Low Interest Rates Will Kill Tax Hikes

MARCH 20, 2012

By WAYNE LUSVARDI

All the proposed ballot initiatives to increase taxes in California are headed for a hard fall at the ballot box – because the economy is sluggish. And the economy won’t pick up speed unless savers and pensioners begin to realize a high enough interest rate on their investments.

That is what can be inferred from a number of economists who have recently explained why the U.S. and California economies are recovering so slowly, if at all.

Economist Carmen M. Reinhart has recently observed that very low interest rates set by government are imposing a “repression tax” on interest earnings.  This “repression tax” is transferring wealth from savers and pensioners to borrowers, and in some cases, to governments.

Economist Robert, Higgs in his article “The Fed’s Immiseration of People Who Live on Interest Earnings,” has similarly observed that the low level of interest income has broken the investment cycle between generations.  The economic cycle is where young people take out mortgages and business loans and pay interest to older savers and pensioners who loan them money. But with abnormally low interest rates, there is no money for the elderly to spend or reinvest.

Echoing Reinhart and Higgs, economist Bruce Bartlett has stated the cost of the government’s policy of deliberately holding down interest rates has been to squelch an economic recovery.

Thus, raising taxes $9 billion, as Gov. Jerry Brown has proposed, or $10 billion, as lawyer Molly Munger wants, would be economic suicide for California.  Such ballot initiatives would impose heavy taxes without priming the pump to get the economy flowing again.

A mild rise in jobs — that often appear before elections and disappear afterwards — is not a sole indicator of economic recovery. Nor does a mild rise in jobs a signal that taxes can be raised despite continued suppression of interest rates by government policy.

For example, a separate proposed ballot initiative to eliminate Proposition 13 reassessment protections for commercial properties — called a “split roll property tax” — alone would increase the state unemployment rate from 9.9 to 13.1 percent.

As long as very low interest rates are robbing savers and retirees of their wealth and suppressing an economic recovery, it is highly unlikely that any of the proposals to raise taxes on the Nov. 2012 ballot will succeed. The tax proposals on the upcoming California ballot are diverting attention from larger federal policy that is squelching an economic recovery.

Yet More Taxes

There are even more taxes in the pipeline: cigarette taxes, oil taxes, gas taxes, out-of-state business taxes, and imposing reassessments for commercial property taxes every year instead of when a property resells, as is now provided under Proposition 13.  The tax proposal on oil and gas would increase such taxes 40 percent higher than any other state in the Union.

These tax proposals do not include the $11.1 billion Water Bond scheduled to also be on the ballot.  The water bond actually would cost about $18 billion with matching fund requirements.  Counting interest, the Water Bond would cost about $36 billion.

A Suppression Tax

Economist Carmen Reinhart states that there have been five ways throughout history that governments have reduced debt:

* Economic growth;
* Austerity plans;
* Default or restructuring of debt;
* Inflation, often surprising;
* A steady dose of financial repression accompanied by inflation.

Reinhart says the current U.S. government policy is suppression of interest rates to investors and savers in order to transfer wealth to borrowers and government.

Reinhart indicates that the “effective interest rate” — the face interest rate minus monetary inflation — is negative for about half of Treasury bill rates.  Moreover, interest rates are below 1 percent in about 82 percent of T-bills.  Meanwhile, monetary inflation is running about 3.5 percent or higher. Thus, the principal in any bank account is being eaten away by unseen tax termites.

Reinhart puts it this way:

“Unlike income, consumption or sales taxes, the ‘repression’ tax rate is determined by factors such as financial regulations and inflation performance, which are opaque — if not invisible — to the highly politicized realm of fiscal policy. Given that deficit reduction usually involves highly unpopular spending cuts and/or tax increases, the ‘stealthier’ financial-repression tax may be a more politically palatable alternative.”

We are unlikely to see any turnaround in federal monetary policy soon to change “repressive” interest rates. On March 14, the U.S. Federal Reserve announced it would continue its exceptionally low interest rate policy for another two years.

