NRPLUS MEMBER ARTICLE T he President’s budget is highly unlikely to pass, and the administration knows it. Indeed, its immediate purpose is almost certainly political positioning ahead of the debt ceiling fight to come. Take one of the “fact sheets” the White House has sent out, for instance; it bears the heading: “The President’s Budget Cuts the Deficit by Nearly $3 Trillion Over 10 Years.” Fantastical, to say the least. But regardless of how accurate Biden’s claims may be, the challenge to GOP congressmen as the debt-ceiling crunch draws near, is to not merely oppose the President, but articulate what they would do.
Taking a longer view, the budget is presumably intended to set the stage for Biden’s reelection campaign, which — at least when it comes to economics — seems set to have a left-wing populist slant. That’s no great surprise, but the greater the certainty that this is the tack that the President will take, the greater the chance that individuals and businesses will start factoring it in when making their medium- (2024 is not that far away, after all) and long-term investment decisions. How much they do so will, of course, depend on how likely they believe it is that Biden will be reelected and whether they think he will have the necessary Congressional majority to get his radical tax proposals approved.
What is taxed, and by how much, gives a good indication of the priorities and preferences of those running a country. The same is true of tax increases, or even proposed tax increases. They send a message.
Looking at what Biden’s administration has already put forward, it’s hard to think that the current administration considers capital formation a high priority. If the budget is approved, tax rates on investment income will see a substantial increase for some. Capital gains would be taxed at the same rate as income for those earning $1 million a year or more, which (if the proposed income-tax rate hike passes) would be at a top rate of 39.6 percent.
To take a step back, it is worth pointing out that there are good reasons why capital gains are taxed at a lower rate than “ordinary” income. Perhaps the most important is to encourage the investment on which, ultimately, any economy depends. The higher the capital-gains tax rate, the higher the return that people will look for before making an investment. That, in turn, will reduce the flow of investment capital put to work in this country, particularly for the riskier projects on which so much of American innovation has always depended. Indeed, the lower capital-gains tax rate also reflects the understanding that investments may be wiped out.
Another reason that capital gains are taxed at a lower rate is as a rough and ready way of mitigating the effect of inflation. Capital gains are not indexed for inflation. So, if an investor buys an asset at 100 and sells it at 130 some years later, he or she will be taxed on the nominal gain of 30. If over the same period, prices have risen by a cumulative 20 percent, the investor’s real gain (excluding any income generated by the asset over the period) will be 10, meaning that the effective tax rate on that real gain will be excruciatingly high. And that’s before these proposed tax increases. Now, assume that over the holding period prices rose by 35 percent. The investor will have a real loss of 5 but be taxed on a nominal gain of 30. That does not seem — to use a popular word — “fair.” It will also hit long-term investors hardest due to the cumulative effect of inflation. And yet we are often told that long-term investment should be encouraged over “speculation.”
Those who argue — unconvincingly, I might add — that the proposed capital-gains tax increase doesn’t matter because it will only affect those who make $1 million a year or more, would do well to remember the “one-off” effect. To explain the effect, the small business owner’s predicament can prove illustrative: After building up his business and taking a modest salary for years, should he be punished by a substantially higher tax rate if he decides to sell that business and thus enjoys a higher inflow of cash that year? Should he be treated as some kind of plutocrat?
Again, even proposing such an increase in capital-gains tax rates sends a discouraging message that investors will not miss, a message that is only reinforced by the revival of the idea that appreciated but unrealized capital gains should, for the very richest, be taxed. Indeed, such “income” would also be subject to a minimum tax of 25 percent if Biden get his way. To put it bluntly, taxing such gains, which might be fleeting — see how many of the paper gains made when the market rallied during the pandemic have evaporated, for example — is, as I have argued before, not a good idea.
Another message sent by the proposed increase in capital-gains tax rates is that the administration is not too worried by looming fiscal problems in some blue states. The capping of the SALT (state and local tax) deduction — whatever one’s views on the matter (I wasn’t a fan) — appears to have encouraged red states to see the virtues of tax competition, which has only been further incentivized by the opportunity to attract remote workers. Of late, there has been a remarkable round of tax cutting in red states (something that we have frequently discussed here at Capital Matters), that has not so far been matched by blue states. In fact, cities such as New York — already in line for additional fiscal troubles because of, among other reasons, the decline in the value of office buildings — have long been dangerously dependent on the taxes paid by their wealthiest inhabitants. Now, the threat of significantly higher capital gains taxes may drive even more of them away.
Currently, capital gains in New York are taxed as income, meaning a top rate of 10.9 percent. Thanks to an extra turn of the ratchet known as tax-benefit recapture, this applies to all the income of those earning more than the amount at which the top rate applies ($25 million). On top of this, add a top rate of 3.87 percent chargeable on income (including gains) in New York City. And then, of course, there’s the misnamed (as we now learn) “Obamacare” charge of 3.8 percent, which some propose should rise to 5 percent. “Basic” payroll taxes add a bit more. Those New Yorkers subject to a new federal top rate of 39.6 percent would thus (if my math is correct) be subject to an overall top rate of around 60 percent on any capital gains. I can’t imagine New York City’s Mayor Adams was too happy to have read about Biden’s proposal. And if she thinks things through, Governor Hochul shouldn’t be either. In California things are much of the same.
