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      06-13-2008, 08:50 PM   #1

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Awesome article on taxes by Ron Muhlenkamp-Must Read

I want to discuss how we produce prosperity. In this regard, the past 30 years have been fascinating. Defining “Prosperity” What does prosperity mean to you? When I ask this question, people respond in terms of a better lifestyle, home, car, or vacation; a secure retirement; funding college education; and so on. But these responses describe how we consume prosperity. I believe we can’t consume prosperity unless we produce prosperity. In the 1970s, we had stagflation. Stagflation is a combination of low growth (stagnation) and high inflation. According to the economic theories I was taught in the late 1960s, this wasn’t supposed to happen. Inflation was supposed to be a result of too much growth. Low growth was supposed to result in lower inflation or deflation. So, stagflation wasn’t supposed to happen—but it did.

In the 1980s and 1990s we had accelerating growth and declining
inflation, along with huge federal budget deficits. When Ronald Reagan
proposed the tax cuts that resulted in budget deficits, conventional economic
wisdom argued that the increased federal borrowing would result in higher
interest rates, a crowding out of commercial borrowers, and a declining
economy. It didn’t happen; interest rates fell, and the economy expanded for
nearly 20 years. What went right?

In the 1970s we had 10% inflation and a progressive federal income tax
rate structure with a top tax bracket of 70%. Inflation of 10% meant that
each individual needed 10% more money each year just to maintain his/her
standard of living. The progressive tax rate meant that if you received a 10%
raise (pretax), your taxes went up 20%. (The numbers are straight from the tax tables of 1979.) A 70% tax rate meant that after a certain level it didn’t pay to work (and produce).

All Work, No Pay?

One day in 1980, I was visiting a couple of clients who are doctors. They had
set up pension and profit-sharing plans, but they also had a plethora of other
plans, including salary deferral, and so on, each of which was designed to
minimize or defer their tax bill. I finally asked them how much of their time
they spent being doctors and how much of their time they spent deferring
taxes. They said they spent about a day per week deferring taxes. So, here you have two highly intelligent, highly trained individuals who spent four days a week doing something useful and one day a week producing nothing, simply
because of their high tax bracket. The 70% tax bracket fed a tax shelter industry that funneled money into areas that were tax-favored rather than economically productive. And we got a glut of boxcars, barges, and “see-through” (empty) office buildings. Meanwhile, my friends who were farmers concluded that the way to get ahead was not to grow more food, but to borrow more money and buy more land. My suburban friends spent some of their working hours planning how to borrow more money and how to buy a bigger house. At about this time, a friend of mine who taught at Duquesne University sketched the following scenario based on a five-day work week:

•Monday, you pay 10% in taxes on your earnings.
• Tuesday, you pay 20% in taxes on your earnings.
• Wednesday, you pay 30% in taxes on your earnings.
• Thursday, you pay 40% in taxes on your earnings.
• Friday, you pay 50% in taxes on your earnings.

How many of you would come to work on Friday? Over the years, I have
asked several thousand people this question. I used to get 2%-5% of hands
going up. Lately, I’m getting zero. People are telling me that, at a 50% tax
bracket, they will quit working. And you don’t have to be an adult to come
to this conclusion.

Let’s take our five-day workweek analogy one step further. Remember that
most people said they would not work at a 50% tax rate. Well, here’s a new
proposition: Pick a person whose name you know, a friend or a stranger. For the next 20 years you will be a partner of that person in a one-way partnership. You have your choice of two sets of terms, as follows:
A: You will receive 30% of everything that person earns over
$30,000 per year.
B.You will receive 30% of everything that person earns from $30,000 to $100,000 per year; and 70% of everything he/she earns over $100,000 per year.

It’s easy to see why many people might choose B, expecting to get more
money. But remember what we saw in our five-day workweek analogy: people
say they won’t work at a 50% tax rate, so they certainly won’t work at a 70% rate. And to your “partner,” the proposed one-way partnership looks like a 70% tax rate. So if people do what they say they’ll do, at the 70% rate you will receive 70% of nothing. And 70% of nothing will always be less than 30% of something.

President Reagan faced the above choice in 1981. The existing top tax
bracket was 70%. It resulted in people in the top tax bracket taking time off,
investing” in tax shelters, and not expanding their businesses. In short, it
resulted in 10% unemployment. President Reagan chose “A”—a top tax bracket about 30%, and the U.S. economy has led the developed world for 25years. Japan and Western Europe have not made a similar choice. As a result, their economies have been slow or stagnant for over a decade. Unemployment in Western Europe is over 10% today compared to 5% in the United States. The key to the “one-way partnership” analogy is perspective. To choose the terms that make you the most money, you must consider the perspective your partner. Though you are setting the terms, your partner is the one producing the wealth. I find this analogy useful because our tax system is set up the same way. The politicians set the terms, but the tax-payer produces the wealth. Some of our politicians would do well to more carefully consider the perspective of the taxpayer.

About a year ago, a U.S. senator said that if he had to choose between a
rich man buying a new Mercedes or Congress taxing that man to buy a new
school bus, he, the senator, would vote to tax the man to buy the school bus.

The senator is assuming that the choice is between the Mercedes and the
school bus. But a Mercedes is discretionary. The man could live without it. At a 35% tax rate, a man who wants a $65,000 Mercedes must earn $100,000 and will pay $35,000 in taxes toward the school bus. At a 50% tax rate, he has to earn $130,000 for that same Mercedes. People tell me that at tax rates of 50% or higher they will not work. In other words, instead of earning that $130,000 for the Mercedes, the rich man might just stay home and relax, which means that at a higher tax rate you will get neither the Mercedes nor the school bus. I believe this is what happened in the 1970s, and I believe this is what would happen should we raise taxes much beyond their current levels.

Bottom line, economics is about people and their choices. The easy way
to understand economics is to put yourself into someone else’s shoes. If you
want to grow the economy, consider the perspective of the people who make
the economy grow. What are their needs? What are their wants? Under what
terms do they have the greatest incentive to work? When you allow people to
benefit from their own efforts, the economy grows, creating more prosperity
for everyone—worker, business owner, and politician alike.
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      06-14-2008, 12:11 AM   #2
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Very interesting read, and very true for me. I find myself in the position that, if we stay the course, either my wife or myself goes to work for less than 60% of our salary - in other words, with the marriage penalty, one of us is paying over 40% in taxes on the first dollar we earn.

Guess what? I stop working June 27, and the $45k I paid in taxes last year to uncle sam? He isn't getting shit this year or next from me. I'll start my own business, and tax savings will be one of my key criteria.

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