The Tax Crunch

California government and public schools have mainly only cut “fluff” out of their budgets over the past three years. There have been virtually no substantial core teacher layoffs.  With the state budget continuing to run a deficit, California government may be staring at real budget cuts to core services.  Thus, there has been political momentum within government and unions to increase taxes, but mainly on the “rich.”

But the rich, along with the middle class, are unlikely to vote for such tax increases as long as interest rates are politically suppressed to reduce government debt burdens.

Moreover, none of the major tax proposals floated by government and unions thus far has included even an iota of pension reform. Brown’s 12-point pension reform is not substantial enough, and unlikely to go anywhere.

Thus, California is probably going to have to resign itself to slow growth and further budget cuts until the debt burdens are reduced.

4 comments

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  1. Beelzebub
    Beelzebub 20 March, 2012, 18:24

    Very informative report.

    Let me add a couple things. The manipulated and artificially low interest rates are referred to as ZIRP (Zero Interest Rate Policy) that is orchestrated by the Uncle Ben of the Federal Reserve, along with the complicity of the Federal Governement. Essentially it is a tax imposed upon savers and the retired who generally depend upon income from safe fixed interest investments. With passbook savings interest rates @ 0.5% or less it is virtually impossible for retirees to invest safely and survive. Many are forced to take higher risk in bonds or the stock market – which is bound to take a steep dive sometime in the next couple years. The Apple stock encompasses a dangerously high % of the total market capital. Eventually something very bad will happen to Apple – just like it happened to Cisco several years back. And when Apple stock takes a hit – so will all stock market indexes – especially the NASDAQ.

    You see, ZIRP, the artificially low interest rates, is really theft from the average common saver and a bailout for the big corporations which receive billion dollar loans from the government @ essentially 0% interest rates and invest that money back into US T-bills picking up an easy 2% difference in profit. Savers are supposed to be rewarded. Instead they are punished and their money is being diverted over to the Too Big To Fails who own Capital Hill.

    So there you go …….. now you know the rest of the story! 😀

    Reply this comment
  2. JoeS
    JoeS 20 March, 2012, 21:05

    Cut wages, benefits, retirements at EVERY level of government.

    Reply this comment
  3. Bob
    Bob 20 March, 2012, 22:39

    There are even more taxes in the pipeline: cigarette taxes, oil taxes, gas taxes, out-of-state business taxes, and imposing reassessments for commercial property taxes every year instead of when a property resells, as is now provided under Proposition 13.

    And let’s not forget all the local tax increases. The criminal idiots on the city council where I live want to see a local sales tax increase, a sewer tax increase and a phone tax increase along with a new tax on those who sell alcohol.

    No matter how much these criminal clowns are allowed to steal it is NEVER enough.

    Reply this comment
  4. Deb McCurdy
    Deb McCurdy 22 March, 2012, 08:47

    Public schools in CA are hanging by their fingernails. The majority of them will have to file a negative budget next year if there isn’t some kind of funding infusion. $20 billion cut over the last four years. CA has the highest student to teacher, student to administrator, student to counselor ratios IN THE NATION. Right now we would have to spend an additional $60,000/year/per classroom just to catch up to the national AVERAGE. An educated work force will benefit CA for years to come. This is actually a do or die moment for CA public schools.

    The PTA/Molly Munger tax initiative, “Our Children, Our Future” relies on a reasonable, broad based, sliding scale income tax on all but the poorest. It provides a more reliable funding stream than just taxing the wealthy. So, basically, I’ll be paying the same amount of money a year that I spend on wrapping paper, cookie dough and magazine subscription fundraisers at my kid’s school — and ALL the students in California will benefit. And I know that when ALL students benefit, the entire state of California benefits down the line. My vote is going with the only initiative that is not backed by a union. http://www.ourchildrenourfuture2012.com

    Reply this comment

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