With the debt ceiling looming, neither side of the aisle would deny that the U.S. has a serious budgetary problem, although they disagree what to do about it. Others, meanwhile, remain — let’s be polite about this — unconvinced that either Republicans or Democrats are prepared to do what it takes to resolve the country’s fiscal mess. With that in mind, over the long term, the best (and most painless) way of resolving the country’s financial problems (or, at least reducing them to a more manageable size) would be for the U.S. to grow its way out of them.
Discouraging investment is not an immediately obvious way of securing that growth, nor is increasing corporate tax rates. Under the president’s proposals, the top rate would increase from 21 to 28 percent, a jump that will also damage companies’ international competitiveness. Once again, even if these tax increases don’t go through, the mere fact that they are on the table will send a message that corporations won’t miss. There are other proposed corporate-tax increases too, including increasing the new share buyback tax from 1 percent to 4 percent (I wrote about buyback taxes last year: spoiler, I am not a fan).
And on the topic of discouraging investment, the President (to quote from the fact sheet mentioned above) “is committed to ending tens of billions of dollars of Federal subsidies for oil and gas companies . . . The Budget eliminates special treatment for oil and gas company investments, as well as other tax preferences”.
That would, presumably, include tax “breaks” designed to encourage oil and gas production. As we have seen, oil and gas companies have been unusually slow to increase their investment in increased production recently despite stronger prices. A part of the reason for this (as I touched on in a recent Capital Letter) flows from the fact that those active in this sector know that their business is unloved by this administration and the Democratic party more generally, quite a few of whose members would like to see a phasing out of oil and gas production altogether, and sooner rather than later.
Many oil and gas production projects take a long time to generate a decent return, where the definition of “decent” will, as with almost all companies, be found by (among other calculations) pricing the risks of beginning a project in the first place. Even if the President’s current proposal doesn’t get anywhere, it will necessarily force any companies taking a longer view, which (more or less) is all oil and gas companies, to price in increased political risk. That, in turn, will mean a decreased number of projects, as more and more under consideration fail to overcome the hurdle represented by that required rate of return. As a result, American oil and gas production will be less than it could otherwise be. That’s not good for consumers, the economy, or the country’s geopolitical position.
Finally, two percentages to consider: The first is the federal tax as a percentage of GDP. In 2022 that stood at about 19.6 percent. The fifty-year average is 17.4 percent. The second is federal spending. In 2022 that stood around 25.1 percent. The fifty-year average is 21 percent. There’s a message there too.
National Review Institute: Ideas Summit
We will be holding an ideas summit in Washington DC on March 30-31.
Topic: The Sources of American Strength
Participants include: Ryan T. Anderson, David L. Bahnsen, Louis Brown, Senator Tom Cotton, Allen C. Guelzo, Pano Kanelos, Megyn Kelly, Terry & Matt Kibbe, Bjørn Lomborg, Jessica Melugin, Douglas Murray, Vivek Ramaswamy, Ian Rowe, Carrie Severino, Elise Westhoff, Rich Lowry & National Review Writers.
More details here.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 107th episode, David is joined by former Trump-era OMB economist, Dr. Vance Ginn, to discuss the history of economic thought; the strengths and weaknesses of the classical, Chicago, and Austrian schools of thought; whether or not we need a Fed; and what to do about excess debt and economic growth.
No Free Lunch
David has also launched a new six-part digital video series, No Free Lunch, here on National Review Online. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
Climate
Shifting energy use toward renewable sources imposes significant costs on consumers, who, given the choice, overwhelmingly opt for cheaper and more reliable fossil-fuel sources. Electrification of cars and appliances also creates its own costs in the form of additional electricity generation and the building of charging infrastructure. Each policy magnifies the cost of the other.
To paraphrase outgoing World Bank president David Malpass, we should not be promoting EVs where there is insufficient “E” to power the “V.” . . .
The Consumer Product Safety Commission is still thinking about your gas stove.
No new regulations have been proposed, but the agency has issued a request for information, which was published today in the Federal Register. It is “seeking public input on chronic hazards associated with gas stoves and proposed solutions for these hazards.” A request for information is a process that agencies use to get feedback from consumers, industry, advocacy groups, and other parts of government . . .
Business History
Power Failure, Cohan’s most recent work, is not a Wall Street saga per se, but it is adjacent. It tells the story of General Electric, an industrial conglomerate with iconic American roots. That Cohan chose to give us the entire 125-year history instead of starting the book in the last 20 years is to his credit. Students of business history deserve to know the intersection of capital and innovation that was instrumental to American progress in the 19th century, and Cohan makes the details and particulars riveting . . .
