The Economics of Socialism

The $300 Million Bribe - A Rant on the Expanse of Federal Redistributive Power

2009-11-24T11:41:00.000-05:00

An event materialized last week and over this past weekend that exemplified why I object to any form of federal welfare. The founding fathers objected to the federal government being a redistributor of wealth because they recognized, based on examples of King George III's England, that once a central government has the power to redistribute wealth, it opens the door for rampant bribery and corruption, and ultimately the loss of the liberties of sovereign states. The founding fathers wanted the state to be the most powerful government entity in the country as far as individual liberty is concerned, but when we look at the picture today, it is obvious that the federal government holds a monopoly on deciding who gets what. This is contrary to the intentions of the founders, thus the Constitution.

As the Constitution states, it is the federal government's job to provide for the common defense, to regulate interstate commerce (the elucidation of “regulate” in the 18th century being drastically different than what it is today), and promote the general welfare. Note there is a monumental difference between promoting the general welfare and providing it. The federal government today is the provider of the general welfare. From Social Security, to Katrina relief, to economic stimulus packages that expand jobless benefits to over a year in many states, to USDA/FHA-subsidized housing loans for minorities, there is no doubt that transfer payments in the United States today hinge almost entirely on the existence of federal dollars for their sustenance.

A vintage example of the federal government promoting the general welfare occurred during President Grover Cleveland's administration:
“Although nineteenth-century government now appears remarkably constricted, politicians in those days were no less predatory and corrupt than our own. Our forebears, however, kept the government within tighter bounds because so many of them harbored ideological hostility to big government, and therefore they often refused to tolerate out-of-bounds government programs, regardless of the proffered rationale. Many things were still viewed as 'not the proper business of government,' an attitude that allowed at least some politicians to survive while resisting raids on the public’s purse and incursions on the people’s liberties. Cleveland was one such political survivor.

Cleveland believed in keeping government expenditure at the minimum required to carry out essential constitutional functions. 'When a man in office lays out a dollar in extravagance,' declared Cleveland, 'he acts immorally by the people.' He fought to lower tariffs, which the Republicans had hoisted to punishing levels, and to hold back the flood of phony pensions that congressmen were awarding in order to buy votes and to placate the Grand Army of the Republic, the most powerful political pressure group of the late nineteenth century.”1
It should have surprised no one, therefore, when Cleveland vetoed the Texas Seed Bill early in 1887. This legislation appropriated $10,000—a trifling sum even in those days—to allow the Commissioner of Agriculture to purchase seed grain for distribution to farmers in certain counties of Texas that had suffered from drought. The president’s veto message read in part as follows:

“I feel obliged to withhold my approval of the plan, as proposed by this bill, to indulge a benevolent and charitable sentiment through the appropriation of public funds for that purpose. I can find no warrant for such an appropriation in the Constitution; and I do not believe that the power and duty of the General Government ought to be extended to the relief of individual suffering which is in no manner properly related to the public service or benefit. A prevalent tendency to disregard the limited mission of this power and duty should, I think, be steadily resisted, to the end that the lesson should be constantly enforced that, though the people support the Government, the Government should not support the people.”
Cleveland went on to point out that the private charity can always be relied upon to relieve fellow citizens in misfortune:

“The friendliness and charity of our countrymen can always be relied upon to relieve their fellow-citizens in misfortune. This has been repeatedly and quite lately demonstrated. Federal aid in such cases encourages the expectation of paternal care on the part of the Government and weakens the sturdiness of our national character, while it prevents the indulgence among our people of that kindly sentiment and conduct which strengthens the bonds of a common brotherhood.”

It turned out President Cleveland was correct in his assessment of the friendliness and charity of our countrymen. While he vetoed the measure introduced by congress, his public announcement promoting the general welfare to the people resulted in a massive private charity drive that raised enough seed and money to outdo congress' welfare bill by ten times the proposed $10,000 federal appropriation. Not only that, but the resources were undoubtedly delivered more efficiently than if government had administered the aid itself, while strengthening the bond between American neighbors - a very noble and American concept if there ever was one; strengthening the bond between neighbors, rather than strengthening the bond between citizens and government.

Fast forward 130 years, and we have a federal government with a budget of nearly $4 trillion this year, and growing. It is the #1 charitable giver in the nation, and growing, with more than 50% of the federal budget being transfer payments (taking from Peter to pay Paul). Every year we are moving further and further away from the federal government we were intended to have.

My gripe with this amount of power is not only that it breaks the bond between American citizens and private charity, therefore making the politicians more successful when they use rhetoric to incite class warfare ("I will make the rich pay their fair share by raising their taxes, while anyone who is not rich will not see their taxes go up a single penny!" and "I think when you spread the wealth around, it's good for everybody").

