“Positive economics is in principle independent of any particular ethical position or normative judgments… In short, positive economics is or can be an ‘objective’ science.”

– Milton Friedman

‘Tis the season for stump speeches and political posturing. Now that we are down to two candidates for President, we wanted to offer some advice to the two candidates in order to ensure a strong economy and higher investment returns. If it were up to us, we would have a low flat tax and let the economic forces of capitalism work. We have included the first tax form established in 1913 to demonstrate how far our current, convoluted tax system has come. We would love nothing better than for us to go back to the original tax form. However, we know this will never happen. Therefore, we wanted to offer the candidates some “positive, objective” advice on their flawed economic policies.

John McCain:
There are two major problems with Mr. McCain’s economic policies that will hurt the US: carbon taxes and executive pay. Both of these ideas use a strong armed approach to change behavior.

McCain is a proponent of creating a carbon tax to restrain global warming. Now we don’t want to argue the facts about global warming (even though global carbon dioxide levels rise after warming occurs – the opposite of what is being espoused by some, and solar flares naturally cause global warming/cooling), but, rather, simply discuss its economic impact. This tax will make us less competitive worldwide – especially to those countries that have no carbon controls (i.e., China, India, etc.). Some studies suggest the cost for a gallon of gas will rise anywhere from $1.50 a gallon to $4.00 a gallon if the carbon tax is passed. With people unhappy now paying over $4.00 a gallon, just imagine what it would be like if you had to pay $6-$8 a gallon. It would cause our economy to screech to a halt. Our Solution: If McCain wants to reduce carbon emissions, use the tax code to create an incentive for people to use other forms of energy. Home ownership in America rose dramatically once people were able to deduct the interest they paid on their mortgage. Why not reduce corporate and individual taxes through direct reduction in their rates or tax credits? For example, solar panels are expensive, but we suspect many more people would buy them if they received a tax credit for the full amount they spend.

McCain’s solution for excessive executive pay is to make all executive pay packages subject to the approval of shareholders. This will not have any impact on executive pay. It would just add another 50 pages to proxy statements that most people will not understand or spend the time to read. In fact, it could actually increase executive pay. What follows are statistics from a book written by Dan Arielly (“Predictably Irrational”) which sheds some light on the issue. In 1976, the average CEO was paid 36 times what the average worker was paid; in 1993 it was 136 times. In an attempt to bring executive pay more in line with the pay of the average worker, regulators in 1993 forced companies to disclose details about executive salaries and perks thinking it would make corporate boards more reluctant to pay high salaries. What actually happened was the opposite of what was intended. CEO’s saw what other CEOs were making and demanded more pay.

Today, the average CEO makes 369 times as much as the average worker! This same phenomenon occurs in sports. Kobe Bryant believes he is the best player in basketball. If he sees that LeBron James is making $2 million more a year than he is, he will demand more money. This vicious cycle continues and, among other things, ticket prices go up. Our Solution: Use the tax code to change the dynamics of executive pay. The US corporate tax rate is the second highest in the world behind Japan. Why not offer a lower tax rate to firms that limit CEO pay to no more than, say, 150 times the average worker pay? Those companies that do this would be taxed at a corporate tax rate of 15% instead of 38%. The lower tax rate would incentivize boards to pay their executives less. It would also require executives to have a bigger stake in their company’s performance and tie executive pay to the pay of the average worker. This would mean, in most cases, that executive pay would go up only if the pay of the average worker goes up. In addition, companies will repatriate money back to the United States for investment here rather than overseas because of the lower tax rate. More money in the US would lead to an increase in employment in the US. Those companies that decide to pay their executives more than 150x the average worker pay will pay taxes at the 38% level leading to a less profitable company and, in turn, a decline in the company’s stock price. No board wants that to happen.

Barack Obama
The main problem with Obama’s economic policies is raising taxes to pay for additional spending. In our opinion, his two most damaging tax proposals are the increase in the capital gains/dividends tax rate and the creation of a windfall profits tax.

Obama wants to raise taxes on capital gains and dividends. John F. Kennedy was correct in stating that when you lower taxes, tax revenues rise because of increased economic activity and when you raise taxes, tax revenues fall. It follows that if Obama wants to increase tax revenues so there is more money to spend, he should lower tax rates. The Bush tax cuts of 2002 provide recent evidence that this is the case. Both economic growth rates and capital gains tax revenue have doubled since 2003. Rev¬enues to the government from capital gains taxes were $47 billion above the projections issued by the Congressional Budget Office (CBO) in 2006. Tax cuts have always increased revenue while tax increases have always decreased revenue. Why? Because people will do everything in their power to avoid paying higher taxes. We have lived through periods like this before at THOR where client questions are geared more towards tax avoidance then investment returns. Our Solution:Lower taxes on capital gains and dividends. This will spark economic activity and increase government revenues. Capital also will be invested in the most efficient manner (which provides better paying jobs for the US!).

The windfall profits tax proposed by Obama on energy companies would crush our economy. This is not a new tax. In 1980, a windfall profits tax was imposed on the US oil industry. It was repealed in 1988. A March 9, 2006, report from the Congressional Research Services indicated that tax revenues expected from the windfall tax fell woefully short of its expected $393 billion – it generated only $80 billion!! In addition, US oil production fell and imports of foreign oil increased. Why would a US oil company increase production if most of the revenues generated from that increase will go to the government in the form of a windfall profits tax? Our Solution: Allow more domestic drilling and don’t impose a windfall profits tax. This will have the impact of increasing revenue to the government by creating great paying jobs in the US and increasing economic activity. It will also add to our security by decreasing our need for imported oil. If we import less oil, our current deficit with foreign countries will drop and the value of the dollar will increase.