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GOP’s Contract With America will strengthen country

The Republican takeover of Congress and the implementation of the Contract With America bodes well for investors, for business and for all Americans. A majority of Americans gave control of both the House and the Senate to Republicans because voters wanted this Contract With America, which includes the following:
–a balanced-budget amendment
–a line-item veto
–reduced capital-gains tax and inflation indexing
–expanded IRAs
–increased estate and gift-tax exclusion and
–a middle-class tax cut.
This program, in general, is good for investors. Predictably, some people hate it. Why? Because some believe that people should not earn too much money, and if they do, they should be more heavily taxed in order to equalize income distribution.
This line of thinking continues that investors should not be allowed to make any more money than they already have. Therefore, anything that increases an investor’s wealth is bad, and anything that increases an investor’s taxes is good.
But who are all these money-loving, greedy, self-centered, avaricious, selfish investors? (Let’s form a posse and find them. If we can’t tax them any more, then we’ll solve the country’s problems and just shoot them.)
Uh oh. We have a problem, because virtually all of us are investors. Anybody with a savings account, a mutual fund, an IRA, a Keogh account, a pension plan or a profit-sharing program is an investor.
Many of us sure don’t feel like investors when we’re stretching to make ends meet, when we have too much month and too little paycheck. We especially don’t feel like investors when we have to borrow to buy things. But when we do borrow, keep in mind that we are borrowing from an investor. The bank or lending company is just an intermediary.
An introductory economics professor taught me that you can really only do two things with money (this was quite a revelation to me, as I could envision roughly 2 million things). In his words, money can only be consumed or invested. In my words, money can only be spent or saved.
People tend to spend a lot when they are in their 20s and 30s, begin to save (invest) in their 40s, and really start saving in their 50s in anticipation of retirement. Decades ago the main investment vehicle was the passbook savings account, but now the average person is a lot more sophisticated.
The news media likes to portray Wall Street as a place very distant (and very removed) from Main Street, and which is inhabited by very different people. In fact Wall Street and Main Street are now almost one and the same. Whereas decades ago there were a relatively small number of individuals who invested in the stock market, today most Americans own a portfolio of stocks and bonds directly through their mutual fund, Keogh account or IRA, or indirectly through a pension plan.
There is approximately $2 trillion invested in mutual funds, Keogh accounts, IRAs and pension plans, and these retirement plans invest in stocks and bonds with the expectation of generating a return for investors. And these investors are us.
So when a program is characterized as good for investors, remember that the beneficiary is all of us.
Now let’s assume some tax provision is good for investors; the investor will make more money as a result of it. Contrary to the school of thought that this is bad because that greedy investor is getting wealthier, this is actually good because the investor can only do two things with this incremental wealth: spend it or invest it. If the investor spends it by buying something, people will be put to work engaged in the manufacture of the item sold. If the investor decides to invest her new wealth, the recipient of that investment will (should) use it wisely to increase wealth, which usually involves putting more people to work.
But what is the difference between allowing an investor to keep some more of her money, or taxing it and giving it to the government? After all, the money has to go somewhere. The difference is the investor will spend it on something that makes economic sense, whereas the politician will spend it on something that makes political sense. These rarely intersect. For example, rail passenger service provided by Amtrak may make political sense, but it does not make economic sense.
So what does all of this have to do with the Contract With America?
Everything. The Contract With America will make investors better off. When investors are better off, business is better off. When business is better off, people are better off. When people are better off, they spend more and invest more. This makes investors better off. When investors are better off …
A balanced-budget amendment will force the government to live within its means. I don’t know any person or any business that can spend more than they earn forever, and neither can Uncle Sam.
If the federal government continues to spend more than it collects, and makes up the difference by borrowing, Uncle Sam will crowd out private investment and increase the cost of capital. As the cost of capital goes up, investment opportunities go down. As investment opportunities decline, the economy declines, and then tax revenues decline, and then federal borrowing increases, which increases the cost of capital. And the cycle repeats.
If you don’t believe me, look at Canada and Sweden. Both are highly industrialized countries with huge social welfare programs. Both are very heavily taxed nations that still have managed to run budget deficits they have funded with debt. And now, both of them are having enormous difficulty raising money in world capital markets.
So what? So imagine if Uncle Sam went looking for a loan to fund this year’s budget deficit, and no one lent us the money. Then what?
Without the balanced-budget amendment, we will continue to borrow now, spend now, and then let our kids inherit a bankrupt country.
