Imagining a World Without Tax-Free Government Bonds

R.A. Hettinga rah at shipwright.com
Sat Aug 22 06:03:34 PDT 2009


...And remember, boys and girls, the canonical "risk free" rate of
return these days is that of a T-Bill.

Maybe not so much anymore?


"House Republicans stood and supported the Petraeus surge so our
troops would have victory in Iraq. Today, House Republicans oppose the
Paulson splurge so that we can have prosperity in America in the long
run. And make no mistake, we understand the gravity of this situation.
But we will not engage in a rush to judgment that destroys the
possibility of the free market and prosperity for American families
for decades to come.

We will not walk out of this room after a forced vote, waving a piece
of paper in our hands, claiming fleece in our time. "

-- Rep. Thaddeus McCotter (R) MI-11, Speech on the floor of the US
House of Representatives, September 25, 2008


Cheers,
RAH
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RealClearMarkets
August 20, 2009

Imagining a World Without Tax-Free Government Bonds
By John Tamny

Last month federal agents arrested a large number of New Jersey
politicians on bribery and money laundering charges. As described in
the Wall Street Journal, one $97,000 bribe was handed off in an empty
Apple Jacks box.

Last week the New York Post exposed the highly suspect activities of
State Sen. Pedro Espada Jr. A self-described "hero" to his largely
Hispanic constituency, Espada was somehow able to secure for his son a
$120,000/year state job. The only problem was that no one in the son's
downtown Manhattan office had ever seen him before because he'd never
shown up for work.

And on Tuesday of this week, Dallas's former mayor pro tem and a city
planning commissioner were charged with bribery and extortion in a
federal corruption case. It seems they'd pressured "developers to
award contracts to friends in the name of supporting minority-owned
businesses."

How does this relate to tax-free bonds? At first glance it's a
reminder to investors that when they purchase municipal and state
bonds, they're helping fund the activities of a pretty sleazy crowd.
Creators of no wealth themselves, politicians seek office to control
and distribute the wealth of others.

When we buy government bonds, we transfer wealth to a particularly
grasping strain of person eager to access the money of others in order
to elevate themselves. If power corrupts politicians, it is private
producers who offer up the wealth that makes them powerful.

What makes this even more despicable is the way in which state and
local polities raise their funds. Government at its core is force, so
the taxing authority enjoyed by our local politicians makes it easy
for them to float bonds ahead of tax revenues. And not as dim as they
often appear, politicians don't stop there.

Indeed, perhaps correctly aware that no reasonably sane investor would
fund the waste that is government if given the choice to invest in
something productive and similarly remunerative in the private sector,
state and local politicians have secured a sweet deal whereby the
income streams from their bonds are not just exempt from local and
state taxes (that's a given), but also federal.

As it is, state and local bonds are more "equal" to a profit seeking
investor than corporate bonds for the explicit promise of tax revenues
to be confiscated from an increasingly powerless electorate. Since
jail is the end result for those who evade taxes, local and state
bonds are mostly a good bet for investors. Corporations, on the other
hand, can't arrest the individuals who choose not to buy their goods
and services.

But as has already been mentioned, the income that municipal bonds
generate is tax free. So assuming a generic New York City bond with a
5% yield versus a corporate bond yielding the same, in income terms
there's no comparison. That's the case because a New York City
resident paying a combined local, state and federal tax rate of 42%
would achieve a taxable equivalent yield of 8.6 percent (5/1 -.42 =
8.6) on purchases of New York munis.

There are a lot of rich people in New York who in an equal investor
environment might fund a lot more private-sector activity, but thanks
to the security and increased yield offered by New York municipal
bonds, private entities seeking capital to grow must offer up income
to investors that not only reflects the risk premium that is part and
parcel of existing in the for-profit world, but more yield on top of
that to make up for the taxable difference. In seeking safety and
yield, the New York rich frequently hand their money over to
governments run by people like Pedro Espada Jr.

This is offensive on its face knowing what we know about him and
others in New York's political class, but the unseen in this instance
is even more horrifying. Indeed, what businesses in New York and
around the world never formed at all due to a scarcity of capital
wrought by the relative income appeal of government bonds?

It's a tautology to say that entrepreneurs can't be entrepreneurs
without capital, and the ease with which local and state governments
vacuum up cash means that on the margin, many entrepreneurs go
wanting. Of course there are no wages without capital either, so when
governments float bonds to fund their bloated, inefficient and
frequently corrupt operations, they're indirectly reducing the size of
all of our paychecks.

If we throw federal politicians into the mix, their ability to fleece
the whole country makes U.S. Treasuries even more appealing. The
income from Treasuries is not exempt from federal taxes (it is exempt
from state and local taxes), but so powerful is the IRS's ability to
tax, U.S. Treasuries are seen as the safest investment of all. The
funds raised allow for various "Bridges to Nowhere", while the unseen
is once again the private concepts that will never see the light of
day due to insufficient capital.

For now, and presumably forever, Americans will accept the preferred
status attached to local, state and federal debt because as an
overtaxed society, we're eager to shield any investment income we can
from the tax authorities. But more than ever it's worthwhile for all
Americans to imagine a world without tax-free bonds. If we do, we
might realize what a bad deal politicians are "giving" us when they
issue bonds paying income that they don't "take."

There's no such thing as a free lunch, and so long as government bonds
are tax free, our standard of living and wages must decline for all
the innovations and jobs lost thanks to governments availing
themselves of a major privilege on our backs. For Americans to imagine
a world without tax-free government bonds is for them to conceptualize
a much more prosperous one. That kind of thinking must horrify
politicians.

John Tamny is editor of RealClearMarkets, a senior economic advisor
for H.C. Wainwright Economics, and a senior economic advisor to
Toreador Research and Trading (www.trtadvisors.com). He can be reached
at jtamny at realclearmarkets.com.





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