Effect of Taxes on the Economy

I stumbled upon an interesting tidbit today; 103 US companies have announced special dividend to their shareholders. Obviously these companies are paying out this dividend to their shareholders to avoid imminent tax increase in the capital gains from 15% to 30%.

This news is a precursor to what may happen to the state of our economy if both personal and capital gains taxes go up. This news also reveals the unintended consequences of raising capital gains taxes. Most seniors will end up paying more taxes as a result of the increase in the capital gains tax rate on their dividend income.

The political gridlock in Washington has made it clear that the battle between raising taxes on the upper income families vs spending cut has taken the center stage.

Choice is clear and distinct for those of us who believe that living within your means is far more important than to increase income as no income is suffice for those who live beyond their means.

While political parties are fighting their holy war to avoid the looming fiscal cliff, I decided to explore history to find the effect of taxes on our economy and federal revenue.

It’s apparent that federal revenue has gone up for the past four years despite the great recession of 2008. On the same token, federal budget deficit has gone up from $9 trillion to $16 trillion in the past four years. No one denies that our federal government is in dire need of raising its revenue.

It’s worth knowing that federal revenue went up by 86% between 1964 and 1970 after Congress passed the Kennedy tax cuts. Revenue went up by 57% between 1982 and 1990 after President Reagan slashed the top marginal rate from 70% to 28%, and the history repeated again when President Bush cut taxes in 2001.

Government spending is at 24% of GDP. This shows that while it is important to raise federal revenue, it’s even more important to limit the runaway spending in the midst of the slow economic growth of our economy. That shifts focus back to spur job growth in the private sector.

Time and again, it has been proven that when taxpayers get more tax savings, they make prudent decision about the best way to invest and/or spend their own income.

The biggest folly is to believe and buy into notion that government knows how to spend our money better than we do ourselves.

If you are not convinced that raising revenue(AKA taxes) can do more harm to our economy, I have narrated some interesting thoughts for you to ponder about.

1.  Imagine that you are in debt up to your eyeballs. It’s time for your family to make some tough decisions about your personal finances. You have lot to pay in credit card debt. The good news is that you have some equity in your home. Is it a good idea to pay credit card debt by raiding equity in your home? I don’t think so. Most people who borrow money from their equity line to pay for their credit card debt end up revisiting same painful dilemma by raking up their credit card debt again. Why? They don’t address their Achilles hill — their hedonic spending problem.

In every second of 2011, for example, the government spent $114,253—even though it was only taking in $73,043 in revenue. According to Face the Facts, that means the federal government spent $41,210 every second that it didn’t actually have. – US News
Unless our government can address runaway spending spree, taxing every rich person won’t reduce our national fiscal woes; on the contrary, effect of taxes may cripple our economic growth.

2.  Imagine that you own a small business. You are selling widgets to your local customers. All of sudden, you have a conundrum to solve — your are only 30 days away from losing your business as your business is burning cash at a faster rate than your annual revenue. What would you do as a CEO? I don’t think you would contemplate charging more to your most profitable customers in order to raise your revenue. You would instead take some painful steps to cut spending drastically all the while focusing more on superior service to all of your customers.

Our federal government is one of the largest enterprises on the planet with revenue of $2.2 trillion in 2010. Since President Woodraw Wilson used 16th amendment to enact income taxes in 1913, personal income tax has become major source of government revenue. No private business can survive hundred years with growing revenue without controlling its costs.

3.  Imagine that you are a salesman for a major corporation. You also have a friend who is a stellar salesman in your organization. Obviously, he makes lot more than you with his hard work and skills. Will you gain anything if your boss informs you that your friend has been forced to let go some of his bonus to raise revenue for the corporation? Absolutely not. If anything, it will stop you from working hard to become a stellar salesman.

While our nation is at the brink of facing a daunting task of reducing national deficit, common sense approach would be to foster economic growth by helping small businesses grow — as they are the engine of growth and prosperity for this nation — to create more jobs and thus more revenue for our federal government.

Those of us who have replaced ‘more’ with ‘enough’ in our lexicon, it is time to let our leaders know that — sometimes — even our government has to learn some painful lessons of personal finance. Do you agree?

source: streetsmartfinance.org