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Capital strike will go on until capitalists treated better

Posted By Christopher Grey On 09/06/2010 @ 6:02 pm In Commentary | Comments Disabled

There is a capital strike going on in America right now.

Those who have private capital are on strike because they don’t like the way that the government is treating them. Money keeps flowing into Treasuries and cash and overseas because risky investments such as stocks and private companies in America are viewed as a bad bet. The investor is taking a lot of risk in this environment. Regulation has run amok. Taxes are about to skyrocket, especially on investors. Prices of risky assets are being inflated by government manipulation. Hiring costs have soared. Why would a rational investor want to take the risk of investing right now? If the government wants investors to take the risk, they need to create a pro-investor environment. Here’s how they can do that.

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In addition to keeping the current capital gains tax on investments held over one year at 20 percent, the government should cut taxes on long-term capital gains of investments held over three years to 10 percent. This would specifically provide a strong incentive for investors to make long-term investments, rather than just speculating or investing for a quick flip after one year. In addition, make this 10 percent tax rate apply only to investments made during the next two years. That would provide an even stronger incentive to invest now rather than wait for the economic situation to improve. Investors need some shock treatment like this to wake them up and get them motivated to take some risk.

Keep the tax on dividends at 15 percent. This is critical because it provides an advantage to owning stock or an investment in a business rather than buying Treasuries, cash or other taxable bonds that are treated as ordinary income. Eliminating this advantage, as the current government wants to do, in an environment that already is extremely favorable to bonds and extremely unfavorable to stocks will cause even more capital to flee stocks for bonds. This is exactly the opposite of what we need right now. There already is too much money in Treasuries, cash and bonds. Money flowing into stocks and businesses in general is at one of the lowest levels since the Great Depression. Keeping the dividend tax rate far below the tax rate on ordinary income is one way to give stocks and companies an advantage over bonds as far as attracting investors.

Freeze all new regulations for two years and exempt small businesses from health-care reform as well as all other new regulations that have been passed since 2008. All of these new regulations and the fear of more new regulations in the future are a major factor that is preventing new business formation and small businesses from growing. This exemption and moratorium on new regulations, especially for small businesses, would remove a huge obstacle to investment and would unleash a tidal wave of new investments and hiring.

Over the next three years, reduce federal government non-defense on budget spending by 20 percent, including the elimination of at least two entire departments. Also, phase in over five years cuts in Medicare and Social Security spending of at least 20 percent. These cuts in spending will provide confidence to investors that the long term future of this country is secure. Right now many investors fear that federal government and entitlements are so out of control that the country will collapse in a few years. This is a major reason that they don’t want to make long term investments.

The Obama administration and some liberals in Congress are getting desperate because of the election coming up in November as they are trailing badly in the polls. Their latest socialist fix for the economy includes massive tax credits for research and development and hiring new workers. Although tax credits are more pro-growth than the tax increases and new regulations they have been piling onto American businesses for two years, they are near the bottom of effective ways to boost growth. The reason is that tax credits just distort market forces and pull economic activity from one area to another. They’re unlikely to generate much in the way of overall growth in the economy. Capital just moves away from areas that aren’t being subsidized by the government into the subsidized activities.

One of the most disastrous examples in recent history of tax credits having an unintended negative economic impact was during the Carter administration. Carter passed a large tax credit for hiring new workers. Many employers responded by firing existing workers so that they could take advantage of the tax credit. This time around I’m sure that the socialists will think it through a little more, but government never can stay ahead of the market. Even if you make a tax credit for new workers only if they are so-called “net” new jobs at the company, there still are many ways for this just to pull money away from other things such as investments in marketing, facilities, or raises and benefits for existing workers.

As for subsidizing research and development, on the surface this seems to be a good idea. However, real research and development doesn’t need to be subsidized. It makes economic sense on its own merits. In reality, a research and development tax credit promotes a game in which companies try to classify as much of their expenses and investments as possible in this category just to get the tax credit. It is an accounting and tax shell game that creates no real growth except for accountants and tax experts. A much simpler way to promote real investment is to keep the capital gains tax low or lower it further for long-term investments as suggested above. Another way to promote immediate corporate investment would be to allow companies to expense, rather than capitalize, all of these items for a few years.

Once again, policies that promote market forces are simply better than socialist policies that try to distort the market and tell companies and individuals how to spend their money. Maybe if we get some change in November, the politicians in Washington, D.C., will finally get this message.

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