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  Nevertheless, the federal government implemented an income tax during the civil war in 1861, which was repealed ten years later.  The government again tried to implement a personal income tax in 1894, but that was repealed a year later after being ruled unconstitutional by the Supreme Court.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.

We always hear about how much CEOs are paid and how horrible it is that they can make millions while they employ people making $10 per hour.  Are they really overpaid?  If they are, how much should they make?  Is $650 million in one year too much for one person, even if they are a CEO?

Perhaps the most absurd example of CEO pay was Steve Jobs, CEO of Apple, Inc., when he was paid $646.6 million in 2007 — one year’s work for enough money to live hundreds of opulent lifetimes.  That breaks down to Mr. Jobs making a little less than two million dollars per day.  Steve Jobs was certainly paid a boatload of money and it is likely that the people assembling iPods in China for less than $60 per month were unable to share in the riches.  Were his efforts as CEO really worth almost $650 million dollars?  Of course he was worth it – and then some.  If you really analyze the numbers you may find that Steve Jobs was in fact underpaid during 2007.

In 2007, Apple saw its net income soar to about $3.5 billion, up more than $1.5 billion over 2006.  Not only did Apple increase its net income by over $1.5 billion in 2007, but the share price went from about $85 at the beginning of 2007 to about $200 at the end of the year.  When you consider that this $115 increase in the price of shares of Apple translates into an increase of about $101 billion dollars in value for the company and its shareholders, you begin to see how $646.6 million is actually a very small number.

The people hiring Steve Jobs are the shareholders of Apple, and their goal is to have Apple increase in value so they can make as much money as possible.  The reason they are willing to pay Mr. Jobs so much for a year’s work is because he is able to give them huge amounts of money in return.  In essence, Steve Jobs was paid $646.6 million to make his shareholders over $101 billion.  He made his “bosses”, as it were, more than $157 for every $1 he was paid.  For comparison’s sake, if the company you work at pays you $40,000 per year and you were as efficient as Steve Jobs, you would be making your boss about $6.3 million in any given year.  Given that situation, it may be time to ask for a raise.

Granted, Steve Jobs does not run Apple by himself, and I can all but guarantee that he has a team of some of the brightest minds in the world around him.  I can also all but guarantee that most of those people are well compensated for their efforts.  You may complain that the people in China manufacturing iPods and other Apple products for $60 per month is not fair and that Steve Jobs should take a pay cut to help them out.  There are a few problems with this suggestion:

1. The people being paid $60 per month are likely very happy with that wage, otherwise they wouldn’t do it.
2. Putting together iPods does not take as much ability or talent as running a successful corporation and deserves far less pay as the supply of people willing and able to do the job are numerous where as the number of people that can run Apple the way Jobs does it is likely one — Steve Jobs.
3. If Apple were to pay its CEO less, then Jobs would have an incentive to work for a company that recognizes his value and pays him more.   The people that would pay the price for losing a talented CEO would be Apple shareholders and everyone Apple employs.

Steve Jobs is but one example of the numerous CEOs there are in the world.  Most CEOs are like Jobs in that they are good at their jobs and deserve every bit of their pay, but there are no doubt bad CEOs that are overpaid.  The beautiful part of it all is that the only people who lose out when a CEO is overpaid are the ones hiring that CEO, the shareholders of that company, so the blame rests solely on the CEO’s boss.  You may imagine that if a CEO is paid less that other employees will be paid more, but that is not how it works for numerous reasons and it is simply never how it will be in the beautiful free market.  CEOs are CEOs for a reason; they are typically well qualified and very good at what they do.

I should note that not all CEOs are paid even close to what Steve Jobs made in 2007.  The average pay for a CEO of an S&P 500 company (500 of the biggest, most successful companies in the world) is $14.2 million per year.  Of course, CEOs of smaller companies make far less than that.

CEOs are paid by their bosses just like the rest of us.  It is safe to assume that they typically make what they are worth because no boss will want to pay their employee more than what they are worth, and if they are being paid more than they are worth they will likely be fired in a very short time.

Seems I can’t listen to a political debate these days without the term “alternative energy” entering the conversation. Even T. Boone Pickens, a well-known American oil man, has sponsored ads demanding that our government implement new standards that decrease dependence on oil and increase the use of alternative energy. Mr. Pickens and others have a point; maybe forms of energy other than oil may be cheaper and cleaner. In fact, with the necessary research such forms of energy would likely be discovered and widely used. But I ask this: Why do we need the government to regulate which forms of energy we use?

Energy should be thought of as a commodity, and if that commodity can be brought about by cheaper, better means than are already in place then those new means will inevitably be utilized in a free market. For example, if the use of ethanol was cheaper, easier, and better than the use of oil then wouldn’t it make sense for you to use more ethanol than gas? You might say that you can’t buy a car that uses alternative energy sources. Don’t automotive companies have an incentive to produce cars that use more efficient forms of energy? Wouldn’t that please their customers and increase sales? Don’t electric companies have an incentive to use the cheapest, easiest, best means of producing energy to provide to their customers? Why should the government have to demand that these electric companies move away from oil and to nuclear energy? If nuclear energy was cheaper and cleaner for the consumers then certainly the electric companies would have an incentive to provide such energy (unfortunately many energy companies are state run or at least the state will limit competition in the sector).