My gripe is not only that federal charity creates and solidifies an entitlement class, many of whom are undeserving and simply taking advantage of a large program that is more difficult to operate efficiently.

My real gripe with this amount of charitable power is the political corruption that entails. A prime example occurred this weekend when Senator Harry Reid inserted $300 million in additional Medicare funding to the state of Louisiana, in an attempt to bribe Senator Mary Landrieu into voting in favor of moving the Senate health care bill forward. The Senate was never intended to have such power that they could redistribute federal dollars to a particular state in order to bribe political votes.

Some more wisdom regarding the interpretation of the General Welfare clause of better men past includes:

In a letter to Edmund Pendleton in 1792, James Madison wrote:

"If Congress can do whatever in their discretion can be done by money, and will promote the General Welfare, the Government is no longer a limited one, possessing enumerated powers, but an indefinite one...."
In vetoing a measure to help the mentally ill in 1854, President Franklin Pierce wrote:

"I cannot find any authority in the Constitution for public charity. [To approve the measure] would be contrary to the letter and spirit of the Constitution and subversive to the whole theory upon which the Union of these States is founded."
James Madison elaborated upon the limitation of the General Welfare clause in a letter to James Robertson:

“With respect to the two words 'general welfare,' I have always regarded them as qualified by the detail of powers connected with them. To take them in a literal and unlimited sense would be a metamorphosis of the Constitution into a character which there is a host of proofs was not contemplated by its creators. If the words obtained so readily a place in the 'Articles of Confederation,' and received so little notice in their admission into the present Constitution, and retained for so long a time a silent place in both, the fairest explanation is, that the words, in the alternative of meaning nothing or meaning everything, had the former meaning taken for granted.”
And before any leftist steps in and tries to convince me that we can pass laws to stop politicians from taking part in this massive scheme of political bribery, kindly go jump off a cliff, because it is inherently impossible to give federal government this much money and power, and then dream that we can pass laws to stop them from utilizing it for political malice. It simply can not be accomplished. The founders knew this, and that is why they structured our government to give the federal government limited power. Presidents Grover Cleveland and Franklin Pierce, too, recognized this in their writings and their vetoes. We chose to ignore their advice throughout the 20th century, and today the federal government is larger and more corrupt than ever, with no end in sight.

A formula we all need to remember is: Political corruption is directly correlated to the amount of money and authority they have access to. That means, the more tax dollars they raise, and the more regulations they have the authority to implement and oversee, the more corruption exists. To think otherwise is naive. Recall the massive overhaul of "Congressional Honesty" that took place when the new congress took power in 2007. What good has it done us? Needless spending, travel, and benefits have increased to record highs. We wont even delve into the rational fallacy of expecting a group of individuals at the top of the totem pole to pass and enforce rules that limit their own well being.

Quis custodiet ipsos custodes?

1 Robert Higgs – The Independent Review

Internet "Fairness Doctrine" on Fast Track for Implementation...

2009-10-23T23:30:00.002-04:00

"The FCC voted unanimously yesterday to move forward in an effort to formalize net neutrality guidelines."

I mean, net neutrality? Who wouldn't be against that, right? It's like "PATRIOT Act!" Hooah! God Bless America. It sounds all free and righteous, right? Well, it isn't. And like the PATRIOT Act, or the radio Fairness Doctrine that Ronaldus Magnus shot down as being unconstitutional in the 80s, the internet version of the Fairness Doctrine is on the way, and it's very un-American... be prepared.

Proponents of net neutrality, such as the writer of this PCWorld article, like to make us think net neutrality, just the very threat of it, has already had success in "keeping the private sector in line":

"Comcast tried to throttle peer-to-peer networking traffic and only changed policy after the threat of FCC net neutrality rules. AT&T sought to block customers from using VoIP services from its wireless network, but changed policy out of fear of the net neutrality rules. The trend seems to be that these providers only do the 'right thing' when the net neutrality gun is pointing at their head."

Wow, so chock full of factual information. How does he do it? Those greedy capitalist pig organizations! It's good that the government is here to keep them straight. And everything the author wrote in that article would make perfect sense... if only it were true. Unfortunately it's false... or only half false. Yes, "the threat of net neutrality" was in the air at the time, but so was "fear" in downtown Manhattan on 9/11. Does that mean "fear" brought down the WTC towers? The real reason providers backed down from bandwidth caps and throttling is because their customers voted with their voices and their wallets if necessary. When Comcast was blocking P2P traffic, customers shifted to their local DSL companies, to other cable competitors like Cox and TimeWarner, or to, God help them, satellite. TimeWarner was going to do the very same thing with bandwidth caps here in NC. Funny enough, their bandwidth caps were only going to be implemented in areas where TW has complete control of the cable market; they weren't going to implement bandwidth caps in any of their service areas that had competing cable companies... food for thought.

