GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Going to Extremes Can Be Very Useful

September 28, 2012 | About:
Billy Joel didn’t know why he ‘went to extremes’

The 1989 hit from Billy Joel noted his manic-depressive swings while saying he didn’t know why they occurred. Only his shrink might hazard a well-informed guess.

I’m willing to propose that ‘going to extremes’ can often give you obvious answers to otherwise 'tough to answer' questions.

1304538599.jpg

QE programs, our national debt and income tax rates have been much discussed during this presidential election year. Let’s take each of these ideas to an extreme viewpoint to see how the ideas stack up.

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Is QE (A.K.A. - printing money) the answer to GDP growth and reduced unemployment? Many seem to think so. This leads right to the ‘Helicopter Ben’ theory where Fed Chairman Bernanke simply dumps massive amounts of paper money overboard to the throngs waiting below. It’s just a larger version of President George W. Bush’s 2008 $600 stimulus checks.

Let’s ‘Go to Extremes’ with Billy Joel. Imagine we somehow were able to credit every single American with $1,000,000 in their bank account overnight. Almost everyone could pay off their underwater mortgages, buy their dream car, rid themselves of credit card debt and wipe out those pesky student loans.

Would that be great? Think about what that would do to prices. Merchants, seeing almost unlimited demand for goods, would instantly ratchet up prices or even pull merchandise from their shelves. Why part with inventory today when tomorrow’s prices are certain to be higher?

The purchasing power of your dollars would erode quickly leaving the double-digit inflation of the early 1980s looking like nothing.

Extreme money printing and its distribution to all would benefit those who had nothing to start with. This would come at the expense of anyone who had savings held in cash. It would also dramatically erode the value of all fixed pensions and annuities.

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Does the size of our National Debt matter? Let’s ‘Billy Joel’ it and see what happens. If excessive debt is no problem and actually creates jobs why not ratchet it up to $100 trillion? We could write off all government held student loans. FNM and FRE-held mortgage principal and interest could be forgiven outright. Forget that temporary 2% FICA cut. Let’s simply use debt to eliminate all FICA and Federal income taxes.

Imagine all the extra buying power that would be available. Wouldn’t that be great for our economy?

The problem? Who would be willing to buy America’s debt if this scenario was real? Like every family that hits its credit limit, the ability to keep living the dream can end very abruptly. This is exactly what occurred when HELOCs (home equity lines of credit) and cash-out refinancings dried up as the housing market crashed.

Look to Greece and Spain as examples of how too much debt plays out in the long run.

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Why not simply raise tax rates on those nasty ‘millionaires and billionaires’? Let’s go to extremes and set a 90% marginal rate like we had back in the 1950s.

When Ronald Reagan was still an actor he made just one movie each year. An interviewer asked him why. Reagan said that with a 90% tax rate it made no sense to make the extra effort. Why work for 10-cents on the dollar?

767110988.jpg

How many doctors, dentists, plumbers, musicians etc. would continue seeing patients, fixing drains, or would endure the drudge (and drugs?) involved in touring the world when most of their labor would make no impact on their own financial well-being? They would have every incentive to simply earn a moderate amount before taking the rest of the week, month or year off.

Would you voluntarily do your job for just 10% of your salary? Some people might. The majority would rather just quit early and go skiing, shopping or to the beach.

The full-out versions of these ‘solutions’ are obvious non-starters. The use of partial-measures deludes many people into thinking they might just work. Why? Because they are fantasies people want to believe in.

Dr. Paul Price Sep. 2012

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 3.8/5 (17 votes)

Comments

gernblanston
Gernblanston - 2 years ago


Dr. Price,

I agree with what you state. May I ask you how you are preparing for the coming storm? I think Buffett is correct regarding gold. I myself am invested in dividend paying stocks which I believe will be a decent hedge. I do think shrewder investors will make a fortune of the future economic downfall. Your thoughts...
Dr. Paul Price
Dr. Paul Price premium member - 2 years ago


In the long run fiat (paper) money will lose a lot of value unless things change radically.

The best asset we have is our ability to earn money through working (if still active) or the chance at earning by proxy with high-quality stocks.

In the short run anything is possible in these uncharted waters. High inflation can be overcome only with real assets (which the companies you own already have). They will mark upwards to market, raise prices and survive that environment much better than cash.

