On Bidenomics....

• 03-Jul-21
• admin

In early May, it had been chock full of news about how President Biden was taking credit for doing a good job since the disastrous administration of Donald Trump.   Biden has indeed been doing a good job.   He took a bow, literally, in front of the nation, on the conclusion of his first 100 days in office, a traditional honeymoon period for American presidents.  Biden is now pushing big plans to restore American pre-eminence in the world, which just a few months ago was thought to be dead and buried.   If he gets what he wants from Congress, then there will be new directions for how the American nation will evolve.   In particular, American capitalism.

Of particular interest to those of us watching from the side-lines, the most important change that will be brought about by President Biden is the system of taxation which affects the American economy.   The talk is that he will not be increasing taxes for Americans below $400,000 per year.   There is less than 2 percent of the entire population who earn more than this level of income.   There will be changes in the top marginal rate of income tax, and since it hits just this small and privileged group, one would think that the other 98 percent would not have a problem. 

Biden’s justification for this tax increase is that over four decades, Americans have enjoyed so much reduction in taxes, that there are just not enough government revenues, short of a booming economy, to pay for the usual budgetary purposes of a government. We have all seen the lockdowns when Congress gets into a partisan and combative mood, takes on the other party and closes the government down.   Even more pertinently, when in the last forty years, the country has been involved in lengthy, expensive and meaningless military conflicts or in running a large military complex around the planet, mostly to safeguard it according to a set of rules designed for the group of nations that used to be the colonial masters of the world, to thrive, a lot of money is needed for that…

Domestically, the Americans want to have their cake and eat it too…low taxes, and privatization of the most basic of social services, healthcare, so that they don’t have to pay for the rest of the community.    Given the revenue situation, healthcare in America is a situation of every man for himself.  The rule of thumb is that each citizen needs to buy his or her own health insurance.   There is little or no public safety net.   As such, healthcare is priced increasingly for the rich, who can pay, but the poor descends into a vacuum, where the solutions for the rich will bankrupt a poor family should they become unfortunate enough to fall sick. 

Similarly, there is no money for infrastructure – roads, rail, airports, and when economics predict that a profit seeking private sector would never spend money on public works that do not earn profits, the American system behaves exactly as such, no matter how infrastructure can indirectly boost the economy with efficiency or overcome “externalities”. 

There is just not enough money to pay for all that.   Especially if you add on a 2-trillion stimulus package to revive an economy that was crushed by covid 19 in 2020.   Revenues of the US government have fallen during the recent recession.   And new taxes have to make up the burgeoning public deficit.  

But politicians in one man, one vote systems cannot hope to survive by saying aloud the word “tax”.   They all learned from George Bush Senior, who asked for his lips to be read, and he still had to do the right thing to increase taxes when the rubber hits the road.

Throughout his election campaign, Biden never said no increase in taxes; indeed he promised to correct the tax system by making the rich pay more.  And now the “rich” has been defined as those earning more than US$400,000 a year.  

Making US$400,000 a year is not necessarily “rich” in the USA, but they are likely to have the ability to pay more taxes.  Most likely, the ones who should be subject to a higher rate of taxation are the folks who actually have no ability to spend all their money in a hundred lifetimes, and these are the billionaires.  Because they not necessarily earning a “wage” from their endeavours, and are likely to get renumerated for their efforts through capital gains, dividends, carried interests and such other risk-taking related activities, they aren’t subject to the same rules as perhaps, their own well-heeled, employees.  So bosses may pay less, and employees may pay more.  That has been the order of the day in the US tax system.

It is a moot question whether such a tax system is fair or not.  Whatever it is, popular sentiment seems to like the definition that those who end up with a huge net worth at the end of the day is considered rich.  How they got rich is not important.  

As a matter of fact, it is actually terribly important, as the how is crucial to capitalism’s continued success or failure.  On the one hand, one can say that the rich took huge risks, and that risk taking should not be taxed like normal steady, iron rice bowl wages.  This is the standard argument against capital gains taxes.   On the other hand, it can certainly be said that the American system is designed for entrepreneurs to capture their gains in ways which cannot be garnered anywhere else on the planet or more poignantly by similar efforts by labour in their own country.  If an entrepreneur is part of that system, the financial routes to wealth are plentiful, and multiplies the rewards to risk taking far more than anywhere else in the world.   It is indeed relevant to ask, should the resultant capital gains be taxed more by the system because the system made it easy?   There is also a case to be argued for that. 

Bidenomics thrust these critical questions to the American public starkly.   The first issue is that there isn’t enough money to pay for the way they want to spend (well, some countries will get by with a lower level of spending), but if Uncle Sam cannot control the spending, then the taxes must go up.  They rather not debate the level of spending by specific categories, with some arguing that reducing the military is taboo, and others saying reducing aid to the poor is taboo.  These are all tough choices best left to American citizens, but the debate will not be resolved easily.   

Since mass taxation is not remotely possible, then it must be selective taxation.   So far, the arguments are easy to follow.   Then the next question is who should IRS selectively tax?   The apparent answer seems to be anyone who earns more than the President (since he makes about US$400K a year)!    Anyway, one can make the rich-vs-poor cut-off at any level and there will still be spirited debate on fairness.  

