Who Cares About Tax?

“China reported an unexpected $7.3 billion trade deficit in February” reports Bloomberg. In an entirely unrelated story, Bloomberg also reports “Australian Employers Unexpectedly Cut Workers in February.” Yes, unrelated…

Australia may be in for a nasty shock if, as Dan Denning puts it, the “dragon exits”. But Canberra is busy with other matters.

Resource Super Profits Tax, Mineral Resources Rent Tax, Emissions Trading Scheme, Flood Levy, Carbon Tax, … Did we miss any?

But who really cares about taxes?

Of course, taxpayers do. Taxes are theft of income after all. Backed up with the threat of police violence. The thing is that, in a really academic theory kind of way, taxes are spent on something that is supposed to be beneficial. Well, at least taxes go to providing something. Even when that is jobs for government bureaucrats.

What we mean by asking “who really cares about taxes” is why are they important?

Think about it this way. What came first; the government spending or the tax? Obviously, the government decided at some point that it would like to spend some money on something. And so it used its power to inflict a tax on the people it had power over.

But it was the desire to spend that came first. Without it, there needn’t be a tax.

The point being that it is spending which is the key to government finances. A government will borrow or inflate if it cannot pay for its spending via tax. And if the government borrows, it must tax in the future to make up the difference. Borrowing is just deferred taxation. And inflation is equally a tax. The key is that taxing, borrowing and inflation are just ways to deal with deficits, which are the result of the spending.

Have you ever heard of a government saving up a surplus? Not just paying down debt, but actually having money saved up. That state of affairs doesn’t last very long, does it?

So if it is government spending which matters in the long run, with tax and inflation merely being the inescapable shadow, shouldn’t political debate simply focus on spending? Why not simply say of tax, borrowing and inflation that it will be at whatever level the spending requires? This would allow us to focus on spending only and take it for granted that more spending requires more tax, borrowing or inflation.

But it’s not quite that simple.

This is where the politician comes in with his free lunch. And we don’t mean the taxpayer funded soirée. We mean the political promise of delivering more than tax, borrowing (future tax) and inflation (hidden tax) take away.

Politicians, instead of making these free lunch promises, should be justifying that their proposed spending outweighs the damage of tax, borrowing or inflation, which must follow the spending. This implies that they must be capable economists…

And you thought the ramblings thus far were farfetched!

But, to clarify, they must have evidence that they are at least aware of the corresponding costs implied in the proposed spending. And they must weight up the two.

A government which spends a small percentage of GDP is likely to be spending it on very valuable projects. As government grows, the projects become more difficult to justify, as all the obviously good projects have already been taken up. Correspondingly, small taxes are politically justifiable, whereas increasing already high taxes is difficult to justify. That’s why more spending and more tax would be more and more difficult to justify if both sides of the coin were considered.

And if another dollar of spending will incur a debt at high rates of interest, the politician would have an even higher burden of proof that the proposed spending should be taken up.

Again, the politician must be aware of both sides of the coin. At the moment, it seems politicians think that spending is free and, thus, that spending should be undertaken for every worthy cause. Taxes are considered separately.

But if you weigh up additional spending with additional tax, the game is up. If the politician desires to increasing spending, tax or inflation must follow at some point. And when the politician or economist begins to recognise the cost of their policy, they will no longer be able to justify it. That’s because the private sector would have done anything that is financially sensible to do. It would have weighed up the projects benefits and its costs. If the benefits outweigh the costs, there would be a profit opportunity. And the private sector would fulfil it.

And the private sector is significantly more efficient, which means it would consider more projects viable than the government under the same constraints.

So, by definition, the government’s activities are situations when the costs outweigh the benefits. Unless the government has prohibited the private sector from taking up the opportunity. In other words, we know our taxes will amount to more than the benefit we receive from the spending.

Of course, the media sees it differently. Any government spending is either for a worthy cause or, where the cause is less worthy, spending is justified as stimulus. The tax to pay for all this is a separate issue to journalists. And the problems that come with indebtedness? Well, you just blame whatever triggers the funding crisis. Whether its falling house prices which reduce property tax revenue, or higher oil prices, which increase the cost of providing public transport.

In Europe they blame the speculators who correctly predict that nobody will want bonds which will be defaulted upon or inflated away. Yes, it’s never the spending that causes a government’s fiscal crisis.

Of course, it’s never just the government which is doing the meddling. The central banks of the world also have legal authority over the people. They decide the price of money – the interest rate. Some central banks peg exchange rates instead. The only difference between the two policies is their stated goal. Their methods are identical: Money printing.

According to those who refuse to connect money printing with higher prices, inflation in commodities is caused by foreigners buying more of them. But why are foreigners buying so many commodities? Because they are so cheap.

It’s just like when Americans buy from China because their products are cheap. Why are Chinese products cheap? Because the Chinese central bank pegged the Yuan to the dollar. In other words, they print money, which devalues the Yuan relative to the dollar. But now that Bernanke has been printing, US dollar denominated assets have become cheaper for everyone else. And commodities are US dollar denominated.