I have an article about the hidden perils of owning gold due to be published shortly.
superguru
Superguru - 2 years ago
Japan saw no inflation by keeping interest rates at 0 and printing money. So what makes people so sure that it will be inflationary in US?
Dr. Paul Price
Dr. Paul Price premium member - 2 years ago
SuperGuru,

Check your bills for electricty, health insurance, gasoline,. groceries etc. and you'll see we've already suffered quite a big dose of inflation. Our government is not prepared to fess up to it as it would lead to much higher, budgetarily unaffordable, COLA adjustments and higher interest rates on more than $16 trillion.

The BLS will continue putting out doctored CPI data to keep the masses uniformed of the truth. They believe that telling the same lie, over and over in every form of media, will convince peole their own experiences are not the norm.

This has been standard operating procedure in communist countries for decades. It has now become common here in the USA as well.


See the link below for details about the inflation that's not being spoken of...

http://www.beatingbuffett.com/?p=3935
LwC
LwC - 2 years ago
More partisan tripe.

Here's a different view that relies on actual historical data, rather than a made-up simplified analogy designed to do nothing more than support the author's agenda:

Tax Cuts Don't Lead to Economic Growth, a New 65-Year Study Finds

By Derek Thompson | The Atlantic – Sun, Sep 16, 2012

Analysis of six decades of data found that top tax rates "have had little association with saving, investment, or productivity growth."

http://finance.yahoo.com/news/tax-cuts-dont-lead-economic-175341899.html

BTW Mr. Price, can you provide a source for the Reagan "quote"? TIA

swnyc2
Swnyc2 - 2 years ago
LwC,

It is common sense that higher taxes discourage work and investment. As Derek Thompson states in the article you reference, there are many factors that affect economic growth, and marginal tax rate is just one of them. While small changes in marginal tax rate are unlikely to change human behavior, large changes surely will.

I think a primary reason why unemployment is so high and middle class income is stagnating is that many jobs are being outsourced to low-cost countries. This benefits companies (and their investors) by making companies more productive and more profitable. It benefits consumers through lower prices. However, those with occupations that are easily outsourced suffer disproportionally. The question we are struggling with as a society is to what extent the government should lessen the burden on those who are victims of international competition (e.g. the unemployed)?

The budget deficit reflects the fact that government now pays out more in benefits than it accrues in taxes. The Fed through "quantitative easing" is essentially printing money to cover the deficit. This causes low interest rates and will lead to progressive devaluation of the dollar. This policy punishes most those individuals that save money in order to fund the deficit. Alternatively, changes in the tax code could target a different group. For example, a higher marginal tax rate will selectively target those with higher incomes.

Whether the government cuts spending, borrows money, or raises taxes is really just rearranging deck chairs on the Titanic. In the short term, it changes who is punished the most, (e.g. the unemployed, the people who save, or those with high incomes), but it doesn't really address the core problem. That can only be done through employing those workers that have been displaced.

This can happen by:

1. Debasing the currency so there is less of a wage difference between the U.S. and low-cost countries.

2. Education and training.

3. Economic growth.

The problem with debasing the currency is that it will take a long time to get there given the wage disparity between U.S. workers and those in low cost countries. However, politically, this is the easiest path.

The problem with education and training is that it also takes a long time, and it assumes an abundance of skilled job openings, which isn't the case

That leaves us with economic growth. The good thing about economic growth is that there is historic precedent that it can rapidly reduce unemployment. However, to promote economic growth the government needs to make structural changes so that we as a society can be more efficient. This involves selectively decreasing regulatory burden and increasing competition. For instance, Energy and Healthcare are two industries where the right reforms could have a huge impact.
LwC
LwC - 2 years ago
Swnyc2,

You wrote "It is common sense that higher taxes discourage work and investment."

In his article Derek Thompson quotes from the study Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945: Analysis of six decades of data found that top tax rates "have had little association with saving, investment, or productivity growth."

What good are your "common sense" assumptions if they are contradicted by the evidence of the historical record? Is it presumptuous on my part to suggest that a reasonable person such as yourself might reconsider one's assumptions when presented with evidence that undermines those assumptions?

