Sunday, April 19, 2009

Predatory Taxation

Imagine this:

A smooth, oily mortgage salesman is selling his product to a newly married couple. Try our adjustable rate mortgage, he says. Its got an initial rate of only 3.5% per annum, he says. Well, technically, the rate will reset after two years, but the prime rate is going down and your payments will never increase. Balloon payment? What balloon payment? You don't think I would do that to you, do you? No, this mortgage is exactly how I say it is. No need to read the contract, just sign here and initial here, and you are on your way to owning your dream house. How can we afford to finance such an expensive house at such low monthly payments, you ask? Why, we'll just securitize your mortgage, of course! We'll bundle it up with hundreds of others, and sell them to investors all over the world. The geniuses at Wall Street have figured it all out. No need to worry, this makes sound financial sense.

The couple, thrilled, sign and move into their new home. They make their low monthly payments for two years, and all seems to be well. But at the end of two years, suddenly, their rate shoots up. They can't afford their new, high, montly payment. Worse, prices of homes in their neighbourhood have begun to fall, so their mortgage will soon be underwater. Even worse, they realise that contrary to what the salesman promised them, the mortgage does not amortise completely, and they will have to make a large balloon payment at the end. Clearly, the costs of staying in their home are higher than they can afford. But the mortgage salesman made it sound so much better! He specifically said that they would not ever find themselves in such a situation.

Now, what phrase would you use to describe the mortgage salesman's conduct? Why, you'd call him a predatory lender, of course. And you'd be right. While I am a little wary of using the P-word indiscriminately, surely such outright lies and innacurate statements qualify.

My question is, if this is predatory, what about a guy who gets elected by promising tax cuts to 90% of the population while simultaneously embarking on the largest peacetime spending increase in his nation's history? He's got financial and economic geniuses on his side who claim that the quantitative easing and the securitisation of his country's liabilities allow him to get something for nothing, but does that really make him so different from the mortgage salesman of the earlier example? The current regime of low taxes may survive in the short term, but the debt that finances current spending has got to be paid back eventually, either through higher government revenues or the devaluation of the currency. People who have been convinced to vote for and support such spending increases based on the promise that their taxes will not be increased have been deceived. "Preyed on", if you will

I therefore propose that Barack Obama's tax policy, insofar as it leads to high approval ratings for him, be referred to as Predatory Taxation.

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11 Comments:

Blogger MarvD said...

Kunal,

Are you paying taxes from Pune? Having just filed my 1040 from Bombay I feel like I have some standing in this matter.

If the only point of this massive spending increase were to build equity, you'd have made a pretty good analogy.

But only 8% of our tax revenue goes toward debt payments -- a pretty good ratio by any standard. Rather, this stimulus measure is, as our president says, a down payment on sustainable growth. We can expect to realize a profit from these investments in infrastructure.

Moreover, by spending now, we're in fact saving money by purchasing raw materials at rock-bottom prices.

Should the spending hike come with an associated tax increase? Perhaps. The president's been pretty clear all along that balancing the budget is a medium-term priority and in order to get there taxes will be raised across the board. At this moment, however, it would clearly do more harm than good.

Cf. 1937.

Matt.

5:21 AM  
Blogger Abhishek said...

For the laymen, here's a short video tutorial on quantitative easing: http://marketplace.publicradio.org/videos/whiteboard/quantitative_easing.shtml

My stomach hurts!

8:54 AM  
Blogger roshan said...

i think you should have mentioned that obama is raising taxes for the remaining 10 percent i.e. those earning above 250k a year.. so it may sound statistically senseless to cut taxes for 90% of the population but we both know that in reality, its the remaining 10% that have the larger chunk of the pie...

11:41 AM  
Blogger Kunal said...

Roshan:

Yes, the tax cuts for the middle class are being counterbalanced by tax hikes for the rich. But surely you see that this is not going to pay for the shortfall. Very high marginal rates for the rich might make sense if you're a strong believer in redistributive justice, but they're not really that good for raising revenue. If you tax people at 70% for income over say, a million dollars a year, far fewer people are going to make a million dollars a year. Again, this makes sense if you want to end income inequality, but it really doesn't help raising revenue.

1:02 PM  
Anonymous Anonymous said...

Balancing the budget isn't a goal at all.

The stated goal has been to cut the US deficit in half.

This was, of course, declared immediately after they finished tripling the deficit.

The concept of "In 4 years, we shall owe only 1.5 times what we used to" isn't really "balanced" at all.

2:25 PM  
Blogger Kunal said...

Matt,
I'm a US taxpayer too, and in fact Uncle Sam's been taking a smaller bite out of my paycheck lately, thanks to Obama's tax cuts.

Re sustainable growth, I must say that it is quite possible that contrary to all historical experience, this time the government might invest the money wisely in infrastructure without waste, politically motivated decisions, porky earmarks and so on. It is certainly possible that there is something excitingly different about this administration (and this Congress) that will make them better stewards of public money than other people operating in the same institutional environment. Just remember, it would also have seemed possible in say 2004 that the housing boom would be sustained indefinitely, and that people buying expensive houses at high rates would never have to worry about going underwater on their mortgage.

The president's been pretty clear all along that balancing the budget is a medium-term priority and in order to get there taxes will be raised across the board.Well, he's not at all made it clear that the middle class tax cuts are temporary. If he's cut taxes and increased spending right now with the understanding that taxes will rise in the foreseeable future, but he implies publicly that the current tax cuts are sustainable, well, that sounds awfully predatory to me.

5:33 PM  
Blogger Shriniwas K said...

Well the United States has the strongest military, so technically they can choose not to repay back their debt... Jo karna hai kar le :D

Then China which buys most of the US treasury notes will be left with a worthless wad of paper. I dont know if this is ethically right or wrong but who is there to make sure US repays its debts to China, Japan India - etc who have bought their trade surpluses in form of US federal treasury notes!

3:15 PM  
Blogger Kunal said...

Reputational effects. Also they will get maajarly downgraded.

There is a reason you see repudiation of debt used as a last resort even by much weaker powers than the US. India's refusal to repudiate was the major factor that allowed the Indian recovery after 1991 to take place.

11:10 PM  
Anonymous sildenafil said...

Damn, that's a pretty shit situation if you ask me, I can't imagine what I will do, because It's not in my plans to be there in the future... I'm not that idiot to fall in that trap.
Good luck

12:18 PM  
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8:45 PM  

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