Clinton Tax Rates, Japan’s Lost Decade, Irrational Exuberance, Dot-Com Bubble, EBT and Job-Creating Capital

Posted by PITHOCRATES - November 14th, 2012

History 101

The Economy of the Nineties boomed because of Japan’s Lost Decade and Irrational Exuberance

President Obama wants to raise taxes on the wealthy.  He wants to go back to the Clinton tax rates.  The economy was booming during the Clinton Nineties.  Better than it is now.  Tax rates were higher in the Nineties than they are now.  While the deficit is greater now than it was in the Nineties.  And the debt is greater than it was in the Nineties.  The conclusion?  Higher tax rates improve economic activity.  Produce smaller deficits.  And grow the debt at a slower rate.  At least, that’s what those who want to raise tax rates say.  The only problem with this is that there are reasons why the economy was booming in the Nineties.  And it didn’t have to do with tax rates.  But, instead, the Japanese.  And irrational exuberance.

The Japanese government partnered with business in the Eighties.  Corporations worked closely together for the good of the export economy.  And the national economy.  This was Japan Inc.  And the economy surged.  Fueled by low interest rates.  People in America worried about the Japanese buying American landmark assets with their fat profits.  An American magazine joked that America would become a wholly owned subsidiary of a Japanese corporation.  A Democrat presidential candidate said America was a fool for not doing what the Japanese were doing.  But the good times didn’t last.  That inflationary monetary policy caused a massive asset bubble.  And when it burst the Japanese suffered a deflationary spiral that last a decade or more.  Their Lost Decade.  This great contraction weakened America’s greatest economic competitor.  Greatly helping the US economy.

Also during the Nineties the Internet was coming of age.  In the Eighties there was the personal computer.  Silicon Valley.  And Microsoft.  A lot of investors were looking for the Microsoft of the Nineties.  No one knew who that was going to be.  But one thing everyone knew was that it was going to be a dot-com.  Investors poured money into dot-coms that didn’t have anything to sell.  Hence the irrational exuberance.  Dot-coms built great office buildings and technology corridors in cities.  New ‘Silicon Valleys’ were appearing across the country.  Kids went to college to learn how to make websites and set up ecommerce.  All these young kids filled these new dot-com buildings.  But when the investment money ran out these companies went bankrupt.  As they had no revenue.  Or anything to sell.  The dot-com bubble burst after Clinton’s Nineties.  Giving George W. Bush a bad recession at the beginning of his first term.  Also, President Clinton pressured lenders to qualify the unqualified for mortgages they couldn’t afford.  Starting a great real estate bubble.  That burst after Clinton’s Nineties.  Causing the subprime mortgage crisis about a decade later.

The Government taxes Small Business Owners as Rich People even though they’re not really Rich People

So there is more to the Nineties than those Clinton tax rates.  The Japanese gave them an able assist.  Then a lot of bad investing creating a lot of artificial economic activity that created a bubble.  That crashed into a recession.  Thanks to a lot of governmental interference in the private sector economy.  They kept interest rates artificially low.  And offered a lot of incentives to get those dot-coms to build in their cities.  Leaving cities with a lot of empty buildings, budget deficits, bloated public sector payrolls and no increase in tax revenue to pay for the additional infrastructure and services.  This is what the Clinton policies gave us.  Not sustained economic activity.  Or a budget surplus.  So going back to the Clinton tax rates is not likely to produce sustained economic activity.  Or a budget surplus.  Especially when President Obama has outspent Clinton over a trillion dollars a year.

So returning to the Clinton tax rates won’t help to reduce the deficit unless they return to the Clinton spending as well.  And that’s not likely to happen.  So what will the increase in tax rates do?  Well, we can get an idea by comparing the Clinton tax rates (1999) to the last tax rates we used (2011).  As they apply to a small business.  The following is an income statement for what could be a typical small business with about $1.8 million in annual sales revenue.