Derek Thompson didn't just pull a single sentence quote from the article at random; he used that quote because it summarized the conclusion reached by the study authors. He also wrote "Does this story prove that raising taxes helps GDP? No. Does it prove that cutting taxes hurts GDP? No." Thompson linked to the published study so that the reader could determine for his/her self if the study conclusion is credible. I'm curious about why you don't find the study to be persuasive. Did you read the study? Did you find some deficiency in the methodology used by the study authors? Did you find some mistakes in the body of historical evidence that the study authors used and that are obviously undermining the credibility of the study? Did you find that the study authors' conclusion is contradicted by the data that they relied on for the study? Why should I accept your stated premise that "It is common sense that higher taxes discourage work and investment", which you assert without any credible evidence provided by you to support that assertion, instead of accept the conclusion reached by the study authors which appears to be supported by credible evidence?

FWIW, in fairness I confess that I agree with many of the other opinions and sentiments that you offered about the general state of the economy. Frankly however, IMO some of your statements of "fact" come across as partisan talking points rather than considered opinions based on facts. Price's article simplistically asserts that higher taxes are bad, and lower taxes are good. In my response to Price's article, I was simply pointing out that his assertions about the effects of high marginal tax rates vs. lower taxes are not necessarily supported by the evidence, but rather IMO are nothing more than partisan rants that all too often can only be accepted as fact if one is willing to ignore the contradictory evidence.

Price seems to in large part make his claim about high marginal tax rates discouraging work based on a supposed quote by Reagan. I asked him to provide a source for that quote because I couldn't find a reference for it through a WWW search engine. He hasn't provided that source. Did Reagan actually say that, or is it just some convenience that Price took from one of those highly partisan websites that he tends to frequent, without checking the veracity of the quote. Or even worse, did he make it up out of whole cloth? A search engine did provide a list of Reagan's movie activities during the fifties and early sixties. While it's correct that during that period of very high marginal tax rates Reagan made only one movie in some years, the fact is that in other years he made two or three movies, or none. Also the record shows that even in years when he made only one or no movie, he still worked in various TV programs and as an ad pitchman. Strangely, the record shows that he worked consistently through those high marginal tax years, but then he retired from acting, TV hosting, and ad pitching after the tax rates were reduced. Simplistic conclusion: Reagan worked when tax rates were high; he retired when tax rates were reduced. This appears to be the opposite of what that supposed quote implies. But hey, if Price can be simplistic, why can't I?

I was curious about what the tax rates were during those Reagan work years so I looked it up at this URL:

http://www.taxpolicycenter.org/taxfacts/Content/PDF/individual_rates.pdf

During the years 1954 to 1963 the highest marginal tax rate was about 90% for income over $300,000. $300,000 in 1955 adjusted for inflation is about $2.5 million today. in 1955 $20,000 had a marginal tax rate of 34%; that $20,000 adjusted for inflation is about $170,000 today. In 1955 the median income AFAIK was about $6,000, which adjusted for inflation is about $50,000 today, and the marginal tax rate for $6,000 in 1955 was 22%. The long-term capital gain tax rate during that period was 25% and the qualification period was six months. Then as now, the game was to find ways to convert ordinary taxable income into long-term capital gains in order to pay the lower rate.


[edited to correct "auto-correction" misspellings]

swnyc2
Swnyc2 - 2 years ago
LwC,

The articles you reference find no historical correlation between tax rates and growth. As I stated in my earlier post, there are many factors that affect economic growth. Taxes are just one of them. It is my contention that these other factors obscure the relationship between tax rates and growth. Just because historical data do not show a correlation, does not mean that no relationship exists.

In fact, I do think most reasonable people would agree that there has to be some kind of inverse relationship between taxes and growth. After all, a capitalist society is based on rewarding individuals for their work. So, I stand by my prior statement that this is common sense. What I think is open to debate is the extent to which tax rates affect growth.

Personally, I think too much emphasis is placed on the tax rate. In my opinion, our representatives should be more concerned with how to spend more wisely our tax dollars. If the government got better value for the tax dollars it spent, I think people would object less to being taxed!

LwC
LwC - 2 years ago
Question: Will you reconsider your assumptions when presented with evidence that undermines those assumptions?

Swnyc2: No.

