President-Elect Obama is literally bringing back a type of draft:

“The Obama Administration will call on Americans to serve in order to meet the nation’s challenges. President-Elect Obama will expand national service programs like AmeriCorps and Peace Corps and will create a new Classroom Corps to help teachers in underserved schools, as well as a new Health Corps, Clean Energy Corps, and Veterans Corps. Obama will call on citizens of all ages to serve America, by developing a plan to require 50 hours of community service in middle school and high school and 100 hours of community service in college every year. Obama will encourage retiring Americans to serve by improving programs available for individuals over age 55, while at the same time promoting youth programs such as Youth Build and Head Start.”

This is truly unbelievable and so ominously indicative of what other steps he may take down the road to serfdom.

HT: Great Mankiw

“Economics isn’t chemistry. You can take any theory you’ve got. If people think it’s going to work, it will work. If they don’t, it won’t.” – Anonymous

While the American people deal with a present-day waltz of government intervention with the wealth they generate, it might be a good time to take a look at when this dance really picked up the beat. The year was 1971 and the president was R.M. Nixon.

The country was suffering from a disturbance of its industrial base, and consumer confidence by August 1971 was at a historically low 55%. Inflation was getting out of control, and unemployment spiraled toward double digits. Labor strikes at ports were causing supply disruptions throughout the country. The dollar was still backed by the gold standard of the internationally agreed Bretton Woods system, and thus pressure was on to devalue the currency. The economic picture was bleak, and Nixon,

who wasn’t one to act until the warning signs were breathing down his neck, decided to deal a heavy hand in swiping the problem away.

His solution to the suffering was worked out behind closed doors at Camp David with some of his closest advisors and consisted of three major parts:

1. Any foreign-owned US dollars would no longer be backed by the gold standard nor would be the base currency for international monetary dealings.

2. All prices, wages, and rents would freeze for three months.

3. All foreign goods imported would be subject to a 10% surcharge to be passed onto the consumer.

This move was widely lauded by economists throughout the world as a step in the right direction. They believed with these actions, the US dollar would strengthen, inflation could be curbed, and US goods would become more attractive to domestic shoppers because they weren’t subject to the tax. The 90 days of price wages would at least give the country a little bit of time to think over how it had come to this point. By 1971, high inflation had become part of the daily routine, with a lot of the cause coming from powerful labor unions and a slightly looser money supply. As unions demanded cost of living wage increases, the price of goods increased, causing the overall savings rate to skyrocket. Consumers became uncomfortable with the higher prices. Productivity had also decreased due to labor strikes and shortages. Stagflation was beginning to take hold. The disarray was palpable, and Nixon, never being shy in orchestrating himself as a leader and savior of the United States, decided that he must act. So what happened?

For starters: epic confusion. In Nixon’s speech to the nation, he stated that there wouldn’t be an overreaching bureaucracy in charge of enforcing the price and wage controls but that it would be up to the “voluntary cooperation of all Americans.” A few labor unions had it in their contracts, drawn up long before

Nixon’s plan, that a raise would take place somewhere in the middle of the 90 days of controls. Their “voluntary cooperation” was in question. In addition, many of the influential labor union leaders of that time saw the price controls as a business-oriented instrument at the expense of the working man despite its efforts to whip inflation. Strikes would continue despite Nixon’s protests. Productivity remained low.

So what was the outcome after the baffling 3 months of price controls in the fall of 1971? Very little. While the nation might’ve felt a little more confident in itself that it had sucker punched inflation by creating inefficient markets, supply, demand, and consumer confidence remained historically low.

The blatant heavy handedness of the republican Nixon administration distinctly parallels the current Bush administration with the exception being that Nixon preached that with government at the command, the economic crisis can be solved. Bush, Paulson, and most democrats and republicans alike preach that with government ownership, the economic crisis can be solved.

The theme is this: When people have nothing else to fall back on, suddenly, it’s the government that can provide us with the answers. Two of Nixon’s unrealized programs (partly unrealized due to America’s then-pitiful economic health) were a universal minimum income and universal health insurance, ideas that, while quite noble in theory, sound decidedly socialist and ripe for failure.

Admittedly, the problems and solutions for 1971 are different from today’s, however, it remains that there’s only so much the government can do to alter the will of the marketplace. The government longs for optimism in the markets. Why should an efficient, optimistic market take instructions from the inefficient unmotivated government? In turn, this bailout should immediately help the large companies, while alienating 300 million consumers.

When government has taken their cut off the top, and the people are outraged; careful now.

There are no shortages of economic fallacies among the mainstream media. Political pundits are so eager to opine on every possible issue despite of their own intellectual shortcomings. These pundits often epitomize the intellectuals who only judge on what is seen.