Taxation is a fundamental cause of the division between Republican and Democratic economic philosophies.   Republicans since Reagan have argued that the economy must be capitalist for Americans to remain wealthy and low taxes is a pillar of such an economy.   High taxes, the argument goes, will depress the willingness for labour to work, since workers will not like the larger part of their income going to the government which may use the money on wasteful programs.  They don’t want government to decide how to spend their money, and low taxes reflect that philosophy.  Low taxes also compel small government.  Unfortunately, this argument goes nowhere when it comes to defence.  Everybody seems to want a larger military, which tempts adventurism in the world, leading to even more wasteful expenditures.  And since the Americans have chosen to pick China as the external enemy, at least in some sort of Cold War, to divert attention away from a deeply split electorate, they won’t be lowering military spending any time soon.  Even if Biden does not have a 1.9 trillion stimulus plan to add to the pile, and then another 4 trillion to build infrastructure and to help poorer American families, there are already a lot of bills to pay.  Higher taxes are the only way out – that’s Biden position.

The Republicans are likely to fight that, tooth and nail.  They will argue that higher taxes on the rich would lead to these folks losing interest to work harder, to build businesses and to employ the less well endowed.  This is been labelled since Reagan’s presidency as trickle down economics – when the wealth of the upper class, spurred on by low taxes, will then create larger businesses to employ the lower classes, leading to the creation of more wealth by all.  In particular, if capital gains taxes were lowered, the argument goes that people will want to become more entrepreneurial, the engines of a capitalist economy.

What we have seen in the last forty years of the track record of low taxation is not what trickle-down economics has predicted.    

There was in fact no trickle down.   Billionaires and other wealth owners have in fact evolved into a narrow class of people who are so fabulously rich they are the equivalent of lords and barons in the feudal ages, with the vast majority of the rest of society remaining as working class serfs.  There are exceptions of course, but the inequality of income in the American economy is now staggering.   There are just a few percent of the population who own the same share of the economy as what the rest own.   This is not the expected results of trickle down economics. 

Bidenomics is now openly pushing back on Reaganomics.   Where Reagan’s policies were to reduce taxes, extensive government and inefficiency in the public sector, the new President is debunking the outcome of the economic revolution in the 1980s.   The Biden team is now pushing for huge, expansive government, financed by borrowing and an increase in taxation, including a significant increase in capital gains taxes.

Depending on what gets through Congress, it is nevertheless a counter revolution.   This push by Biden will not only unravel what Trump has done, which is good because all Trump accomplished was to give tax breaks to a very narrow class of people, but also what Reagan has done.    It is still not clear the latter is necessarily a good thing.   Why not?

Firstly, can only the upper middle class carry the burden of increased taxation?  Earning US$400,000 a year is not “rich”, it is upper middle class.  And these are likely to be professionals and high salaried employees.   They are surely hard working people who don’t create new businesses that employ thousands.   They don’t create jobs like the billionaires can.  We may end up with a situation where some of the work ethic of upper middle class folks is deflated and the super-rich can still avoid their tax bills through legal channels that only entrepreneurs have access to.   The proposal to “tax the $400,000 plus work force” may have negative effects.

Furthermore, the capital gains tax proposal can be really damaging.   When a business person takes risks, and most of the gains on success go to government as taxes, then indeed the odds are that people may shy away from taking those risks.   If you bet with one dollar, and you lose, you lose all of that one dollar; but if you win, you keep only 40 cents… That would really hurt the risk taking drive.   Of course, if we argue that if the system is such that it is quite easy for people to make gains rather than to suffer losses, then capital gains taxes can be interpreted as a form of infrastructure that would enable future generations to take those same entrepreneurial risks.   In the above statement, the situation would be better understood as : if you bet one dollar 10 times, and when you lose you lose all that, but only keep 40 cents, but you win 8 times out of 10, then risk taking is not going to be discouraged by capital gains taxes. 

In most countries in the world, there is no path to getting super rich through entrepreneurial risk taking, given that corruption and inefficient capital markets make wealth creation a lot murkier and hugely more difficult.   If the American government needs to take money from the current successful entrepreneurs through capital gains taxes, to continue to build the systemic infrastructure (and I don’t mean roads and airports) which only government can provide to ensure a smoother path to entrepreneurial success, then capital gains taxes may be justifiable.  

For example, what can be done is to complement capital gain taxes with a system of grants and incentives to enable next generation innovation, ie a system of negative taxes on critical types of activities to put entrepreneurs on the path to easier success.   This is a sort of systemic infrastructure, which can include clearer channels to start-up financing or loans.  Or if rich people invest in new enterprises, then perhaps part of their investments can be offset against their capital gains tax bill.

All of these measures are still very much up in the air.   All we hear now is there will be higher taxes, and those selective taxes are not necessarily for the long run good of the economy.   They need not be bad, but we need to see what other complementary plans there will be in Bidenomics, before we throw Reaganomics out the window, like we would do with bath-water.  Let’s see where the baby is first.

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Wai Cheong

Investment Committee

The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.