At no point in our history did the United States Government demand that every person creating energy had to use oil to do so. No, oil became so popular because it was cheaper, easier, and cleaner than any other form of energy at the time. The same would be true of any alternative energy sources that come to market that are cheaper, easier, and cleaner than oil.

There is no doubt that any transition away from oil as our main source of energy may be considered to be a slow one given all of the machinery and infrastructure already setup to support oil, but if that alternative energy source is so much better than oil that it should be used in place of oil, then the incentive will inherently be in place for people and businesses to move away from oil and to the new energy source. One of the most beautiful features of the free market is that it naturally replaces old, inefficient methods and products with new more efficient substitutes. There is no reason to believe that anything would be different if energy was left to the free market.

So next time you hear a politician tell you that the government has to do something about the “energy crisis”, you will know that this is just another way that they are trying to take power away from you and play big brother. Hold on to your power and let the market decide which form of energy is best. Governments create big mistakes and minor accomplishments, the market does the opposite.

Below is the most up to date draft of the U.S. Government’s “Bailout Plan”. I wanted to post this so everyone could see exactly what the government has planned. Please note that this is not the final draft and it has not been approved by Congress, but this is the draft that Hank Paulson, George W. Bush, and, though they have recently changed their tone, John McCain and Barack Obama supported.

Please pay special attention to Section 8. Please comment.

LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY

TO PURCHASE MORTGAGE-RELATED ASSETS

Section 1. Short Title.

This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.

(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

(b) Necessary Actions.–The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:

(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;

(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;

(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;

(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and

(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations.

In exercising the authorities granted in this Act, the Secretary shall take into consideration means for–

(1) providing stability or preventing disruption to the financial markets or banking system; and

(2) protecting the taxpayer.

Sec. 4. Reports to Congress.

Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.

(b) Management of Mortgage-Related Assets.–The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Mortgage-Related Assets.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.

(d) Application of Sunset to Mortgage-Related Assets.–The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases.

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding.

For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Sec. 9. Termination of Authority.

The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt.

Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform.

The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions.

For purposes of this section, the following definitions shall apply:

(1) Mortgage-Related Assets.–The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.

(2) Secretary.–The term “Secretary” means the Secretary of the Treasury.

(3) United States.–The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.

On Monday, September 15, 2008, Henry (“Hank”) Paulson, the Treasury Secretary (bald guy you’ve seen on TV talking about the economy), announced that although he felt it was necessary to bailout Bear Stearns and outright take over Fannie Mae and Freddie Mac, that the government was getting out of the business of takeovers and bailouts.  He announced that the government would not come to the aid of Lehman Brothers as they filed for bankruptcy and that no government money would be given to AIG – that it “has got nothing to do with any bridge loan from the government. What’s going on in New York is a private sector effort.”  Mr. Paulson nobly went on to state, “I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.”  Perhaps one of the most admirable statements that Paulson made was, “We’re very vigilant, but we do not take, and I don’t take, lightly ever putting the taxpayer on the line to support an institution.”

Transcript here: Paulson Transcript

After hearing this speech I was somewhat pacified, I thought that Paulson, Bernanke, and Bush had determined that there had been enough government intervention and that the United States would resume its free market activities.  I went to bed relatively pleased on Tuesday night.

As I walked into the office on Wednesday morning I saw that I was the first one to arrive and picked up a copy of the Wall Street Journal outside.  As I unrolled it in my office I soon realized that I had been misled, the headline in bold lettering on the top of the front page read, “U.S. Plans Rescue of AIG to Halt Crisis; Central Banks Inject Cash as Credit Dries Up.”  Paulson had lied about the federal government not providing a bridge loan to AIG, which had become clear.  The U.S. Government is to lend AIG $85 billion to be repaid within 24 months.  But that is not all, the U.S. Government also assumed an 80% stake in AIG – meaning the company is now owned and operated by the United States of America.  This after the government had already nationalized Fannie and Freddie.  The U.S. Government has officially begun nationalizing what were previously private companies – the first step toward socialism.

If it were to end there then I would hope that there would be widespread outrage among the public, but nothing worthy of panicking over, just some disgruntled seekers of liberty.  Unfortunately it doesn’t end there . . . it doesn’t even come close to ending there.  Paulson, Bernanke, Bush, and apparently most of the legislative branch are now pushing hard for a $700 billion general bailout package.  In this package the government would essentially buy assets for much more than they are worth from struggling financial institutions and other companies.  In return, the government would receive shares in each company that took part in any transaction and the government would hope that the assets would appreciate in value and be sold at a later date.