They're ridiculous bandwidth caps, too. Something like 5GB of bandwidth @ 7mbps for $40, and then some hellacious charge for every 1GB above that. But those bandwidth caps were never implemented. Why? Because TW customers voted with their voices and their wallets, and due to public outcry, TW backed down.

The proponents of net neutrality say it is to make sure providers aren't discriminating against people, and to ensure "people who pay more or have more power aren't getting faster service."

Now I know all the little Marxists on here are jumping with joy at the sound of that. After all, why should I only be limited to 3mbps internet because it's all I can afford to pay for. I think I truly deserve 6mbps internet, I just can't afford it... and while we're at it, why should I be driving a Bronco because it's all I can afford to drive? I see all these people on the road driving 5-series BMWs and Infiniti QX56s, I think I deserve one of those, too.

On the surface net neutrality seems "fair and free market," but what it does is it gives the FCC authority to monitor and dictate internet bandwidth and usage. It also violates the very simple rule that "government can not create free markets. A government free market is an oxymoron, it doesn't even make sense. The government currently wastes billions of dollars giving big line companies like AT&T funds to subsidize internet expansion into rural and higher risk areas, putting smaller localized line and provider companies at a tactical disadvantage to compete with the el-humongo datatel company AT&T. Net Neutrality will only expand this ridiculous program of putting smaller companies at a disadvantage against the mega-companies. Free market my ass.

Once the federal government has control of the bandwidth and the oversight, they have control of the access to information. After all, with so many billions of federal dollars invested in our internet infrastructure, it would be silly for the federal government to allow "just any old information" to be sent through those lines, right? After all, it is the government's job to be impartial and unbiased, and if there is a disproportionate amount of info crossing the government's lines that is one-sided, it makes the government look bad, so it is the FCC's responsibility to regulate that information to balance it out. Sound ridiculous? It may be ridiculous, but it's also true.

State and local governments oft give line companies and utility providers de jure monopolies in most areas. So, if you are unhappy with the current system, but you also don't want the federal government stepping in to, for lack of a better term, take it over, the course of action is to vote and write your local representatives encouraging them to allow more competition in your area. No one said democracy was a cakewalk.

It Looks Like Social Security is Going to be Bankrupt Sooner Than We Thought... Shocker.

2009-10-21T21:31:00.008-04:00

The media is in a ruckus over the new numbers released regarding the prognosis of Social Security. It's not looking good. So, as I was sitting down today, rather than doing what I was supposed to be doing, my mind began to wander...

Here are some quick calculations I ran that piss me off to no end: Our take-home pay is decreased by 12.4% due to our "contributions" to the Social Security system. That money of course, like any other ponzi scheme, is immediately sent from the Treasury to the mailbox of some geriatric in West Palm Beach. It seems like a logical system to politicians, but the reason it's called a ponzi scheme is because current investors, who have an effective basis of $0, are kept afloat by new investors. When the new investors dry up, the current investors' bases of $0 are fully realized, and the system collapses. Madoff went to jail for this exact same thing; the only difference being Madoff's investors were voluntary, whereas we are forced to pay into this scheme at gunpoint. The very politicians who favor expanding and taxing even more the social security contributions of individuals, are the same ones who were lambasting Madoff for running the very same operation they are running! Hypocrites! Idiots! If I had my way they'd all be drawn and quartered on the Capitol lawn, and their limbs thrown to the rabid ducks in the scum-infested reflecting pool in front of the Lincoln Memorial.

The average American takes home a little over $40,000 per year. Without a Social Security tax, our incomes would be closer to $45,000. If we all used that extra $5,000 to invest in our Roth IRAs every year from our 20s onward, we could retire at 65-70 as MULTI-MILLIONAIRES. Instead... we give that $5,000 to the federal government, which, of course, immediately disappears. But when we reach age for withdrawal, the average American receives $1,153 per month from Social Security. $13,836 per year. Assuming we live a very liberally estimated 25 years from the day we withdrawal benefits, that is a total of $345,900 nominal dollars over 25 years. Annual cost of living adjustments (COLAs) are made to the benefits, but the real purchasing power of those checks will remain about equivalent to what $345,900 would buy today.

On the flipside, those of us who opted to manage our own retirement, would wisely begin withdrawing (tax free, of course) funds from our Roth IRAs as soon as we hit 59.5 years old, ratably with the timing of the market at that time, and placing the withdrawals in safer investments like money markets, CDs, and low yield bonds. That way when we reach 65 or 70, or whatever age we decide we want to cruise around the world, we will have several hundred thousand dollars more than the social security folks. Oh, and the best part? We won't be paying income taxes on the adjusted principle of our withdrawals, the social security folks may be.