This is a very summarized income statement using some typical percentages for cost of sales and overhead.  This also assumes about $350,000 of debt on the company books.  Giving an interest expense of about $28 grand.  When you subtract all of these expenses from revenue you arrive at an earnings before taxes (EBT) of $358,016.73.  For many small business owners this EBT flows to their personal income tax return as personal income.  Which sounds like a lot.  But business owners will leave most of this money in their businesses.  So while the government taxes them as rich people they’re not really rich people.  For what the government doesn’t tax away will become retained earnings.  And reinvested back into their businesses.

Higher Taxes and Higher Regulatory Costs hurt Job Growth by taking away Job-Creating Capital from Businesses

All right, so let’s look at what the government would tax away.  Based on the 1999 tax rates.  And the 2011 tax rates.  Using the tax rates for married filing jointly we get the following income tax for each set of tax rates.

The 1999 tax brackets give an effective tax rate of 31.4%.  In 2011 that fell 4.7 points to 26.7%.  Which increased net profit from 13.7% in 1999 to 14.6%.  An increase of 0.93 points.  Not as big a change as in the income tax rate.  But it’s an additional $16,730.50 the small business would have to reinvest into the business.  Which could pay for a lot (even help pay their interest expense).  Especially over time.  In two years that’s about $33,461.  In five years that’s about $83,650.  In ten years that’s about $167,300.  That’s a lot of ‘free’ money the business could use to grow their business that they didn’t have to pay back.  But if we returned to the Clinton tax rates that’s money these businesses would no longer have to invest into their business.  Forcing them to pay to borrow money.  Adding additional interest expense.  And burdening the business with greater debt.  Which would be a disincentive to add additional costs.  Like creating new jobs and hiring people.

A lot of small business owners don’t pay themselves.  That is, they don’t get a paycheck like everyone else in their business.  Instead they distribute earnings from the business.  People think all business owners are rich.  But here’s something they don’t understand.  Even though they pay income taxes on their total business earnings they may only take a small percentage of their earnings out of the business.  In this example the married couple draws $75,000 a year to live on.  Even though they paid income taxes on $358,016.73.  Netting only $75,000 on these earnings would be like having 79.1% of your earnings withheld in taxes from your paycheck.  While these numbers vary among business owners this generally holds true.  They pay taxes on amounts far greater than what they take out of their business to live on.

If we go back to the Clinton tax rates it will reduce the amount of investment capital owners have to grow their business.  Which new regulations have already reduced by increasing costs.  With the unknowns of Obamacare basically freezing all new hiring.  As small business owners don’t know if the government will leave them enough money to grow their businesses.  Or even enough to maintain their current business operations.  Which is how higher taxes and higher regulatory costs hurt job growth.  By taking away job-creating capital from businesses.

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President Obama Speaks to the Chamber of Commerce

Posted by PITHOCRATES - February 7th, 2011

Businesses Keep Lots of Cash on their Balance Sheets during Bad Economic Times

Trying to remake his anti-business image, President Obama talks to the Chamber of Commerce (see Obama reaches out to business leaders by Lara Rowland posted 2/7/2011 on The Washington Times).

“Now is the time to invest in America,” Mr. Obama said, adding that U.S. companies have nearly $2 trillion sitting on their balance sheets. “Demand has risen more slowly than any of us would like. We’re in this together. But many of your own economists and salespeople are now forecasting a healthy increase in demand, so I just want to encourage you to get in the game.”

This illustrates Obama’s lack of understanding of business.  Let’s explain what’s wrong with his thinking by using an analogy.  During bad economic times, when there are ‘lay-off’ rumors at your workplace, do you spend money?  Or do you save money because you are unsure of the future?  Most people will save their money.  So if they do lose their job, they’ll have some cash to get by on until they can find another job.  The so called ‘saving for a rainy day’.  That rainy day is you without a job.

Businesses aren’t that different from people.  In fact, people run businesses.  So they think like people.  And during bad economic times, when sales are down and you may have to lay people off because you’re not selling anything to pay the bills, do you spend money to hire people?  No, you don’t.  You save your money.  To make sure you have cash to pay your bills when you don’t have the revenue coming in like you once did.