Read story here: WSJ Article

In addition to this, Henry Paulson has taken it upon himself to advise that the legislative branch and the president give him absolute control of the $700 billion to be distributed as he sees fit without any interference from the courts or any other branch of government.

Read story here: Bloomberg Article

Hank Paulson essentially wants to have a $700 billion account to go around buying assets and companies for the U.S. Government on his own authority with no checks or balances.  The problems with this are glaring.

The scary part of all of this is that everybody in the media and in the legislative branch seem perfectly content with everything that is being suggested.  Let us consider the magnitude of $700 billion for a minute.  The value of Microsoft, General Electric, and Toyota combined is less than $700 billion.  The U.S. Government could purchase almost every major financial institution for $700 billion.  To put it another way, it is about $2400 per person in the United States – young or old, rich or poor – almost $10,000 for a family of four.

Perhaps most important is the question, “Where does all of this money come from?”  Well, the same ways the government gets all of its money, by taxing citizens and by creating inflation (see inflation article on riseofreason.com).  Whether or not you agree with this plan, you will end up paying for it, every American will, rich or poor.

For those of you that believe this measure will help “Main Street” America and that spending our tax dollars is worth it, consider this: everybody in the United States will be responsible for paying for this, no matter how rich or poor you are, but it will only seriously benefit the very wealthy.  The government will be buying assets that are held by the wealthiest people in America via large financial institutions.  These people’s stocks, bonds, and other assets will be propped up to values that are nowhere near what the market would pay and the entire country will have to pay the tab.  If you are trying to help the average American, this is not the way.

Any of various theories or systems of social organization in which the means of producing and distributing goods is owned collectively or by a centralized government that often plans and controls the economy.  That is the definition of socialism.  This is where we are headed.  Socialism is the exact ideal that is supported by all of these bailouts.  Socialism will destroy America if we continue on this path.

You may think that the government will keep its word and sell off these assets for more than they bought them for and sell off AIG and all of the other companies it has bought and will buy after the market “stabilizes”.  You may think that.  Given what the government has told you, it would be nothing less than reasonable to think that.  But if you have lived long enough or studied hard enough the actions of government and the history of such blatant interferences with the free market you will know that the reversal of such acts is damn near impossible.  Take my word, Fannie, Freddie, and AIG will be government owned for as long as we are alive, and so will any other companies that the government nationalizes after this day.  Fannie and Freddie own between 60% and 70% of the liens on residential properties in the United States and AIG is the largest insurer in the nation.  The government has taken large steps to gain more power and have a better hold on every person’s life in this nation.  Perhaps I am early to sound the alarm of impending socialism, but if this nation continues on the path she is on today we will all be dreaming of yesteryear.

Long live the free-market and liberty in these United States of America.

I’m sure most of you are aware of the fact that on Friday the SEC effectively banned short selling of about 799 financial stocks. But I’m not sure whether or not people are actually aware of the unintended consequences of doing so. Everyone sees the headline of “Dow soars” and “Nasdaq rebounds”, but through their positive reactions to the SEC ruling, it is pretty evident that most people are in the dark in terms of what it actually means.

Two points stand out above the rest:

1. The rally really wasn’t a rally – it was just the fact that every short seller had to cover their position. If you look at the technicals of the trading and a chart of the trading, the rally was simply a “gap up” in the mornings. What this means is the rally wasn’t volume driven, it wasn’t as if a stock traded up to 70 from 50 slowly throughout the day. The opening bid of the biggest gainers was pretty much where it ended up for the day. It wasn’t as if people were “more willing” to buy and to “pay more” per share of stock as the news media would have you believe, but it was people were “less willing” to sell (primarily because it was now illegal in many cases).

2. The banning on short selling of financial stocks creates massive massive mis-pricing. Case in point: Merrill Lynch being acquired by Bank of America for .86 BAC shares per MER. Their respective closing prices were as follows: 37.48 BAC and 29.5 MER respectively. This means that (ignoring all time value of money arguments and built in risk), Merrill Lynch should be trading at $32.23 per share. That reflects roughly a 10% discount to which the deal was valued and agreed upon. This may not seem shocking, but it is considering the deal is expected to close within 4 months and there is little to no resistance to the deal since it has strong Fed and government backing. So what causes this?

Well, the quintessential arbitrage trade here would be to short Bank of America shares and to long Merrill Lynch, but oh wait, you can’t short Bank of America shares anymore! So the only thing would be to long Merrill Lynch, but all this would really do is potentially inflate an asset simply because it is pegged to another inflated asset… all in all, creating massive amounts of mispricing.

Are there ways around this? Sure, you could always buy put options on the asset and I suppose put options is the new short sell, but it’s clearly not as effective a means of hedging.

Yet again, this is simply another example of how the federal government is trying to have all the benefits of capitalism and trying to use government intervention to prevent any of the “necessary destruction” of capitalism from occurring. But, the essence of capitalism is the idea of creative destruction which “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one” (Schumpeter).