Anatomy of the Negative Income Tax

Manhattan Institute Scholar and author Guy Sorman has published an illuminating examination of the negative income tax (NIT) entitled "Why Not a Negative Income Tax? Replace the Welfare State with Cash Subsidies for the Poor."

The article notes that the federal welfare apparatus alone cost $522 billion in 2008, growing every year, and that does not even count all the welfare agencies and bureaus at the state and local levels. Further, as economists and other observers have pointed out, welfare has an "infantilizing" impact on recipients, because they are subjected to government oversight and direction of their food purchases, housing choices, child rearing, and many other areas of their lives.

Instead, the great economist Milt Friedman (whose ideas we have highlighted in these pages many times before, such as here and here) proposed replacing the welfare state with the negative income tax. While the concept of a negative income tax may sound shocking or confusing at first, it is actually quite easy to understand, and Professor Sorman explains it very well in his essay, and then explores its many advantages over the current welfare system.

We certainly aren't advocating an increase in the scope and power of the IRS or in levels of taxation (a subject we have covered extensively in previous posts). However, while recognizing that there is no perfect fix to any problem of this magnitude, we do believe that the concept of the NIT deserves careful consideration.

This is an extremely important subject, as the cost of the welfare state is so huge that we have previously called it "The question of our time." The costs of the welfare system are among the primary drivers of calls for higher taxes and austerity plans, both of which can act to throttle economic growth.

We applaud Professor Sorman's excellent examination of the negative income tax, and suggest that all investors become familiar with this issue.

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For later posts on this same subject, see also:

• "The question of our time, continued" 03/14/2011.

• "In defense of the politicians" 04/07/2011.

• "The silver lining to the S&P change in outlook" 04/19/2011.

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Morning investment comments from Gerry Frigon

Catch Taylor Frigon Capital Management's President and Chief Investment Officer Gerry Frigon live every morning at the opening bell on KCOY television's "Your Money." For investors outside the Central Coast area of California (from Santa Barbara to Monterey), those segments can be found on the internet at KCOY's website.

This morning, in the clip above, Gerry discussed the importance of the end of the mark-to-market accounting fiasco, which we have discussed on this blog in numerous previous posts stretching back to March 2008 -- see here, here, and here for more details.

The subject is also related to the "ideology of modern finance" that we discussed in this previous post, an ideology with which we strongly disagree but whose adherents believe (in the words of authors and investors -- and fellow critics of this modern financial ideology -- Andrew Redleaf and Richard Vigilante) "it is dangerous to even try to out-figure the all-seeing market on price or value." Those who supported mark-to-market are now raising howls of protest, and at the bottom of their arguments is that erroneous belief that market prices are always right (a version of the efficient market theory) -- an assertion that is just plain wrong.

To see previous editions of Gerry's morning commentaries, check out the videos below.

Monday, February 7, 2011

Friday, February 4, 2011

Thursday, February 3, 2011

Wednesday, February 2, 2011

Tuesday, February 1, 2011

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The foundation of freedom is primarily economic, not political

Venture capitalist Bill Frezza has published an excellent essay today entitled "Egypt needs free enterprise more than democracy." In it, he refers to and expands on the insights published by influential economist Hernando de Soto last week in that author's Wall Street Journal editorial entitled "Egypt's economic apartheid," which catalogs the lack of property rights in Egypt and the numerous obstacles to starting any kind of business there.

In his article, Mr. Frezza argues: "The deepest malady afflicting the Egyptian people, and most other underdeveloped countries for that matter, is not lack of the vote. It's the inability to open a bakery without spending two years hacking and bribing through a bureaucracy designed to stomp on independent businesses."

Agreeing with Mr. Frezza, which we do, does not mean that one does not think democracy and a vote are important human rights, which we do as well. The important point that he is making is that without economic freedom, the trappings of political freedom (including the vote) are meaningless. In other words, the foundation of freedom is ultimately economic, rather than political, and that is a very crucial point (and one that many who do enjoy freedom sadly do not understand).

We have argued this point last year, in this post entitled "Jefferson on economic freedom," in which we quoted Thomas Jefferson on the subject, as well as George Gilder, who made the argument this way:

"Elections -- counting heads rather than breaking them -- are a prime tool of democracy, but hardly its essence. [. . .] Elections every day would not make a democracy of a society in which the decisive political forces are teenage gangs with guns and terrorist courtiers doling out foreign aid to an intimidated populace. No tenable theory of democracy allows the majority to destroy or expropriate the minority. Without a functioning and legally protected capitalist system, democracies swiftly sink into ochlocracies. Without the independent private sources of power imparted by free businesses, unbiased courts, and other institutions of economic order, any democracy becomes a despotism ruled by any tribe of thug politicians that manages to gain control" (the Israel Test, 224-5).

