Home » Uncategorized » Life After Financial Armageddon

Life After Financial Armageddon

Is this the end of capitalism as we know it? A stock market that sees a 504 point dive in one day following bailouts of Fannie and Freddie Mac, Bear Stearns, the demise of Lehman and the terrible takeover of AIG marks a cataclysmic end to the great credit bubble of €˜08. Who’s next? One …

Is this the end of capitalism as we know it? A stock market that sees a 504 point dive in one day following bailouts of Fannie and Freddie Mac, Bear Stearns, the demise of Lehman and the terrible takeover of AIG marks a cataclysmic end to the great credit bubble of €˜08. Who’s next? One would like to think that only Henry Paulson knows for sure, but we suspect even he is groping for answers. With each failure since IndyMac several months ago the final shoe is said to have dropped except that this financial crisis is a centipede with many more shoes to go.  

The great financier, J. Pierpont Morgan, who had seen several financial crises in his time, once described credit-the lifeblood of any banking system-as “man’s faith in his fellow man.” With each thunderbolt of bad news there seems to be precious little of this remaining. Capital markets could use all the good faith they can muster right now to avoid a deflationary collapse while credit markets adjust. What might help? 

For starters it doesn’t help having our Presidential candidates pointing fingers at one another when the fire is gutting the house. Railing against the greedy CEOs of Wall Street may be very populist and applause getting for John McCain but it’s not that helpful. Blaming Bush for lax regulation is a reflexive response for Obama, but however much truth there may be in this, it too doesn’t help very much to get to a solution.  (If George W. is the simple-minded marionette of Dick Cheney’s puppeteer string puller why isn’t this crisis the vice president’s doing?) 

Access to capital is the oxygen on which our $13 trillion economy depends. Does either candidate promote tax policies that promote growth and supply this oxygen? Barack Obama and John McCain have laid out strikingly different tax agendas. Citing growth as his priority McCain would seek to make the Bush tax cuts permanent. He also proposes to reduce the corporate income tax rate-the second highest in the world after Japan-and to provide relief from the Alternative Minimum Tax (AMT). Obama’s proposals are very different. He is primarily interested in “restoring fairness to the tax code.”  He would accomplish this by raising ordinary income, capital gains and dividend tax rates on all taxpayers earning more than $250,000 and restoring the top two tax rate brackets in effect before 2001. He is silent on the AMT. 

Obama’s focus on “fairness” is another way of saying redistribution. He would preserve the Bush Tax cuts in low and middle-income households, but would raise capital gains and dividend rates in the top two brackets by up to one third. 

Both candidates have very different ideas on how business should be taxed. Obama has put forward a few modest proposals such as a research and experimentation credit and a new refundable health tax credit for small business to cover the cost of health insurance premiums.  McCain would lower the top corporate tax rate from 35 percent to 25 percent and allow businesses to write off all investment in equipment immediately. As Chief Executive reported last Spring (Inbox, March 2008) The U.S. statutory corporate tax rate of 39.3 percent is the second highest after Japan among OECD countries.  

Lowering this rate would be helpful in advancing U.S. competitiveness. A KPMG annual survey of corporate and indirect tax rates for 2008, showed that the U.S. corporate income tax rate was higher than all other global regions, 14.1 percentage points higher than the global average and nearly 17 percentage points higher than the average among European Union nations. According to the KPMG report, 23 countries have lowered their corporate tax rates this year, and no nation has raised its rate since last year. Last week, for instance, Sweden announced a series of proposals to improve its business climate, including a plan to cut its corporate tax rate from 28 percent to 26.3 percent. If socialist Sweden sees the wisdom of incentives for deploying capital sensibly one wonders why the political class in Washington doesn’t get it.   

In addition, allowing faster write-offs of business investment would dramatically reduce the tax on returns to overall business investment which would mean more jobs and fewer penalties on growth. Robert Carroll, vice president for economic policy at the Tax Foundation summarizes the two candidates’ positions in the following table.

 Tax Relief for Businesses

 Senator McCain

 Senator Obama

  • Lower the top corporate tax rate from 35 percent to 25 percent.
    (-$734.7 billion)
  • Allow investment in equipment to be written off immediately.
    (-$45.0 billion)
  • Expand and permanently extend the research and experimentation credit.
    (-$133.1 billion)
  • Expand and permanently extend the research and experimentation credit.
    (-$155.1 billion)
  • Small Business Health Tax Credit. New refundable tax credit of up to 50% on premiums paid by small businesses.
    (NA)
Source: Estimates are from the Urban-Brookings Tax Policy Center, Tables T08-167, T08-0192 and T08-0193, August 14, 2008.

Carroll notes that the perspective of the two candidates is very different. One wishes to use the code to redistribute income from one group of Americans and to give it to others.   Under this regime there will be fewer incentives to work. Interestingly Obama will tax carried interest as ordinary income which will affect partnerships and hedge funds-the very people that have donated generously to his campaign. The other wishes to change the economic system to improve incentives. Senator McCain provides broad tax relief and channels most of it to businesses, with the notion that the best way to help workers is to encourage investment. 

Obama apparently believes there are few behavioral affects as a result of tax rates. But speaking at a Manhattan Institute Forum, E.J. McMahon, the institutes’ senior fellow for tax and budgetary studies disagrees. “The cost of capital has declined each time the after tax dividend and capital gains rate has been reduced,” he says.  “If you want a good example of what life would be like under a tax system such as that proposed by Obama, consider New York City in the 1970s.”   

Never mind the retail investor. Now even the pros are running scared. The markets will be ruled by fear. It’s time our Presidential contenders addressed the fear head on and debate what will best give the system the oxygen it needs to revive.    

About JP Donlon

JP Donlon is the Editor-in-Chief of Chief Executive magazine.