LOL

shb600
Shb600 premium member - 1 year ago
LwC,

What a surprise, partisan tripe disguised as an academic study. These studies on tax rates vs. GDP growth do not factor in things like deductions, shelters, inflation,capital gains rates, dividend rates, the percentage change in taxes, corporate taxes, tax rates in other countries,the amount of changes in growth of GDP,etc. No policies can repeal the business cycle. So where the country is in a business cycle will have large effect. GDP can be highly misleading as there are a lot of things that can raise GDP that are not good return on investment(see Chinese fixed investment, over-investment in Telecom infrastructure 1990s, most government spending). Many things are unknowable. Like the fact that Obama claims he "saved" millions jobs with his policies. There is no way to prove that or measure it. The studies you rely on are highly-flawed and overly-simplistic. I'm sure you'd be opposed to simplifying the tax-code so people could understand as well.
LwC
LwC - 1 year ago
"The studies you rely on are highly-flawed and overly-simplistic."

Please explain how that's the case.

Specifically, what are the flaws in the study cited in the article?

shb600
Shb600 premium member - 1 year ago
Please see my previous post
LwC
LwC - 1 year ago
Again, specifically, what are the flaws that you claim are in the study cited in the article?

Did you read the study referred to in the article?

Referring to the study cited in the article, and assuming you did read it:

Did you find some deficiency in the methodology used by the study authors? If so, please describe and explain that deficiency.

Did you find some mistakes in the body of historical evidence that the study authors used and that are obviously undermining the credibility of the study? If so, what are they?

If you did not find mistakes in the body of historical evidence that the study authors used and that are obviously undermining the credibility of the study, did you find that the study authors' conclusion is contradicted by the data that they relied on for the study? If so, how so?

Specifically, what are the flaws in the study cited in the article?

shb600
Shb600 premium member - 1 year ago
Again, I already addressed these. Keep reading the Atlantic Monthly for your partisan tripe. This is a liberal study that is at best highly in-conclusive for all the reasons previously stated. GDP growth is not the holy grail of economics. There were years in the Great Depression when GDP growth was very high. Should we conclude that those were wonderful times? Do you companies not make decisions all the time based on tax rates? Do companies not incorporate in lower tax countries or states and move operations to these places or make deals with governments to get lower tax rates? You seem to want to ignore all empirical evidence that tax rates effect behavior because it does not fit into your political ideology.
Dr. Paul Price
Dr. Paul Price premium member - 1 year ago
I haven't heard anybody come forward yet to say they'd gladly keep doing their job for 10% of their current pay.

Any takers?
LwC
LwC - 1 year ago
"This is a liberal study…" Really?

My guess is that you never read the study. If you did you might have noticed that the study came out of the Congressional Research Service of the Library of Congress:

--The Congressional Research Service (CRS) works exclusively for the United States Congress, providing policy and legal analysis to committees and Members of both the House and Senate, regardless of party affiliation. As a legislative branch agency within the Library of Congress, CRS has been a valued and respected resource on Capitol Hill for nearly a century.

http://www.loc.gov/crsinfo/

--The Congressional Research Service (CRS), known as "Congress's think tank",[2] is a public policy research arm of the United States Congress. As a legislative branch agency within the Library of Congress, CRS works primarily and directly for Members of Congress, their Committees and staff on a confidential, nonpartisan basis.

http://en.wikipedia.org/wiki/Congressional_Research_Service

shb600
Shb600 premium member - 1 year ago
LwC,

Hmm, a government bureaucracy with no biases... really? Just like the EPA? Dept of Education? really? The researchers should be fired. Their research has it the very best not stopped $1trillion+ deficits and given us no long-term path.

Keep guessing
LwC
LwC - 1 year ago
Well, since you don't dispute my guess that you haven't read the study that you have pretended to know so much about, IMO it's fair to assume that you in fact haven't read it. Which IMO means that all that you have written about it is just so much BS and a waste of time.

Whatever. LOL.
shb600
Shb600 premium member - 1 year ago
Not interested in your guesses or assumptions. You continuously demand for answers from people(when they've already answered the question or made the point previously) and yet don't respond to others questions. The study you are so fond of falls into the lies, damn lies and statistics category.
LwC
LwC - 1 year ago
All right then, did you read the study cited in the article? [yes/no]

Please leave your comment:


Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
Free 7-day Trial
FEEDBACK