We're in good company when we make this argument. Thomas Jefferson was heavily influenced by philosopher John Locke (1632 - 1704), who made the exact same argument. Locke believed that property rights are a natural human right (along with life and liberty), and went so far as to say that "government has no other end, but the preservation of property."

In his Second Treatise on Government, Locke argued that if the power of the government (even if democratically elected) is used to seize people's property or harass their persons, it is nevertheless a tyranny, while a monarchy that secures life, liberty and property is far more free. He wrote:

"'Tis a mistake to think this fault is proper only to monarchies; other forms of government are liable to it, as well as that. For wherever the power that is put in any hands for the government of the people, and the preservation of their properties, is applied to other ends, and made use of to impoverish, harass, or subdue them to the arbitrary and irregular commands of those that have it: there presently becomes tyranny, whether those that thus use it are one or many" (paragraph 201).

These principles are very important to understand, especially in light of the current events in the Middle East.

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George Gilder lights the beacons of Gondor!

Anyone who has seen Peter Jackson's epic cinema adaptation of J.R.R. Tolkien's Lord of the Rings cannot fail to remember the visually stunning and dramatic scene in the third movie -- the Return of the King -- when the beacons of Gondor, an ancient alarm signal used to call for aid in the event of dire emergency, are lit. One by one the beacons flare up along the mountain range between Gondor and Rohan, leading to a crisis point of decision by the King of Rohan, who must decide whether or not to heed Gondor's call.

In the movie (in something of a change from the original text), the character of Gandalf -- one of the few to perceive the big picture, whose warnings are often dismissed or mocked by those who should listen to him -- is instrumental in the decision to light the warning beacons.

Recently, the far-seeing American author and technologist George Gilder has published a warning of similar urgency, presenting leaders with a similar crucial decision. In "The California Green Debauch" he expands on the arguments of his Wall Street Journal editorial of November of last year, and explains why the destructive "green" movement could directly cripple future economic growth, technological advancement, and ultimately the main bastion against totalitarianism in the world for the past sixty years, US military superiority.

In the article, he makes an eloquent argument for the importance of the venture capital mechanism for connecting capital with innovation, and says plainly: "Most people do not grasp the centrality of venture capital to the US economy. All the key technologies that support US wealth and power were developed by companies crucially supported by venture capital companies in California." George in fact believes that the venture capital industry is America's most important asset because the connection of capital with innovation has been directly responsible the nation's "technological leadership, military power, and roughly a fifth of GDP."

It is a hard-hitting piece that pulls no punches. We believe every investor should read it and understand it. More importantly, like the beacons of Gondor, we believe it is a warning of utmost urgency, and one that calls for difficult decisions, and ultimately for action.


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Professor Walter E. Williams on the origins of conflict

Every investor should become familiar with the work of Professor Walter E. Williams, the John M. Olin Distinguished Professor of Economics at George Mason University. He is the author of six books, one of which was made into the PBS documentary series Good Intentions, as well as a host of articles and publications and an ongoing syndicated column.

Recently, Professor Williams published a very insightful column entitled "Why We're a Divided Nation."

In it he notes that, while people may have passionate loyalties to various lifestyles and products, one rarely hears of conflict until government steps in to privilege one group at the expense of another.

He asks: "When's the last time you heard of rock and roll lovers in conflict with classical music lovers, or Mac lovers in conflict with PC lovers, or football lovers in conflict with golf lovers? It seldom ever happens. When there's market allocation of resources and peaceable, voluntary exchange, people have their preferences satisfied and are able to live in peace with one another. Think what might be the case if there were a political decision of whether there'd be football or golf watched on TV, whether we used Macs or PCs and whether we listened to classical music or rock and roll."

This is a profound insight, and Professor Williams follows it up by drawing the link between government's privileging one group at the expense of another and the larger concept of the "zero-sum game." We have written extensively about the zero-sum mentality, and its connection to investment questions, for example here and here.

It strikes us that this subject is incredibly important for investors to understand, particularly in light of the recent conflict in the Middle East. Much (but not all) of the conflict in the Middle East is in fact related directly to what Professor Williams is discussing, in that the doling out of "aid" by the United Nations often ends up pitting one group against another, and the doling out of wealth by autocratic regimes within countries such as Egypt tends to create the same result.

We won't go so far as to say that reducing the impact of government will turn all groups as peaceful as the situation in which PC-lovers and Mac-lovers have passionate views about their products but feel no need to kill each other. Given the opportunity, some people will always seize what belongs to others by violence, and this fact is why the rule of law is always necessary before the benefits of free enterprise can ever hope to arise.

However, Professor Williams is absolutely right about the deleterious impact of zero-sum thinking, and the potential for government interference to create zero-sum conditions where none need to exist. Free enterprise will never create a situation in which armies and police forces are not necessary to maintain the rule of law (since free enterprise cannot operate without the rule of law). With that understanding, however, reduction of government interference can go a long way towards removing zero-sum conditions and the conflict that they create.

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