Capitalism - Let's Talk Taxes

"Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.” Ben Franklin said it back in 1789, and it certainly holds true over 200 years later! Taxes are a joyless, but necessary, function of any well-run society. Taxes pay for shared resources like roads, schools, military, and other government services. But is there a "right" or "wrong" way to tax? Do you tax individuals, companies, commerce, and/or assets? And what implications do taxes have on you as a citizen - and your personal finances? This week, I will be continuing my series on capitalism by diving into the thrilling world of taxes!

Paying taxes in cash? Baller alert!

U.S. Taxes Over Time

The main means for governments to pay their expenses are taxes. As citizens, we pay for government assets, facilities, and services. But we all pay different amounts - through our income, purchases of goods and services, and other means. Plus, corporations pay taxes. Using the U.S. as an example, tax policy has fluctuated greatly over time. For perspective, here's a chart showing corporate tax rates since their introduction in 1909.

As you can see, the corporate tax rate was only 10% when first introduced, spiked up to over 50% in the 1950's, and has fallen to the current rate of 21%. Of course, this resulted in a major fluctuation in revenue generated for the federal government. So, was that loss in corporate tax revenue offset by higher individual tax revenue? Of course not! See the chart below of highest marginal tax rates (data courtesy of Tax Policy Center). As you can see, they actually track closely to the corporate tax rate!

The federal government had times with higher corporate and individual rates (~50% and 90%, respectively, in the 1950's), and, of course, more revenue as a result. Today, we have relatively lower rates (21% and 37%). So how does the government operate with such fluctuations in revenue? Three key inputs - expenditures, debt, and inflation. To present some perspective on how much in taxes we (individual and corporations) pay at the federal level, here is a chart of what the federal government is spending relative to the national GDP. Since it's a percentage, it's comparing like-for-like data with consideration for inflation.

Outside of the outliers in the late 1910's and early 1940's (World Wars I and II), the spend relative to the GDP generated is trending upward. Compared to the decrease in in tax rates, how can the federal government afford to spend more? Simple answer: it can't! This is why the U.S. is engaged in deficit spending, where the government issues debt (in the form of bonds) to cover its expenses. Deficit spending is often confused with the federal deficit. Here's an analogy to personal finance - deficit spending is like running up a credit card regularly and not paying off the balance once due. The federal deficit would be all the debt you have - the total credit card debt, student loans, mortgage, etc. And, in case you're curious, here's the national debt clock. Yikes. For my international readers, here's the link to the debt/GDP live data for some other large countries.

Notice the downward trend in the national debt post-WWII, when both corporate and individual taxes were higher. Today, with lower taxes and increased spending, the national debt has risen back to near the GDP. Makes sense, right? In personal finance, if we increase our spending without increasing income, we will increase our debt. But there's one lever the feds can pull that we can't replicate as individuals - monetary policy.

Interest Rates

One way a country can drive economic grow (or moderate an overheating economy) is by influencing interest rates. In the U.S., the "Fed" (or Federal Reserve) basically pumps money into the economy that drives interest rates. CNBC does a great job of explaining this complex process in a simple manner that I will not plagiarize, and just refer you to instead! Essentially, the Fed uses this tool to drive rates higher or lower, depending on need. For example, during recessions, the Fed drives down interest rates to encourage borrowing - which in turn they hope will spur economic growth. In overly strong economies, they will increase rates to prevent inflation, where consumer goods increase in price too rapidly.

As a sovereign nation, countries may distribute currency that is to be honored by its citizen as legal tender to be exchanged for goods and services. Of course, this currency is only as good as perceived. Understanding that relationship is critical to all of our financial well-being... and leads me to my soap box below.

MMT is Empty

Before I close out on taxes, one tangential topic I feel I need to address is MMT, or Modern Monetary Theory. For a more academic definition, please see this link. For my succinct take, MMT argues that nations can print as much of their own currency as they want to pay for government expenditures without consequences. The theory explains that money has no tangible value - and a country's true wealth lies in natural resources, labor, etc. From the link above, here's how MMT pioneer Warren Mosler explains his theory: "What happens if you were to go to your local IRS office to pay your taxes with actual cash? First, you would hand over your pile of currency to the person on duty as payment. Next, they’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the taxpayer, left the room, they’d take that hard-earned cash you just forked over and throw it in a shredder."

I will concede that the idea of giving money back to the same government that printed it seems silly in some regards. Currencies are meant to be circulated by a government to promote exchanges of goods and service, without relying on a barter system to conduct commerce. However, if you don't find MMT silly yet, tell me this. If you had $10, $10,000, or even $1 million today, would you be worried about the buying power of that money if the feds suddenly adopted MMT policy? Would you consider going out and spending this money to get a more tangible asset in exchange? Would businesses - also recognizing the impact of MMT policy - raise their prices as you and everyone else is looking to part with their less-valuable money? And, as basic supply-and-demand tells us, increased demand will drive down supply and lead to increased prices. As supplies of houses, cars, and other goods dwindle, prices continue to drive up. And that, my friends, is where inflation rears its ugly head. Of course, this isn't an immediate chain of events. In fact, there are elements of MMT today.

Is it a coincidence that gold, Bitcoin, property, and other assets are going up in value over the last few years? Is a migration away from the almighty dollar already in the works? There is an imaginary line - a threshold - where you get enough people thinking the same way about something (e.g. Wall Street Bets) and it can change everything.

Last week, I'm talking about relationships, this week it's tax policy. Who knows what next week will hold? Until then, get your taxes filed and have a great one!