That being said, is our method of retirement a little riskier than social security which is "backed by the full faith and credit of the US government?" Yes it is, but high risk, high reward. And it's worth it to me to have hundreds of thousands more disposable dollars upon retirement. Some people may not be willing to go through with that, and may opt for something safe and low yield like social security, and that's fine. If we want to be socialists and give them that option (rather than simply allow individuals to invest that same money in equally safe investments via the private sector...), they can have that opportunity, but my argument is, why do we all have to be forced to pay for it!? It all boils down to my gripe with the public option. If we want to be little leftists and have a public option, OK, but why will we all be forced to pay for it!?

So now, I will have paid God-knows-how-much into Social Security, and by time I reach the federally mandated retirement age (which at that time will probably be 80+), I will be means tested and denied compensation at worst, or receive compensation less than the principle I paid in over the remainder of my shorter life at best. Either way, this is a very long-term investment that we are all going to take a loss on, and it angers me. It should anger all of us. There's no magic to the social security system. They can only pay out what they bring in, and when there isn't enough coming in to cover what's going out, they either reduce the benefits of the recipients (means testing), or reduce the number of recipients altogether (increasing retirement age).

None of this is complicated, and it angers me that I am having to pay for all this, and tens of millions of people in America are going through the same thing and don't even realize it. Worse yet, a lot of those who do realize it are OK with it! And why shouldn't they be? After all, "we're from the government, and we're here to help."

The Simple Alternative to "Health Care Reform"

2009-09-05T14:31:00.001-04:00

There are a couple of very simple and relatively inexpensive things that can be done to help us all out here:

1) Federal government allows insurance companies to compete across state lines.
2) States stop mandating what insurance policies in the states "must" cover. I don't smoke, I'm not a drunkard, nor am I a crackwhore. Why do I have to pay for smoke/alcohol/crackwhore rehab coverage on my insurance policy? Because the state says so...
3) Federal government allows catastrophic/high deductible plans and Health Savings Accounts (HSAs) to continue existing. They are great investments for young, healthy people with average incomes.

Let the insurance companies carry policies across state lines to get more healthy, low-risk people on their rosters, spread the risk, and lower costs logically, safely, and for a LOT less money that what the federal government is wanting to do. Conversely, allowing policies to carry over state lines will also allow them to create larger pools of riskier, unhealthy people, which will succeed in spreading the risk and lowering the cost for them as well. It's a win-win, and more importantly it doesn't cost $1 trillion to implement, it just costs the politicians giving up some of their centralized power... but we can't have that!

In a market that already has thirteen hundred (1,300) participants, it's foolhardy (read: stupid) to believe that ONE (1) more insurance provider will have this dramatic effect of lowering costs and leveling the playing field.

All of you out there who pay out the ass for private insurance are doing so not because the private system as we know it is broken, it's actually working exactly how it's supposed to. It's because you are paying the costs rolled over to private insurers by providers who are not getting paid enough by the existing public option, which already controls nearly 50% of the health care market. Creating a public option that charges artificially low rates and brings more and more people into the public system will only succeed in costs being rolled over to private insurers more and more, causing the premiums we pay for private plans to sky rocket until it is literally unaffordable for any one except for the richest Americans. Meanwhile, the rest of us "average folk" are hung out to dry with an inefficient system plagued by lower quality care and supply shortages.

Happy voting.... unfortunately the decision about the future of our health care has already been made, and is at this point irreversible. We made the health care decision in November 2008. Prepare for private policy costs to continue to increase. Prepare to be forced on to the government plantation, whether you like it or not.

All Americans Will Experience a Tax Increase

2009-01-04T20:16:00.003-05:00

With the Fed and politicians injecting liquidity into the economy like jelly into a donut, what can we expect to come out of all this? While many independently intelligent Americans may have voted for Barack Obama due to his message regarding tax cuts for all Americans (except the ones who worked the hardest and earned the most), one thing that is being overlooked is the hidden tax that an Obama administration and all-leftist congress will place on the heads of all Americans - inflation.

While an income tax is a government action that decreases the purchasing power of the individual, price inflation is essentially no different. With an income tax, money is taken from your gross income to decrease your purchasing power, and with inflation, the government is printing so much currency as to lead to its devaluation, thus the inflation of the price of goods and services, which also hurts an individual's purchasing power. The dollar you earned today does not buy the same amount of product as the dollar you earned six months ago; this is a tax, and everyone who consumes goods and services in the US pays it. If price inflation was 5% last year, and your total income increased 2%, you effectively paid an extra 3% in taxes that will not be listed on your 1040 this year.

