Economics for The Rest of Us by Lawrence Meyers 8 Aug 2011 post a comment Share This: I get tired constantly repeating myself to my fine friends who are on the Left side of the political spectrum when it comes to economic, fiscal, and business realities. It's not their fault. I used to be the same way. However, following up on a good article about economics for dummies, I thought I'd add some basic concepts that everyone should understand -- regardless of political beliefs. This stuff isn't that hard to understand. My old high school math teacher would just drill me over and over on something until I got it. Risk, Reward, and Investment A rich person makes all his income, more than $250,000 each year, from investment income only. Investment involves taking a risk. In exchange for that risk, an investor is rewarded. The greater the risk, the greater the reward. Imagine two cups. Under one is a dollar. You bet one dollar and choose one cup. The odds of picking the right cup are 1-1. If you are right, you win one dollar. Imagine ten cups. Under one cup is ten dollars. You bet one dollar but choose only one cup. The risk of choosing the right cup has gone up to 9-1 against you. Don't you think you deserve a higher reward for choosing that one right cup? If you don't think so, I have a bridge I'd like to sell you. Investment works the same way. The IRS charges a capital gains tax on investment income. If Mr. Rich Person makes an investment, and sells it in less than one year, he gets taxed at the highest rate (35%). If he holds it longer than a year, he is taxed 15%. Why? Because 1) holding an investment for a longer period of time is riskier than for a short period of time, and 2) the government wants to encourage people to invest for long periods of time in things that build the economy, instead of speculating on short-term profits. If that lower tax rate were raised or eliminated for long-term investments, what do you think Mr. Rich would do? Think about it for a moment. What would you do? Would you make the investment anyway? Maybe, but the stock market would see even more volatility, since more people might speculate rather than invest, moving money in and out, buying and selling. Volatility creates uncertainty. Uncertainty encourages people to keep their money on the sidelines, where it does not contribute to the economy's growth. Some investors would be less likely to sell their profitable investments and trigger the higher capital gain tax. That keeps money in investments that grow the economy. But then the government collects no taxes, so tax revenue would fall, creating a wider federal budget deficit. Furthermore, never selling increases risk, and you may not be inclined to invest in the first place, keeping your money again on the sidelines. Instead of investing, would you spend it instead? No. Why? Remember, you make all your income from investments, and now you're not investing, so you have no income. So instead, your money sits on the sidelines. How Does Investment Help The Economy? Suppose you have a great new company with a revolutionary portion-control product that will help people lose weight. Somebody invests in you. Now you can expand, so you will need to hire workers. That creates jobs. Who invests in the company? Rich people. Why? To make money. How much investor dollars could there possibly be in start-up, or what's known as "middle market", companies"? The most recent statistic: $2 TRILLION. I should know. I broker some of these deals. Think how many jobs could be created with that money. Suppose capital gains taxes increase. A lot of that investment money vanishes. Why? See above. The same idea applies to stocks. The more money invested in stocks sends stock prices higher. A higher stock price means a company is worth more. A more valuable company can borrow money against its value to expand and create jobs. How to Spook Investors The higher unemployment is, the fewer jobs people have. Fewer jobs means people have less money to spend. If people have less money to spend, they are going to stick to necessities. Demand for treats like vacations, Tiffany's, and cars will fall. When demand falls, companies make less money, profits fall, and stock prices decline. Companies cut back, and workers are the first to go. That starts a vicious cycle. Now those people have less money to spend...and so on. It gets worse. Investors don’t want to invest money in companies when profits are falling! Would you invest money in a bowling alley if fewer people came to bowl? Investors hoard their cash. Now there's less investment, so new small companies can't find money to expand and hire. Some investors may even sell their investments to avoid these hard times, sending stock prices lower, and making it even harder to borrow money to hire people. Why Government Spending Usually Fails If rich folks won't invest, why can't government fill the gap? Here's an idea! The government gives big tax credits to solar manufacturing and installation companies for every worker that is hired for a period of 3 full years. These people are trained to manufacture solar panels, and to install them on residences in areas of the U.S. that receive the highest number of sunny days each year. The panels are offered at an affordable rate to homeowners, and even subsidized by the government. Not only are thousands of jobs created, but the solar company makes a fortune, pays less taxes on them thanks to the credits, homeowners see energy savings, and we've reduced our dependence on foreign oil. That would really be something. And it could never happen. Because government spending doesn't