Do IMF Bankers All Go to The Same Tailor?

Cut From The Same Cloth, Do You Think?

Will the Buffet Rule impact Tax Free Municipal Bonds?

Short answer is “How Can It Not?”  When the effective rate of taxation is raised on an investment, then less capital will flow to that investment.  All else equal.

The dirty economic secret no one wants to talk about in DC is that the Buffet Rule would NOT be a tax on labor but instead a new tax on capital.

Follow me here:

Wealthy people use tax-free bonds as a significant percentage of their asset allocation and hence much of the income of the ‘wealthy’ is derived from dividend income and capital gains — and NOT from labor.

Tax free bonds fund our beloved infrastructure projects on state and local levels and much of the capital invested in these bonds flows from people and institutions (groups of people) who want low-risk and tax-free income.

To be effective, the so-called Buffet Rule would have to raise new tax revenue by taking a new bite from income derived from investments in (formerly) tax-free bonds.

We should really call the Buffet Rule a new Alternative Minimum Tax on Capital.

Why? Because if it quacks like a duck…

Were the Buffet Rule to pass, then rational investors would adjust to the new tax regime.  This will reduce incentives to buy these low-return bonds on the margin.  Which in turn would result in an increase in cost of capital to fund these infrastructure projects — projects that build our schools, roads, airports, etc.  The outcome would be less infrastructure work per dollar of capital.  Less efficient capital means less capital production on the margin.

So the Buffet Rule could actually mean less bridges, roads and schools as we ride the Slippery Slope of Progressive Inanity to Achieve Economic Growth.

Q:  Why would tax-free bonds be disadvantaged against other opportunities?

A:  Because the Buffet Bite would be bigger on a relative basis.

If you have to pay the New Capital AMT you may as well invest in riskier investments with the opportunity for a greater rate of return.  The bigger the size of the Buffet Bite to ‘equalize’ tax rates to the Middle Class Tax Rate, then the more that (formerly) tax-free munis and their brethren are impacted.  This makes it tougher to attract investment dollars as they compete in the capital markets.

The famous Chicago School of Economics theory of “Rational Expectations” makes the conclusion obvious.  Obvious to all, of course, except to those of the Krugman Kamp of Economics.

Buffet Rule = Circular Firing Squad of Unintended Consequences

Here’s my take on the fatal flaw of the Obama’s so-called Buffet Rule:

1.  The Buffet Rule is designed to raise tax rates on the wealthy, but it would be better said as raise the tax rates on high income earners.

2.  People with the highest incomes usually make most of their income as dividends or capital gains instead of as wages or salary.

3.  So to be effective the Buffet Rule would have to raise the cut the government takes for dividends and capital gains.

I think there’s nothing controversial here so far but follow me now:

4.  People with wealth often buy Tax Free Bonds so they can avoid paying taxes on the income they earn investing their capital.

5.  Tax Free Bonds = State + Municipal Bonds.   Not all, but usually state and municipal bonds are tax free.  Many are triple tax free.

6.  State + Municipal Bonds finance the construction of schools, roads, bridges, dams and other infrastructure.

That was easy.  These days almost everybody wants more and better schools and infrastructure.  Nothing controversial.  Heck, the tall guy in the good looking suit has been stumping around the country about our need for more of this good stuff.

7.  Here’s the rub:  POTUS wants to build these things but POTUS also wants to raise the effective tax rates of those who buy the very bonds that finance most of these infrastructure projects.

8.  So if implemented, the Buffet Rule would disincentivize people from investing their capital in the types of investments that fund infrastructure projects.

9.  Load Rifles.  Form Circle.  Aim.  Fire.  Repeat Again as Necessary.

The pitch is easy to understand:  millionaires shouldn’t pay a lower tax rate than the working middle class types who make America great.  Check.

Like just about every “Genius” progressive idea, the devil is in the details.  And the end results is often the opposite of that intended by the solons who conjured it.

Especially when it’s done in the name of “Fairness” to the middle class.