It's not all bad news, however. A time of high inflation, for a responsible consumer, can be a great time to save money. With estimates floating around of 7-9% annual inflation over at least the next year, a good way for you to save money is to not buy anything with cash. Instead, buy items using your credit card and pay it off on the next billing statement, being careful not to accrue any interest or penalties. By doing this, you can potentially save up to half a percent on your items. Assuming annual inflation is a conservatively estimated 7%, delaying payment of your goods by one month will place inflation at .58%, effectively making the amount of money you pay for your goods .58% less than they would have been if you would have paid for them in cash one month earlier. Do this for most of your consumer goods for one year, and savings can easily be in the hundreds of dollars. This maneuver also has the added benefit of improving your credit score. In a down economy, banks are generally less apt to loan to people with poor credit ratings or history. Responsibly handling your credit cards and paying off items promptly will do wonders for your credit score, and make your life a lot easier during the recession and even after the economy swings upward.

A Recipe For Failure... And America Doesn't Bat an Eye

2008-12-01T22:17:00.005-05:00

As president-elect Obama has so diligently and strategically pointed out, America is due for a "significant recession." I suppose I could go on a tangent about how this recession came to be, but I'll save that epic novel for a later post. For this short blog I will expound on the methodology the next government plans on using to go about stimulating economic growth.

With the Fed again having interest rates nearing rock bottom and the economy still stuttering, it will no doubt be the federal government's fiscal hand that makes or breaks this recession. In two general terms, the government has two options of stimulating economic growth: temporary and permanent infusions. We are all-too familiar with Washington's beloved temporary infusions; most of us got one this past summer in the form of a $600-1200 check. These handouts did a little to increase consumer spending in the summer months. Congress and the president-elect have mentioned another temporary infusion much larger than the first. The goal of this infusion, again, is to stimulate aggregate demand and send the economy soaring into the 21st century. Some of the proponents of this use the first Bush stimulus package in 2002, which was very successful, to support their argument for another rebate check. What these politicians don't mention is that Bush's initial rebates were coupled with massive cuts in personal income and capital gains taxes, or permanent infusions.

Economic theory and graphs aside, let us just look at this from a common sense perspective. If you give an individual a one-time check, what are they going to do with it? Save it. Use it to pay bills. Maybe they'll spend some of it. However, if you sit the person down and tell them you are going to cut their taxes by 5% for at least the next 8 years, what are they going to do? The increased security and predictability of the permanent infusion will encourage the individual to invest that money into long-term assets like businesses, capital, employees, and best of all, financial institutions!

One of the problems in the economy right now is uncertainty amongst lenders over which prospective customers are worth the institution's investment. In the available-for-sale securities market between financial institutions, are these packaged securities really worth what they say they are? The government already took the wrong course of action in their $850 Billion & counting Bailout package in October, which did nothing to unfreeze inter-institutional trading and lending, because it did not remove the uncertainty of valuation from the securities that make up the balance sheets of these respective institutions.

Since we have failed to tackle this problem from the business-end, the government still has the opportunity to help fix the problem from the consumer end. A permanent infusion (tax cuts) will give consumers the extra cash flow to then infuse financial institutions with fresh loans for business expansion and new equipment. This form of infusion can work. Another huge temporary infusion may very well succeed in boosting consumer spending for one quarter and printing off even more money that we don't have, but it will not succeed in the ultimate goal of stimulating long-term economic growth. The president-elect saying this will be a "significant recession" is simply giving himself a cushion to fall back on when their next poor investment backfires.

The only problem with a tax cut is that it would require the government to cut spending and do with less, and the government shrinking in size and scope would most assuredly lead to a lapse in the space-time continuum and the implosion of the known universe.

My next post: The real problem with the Big Three

Obama's "Tax Cuts"

2008-10-16T13:56:00.004-04:00

The big issue in the media nowadays regarding Obama's venerable tax plan is how the numbers behind his "tax cuts" don't add up. Right now almost one third of the American workforce pays no income taxes once they receive their standard deductions and refundable credits. Obama's tax plan will essentially expand refundable credits to the lower income earners and put about 40% of the workforce off the tax grid completely. I have my personal gripes with the public policy effect of having this much of the voting population with no equity in the federal budget (namely apathy in regards to where that money goes), but I'll limit this post to facts behind the numbers. Recently the McCain campaign has been abandoning the Bill Ayers story, which they should have been concentrating on months ago, and is now shifting to policy issues. They have been harping on Obama for his comments about "spreading the wealth" and his "tax cuts for 95% of America" statements.

When asked about how his administration does not have a socialist platform with a third of the workforce effectively receiving income tax refunds for income taxes they never paid, his campaign and The Tax Foundation responded by saying that the refundable credits would also help to offset the burden placed on them by "payroll taxes, corporate income tax, excise taxes, etc."

