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Saturday, May 5, 2012

An American Tale of Free Enterprise

First, an example. Ethanol tax credits expired on Dec. 31, and what do you think happened? If you guessed the prices rose, you are incorrect. Over at Redstate is an article with a chart showing the prices, and they dropped! A terrific example of what government interference can do to a market.

Weren't you always taught (in left-leaning union-run schools with accompanying textbooks) that government had stepped in and saved America from the Great Depression, and the role of government regarding WWII had the same effect? So had I been taught, not that I believed all that. Government isn't the answer to the successes of America during that time. That distinction belongs to free enterprise. See How Free Enterprise Saved Civilization up at Forbes, by Steve Forbes. It's a book review of Freedom's Forge: How American Business Produced Victory in WWII. From the end of the review:
So why is it that the astounding achievements of American business during World War II have been virtually erased from popular imagination? Precisely ­because it was business, not government, that performed the miracle. As Herman puts it, “Those … left out of the major decisions about the economy during the war—New Dealers and others—took their revenge by seizing control of the historical message. Business had had nothing to do with the miracle of war production, went the narrative. … It was the vast resources and extended reach of the federal government all along.”
Thankfully Freedom’s Forge sets the record straight, comprehensively and compellingly. Free markets, not big government, are the true source of America’s incredible strength. They enabled us to win World War II, thereby saving Western civilization. And since the war free markets have produced an endless cornucopia of new products and services—and will continue to do so as long as they exist.

The WSJ describes The 2013 Fiscal Cliff Could Crush Stocks.This is important. This is the nitty-gritty of how taxes will impact the market, investors, and the rest of us who have savings accounts, bank accounts, employers, etc. The 1%ers and 99%ers are really all in this economy together, after all.
The big deal is that one key element at stake here is not a matter of theory at all—it's simple arithmetic. And it leads to the simple yet alarming conclusion that unless current law is amended before year-end, the stock market has to fall by at least 30%.
It's all about how dividends are taxed—and the reality that we are facing the biggest single hike in dividend tax rates in history.
The market sets the price of a dividend-paying stock so that it will pay the after-tax yield required to attract capital. When the tax rate on dividends goes up, the after-tax yield necessarily goes down—to restore the after-tax yield to its required level, the stock price has to fall.
Please bear with us through an explanation that involves a little arithmetic. If you are an investor, this is important.
Consider a stock trading at $100 that pays a $10 dividend every year. Under current law, an investor pays a 15% tax on that dividend, so he gets to keep 85% of it, or $8.50. So the after-tax yield on that stock is 8.5%.
After year-end, under current law, the top dividend tax rate will rise to 43.4% from 15%. That's not only because the temporary low 15% rate granted under the 2001 Bush tax cuts will revert to the prior rate of 39.6%. In addition, a provision of ObamaCare slaps a 3.8% surtax on all forms of investment income, including dividends—the resulting total is 43.4%.
So on Jan. 1, an investor won't keep $8.50 of that dividend—he'll pay a 43.4% tax and keep only $5.66. Suddenly, a stock that yielded him 8.5% now yields only 5.66%.
He goes on about the impact of tax increases on bonds and dividends. I recommend reading the article yourself if you have time. Here is a final quote:
The same logic also applies here to bonds, because at year-end the top tax rate on interest income will rise to 43.4% from 35%. According to our simple arithmetic, if the yield on a 10-year Treasury is 2% today, it would rise to 2.3% with next year's tax rates. That's a whole new version of the Laffer Curve, one in which higher taxes drive higher government debt service costs.
So just by the numbers, the fiscal cliff matters. Investors are wrong to blithely assume that the boys in Washington will somehow do the right thing and it will all work out in the end.
All these tax issues will have to get negotiated in the lame duck session of Congress after what is likely to be an unusually bitter election season. And it's highly likely that an increase in the statutory debt ceiling will have to be negotiated at the same time, in order to avoid a Treasury default—investors would be wise to remember what a near-death experience that was last August.
Yes, I do remember that experience. I would have preferred default with American politicians finally facing up to their economic malpractice and balancing the budget with a return to baseline budgeting!

On a separate occasion, Forbes interviewed former President George W. Bush. I remember thinking whenever disaster struck again and again throughout Bush's presidency how glad I was that he knew economics. The whole interview is highly informative on the workings of the economy in general, including trade agreements and how taxes and government policies shape or limit the economy as the case may be. Here is a small excerpt:
Bush: If the goal is private-sector growth, tax policy ought to encourage, not discourage, the job creators, the small businesses, the 70% of new jobs. I don’t think people really understand that aspect of the tax code. Therefore, if you raise taxes on the so-called rich, you’re really taxing job creators. Which either means that people don’t really understand the implications or the objective is not private sector growth but public sector growth.
I think that keeping taxes low did help buffer a difficult economic situation. And I think raising taxes is going to take capital out of the hands of those creating jobs.
Secondly, if you raise taxes on capital gains and dividends, you’re taxing investment. The private sector requires investment in order to grow. You’re taxing pensioners and savers. The fundamental question is, “How do you believe the economy of the country should grow in the long term? Do you believe it ought to be through public sector initiative or do you believe it ought to be stimulating the private sector?” I’m confident we’ll hear people making the case that the best way to grow our economy is through stimulating the private sector.
Forbes: It’s very telling that at a time when taxes rose very sharply in the 1970s, we had European-style growth rates. When the reforms started in the early 80s, we went back to having fun again.
Bush: No question, much of my thinking was informed by President Reagan. He had a vision and a philosophy. I’ll never forget the days of malaise in the late-70s. We were basically told our country was through – that’s a slight exaggeration, but nevertheless there was the sense that America had lost a step. Then we have a president show up and say, “Here’s a better tomorrow. And oh by the way, I’m going to trust the people by working on tax cuts.”
No one could have predicted at the time – you might have, but very few people predicted the robust economic recovery after a very deep recession.
No doubt the tax cuts that we put in place were inspired by the decisions in the early ‘80s. And the consequences of those actions – supply-side economics was no longer just a theory, it was a practical way, in my case, to deal with a recession that was ongoing when I first got elected.
The numbers you find from the media about Bush's tenure in office are numbers that don't tell the entire story. Just so you know. Long live free enterprise and free markets in America. That seems incompatible with Obama's vision for America.

Rush reports that, "Census Bureau data published on Wednesday of this week says the startup rate fell to an all-time low of 7.87%, down from 8.1% in 2009." Obama and business still aren't friendly with each other after an additional year either.

*5/7 FoxBusiness reports Best And Worst States for Entrepreneurs

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