Few have been as appalling on the issue of oil prices as Bill O’Reilly. O’Reilly has engaged in a hyper populist crusade against Big Oil, speculators, and their alleged price gouging. For months he has been decrying the record profits of big oil and their incessant exploitation of the little guy.

After President Bush announced that the ban on offshore drilling would be lifted, oil prices dropped immediately. Bill asked, how can this be? No additional oil has entered the market. This obviously can’t be simple supply and demand. No this must be price gouging.

This is an issue that has become increasingly frustrating for me. In order to end it once and for all, I am going to present the simplest and most easy to understand analogy.

Price are not determined by how much supply is currently in the market, they are determined by how much supply is expected to be in the market.

How can this be?

Suppose Elton John is coming to town. You love Elton. I mean you really love Elton. There is nothing more you could want than to see him rock out. The problem is that all the tickets are already sold out.
You are desperate so you approach a ticket scalper to remedy your situation. He offers you a ticket at $100 a piece. You know that this is a little steep- only a few days ago prices were $85 from the scalper and a week ago $50 from the actual concert venue,. But demand is high and supply is getting lower and lower and you reluctantly agree.

Right before you hand over the money your best friend calls you and says, “Guess what! The Rocket Man is going to release 5,000 more tickets tomorrow at $50!”

So what do you do?

Do you buy the ticket at $100 or $50? The very instant that you received the price information the market price for tickets dropped. Tickets went from $100 to $50 in an instant- even though no additional tickets have entered the market that night. The supply remained unchanged and the market price changed even though no tickets have even been printed yet! How can this be?

It happened because prices are not determined by the physical supply of goods, but by the expected supply. It didn’t matter that the tickets had not yet entered the market; you knew they would and therefore reasoned accordingly.

Oil is much the same way. When a ban of offshore drilling is lifted, it signals to the market that supply will increase. Speculators will want to avoid losing money and bet that the market prices will began to drop and firms that purchase future contracts will do so at a lower price.

It always comes back to the fundamentals: supply and demand. It always comes back to seeing what is the unseen…

Thank you Bastiat.

Over the past century, there has been an unprecedented shift in power from the states to the federal government. The idea of 50 relatively autonomous states under the blanket of the federal government has completely been thrown out the window. Go to another state and you will see that there are tremendous differences in the people; their ideologies, their “typical” jobs, their culture, and even their demographic make-up. Yet, you will always find that one relative constant: all of them have essentially the same laws, income taxes, and government services. Now, how does it make sense for the same set of “one size fits all” rules and regulations to apply to 300 million people who are all incredibly diverse in their needs and wants.

It doesn’t.

It breeds inefficiency. If there is one way to describe the federal government, it would be inefficient. If you are a congressman from a state, and a potential project is being talked about in congress, you will push your hardest for it to pass… even if the costs outweight the benefits. The reason for this is you are really only paying 1/50th (for simplicity sake, I’m assuming all 50 states are the same size tax revenue wise) of the cost. This may not seem like a huge deal, until it happens over and over again and all 50 states are doing it. The bottom line is there is absolutely no incentive to reduce spending since all the costs are spread around.

Imagine how much more efficient and strong our economy would be if each state could specialize in the needs and wants of its citizens. This was the original idea of the whole 50 state system! It allowed for each state to set its own rules that fit its own people. It was a brilliant idea, and it still is. The idea that we could have 50 states each competing with each other economically and ideologically for people, and competition drives efficiency. For example, states would have incentives to actually reduce spending, not only because they are paying the whole 100%, but also, the more they save, the more they can reduce taxes or provide services to its citizens.

The fundamental concept behind the free market is that no transaction occurs unless it benefits both parties. This is a concept that is violated over and over in our country. People are paying taxes for services that they do not want and they are not receiving services that they are willing to pay for. Under the “original” concept of the United States, the taxpayers actually had a voice… which today has been reduced to the faintest of whispers. Sure we can determine the President, our congressmen, but can we really drive our politicians to change? I would argue we have very little impact, because of how un-localized our voices are. The more local and specific your voice is, the stronger it is. A single voice among 300 million is quite miniscule, but a single voice within a single state is magnified by about 50x.

To be honest, I’m getting sick of everyone talking about how “Washington is broken”, because it reminds me of just how far we have fallen away from the original founding principles of the country. I’m not angry that Washington is broken, I’m angry that people aren’t questioning when Washington became the sole decider of all things American. When is the last time you heard someone say “Albany is broken” or “Phoenix is broken” or “Olympia is broken”. Chances are it has been a long time. In fact, state capitols have become such a figurehead name and they don’t even have any importance in the grand scheme of everything (to test this, try naming all 50 capitols… I had enough difficulty naming 3). Well, at least relative to their intended importance set forth by our founding fathers.