You see, it’s not as easy as President Obama thinks it is.  Businesses can’t create good economic times.  They can only wait for them.  Which is what they’re doing now.  And have been for about 2 years now.

Lower Taxes Stimulate Economic Activity and Create Jobs

Part of the reason why there aren’t good economic times is because of high taxes.  High taxes increase the cost of doing business.  And leaves people with less disposable cash to stimulate economic activity.

“If we’re fighting to reform the tax code and increase exports to help you compete, the benefits can’t just translate into greater profits and bonuses for those at the top,” he said. “We cannot go back to the kind of economy — and culture — we saw in the years leading up to the recession, where growth and gains in productivity just didn’t translate into rising incomes and opportunity for the middle class.”

Interesting.  Whose money is it?  Who made those profits?  Guess it’s a moot point.  Because the president believes it’s his money.  And if he chooses to allow businesses to keep more of it, well, they’ll have to make it worth his while.

But you don’t run business by dictate.  If that worked the Soviet Union would have won the Cold War.  But they didn’t.  Because business doesn’t work that way. When businesses see rising demand and rising revenues, then they hire people.  To meet the rising demand.  So they can make more money.  That’s how you create jobs.  Not because they are told to hire more people than are needed to meet demand.  It just doesn’t work that way.  Again, I refer you to the former Soviet Union.

Excessive Regulation Inhibits Economic Activity

Another reason is for poor economic times are excessive regulations hindering economic activity.

Separately on Monday, the Republican chairman of a House oversight panel released a raft of letters from businesses weighing in on the nation’s biggest regulatory impediments to job growth. Environmental Protection Agency rules were the most often-repeated complaint, according to documents posted by Rep. Darrell Issa of California.

Like higher taxes, excessive regulations increase the cost of doing business.  When you can’t expand your business because the land you want to expand onto has a small depression that holds water after a heavy rain and is classified as a ‘wetland‘ during the permitting process, that hinders economic activity.  They don’t allow the business to expand.  And the mosquitoes get a nice breeding ground during rainy days.  And it’s important to protect their habitat.  So we can spray it later to control the spread of the West Nile Virus.

The most Successful Regulation Shuts Down the Industry it Regulates

The Environmental Protection Agency is pro-environment.  And the best environmental position is no manmade impact on the environment.  That is, no business.  Therefore, the Environmental Protection Agency is anti-business.

This is typical of regulation.  The safest car is one that doesn’t drive.  The cleanest power plant is one that doesn’t produce power.  The safest oil rig is one that doesn’t drill.  You get the idea.  Regulation, in general, is anti-business.  The greatest success these regulations can have is the elimination of the industry they’re regulating.  So it is a tug-of-war.  Business on one side.  And the regulators on the other. 

“There’s no doubt that when you had the financial crisis on Wall Street, the bonus controversies, the battle around health care, the battle around financial reform, and then you had BP — you just had a successive set of issues in which I think business took the message that, well, gosh, it seems like we may be always painted as the bad guy,” Mr. Obama told reporters. “And so I’ve got to take responsibility in terms of making sure that I make clear to the business community, as well as to the country, that the most important thing we can do is to boost and encourage our business sector and make sure that they’re hiring.”

There’s a reason why businesses feel like they’re painted as the bad guy.  Because the Obama administration paints them as the bad guy.  One accident on a BP rig in the Gulf of Mexico and the Obama administration shuts down all offshore drilling.  Now all the rigs are not drilling.  And the regulators have regulated best.  In their opinion.

We are a Nation that has a Government

There’s a reason why the Obama administration and business don’t have a good relationship.  Business understands business.  Obama doesn’t.  Businesses want a business-friendly environment so they can grow and become prosperous and create jobs.  Obama wants the same thing only without the being prosperous part.  Because any ‘excess profits’ belong to the government to fund their government spending.  For President Obama believes that we are a government that has a nation.  Unlike Ronald Reagan who thought we were a nation that had a government.  Business liked Reagan.  While Barack Obama goes to the Chamber of Congress to persuade business that his anti-business policies aren’t anti-business.

Sorry.  But when you have to persuade people that you’re not anti-business, you’re probably anti-business.

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