Fiscal Policy
The Congressional Budget Office released its first new federal-budget projections in nearly a year last month. If you missed it, you are not alone. Even as the CBO showed budget deficits soaring toward unsustainable levels, most of the print media offered respectful placement as a one-day story and then moved on. Cable news barely covered this confirmation of Washington’s rapidly deteriorating fiscal picture. The White House offered no press release promising to address the sea of red ink, nor did Republican or Democratic congressional leaders.
The indifference was not always this deep. . . .
John Hendrickson & Vance Ginn:
Iowa’s anticipated $1.6 billion budget surplus for FY 2023 is nearly as much as the $1.9 billion surplus recorded in FY22, with another $2.2 billion surplus expected in FY 2024. The state should have $895.2 million in reserve funds in FY 2023 and $962.5 million in FY 2024 — the statutory maximum for those years. The state’s Taxpayer Relief Fund — the fund into which excess tax revenue is placed so that it can be returned to taxpayers by the legislature — was worth $1.1 billion in FY 2022, and is on track to grow to $2.7 billion in FY 2023 and then to $3.4 billion in FY 2024 . . .
One of the most significant policy actions the Biden administration took last year was its order “forgiving” federal student loans, but you wouldn’t know that from reading Biden’s new budget.
Released today, the budget contains a lengthy statement highlighting the president’s economic policies. Every White House budget proposal has a section like this, and no matter who is in office, it contains exaggeration and spin meant to give the president credit for complex economic activity that he really has little effect on. What’s notable this time, though, is the complete absence of any mention of the $400 billion student-loan order . . .
Budgets reflect a president’s priorities, and President Biden’s makes a few things very clear . . .
Share Buybacks
George Will has written a scorcher of a column, in a way that only he can, against Democrats’ demagoguery on stock buybacks.
He writes that Chuck Schumer “has spent as much time as an NFL linebacker as he has in private enterprise,” and that for Joe Biden, “the private sector is a region as foreign as Outer Mongolia.” Will writes, “Hostility to buybacks arises from foggy economic thinking that is encouraged by the progressive animus against the people and processes that create the wealth that progressives delight in redistributing.” . . .
Housing
Rather than slipping into the recession that many economists had predicted, the economy seems to be gaining momentum. One potential explanation for this might be that today’s economy is less sensitive to interest rates than expected as a result of the interaction between inflation and taxes.
In an echo of the 1970s, interactions between high inflation and the tax code have caused effective mortgage rates for many households to decline despite the Federal Reserve’s intent to bring its policy rate above 5 percent . . .
Cash
[W]ith the loss of cash also comes the loss of anonymity. When you pay with a card or a phone, there is always an electronic trail of both your purchases and your whereabouts. You are forever on the grid, subjecting yourself to the monitoring of nosy, prying busybodies . . .
ESG
Pension-fund management has had its share of controversy and disagreements since then, of course, but these obligations were relatively straightforward until we reached the era of socially responsible investing and its current misbegotten stepchild: environmental, social, and governance (ESG) theory. ESG effectively opened the door to all manner of investment managers (rather than those managing funds with a specific remit to include nonfinancial items among their investment goals) directing capital not just in the interest of generating return but in a way consistent with progressive political goals. Advocates of ESG investing often claim that their desire for profit comes first, and their other goals come second, but introducing any additional considerations into the mix changes the long-standing expectation that pension managers are supposed to be focused entirely on delivering good returns for retirees, full stop . . .
Regulatory Policy
The Owner-Operator Independent Drivers Association (OOIDA) wrote a letter to Senate labor committee chairman Bernie Sanders (I., Vt.) and ranking member Bill Cassidy (R., La.) to oppose President Biden’s nomination of Julie Su to be the next secretary of labor.
The media has tried to portray Su as “pro-worker,” but really she is just pro-union. The vast majority of truck drivers in the United States are not unionized, and many are small-business owners. The OOIDA represents 150,000 independent owner-operators all across the country . . .
Inflation
Prominent Democrats are doubling down on the supply-side inflation narrative. At the semiannual monetary-policy report to Congress, there was a concerted effort to portray ongoing inflation as beyond the Fed’s control. Supply-side inflation is possible, and in the early post-pandemic months, it was a reasonable concern. But the facts since then don’t fit the story. This is old-fashioned, demand-driven, monetary-policy-induced inflation — and the data prove it.
If supply problems were in the driver’s seat, we would observe rising prices and falling output . . .
Rent Control
I have lived in Colorado for over 25 years. For some time, my wife and I have considered purchasing a rental property as a retirement investment. And when considering where to buy, Colorado has always been an attractive option. The state has a tight housing market, high rents, and a landscape that draws people from all over the country.
Unfortunately, the 2022 elections vastly expanded the Democratic majorities in the state legislature, and the newly empowered progressive majority has other ideas. Chief among them is trying to repeal the state’s prohibition on local rent control, which has been in place since 1980 . . .
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