Larry McDonald has a mini crusade on adopting a flat tax. The proposal most likely encounters more political issues than purely economic ones. But a flat tax is one way of looking to solve the large economic issue. Mainly, we are a society wedded to the urgency of consuming now and have become terrible savers as a result. While politicians may be setting up financial literacy task forces and regulating the financial industry, it may best spend more time looking at how the tax code promotes us the wrong type of behavior (unless, conspiracy minded people think this is exactly the type of society leaders want…).
For example, the American estate tax is a punitive tax (the Federal tax is 55% in 2011 with an exclusion amount of $1 million assuming Congress does not pass other legislation) which implicitly encourages people to spend it in life rather than pass it onto generations. The larger, more global problem, is that interest income on savings is taxed higher than any other form of investment income.
The reason for this policy used to make sense. When North American society actually saved and the economy was in a long boom period, the tax code was attempting to discourage the taxpayer from stashing money in high-interest savings accounts and, instead, encourage investment in industry by investing in equities. This policy works if you assume: (i) the population is saving; and (ii) the demographics were aligned in such a way that a taxpayer could enter into the risk-reward of investing in equities.
But what happens if you have an aging population with less risk tolerance and the household savings rate is in the single digits? Is the tax code not penalizing savers, the people you most need in an over-leveraged economy, and also forcing seniors, who have the least amount of risk tolerance, to move into equities?
As a matter of industrial policy, governments want people to invest in our innovators and risk takers. Where would Apple (NASDAQ: AAPL) and Research in Motion (NASDAQ: RIMM) be if not for its early shareholders? But should we begin to readjust the balance between risk and reward to reward savers and to recognize that North American society is aging?
For example, could not the first $2,000 in interest income be tax-free? If governments are attempting to force financial institutions to lend to small business (one of the platforms of the Liberal Democrats in England who now sit in the coalition government), is not the carrot to encourage more lending tax policy aimed at increasing deposits? Alternatively, make interest earned on government bonds tax-free (this has already occurred in some jurisdictions). It could certainly help some cash starved governments.
These are just two ideas I thought of to encourage savings. Any additional ideas are more than welcome. We need to get off this merry-go-around of empty consumption and policies encouraging moral hazard to something more economically and socially sustainable.
Source: www.istockanalyst.com.
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