create many jobs, and the ones it does create cost more than just paying someone off the street a regular salary. Why? Government spending wastes taxpayer money because politicians are self-serving. By every single metric, stimulus money was wasted. Visit www.stimuluswatch.org. The "most expensive" items went to states for "government services" and "education funds". What does that mean? Who got that money? Where are the jobs? Why was this money just thrown to the states without any oversight whatsoever? Were any jobs created? From late 2009 through mid-2010, private sector employment increased 1%. Government jobs increased 2.5%. Those gains have since been lost. How much money has been wasted? The national debt went from $5.3 trillion on the day Bush took office to $10.6 trillion the day Obama came in -- an increase of $5.3T. As of July 31, the debt was $14.3 trillion -- Obama has increased it 70% of the amount Bush did in 30% of the time. How can anyone believe the idea that government spending creates jobs, given how much has been spent, and where unemployment and the economy are today? Who Cares About The Debt? A credit rating agency just downgraded the quality of US debt for the first time in history. Why? Because there is concern that the US must spend so much money just to pay interest on its debt, that there is just that much more concern about certain debts not getting paid. The cost of borrowing (interest) for the US goes up because it is riskier to loan to us. That's bad for you and me. Why? Investors will be that much more afraid about buying or holding U.S. bonds. So they will sell those bonds. When the price of a bond goes down, the interest rate goes up, because you must incentivize new investors to take on greater risk and earn those greater rewards. When U.S. bond interest rates go up, all interest rates go up -- mortgages, credit cards, car loans. etc. Now it's harder for businesses to borrow money to hire people and expand. It's harder for people to borrow money to buy a house (as if the banks weren't tight enough). Why Not Raise Income Taxes on The Rich? Okay, so I've lambasted all the spending. Why not raise more revenue? The answer lies in the discussion on investment above. The more money you take away from the rich (or anyone else), the less money there is for investment. Now if this money went directly into government spending that would unquestionably create jobs, you might even find some rich people agreeing to a tax hike! But I've just shown that the government has been a very poor steward of our money. Not to mention that some of that money has to be used to pay the interest on the debt! What else happens if you raise taxes on the rich? One study suggests they decrease their charitable contributions (unless you are a Democrat, in which case you give less than Republicans anyway. And if you're Joe Biden, you barely give anything at all). What about the argument that "the rich don't pay their fair share"? Define "fair share". What is it? How is it calculated? Is it an absolute dollar amount or a percentage? How much more is "fair", exactly? Enough to make things "fair"? What does that mean? You've heard this before: The top 1% pay 38% of federal income taxes, while the bottom 47% pay no income tax at all. So who isn't paying their fair share? Seems to me that 47% of America is getting a free ride. Why aren't they paying more? About Loopholes Do rich people use "loopholes" to avoid paying personal income taxes? With few exceptions, I have prepared my own taxes each of the past twenty years. I know the tax code better than some accountants. In my high-income years, I always seek out a highly-regarded accountant who can help shelter income from taxes. Every year I get the same answer: except for contributions to retirement plans, there isn't any way to do it. I can put up to 20% of my income into a 401K ($49,000 maximum) and not pay taxes on that amount. However, when I retire and withdraw that money, I will be taxed on it. The government gets their take no matter what. There are no "loopholes". If you know of any legal ones, PLEASE tell me. I want to exploit them. Conclusion The economic disconnect between Liberals and Conservatives stem from two basic concepts. First, America was never designed to be fair. It was designed to be just. Justice is resolving disparities based on what happened. Fairness is resolving disparities based on why something happened. Our justice system was created around the blind weighing of facts, not feelings. Liberals insist on feelings and fairness. Conservatives insist on facts and justice. Second, you can have anything you want, you just can't have everything you want. The shocking truth is that most Americans are bleeding-hearts. We do care what happens to our fellow man. However, not every single problem can be attacked, much less solved. Government can attack some problems -- ideally ones that bring help to many people. Medicare, for example, is a good idea. The elderly have contributed much to build our nation. We should take care of them within reason. Charity can help fill gaps on other problems. However, we simply do not have the money to solve every single problem. What the Constitution did was to create a republic where the government was supposed to be limited, given that America was breaking free from a tyrannical King. The beauty of America is that if there is a problem that someone wants to solve really badly, nothing stops them from devoting their time, effort, and money to tackle it. They themselves can have anything they want, if they want it badly enough. They just can't have it all.