It's all very fancy verbiage that, to the uninformed voter, seems fair. But here's my take on the Obama campaign's burden-offsetting refundable credits:

Payroll Taxes: "Oh, but this is to also refund their payroll taxes!"

Ah, well in that case, it means their contributions to medicare and Social Security are also being refunded... this is 40% of the population with little to no basis in the system who will be drawing checks in the future based on a number they supposedly paid in in the present. Where's that money coming from in the future? They tax "the rich" for it, and deny "the rich" the privilege to withdraw it when their time comes. Problem solved.

Corporate income tax: I don't know what they're trying to get at here. These lower 40% of wage earners aren't "corporations," they're people, so I am assuming these guys are talking about the lower 40% who have equity stakes in S-corps, partnerships, etc. Now that I think I know what they're talking about, it still makes no sense considering S-corps and partnerships are flow-through entities anyway, and what that means is the income of the "corporation" or partnership is distributed to the "corporation's" shareholders, and taxed at the shareholders' marginal rate on the 1040 - which makes the "corporate tax" argument null and void, and not even worthy of being mentioned in the explanation because it has no effect on their income taxes. Any "corporate" income will have already determined whether they are in the marginal bracket to receive an "Obama tax cut" or not - but it does jazz it up a bit to make the future welfare recipients seem as if they are contributing to the system rather than parasitically sucking from it.

Excise taxes: Ah, so now they are getting their gas taxes refunded, which means 40% of the people aren't contributing to the funds to rebuild and maintain our roads and highways. They're getting their cigarette taxes refunded so now they aren't paying for their fair share of SCHIP (how much do you want to bet some of those lower 40% of earners have kids subsidized by SCHIP?) Plus, I thought excise taxes were meant to discourage despicable things such as smoking, shooting, and drinking... why do these people deserve to get that money refunded to them? After all, the DC liberals are the ones who enacted those taxes in the first place. Seems kind've counter-productive to me, but then again I'm not a fan of the federal government partaking in social engineering via taxes either, the DC liberals are; thus they have more 'splainin' to do for this kind of thing than me.

So these taxes listed by the Tax Foundation that are supposed to put us at ease with the fact that we are becoming a nation of redistributionist socialists are null and void in regards to determining the Obama "tax cuts."

The Windfall Profit Dilemma

2008-07-02T22:33:00.001-04:00

The media and certain politicians have been clamoring about this taboo word in American business – windfall profits. Each of the two major presidential candidates have made their positions publicly known regarding their stance on oil company profits in relation to the rising price of fuel. While they both have grievous fallacies in their logic that defy common sense economic principles, in this essay I would like to evaluate the particular stance of the presidential candidate Barack Obama. He has pledged to tax the “windfall profits” of the oil companies, citing the oil industry’s $132,000,000,000 profit last year. The intent of this article is not to open a salvo on Senator Obama as an individual or to lambast the seemingly universal platform of the Democratic Party regarding the oil industry, rather the purpose of this article is to shed some light on what I believe to be the most overused and misunderstood term of this election season.

What is a windfall profit? It is a term whose definition has been changed over the course of politics to benefit the populist motives of the particular group in power. Throughout history up through the latter part of the 20^th century, a windfall profit was defined as: a profit, or capital gain, derived from an investment in which the receiving entity did not contribute to the creation thereof. This may seem complicated, but in actuality the concept is very simple. As an example, let us take two striving entrepreneurs, Jack and Sally. Jack believes he has invented a new shampoo bottle that can revolutionize the shampoo bottle industry. Jack approaches Sally to convince her to contribute capital towards his shampoo bottle venture. Sally, believing that the idea would not be profitable, declined any financial backing to Jack. Thus, Jack pursued his shampoo bottle venture exclusively. Ten years go by, and Jack’s shampoo bottle idea finally takes off, and Jack becomes an overnight millionaire. Just to show Sally that his idea was in fact marketable, he sends his old friend Sally a check for $10,000 of his shampoo bottle earnings. Sally graciously accepts the gift. Which of these two individuals would be pegged with a windfall profits tax? Using the historically accepted definition of a windfall profit, it would seem that Jack’s millions of dollars would be recognized as ordinary operating income, seeing as though he had a risk, or financial investment, associated with every step of his shampoo bottle venture, from the conception of the idea to the manufacturing of the bottles. He had everything to lose in his investment, so any capital gain derived from it is legitimate. Sally, on the other hand, had no part to play in Jack’s shampoo bottle business, yet she received a large sum of money from Jack’s company, effectively reaping the benefits of the company’s success without having any basis or risk in the company itself. Poor old Sally is going to have to pay a windfall profit tax on her check from Jack.

