the road.
Wealth is generated as skilled human labor actively turns out quality products which did not previously exist in a manner that is effi cient and profitable. From the front end of the production line to that very last manufacturing task, value (wealth) is added to those starting point ingredients. This is the distilled essence of wealth creation. Tax policy should be tailored to reward the creation of wealth while punishing economic activity which obstructs or is parasitical to wealth formation.
A relevant example might clarify this point. Steve Jobs, co-founder of Apple Inc., recently passed away. If Mr. Jobs had inconspicuously tinkered with computers in a garage his whole life and left all his innovative ideas in stacks of dusty notebooks, he would have created very little wealth. Instead, Steve Jobs embarked on a risky financial adventure and transformed the concepts he envisioned into actual physical products. He became a very wealthy man — not ‘rich’ but ‘wealthy’.
Why? Because Mr. Jobs received only a very small fraction of the added value generated through the manufacture of his innovative products. The overwhelming bulk of generated wealth is embodied in physical capital (plant and equipment), suppliers and supply chain operators, wages for a huge skilled labor force, dividends received by Apple shareholders and most significantly the subsequent impact his machines have on efficiency and profitability when purchased and deployed in the workplace. Tax policy should target and reward these types of business operations through tax breaks, tax incentives and accelerated rates of capital depreciation.
Not all profitable business activity generations wealth. Wall St. centered financial speculation is both profitable and rampant in this economy, yet such activity creates financial bubbles and constitutes an impediment to wealth creation much like clipping the edges of coins was a drain on the king’s treasury in 18th century England.
While coin clipping was illegal and punishable by death, the reckless practices unleashed by financial market deregulation legitimized a Wall St. business model maliciously built around schemes that border on securities fraud. For instance, the knowing promotion, sale, bundling and then resale of toxic sub-prime mortgage assets while simultaneously betting on the failure of those very same investment packages via hedge fund credit default options and swaps inflicted a financial collapse which drained the pool of public sector funds which should be devoted to enhancing our competitive standing.
Capital markets in America have sharply veered away from fulfilling their traditional role of long run financing commitments to promising wealth creating business ventures like Apple Inc. and instead prefer to ‘game’ the financial system for highly leveraged short run profits derived through speculation. The explosion of scandalous investment behavior was further incentivized by preferential treatment through the tax code.
Following financial sector deregulation, lower rates of taxation were generously bequeathed upon Wall St. derived profits known as ‘capital gains’. Competent tax policy would discriminate between speculation and wealth creation. Capital gains achieved via hedge funds and ‘short selling’ schemes should be taxed at very high rates, while capital gains achieved by productive long run oriented business entities should be encouraged through much lower rates of taxation. It is no coincidence that the flat tax crowd opposes financial market reform and re-regulation.
Over the past 40 years the U.S. economy has undergone a tremendous transformation from a manufacturing based powerhouse to a financial service sector dominated paper tiger. Both Democrats and Republicans are equally responsible.
A revolving door exists between Wall St., the Securities and Exchange Commission and the Treasury Department. Proper regulatory oversight is seriously lacking. Each political party is awash in large donations from financial service sector interests.
Many, under the banner of spending cuts, want to shrink and disarm the federal agencies tasked with monitoring Wall St. as the daily volume of Wall St. trading has exploded into realms of speculation measured in hundredths of a second. Professional traders now deploy cutting edge computers driving by sophisticated, closely guarded secret algorithms designed solely to take advantage of incremental price changes over fractions of a second by trading huge volumes of stock.
Those fractional pennies add up across billions of daily trades. The pointless nature of this kind of ‘money making’ is suggested by the traders who refer to their investment decisions as ‘plays’. That is because no wealth is created, no durable value is added to any good or service of substance.
Financial markets in the West have largely deteriorated into casino gambling venues where fast bets are placed on short term price swings. Not surprisingly, fi- nancial statistics now reveal that the odds are stacked in favor of computerized flash traders armed with their sophisticated algorithms and insider connections.