A line-item veto will reduce the pork in our fiscal diet. Remember the congressman who sought a $500,000 appropriation for the construction of a Lawrence Welk Museum in his district? While the masons and carpenters who would have built that museum would have been better off, the taxpayers would be worse off by half a million dollars. Assuming the average taxpayer pays $2,000 a year in federal income taxes, it would have meant 250 people would have to work for a full year just to fund the construction of this pork-barrel project. How many taxpayers would have to work every year just to fund the museum’s annual operations?
If Lawrence Welk merits a museum, either let his estate endow it, or let private enterprise build it on a for-profit basis.
Reducing the capital-gains tax rate will make investors better off, as discussed above. But the argument against this and other tax cuts for the rich is that we cannot afford it. That is, if we cut taxes, the rich will get richer, and the federal deficit will get worse as tax receipts decline.
Opponents of a capital-gains tax cut argue that a $1 tax cut translates to a $1 loss of tax revenue. This is known as the static model, and is used to support the argument against giving those rich investors a tax break. As proof, opponents of a capital-gains tax cut point to the dismal failure of the Reagan-era supply-side tax cuts: the resulting widening federal deficits and increasing income inequality.
On the surface their argument sounds good and their proof looks good, but neither is valid. President Reagan proposed massive personal and business tax cuts, not just a capital-gains tax cut, coupled with massive spending cuts. Congress wanted neither, but chose to implement the politically popular portion of the proposed tax cuts (while actually increasing the capital-gains tax rate) and avoided the politically suicidal spending cuts.
The result is obvious: Both the budget deficits and the national debt soared. Government spending is out of control: Adjusting for inflation, the proposed federal budget just released by President Clinton is twice the size of the federal budget during President Nixon’s last year in office. (Did our population double during this time?) And the rich not only pay a disproportionate share of their income in federal income taxes, they also pay a disproportionate amount of federal income taxes.
Further, the increasing income inequality of the last decades is not a function of tax cuts for the rich but is part of a broader phenomenon. The U.S. economy is undergoing a powerful transformation from a goods-based economy to an information-based economy. Uneducated and unskilled people often were able to find jobs in manufacturing companies in the past, but cannot in today’s more technologically demanding business world. Differences in education, and not differences in tax rates, account for differences in income distribution.
Advocates of capital-gains tax cuts argue that the static model is unrealistic, and instead rely on a dynamic model that assumes investors will alter their behavior in response to altered economic conditions. The dynamic model argues that a $1 capital-gains tax cut will unlock several dollars of capital gains and will actually increase tax receipts.
Opponents of the dynamic model argue that while it may be true that investors will change their behavior now and that tax receipts will go up in the next few years, it will end up costing the Treasury money once the supply of capital assets have been completely sold (unlocked).
This line of thinking presumes that there will only be a brief rise in tax revenues as capital gains are unlocked when owners of capital assets become motivated to sell. But this argument misses the critical aspect of a capital-gains tax cut: Capital-gains taxes will increase not simply because owners are now willing to sell, but because new investors are now willing to buy. And if new investors are now motivated to purchase capital assets in 1995, why won’t they be motivated to buy in 2000, or 2005, or 2010?
Furthermore, it is absolutely amazing that politicians whose long-term planning never extends beyond their next election suddenly become horrified over something that may occur in 2005 or 2010. Why aren’t they equally horrified over the probable bankruptcy of the Medicare and Social Security systems in 2005 or 2010?
Expanding IRA accounts, and restoring their tax-deductibility, will encourage people to save rather than spend. Since the U.S. has the lowest savings rate of all the industrialized world, this will only benefit us as we shift from consuming now to investing for the future. Expanding IRAs is often talked about as something of a tax gift for Americans. The reality is that IRAs must be expanded, because Social Security as we now know it will not be available when the Baby Boomer generation retires.
Increasing estate and gift-tax exclusion again sounds like a gift for the rich. But what is the single biggest problem an entrepreneur faces trying to start a business? Capital formation: accumulating and raising the necessary capital. What do estate and gift taxes do? Inhibit capital formation. Increasing estate and gift- tax exclusion will enhance capital formation, which will lead to business formation, which will lead to jobs being created, and on and on.
Should the middle class get a tax cut? While politically popular, if you look at the tax code, you’ll find that the middle class is the beneficiary of many tax benefits, loopholes and subsidies. If the middle-class tax cut is offset equally with spending cuts, then America will be better off. But without the spending cuts, where can the government recoup the lost tax revenue? From the poor? Hardly. From the rich? The rich are already burdened with both higher taxes and higher tax rates than everyone else.
No government program is perfect, but the Contract With America will reduce government spending and waste, put more money in the hands of investors, lower the cost of capital and make all Americans better off.
(Stuart Marsh is president of Genesee Funding Inc., a privately owned, federally licensed small-business investment corporation.)


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