Now that the definition of windfall profit is out of the way, how do Senator Obama and his party feel this scenario can be applied to the oil companies with their $132 Billion profit? That number in and of itself is mind blowing, isn’t it? The rich tycoons at big oil are making $132 Billion profit in a time when gas prices are $4 per gallon, doing an injustice to the working man. It’s the government’s job to step in and stop these corporations from ripping off American citizens, right? And the best way for the government to intervene is, naturally, to step in and tax those “windfall profits,” reducing the company’s inclination to make those dirty profits again. While the simple number, $132 Billion, may invoke strong emotions that are beneficial for empowering a particular political party’s voting bloc, that number in and of itself is not the whole story. I will take this opportunity to break down profits of ExxonMobil to see exactly where that $132 Billion came from. According to ExxonMobil’s audited income statement, their profit margin for FY2007 was 9.72%. For simplicity’s sake in my examples, I will use 10% as their profit margin, which in reality will overstate their actual income by tens of millions of dollars given the sheer volume of sales ExxonMobil recorded, but it will also make the numbers easier to calculate and follow for the sake of this essay. Given a 10% profit margin, we can conclude that for every $1 XOM invested, they received $1.10 in return. That 10 cent return on investment, multiplied by the gargantuan volume of investments, or risks, the company made, those meager returns on investment eventually amount to a massive $132 Billion over the course of 12 months of business. Now let us delve into whether a 10% return on investment is suitable for the company. An individual can find a decent, low risk Certificate of Deposit with around a 5-6% interest rate. All that is entailed with a CD is that the individual deposit his capital for a pre-specified period of time, and in return the financial institution pays the individual a pre-set amount of interest for the individual giving the financial institution the privilege of utilizing the individual’s funds. Given the definition of a CD, we can conclude that CD’s are considered very low risk investments that yield anywhere up to a 6% return in given market conditions. Now let us transition into the investment risks of oil companies such as ExxonMobil. In the oil industry, sunk costs are very common. Before an oil company drills for crude, they must pay geologists to determine to the best of their abilities whether the company will find any crude in the hole. They must pay environmental firms to conclude that there will be no adverse environmental effects from drilling in that particular location, and they must pay the federal and state governments exploration fines and protection costs to have the ‘privilege’ of being able to drill for crude in this great country in which we live. Once it’s said and done, ExxonMobil can spend over $1 Billion on preparation for drilling a hole in the ground, and they may or may not get any crude out of that hole. The risks are very high, and once the exploration and preparation costs are sunk, there is no way for XOM to re-obtain that capital. Given the high regulation and risks entailed with the oil industry, some would say that a 10% return on investment is considerably low when taking into account the fact that you can just as easily invest your money in a low-risk CD and get a 6% return on it. If this example alone is not convincing, consider the mid-1990s when oil companies sustained just as many risks as they do today, yet their profit margins were only 5%. Given this situation, would a wise investor contribute capital to a high-risk industry that gives a 5% return such as the oil industry, or a low-risk investment that gives a 6% return, such as a CD? The everyday risk averse investor would stick with the CD.

Now that we know where the profits come from and why they are the way they are, I will attempt to grapple the ever-prevalent idea that oil companies are overcharging Americans, and making too much money off the back of the working man, that they are “price gouging.” It has been given that ExxonMobil’s profits were 10%, or 10 cents for every $1 of fuel sold. Some say this is too much. Rather than disagreeing with that argument, which by the way, I do, I will take another approach. The federal tax on a gallon of gasoline is 18 cents. The average state tax on a gallon of gasoline is 42 cents. Thus, on average, 60 cents of every gallon of gasoline you put in your tank goes to the government. Using the current average price of gasoline, $4, we can conclude that the government receives an exclusive 15 cents of every $1 of gasoline sold (60 cents / $4 per gallon). In other words, ExxonMobil, who is in the business of extracting crude and distributing gasoline, earns 10% on their core business, while the government, who shares none of the industry risks that ExxonMobil has, righteously receives 15% of the earnings. Am I wrong for seeing the inherent flaw in the status quo? For those out there who claim the oil industry is price gouging, I ask the question… who exactly is gouging whom?