I love the idea of the United States of America. Fifty states all operating independently but under one united entity. But, I fear that over the past century the fifty states are no longer operating independently under one entity, but they have become one entity. Being united is great, but not when it comes as a Washington mandate.

Imagine for a minute, that you’re a middle aged guy in the southern Orange County enclave of Monarch Beach, California at the St Regis Hotel and Spa enjoying a back massage from an attractive, busty Swedish female in a tight white golf shirt and curving white pants. You’re on an expense account with your colleagues, living the life you dreamt about as an early 20s college grad. All those years of school, all those reports, all of those business meetings you slogged through, have culminated into this climatic high of total relaxation and visual pleasure. You deserved it, you think.

On the other hand, the company that is sponsoring this trip is on the brink of losing one of its key businesses that insures mortgaged back securities. That company is AIG. Should you be on this business trip at all? It his just some selfish indulgence? Let’s briefly review what exactly AIG does today to help answer this question.

AIG is a diverse multinational conglomerate that has over $1 trillion in assets and almost $80 billion in equity. They sell almost any insurance you can possibly imagine and they have side businesses as well; anything from leasing planes to ski resort ownership.

As you perhaps know, AIG was hemorrhaging money in their insurance of mortgage-backed securities, sometimes called credit default swaps (CDS). This was an investment, a bet if you will, that AIG offered to people in hoping that certain mortgages would not be paid and go into default. In the wake of the current mortgage crisis, many people are now owed money off of homeowners defaulting, and as such, AIG has been paying out a lot of money, to the tune of $18 billion over the last three quarters.

With this large loss, AIG asked for help from the federal government to shore up their balance sheets, and on 16 September 2008, Treasury Secretary Henry Paulson with the help of his friends at the United States Federal Reserve extended to AIG an $85 billion bridge loan if they needed it. The terms of this loan are highly unfavorable to AIG: Interest rate of 8.5% on top of the 3-month LIBOR rate, which hovers somewhere around 4.5%, in addition to the feds seizing almost 80% of AIG’s equity and using virtually all of AIG’s assets as collateral. Since then, the federal government has made available an additional $37.8 billion. Since 3 October, AIG has drawn $61 billion from the government’s loan.

Contrary to my libertarian leanings, I think this loan was a great opportunity both for the United States government and AIG. The unfavorable terms of the loan give AIG motivation to become a more streamlined business. If AIG eventually fails, then the government will be the owner of their trillion dollars worth of assets, many of which are quite profitable.

But right now I’d like to get back to the ethics of spending $400,000 of company money on a resort vacation weekend in Southern California. One of the ironies of all of this, is that the money was being spent in an area that was hard hit by the mortgage crisis. At least they are flowing money to the local economy. Practical amusement aside, many people in the general public met this story with immense outrage.

Anderson Cooper dedicated almost 35 minutes of his program to it. He wants to “keep ‘em honest.” Local news in Houston led the newscasts with people on the street interviews expressing outrage. But, in fact, I think a lot of the outrage is rooted in the primitive emotions of jealousy. The company sponsored the trip before the government loan, and the persons who went on the trip were part of their life insurance business, which is based out of Houston, Texas, not even in the same stratosphere as the CDS business based in New York.

Sure, $400,000 is an extravagant amount to spend on a week of vacation for high-performing executives, but who are we to say that they didn’t deserve it? It is ultimately up to AIG how they want to spend the money the government gave them. If they want to depreciate their assets by blowing $400 grand on a week in California, so be it. It’s either their gain, or their loss.

And it’s apparent from the terms of their loan, they have much to lose.

I’ve found that people seem to take the income tax in America for granted.  It seems to be that everyone just takes it in stride and figures that it is necessary.  I’ve even heard a great deal of people refer to paying your income taxes as “patriotic.”  Joe Biden went as far to say that paying more income taxes is patriotic.  What does an income tax really represent?  How and when did Americans begin to be taxed on their incomes by the federal government?  These are simple questions that have complex and frustrating answers.

It turns out that our original Constitution specifically prohibited a personal income tax in a bit of a round-about manner.  Nevertheless, the federal government implemented an income tax during the civil war in 1861, which was repealed ten years later.  The government again tried to implement a personal income tax in 1894, but that was repealed a year later after being ruled unconstitutional by the Supreme Court.  It took until 1913 for Congress to finally legalize a personal income tax on American citizens, and they had to add an Amendment, the 16th, to the Constitution to do it.