People who accept China’s currency manipulation as being the cause for unfair competition must also accept that Bernanke’s dollar printing is what is causing commodity prices to rise. You can’t have your dumplings and eat them.

And here is where it gets interesting for Aussie stock holders.

If the Australian stock market is dominated by commodity and resource shares and those shares rely on commodity prices, that could mean the Aussie market is set to have a negative correlation to the US market. If US stock markets fall because of higher oil and other prices, the ASX’s resource stocks should rise. And you have Chairman Bernanke to thank for the trend of higher resource prices.

On the day I’m writing this, that appears to be the case. The Age reports: “Australian stocks remained lower today, with resources stocks falling due to lower commodities and metals prices.” US stocks rose, but the ASX didn’t follow the lead because the resource sector got hurt by the lower commodity prices.

Maybe the Aussie resource sector will become the inflation hedge of choice for overseas investors. After all, it produces the commodities whose prices are being inflated, and the Aussie dollar would continue its uptrend as the dollar falls. A win-win under quantitative easing conditions.

But you do still have to pick the right stocks. And that’s what our very own Stock Doc Alex Cowie does here in St Kilda with his newsletter Diggers and Drillers.

Ever seen those managed fund brochures? Where they try to con you into giving them money? Well, you will usually see a number of metrics reported in them. Among these indicators are the fund’s 1 year return and the 5 year return. Academics claim to have proven that fund managers can’t outperform the index, so let’s check out the index’s performance over a 1 year and 5 year timeframe.

The ASX 200 is about flat on both counts. Those poor finance professionals must be feeling really deflated. Remember, this is Australia in boom times.

Maybe the strong Aussie dollar is encouraging money to leave the country? To places like Aspen, Colorado, where Australians are disproportionately represented in the property market.

Could you join them? Taking a look at the Stock Doc’s portfolio in his latest issue certainly suggests it’s within reach for Diggers and Drillers subscribers. The average 50% gain is remarkable. His first 2011 pick is up almost 37% as I write this!

But the USA may not be the best place to go with your “hard won” investment profits.

In an attempt to keep his hands clean, Barack “Peace Prize” Obama has asked the democratic civil libertarians which rule in Saudi Arabia to supply the Libyan uprising with weapons. And he has given Gitmo the go ahead to continue its activities. And he has continued handing out waivers from his landmark healthcare law – for selected entities. More than 1000 waivers have been granted.

So America is looking pretty shaky. But Obama has had some limited success. His desire to “spread the wealth around” is being put to practice:

“Government payouts-including Social Security, Medicare and unemployment insurance-make up more than a third of total wages and salaries of the U.S. population, a record figure that will only increase if action isn’t taken before the majority of Baby Boomers enter retirement.”

According to its proponents, socialism is inevitable. Except it’s too expensive to work, so capitalism is inevitable. Sometimes, political systems escape this cycle and inject some corporatism, which is like socialism for the benefit of the big companies and their chiefs. Obama seems to have combined socialism and corporatism remarkably well. Bailouts and handouts. Redistributions and tax breaks. Wars and peace prizes.

Even the supposedly independent central banks have been subjected to corporatism. Goldman Sachs seems to have invaded central bank boardrooms around the world. The head post at the New York Federal Reserve, which implements US monetary policy, is held by a Goldman Sachs alumnus. The Bank of England Monetary Policy Committee’s latest addition is a Goldman alumnus. The leading contender for the ECB’s presidency (Mario Draghi) is a Goldman alumnus. Here in Australia, we had a certain Mr Turnbull who was with Goldman for a time. Heck, even your editor has been on the inside, doing an internship at a Goldman Sachs joint venture firm here in Australia. But don’t tell anyone.

In the spirit of our experiences as an intern, here is our solution to the world’s debt problems. And guess what? It involves central banks printing money!

A step by step guide for Mr Trichet and Mr Bernanke:

  1. The ECB creates Euros and buys all, or the vast majority of, the USA’s debt.
  2. The Federal Reserve prints Dollars and buys all, or the vast majority of, the various EU nation’s debt.
  3. The USA defaults on all debt held by the ECB.
  4. The EU nations default on debt held by the Fed.
  5. Both central banks retire the funds created in the effort.

It could be completed in hours and nobody would have to know they were going to do it.

Nick Hubble
For Markets and Money Australia

Nick Hubble
Nick Hubble is a feature editor of Markets and Money and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about Markets and Money, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails.

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RBNZ puts a spanner in the works, restricts covered bonds to 10% of local banks balance sheets whereas up to 70% of depositors funds is being committed to whalesale funders here. They are requiring strict compliance with the full capitalisation hurdle by defined dates in order for the Australian banksters to turn branch operations into NZ localised subsidiaries, and yesterday they announced as a special welcome to the Aussie banksters that a “too big to fail” regime is coming. The Kiwi’s are declaring war on the Aussie banksters just as global milk prices are reversing their recent bubble. Will they… Read more »
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