Now that the groundwork has been completed, let us transition back to the term “windfall profit.” Once again, windfall profit is defined as: a profit, or capital gain, derived from an investment in which the receiving entity did not contribute to the creation thereof. Politicians like Senator Obama would have us believe that the profits earned by ExxonMobil are to be considered “windfall,” and therefore should be taxed accordingly, effectively placing a double tax on the company’s earnings – a tax on gross income, and then second tax on the resulting net income. Since this message is clearly clouded in political spunk, I believe the best way to approach this is to take the oil industry and break it down into something that I call “The Gas Cycle.” What are the steps involved in the process of an oil company to bring gasoline to bear in the consumer market? In my gas cycle, the six-step cycle includes: Exploration, Extraction, Transportation, Refinement, Distribution, and Collection. Taking each step of the gas cycle, we will decide whether the expenses incurred by oil companies are directly attributable to the terminal earnings, thus excluding those earnings from a windfall profit category. Do oil companies make a direct investment in the exploration and extraction of crude? They most definitely do, spending billions of dollars every year in search of fresh crude reserves. Do oil companies make a direct investment in the transportation, refinement, and distribution of gasoline? Once again, yes they do. They pay for the oil tankers to transport the crude halfway across the world, and they spend billions of dollars every year increasing refining capacity and streamlining refining and distribution operations throughout the world. Are the collections from the sale of the distributed goods therefore attributable to ordinary operating income or are they considered a windfall profit that should be double taxed? Using our historical definition of a windfall profit, a profit, or capital gain, derived from an investment in which the receiving entity did not contribute to the creation thereof, I would conjecture that the answer is No. Operating income of oil companies does not qualify as a windfall profit, and should not be treated or taxed as such. Not to mention, believing that increasing the tax on corporate profits is an effective method to go about lowering the price of the good that the corporation supplies is counter-intuitive at best, and it completely negates centuries of proven economic principles – but this is another argument for another article.

Given that it is incorrect to classify oil company profits as windfall profits, I have a longstanding question that I’d like to throw into the debate arena. Since it has been our very own government officials who have been shrieking about the windfall profits of oil companies, it made me contemplate the government’s role in the oil industry, and to what extent the government’s income from the sale of gasoline was considered legitimate. We know that oil companies have everything to gain and everything to lose in crude exploration – just a few bad drilling decisions could lead to a company the size of ExxonMobil going under in an industry as internationally competitive as theirs. What financial basis does the government have in the gas cycle? What investment does the government have to lose if the oil company drills a dry hole? What financial risk do they carry in the success of crude exploration? They carry no risk, yet they still receive more income from the sale of gasoline than the oil companies themselves do. So I ask this question, “between the oil companies and the government, whose ‘windfall profits’ should we really be concerned with?”

Tax Cuts For the Rich?

2008-01-20T16:53:00.000-05:00

I was never able to figure out what these "tax cuts 'for the rich'" were that the politicians kept blabbing about. Perhaps y’all can help me out here. I know this talk is all in reference to the Tax Relief Act of 2004. What I can't seem to figure out is how anyone can think this was simply for the rich. It completely did away with the marriage penalty and made the standard deduction for Married Filing Joint twice the standard deduction of filing single, like it always should have been. This helps everyone, and since it is a flat deduction (e.g. a poor couple gets to deduct $10,000 just like a rich couple gets to deduct $10,000) it could really be argued that it is a regressive tax benefitting the poor more than the rich. It also upped the Child Relief credit from $600 to $1000 per child. It's a refundable credit so even once your taxes paid for the year reaches $0, you still get the money back (effectively giving you money from someone else's pocket)... and for every $1000 over $100,000 a family earned, the tax credit begins to drop off until it hits $0, also making it a regressive tax benefitting lower income families. The Act also implemented a 10% tax bracket for those making less than about $7150 per year (from the 15% bracket), benefitting the very poor. On top of that, it lowered all the other tax brackets (25% from 28%, 28 from 30, 33 from 35, and 35 from 38.6). In effect, some people got a 5% tax break, a vast, vast majority got a 2% break, and some got a 3.6% break. There are also a truckload of other tax credits for teachers and low income workers that I won't even begin to delve into.

The politicians, when they talk about these "tax cuts for the rich," I believe are referencing the 3.6% tax cut that those families making over $326,000 per year received. We have to keep in mind that this tax relief package was designed to stimulate a stagnant economy, and the best way to do that is to free money up with the big investors and small business owners (those making over $326,000), to encourage them to invest into new business ventures and hire more employees. Four years down the road we can see that the plan worked very well, almost too well... but I just don't see how anyone running for national office could stand up and with a straight face say Bush's tax cuts were "for the rich." Sure, the rich got more money back than the poor, but that's only because the rich paid in exponentially more than the poor. The top 25% paid 86% of the total income taxes collected by the government. In 2006, the top 1% paid 39% of the total income taxes. When Bush took office, the top 1% paid 37% of the income taxes. Thus, as a tax base, those in the highest tax bracket contributed 2% more to the federal coffers than they did before the tax cut. This is where it boils down to the science of tax cuts ("for the rich," if you will). The tax cuts given 'to the rich,' that increased investment and hiring succeeded in creating more "rich," who in turn also had to pay the evil reduced 3.6% tax rate - but the more rich people still produced from the 3.6% tax break increased the government's revenue on rich people that were created from the successful investments made from those tax cuts... summarily causing the rich to pay more of the federal income tax than they were before the tax cut...