Saving and investment are already double-taxed several times over. This includes the inheritance tax, which is slated to rise substantially next year. But taxing successful investors and earners is the exact wrong policy.
Alan D. Viard of the American Enterprise Institute writes that 2007 tax returns from households with incomes greater than $200,000 reported 47 percent of all interest income, 60 percent of all dividends, and a “staggering” 84 percent of all net capital gains. These folks are the economic activists, the ones most likely to reemploy their investment gains into new job-creating businesses. But these new tax penalties will blunt their investment activities, thereby reducing the demand for money. Of course, the whole economy will suffer as a result.
Even with the same volume of money in circulation, new tax penalties from Washington will lower money demand for investment purposes, making each new dollar printed by the Fed that much more inflationary. So the great risk is that rising tax rates will make the Fed’s bloated balance sheet even more inflation prone over the next few years. As many have noted, inflation itself is the cruelest tax of all.
The original supply-side model crafted by Robert Mundell and Art Laffer argued that low tax rates and a tight-money-linked sound dollar was the best path to maximizing economic growth. This model prevailed through the highly prosperous 1980s and 1990s. Launched by Ronald Reagan, it basically continued, with a few bumps here and there, through Bush 41 and Bill Clinton. But the dollar side of the model was badly broken during the 2000s, and at the moment, it looks like it may stay broken.
This is a crucial juncture. The Fed is going to encounter excruciatingly difficult problems as it deals with the magnitude and timing of its decisions to start withdrawing excess cash and raising the fed funds target rate. Markets should be the guideposts for these decisions, not the unemployment rate.
Janet Yellen, who served as a top economic advisor to President Clinton and was a Clinton appointee to the Federal Reserve Board, has for the past six years been the president of the San Francisco Fed. She is a very able economist. But if you work from the wrong money model, you are likely to get the wrong money results.