The first federal personal income tax in the modern era was in 1913 an amounted to 1% of earned income for everybody earning under $20,000, which in today’s dollars would amount to over $400,000.  People were only taxed the maximum amount of 7% of earned income if they made over $500,000, or about $10.4 million in today’s dollars.  By comparison, for 2008 the federal personal income tax schedule has persons making under $32,550 paying 15% on their taxable income and the maximum tax rate of 35% kicked in at $357,700; quite the difference from 1913 when you only had to pay the maximum rate of a whopping 7% if you were obnoxiously wealthy.  The maximum tax rate did rise during World War I all the way up to 77% in 1918.  However, people were only taxed at that rate for income exceeding $1 million, or about $14 million today.

Personal income taxes stayed relatively low – never exceeding 5% of earned income for most people – until our old friend Franklin Delano Roosevelt came into office. Though he is thought of as defending the poor, he boosted the lowest tax rate, for income under $2000 (about $23,000 today), to the highest rate it has ever been, 23%.  Following that time, the lowest it has dipped is 11% and it stands at 15% today.  Another remarkable event that took place in FDR’s term in office was the level for the top income tax bracket came down drastically.  In 1941 the top income bracket was taxed 81% for all income exceeding $5 million (about $70 million today).  In 1942 FDR changed this bracket to 88% for all income in excess of $200,000 (about $2.5 million today).  Two years later it would jump up to 94% for about the same level of income.  Granted, this was a time when the United States was engaged in World War II, and during such times taxes and government spending understandably get out of control.  The problem is that income taxes never came down much from that time, and the level at which you entered higher brackets kept falling.  The funny thing about taxes is that the government can tell you that they are lowering them and they will lower the rates, but they will also lower the bracket levels, so in essence everybody ends up paying more because although their old bracket has a lower rate, they are in a new bracket with a higher rate than they were paying.

So we know how the personal income tax came to be what it is today, but there is much more to a personal income tax than we typically care to consider.  There is a reason that the authors of the Constitution prohibited the direct taxation of people’s income by the federal government.  The United States Government is essentially asserting that it owns you and your production, so you must give a portion of anything you produce to the government.  An income tax is not given voluntarily; it is directly withdrawn from your paycheck or else has to be paid at the end of the year.  If you are under the notion that you and your production are under the ownership of the United States Government then this article is of little use to you, but if you feel that you own your production then the income tax must be seen as absolute theft.  Should you decide that you feel you wish to keep more or all of what you produce then men with guns will come and force you to give your money to the government or spend your time in a jail cell.  If you do not believe that these men with guns will come then try not paying your taxes for a long enough period, and you will undoubtedly be encountered by armed men to drag you to jail.

One obvious problem with the income tax is the socialistic ramifications of it.  We always hear people suggesting more progressive tax systems, but if you look at the statistics, our tax system is already wildly progressive (meaning the rich pay more than the poor.  For example, the top 1% of income earners in the country pay more than 30% of the income taxes.  The top 25% pay more than 80% of the taxes.  The top 50% of income earners pay more than 96% of all income taxes in the United States.  It would be difficult to institute an even more progressive tax system than the one we already have.  In essence, the poor are having their lives subsidized by the rich – one of the cornerstones of socialism and a recipe for a failed society.

Another problem with the income tax are the resources associated with collecting it and avoiding it.  Every year billions upon billions of dollars are spent by people and companies to avoid paying more taxes than they absolutely have to and equal amounts of money are spent by the IRS in an effort to collect income taxes.  The budget for the IRS in 2008 is $11.1 billion.  All of this money spent by companies and the IRS is complete waste.  These are essentially transaction costs for a tax system that, if it must be in place, should be much more efficient.  This is a good case for a straight flat income tax, if we have an income tax at all.

Perhaps the most severe and threatening problem with the income tax is that it discourages production.  The lower income earners do not pay taxes, so every dollar they make they get to keep.  On top of that, the lower income earners are able to take advantage of many valuable government handouts.  As people earn more money in the lower income levels they experience a phenomena where even though their paychecks are higher, they are not able to spend anymore money because there are less government handouts for their income level.  As they move even further up the income ladder, they are faced with increasing amounts of every additional dollar earned being taken away from them.  At the 35% income level people are essentially faced with the predicament that you can only keep 65 cents of every dollar you earn.  As such, they really only have 65% of the motivation to make that next dollar than they would have otherwise had if there were no income tax.  To have a system that directly discourages production within a nation is entirely counterproductive and is the converse of what was intended by the founders of this nation.

Nations that have lowered their income tax rates (i.e. Ireland until lately and Hong Kong) or abolished it altogether (i.e. Dubai) have seen tremendous economic growth and prosperity.  Dubai has moved from having its people live in squander to being one of the wealthiest nations in the world.  Most of this, if not all, can be attributed to laissez fair government and no income taxation.

The more you know about your rights and your history the less power the government has to take from you.  Income taxes are one of the most counterproductive measures instituted by our government and must be scrutinized very quickly.