“Taxation is a pivot upon which economies, countries, governments and empires rise and fall. It can mean the difference between war and peace, prosperity and ruin.”

— Nathan Lewis

President Bush proudly signed off on a $170 billion stimulus package last week. Congress willingly approved. The two peacefully joined hands for the first time since they surmised to free Mesopotamia.

This time, however, they focused their do-gooder righteousness on the struggling American consumer. In a last-ditch effort to avoid the big “R,” Washington procured no less than $300 ($600 in most cases) for every man, woman or child who earns a paycheck or receives Social Security.

Mr. Market smiled. The cadence of the buy-now-pay-later American generation lives to see another day.

Morality aside, dear reader, you must forgive us for spoiling the fun. But from where exactly does this $170 billion magically come?

The last time we checked, Congress doesn’t produce widgets for Chinese consumption. It doesn’t sell government land. Nor does it rent its legislative acumen to some chaotic third-world country. It’s up to its ears in debt. The latest budget promises only to borrow much more. So where exactly did Congress find $170 billion?

We assume the deal went something like this…

The U.S. Congress turned to the U.S. Treasury. The U.S. Treasury turned to foreign buyers (China). Foreign buyers should (and will) require a higher rate of return for holding a depreciating fiat currency. But they shrugged. They knew that money would make its way back to China through a Wal-Mart near you. So they acquiesced. They lent Hank more money. Meanwhile, the juice keeps running.

Unfortunately, before long, Washington will receive a bill. It’s postmarked “Beijing.” Government opens the little white envelope to find it owes the Chinese $170 billion big ones, plus interest. It sighs…

So once again, Congress will turn to the U.S. Treasury. The Treasury balks. Chinese loans aren’t an option.

Hmm… It scratches its head.

Then, like a child playing one parent against the other, Congress runs down the street and knocks on the other benevolent banker’s door.

But “Helicopter Ben” squirms.

Lower rates inject more money, he muses, but there’s only one way that money will make it to Washington’s bank account.

The endgame: Congress must tax.

At first, Washington turns to tariffs. “Tax the foreigners,” it shouts. “Secure our borders! They’re the ones who stole your jobs… They’re the reason we’re in this whole mess!”

China grimaces. Projection doesn’t work. It waves its finger like a parent whose cookie-obsessed child comes home with a toothache.

“Tread lightly,” Beijing warns. “More than a trillion or so American IOUs don’t need a new home, do they?”

Uncle Sam agrees. He’s left with no option. He must now tax every man, woman and child who received a check. If that weren’t enough, every $300 handout will now require $330 in return.

Unfortunately, Americans are tapped out. They were told to spend their windfall, not save it. The magical $170 billion now sits in a Chinese sovereign wealth fund. In return, 50-inch plasma TVs, flawed diamonds and a fresh coat of paint adorn the American landscape.

So Washington turns its guns on another time-tested villain: The rich. It preys on John Q. Public’s fear and greed… It vilifies the top 1%.

“Make them pay,” it screams. The rich…they’re the ones to blame.

The masses quickly jump on board. A button-down, neatly tucked family of four adorns the balcony for the State of the Union. The legislators gasp. The president puts forth a multibillion relief package. Congress applauds. “Save the middle class,” it cheers. The spin machines anxiously assemble outside the great hall. They crave their pound of flesh. They eagerly ingest the doctrine spewed inside. They pontificate about the great command. Ratings rise.

By spring, big business and big money get slapped with the so-called “relief” tax.

And like the Chinese, big business gives a grimace. It’s seen this trick before. It’s no dummy. It passes the tax like a hot potato.

Prices rise. Consumption wanes. Before long, production falls. Eventually, cutbacks ensue. Workers lose jobs. More Americans unknowingly join the button-down, neatly clad family of four. So it goes…

The point, dear reader, is this: Efforts to tax the rich prove counterproductive. In a cruel twist of fate, Nathan Lewis, author of Gold: The Once and Future Money, points out:

“By attempting to make the wealthy foot the bill of government, in effect, the policy shifts the burden to the lower income classes. In 1980, for example, when the top income rate was 70%, the top 1% of income earners paid 19% of all the tax revenue and the lower 50% paid 7.1%. In 1988, after the Reagan tax cuts lowered the top tax rates to 28%, the top 1% paid 27.5% of all tax revenue and the lower 50% paid 5.6%.”

Analogous patterns can be seen in both the ‘20s and the ‘60s. “In 1921,” Lewis notes, “the top tax rate was 73%, and by 1926, it had fallen to 25%. In that period, the percentage of tax revenue paid by those with incomes over $100,000 (about $1.75 million today) rose from 28.1% to 50.9%. The percentage of tax revenue paid by those with income under $25,000 fell from 40.1% to 14.5%.”

Britain also shared a similar experience during the Thatcher administration.

You see, higher taxes discourage higher production. Fewer widgets mean fewer sales and fewer jobs. Fewer sales slips and W-2s equal less tax revenue. Meaning, passing the buck to the top 1% not only shrinks the overall size of the pie, but this misguided public policy also forces the middle and lower classes into paying more.

“What a country wants to make it richer,” economist John Stuart Mill wisely surmised, “is never consumption, but production.”

Unfortunately, we have it backward. We base progress on consumption. If we can’t afford more, well, then we’ll borrow more to keep the party going. But eventually, the music must stop. And the cleanup won’t be easy.

But to the magic moneymakers in Washington, that’s someone else’s problem.

As Bill Bonner points out in his latest book, Mobs, Messiahs and Markets:

“The goal here — as with all government programs — is to produce the desired benefits while pushing the costs onto someone else. That’s how politics work. You promise something…and you force someone else to pay for it. You rob one Peter voter…and spread the loot among the Pauls.”

Ahh, the beauty of politics.

Until next time,

Christopher Hancock
February 19, 2008

P.S.: Whether or not you agree with the Stimulus Plan, the real question is: How are we supposed to make money in times like this? I think you’d agree that it’s not in the U.S. That’s why I tell my Free Market Investor readers to look elsewhere.

Christopher Hancock

Christopher Hancock lives and breathes emerging markets. He travels extensively and utilizes his contacts across the globe to recommend the best international investments in the world. After working with Citigroup in Hong Kong on the challenges and opportunities associated with the forthcoming RBM flotation reform, Christopher left many of his friends behind and decided to return to the States to pursue a career in equity research. Special Report: Imagine Getting Rich as Ignored Stocks Soar- How you could turn $200 into $1.2 million!

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