Even less surprisingly, a ‘transaction tax’ on all Wall St. trades was roundly shot down by the political establishment of both parties. A transaction tax would decrease the frenzied volume of daily trades and help stabilize volatile, ‘over played’ stock markets. Unfortunately for Main St. and the desire to conduct business in a more stable economic atmosphere, the big financial players want volatility. Volatility means price swings and price swings mean opportunities for profitable speculation.
Both Herman Cain and Rick Perry oppose financial sector reform and refuse to utilize the federal tax code as a tool to punish speculation and reorient the economy towards meaningful production of wealth. Wall St. is given the green light to continue making money at the expense of creating wealth.
Trade policy is an arm of tax policy. Since America imports significantly more than she exports, trade policy must become carefully integrated with tax reform. Steve Jobs and Apple Inc. again provide a teachable moment in this regard.
Mr. Jobs decided to manufacture and assemble Apple products in China. This was indeed a prudent business decision. Wage rates in China range between $7 to $12 per day. The Chinese government subsidized state-of-the-art factory, port and rail facilities to compliment and enhance Apple operations. China allows factories to externalize many costs of production so that they can operate more cheaply and China strategically undervalues its currency so that her exports are artificially cheap.
China understands that wealth moves from a mere abstract economic concept to hard-edged reality on the factory floor in the production process. Their objective is to ensure Apple manufacturing digs in for the long haul, turning out quality exportable products well into the future. The real world wealth realized by the engineers and managers at Apple headquarters in California is absolutely dwarfed by the wealth generated in China by the vast supply, production, assembly and shipping operations required to put that iPhone on the local Walmart shelf.
Look at outsourcing another way. America has carefully constructed the finest college and university system in the world precisely to develop and fertilize innovation, the lifeblood of economic growth. Much of that system has been built and maintained by significant taxpayer public funding.
If talented students develop their cutting edge ideas within our system but then go offshore to build their innovative products then our higher institutions of learning, research and development become invaluable U.S. subsidized nursemaids for China’s powerful economic development as well as all the other offshore manufacturing hot spots. This constitutes economic suicide and is playing out on the nightly news.
Globalization via highly portable technology and knowledge has changed the game by tilting the board toward low wage, less regulated, weak currency nations. You can’t expect corporations to stay in America and be uncompetitive. The only way to change the profit calculations of corporations that go offshore to take advantage of unfair trade practices is to impose tariff penalties which level the playing field.
Tax and trade policy need to be integrated. It has been recently reported that several American innovators of promising next generation batteries and L.E.D. lighting will be making their products in China. Strong tax incentives for domestic start-up manufacturing coupled with tariffs might have kept these industries at home. Flat tax schemes oversimplify the tax code to our economic detriment in a complex, competitive world.
When it comes to taxation, forget about rich vs. poor or white collar vs. blue collar. Think along the lines of ‘makers vs. takers’. The tax code should be reformed to reward the creation of wealth and punish parasitical coin clipping operations. This requires a sophisticated tax code, not a simplistic one.
Cain and Perry refuse to make the critical distinction between producers and moochers. They argue that a flat tax approach is the most equitable arrangement. They claim that a flat tax coupled with radically scaled back government, deregulation and downward market pressure on U.S. wage rates will make America competitive once again.
They reject the notion that reckless financial speculation in a deregulated climate with preferential tax rates is a problem. They reject the notion that unfair trade practices must be taken on directly through the tax code with stiff tariffs because such interventions interfere with free market mechanisms and might spark a trade war.
Really . . . a trade war? China decided over 20 years ago to bring down the West with one sided, trade war armored economic policies. America and Europe are in the final rounds of that fight and we have yet to put up our fists and swing back.
Why? Because the paper swapping, dividend driven, thick financial portfolio elites find this arrangement very profitable. Much to the disgust of old school Republicans like Paul Volker and David Stockmann, these short run driven money ‘takers’ now dominate the top income brackets. They now influence policy in Washington and fund the political campaigns.
The American middle class has been tossed into the back seat and taken on a one-way ride to insolvency. It is time to seize the wheel and reject simplistic flat tax schemes spouted from the driver’s seat. While 9-9- 9 makes a good bumper sticker, it perpetuates our long run inability to create wealth by the ‘makers’. JAMES LEWIS Whitesburg