The most important financial post I'll ever write

The Arithmetic Limits of Power

From: [url]http://market-mousetrap.blogspot.com/2013/01/01132013-arithmetic-limits-of-power.html[/url]

Let’s start with a few goals:

1) Give the United States government as much money as possible

2) Give the United States President as much power as possible

3) Make taxes as fair as possible

These are well known to be the goals of the current President of the United States, and I want to help him achieve these goals.

No, seriously. I had a bit of a revelation a few days ago that completely changed my understanding of what this country needs, and it really truly needs President Barack Obama to have as much power as we can possibly give him.

The revelation was the calculation of the true Laffer Curve that I produced in my January 10, 2013 post:

[url]http://market-mousetrap.blogspot.com/2013/01/01102013-calculating-true-laffer-curve.html[/url]

Here is the graph again – because it’s probably the most important graph I will ever produce in my lifetime:

[ATTACH=CONFIG]16906[/ATTACH]


The red line is an idealized Laffer Curve I produced for short term capital gains on my November 17, 2012 post:

[url]http://market-mousetrap.blogspot.com/2012/11/11172012-how-to-really-soak-rich.html[/url]

Short term gains are produced by a person who has no concern for the tax impact, so it is behavior neutral. That is, it assumes no effect of tax rates on investor behavior.

The curve achieves maximum government revenue at 35%.

The second line – the blue line – is the actual revenue curve created by each percent of historical maximum income tax rates from 1940 through 2011, with rates ranging between 28% and 94%.

The revelation is that these lines have the same slope, and the same maximum revenue point: 35%.

So then, our first goal is relatively simple: set the maximum income tax rate at 35%.

Now for the next goal – give the President of the United States as much power as possible.

This one should be an obvious extension of the first goal. Money is power, and the more money the United States government has, the more power it has. But the President is not just the President of the United States government. He is the President of the United States itself – that is, the entire country. So, the more powerful the country is as a whole, the more powerful is the leader of that country.

To put this into perspective, let’s imagine two leaders, and two countries: Ronald Reagan and Fidel Castro in the 1980s.

Fidel Castro has absolute and unlimited power in a tiny impoverished country. Ronald Reagan has limited power in the greatest economy on the planet.

Who has more power?

Right, Reagan.

Power isn’t having the biggest piece of the smallest pie, but a big piece of the biggest pie on the planet.

Our goal is to make President Obama TRULY powerful, not relatively powerful. We don’t want to give him the illusion of unlimited power in some backwater banana republic, but we want to make him the leader of the most powerful force the world has ever seen.

So then, we need something different from a Laffer Curve.

We need a Rahn curve.

[url]http://en.wikipedia.org/wiki/Rahn_curve[/url]

and,

[url]http://www.adamsmith.org/blog/tax-and-economy/the-rahn-curve[/url]

I had actually included that curve in my November 17, 2012 post, but I’ll post it here with the formal names:

[ATTACH=CONFIG]16907[/ATTACH]


So, to recap, the first goal is achieved with a maximum tax rate of 35%.

The second goal is achieved with an average tax rate of 15%.

(This includes, of course, government spending capped at 15% – we don’t want to be Zimbabwe or Argentina, now, do we?)

But what about the third goal? Don’t we want people to pay their fair share?

Of course we do!

The answer is in optimizing BOTH the Laffer and the Rahn curves. You want the maximum tax rate at 35% and the average tax rate at 15%.

Oh, and you want to give tax breaks to folks who truly need them.

That’s where the “taxpayers” line comes in on that last graph (above). Notice how it’s not a straight linear progression, but instead a logarithmic progression. That’s the beauty of a progressive tax code. The vast bulk of the revenues are generated from the wealthy.

So, on a logarithmic scale, if the top rate is 35%, what is the average rate?

Sorry, not 15%. It’s 19%.

What the heck do you do with that other 4%?

Simple: deductions.

But we want to do the tax rates and deductions using an old Communist formula: “from each according to his ability; to each according to his need.”

Reword that to “tax rates according to income; tax deductions according to need.”

The rates will be progressive.

The deductions will be flat. They won’t do so much for the rich, but they’ll do a lot for the poor.

In 2011 the United States GDP was about 15.09 trillion.

The United States population was about 312,780,968.

GDP per capita was 48,244.62.

4% of GDP per capita was 1929.78.

So, then, allow up to 1929.78 in deductions per person in the household represented by the taxpayer.

There’s your 4%.

Oh, and you set the mid-point on your logarithmic tax scale at the average GDP per capita of 48,244.62.

The tax brackets break down to these:
35% $300,000 and up
30% $250,000 $299,999
25% $200,000 $249,999
20% $150,000 $199,999
15% $100,000 $149,999
10% $50,000 $99,999
5% $0 $49,999


Keep in mind that the ONLY deductions are 1929.78 per person in the household represented by the taxpayer.

Now, that last point is probably unfair. After all, there are people who have really severe hardships and need more than others. This is where you would need some kind of finesse – but the AVERAGE deduction for the population as a whole would have to be that 1929.78. If some got a 20,000 dollar break for medical hardship others would do without.

The brackets would be reset as total GDP and U.S. population changed, but it took me ten minutes to calculate the logarithmic progression, and now that I have the spreadsheet I could update it in ten seconds with two (and only two) points of data: total national GDP and total population.

And that’s it.

We would achieve all three goals the President says he wants: money, power, and fairness.

Notice also how these tax brackets would also make President Obama the most popular President in history.

Not bad for one evening of work.

Also notice how this accomplishes Democratic ENDS by Republican MEANS. In other words – an end to gridlock!

Now, can you clue in your congressmen and the White House so we can move on with our lives and end this stupid political posturing?

Oh, and Mr. President: you’re welcome.

Tim

tim,

that is pretty amazing and incredibly interesting. thanks for posting it.

lisa

Thanks for the kind words, Lisa. I appreciate it.