An Heavenly Tax System - A Tax System that you actually want to have

I've been an entrepreneur all my life. I always loved the stock market. I always hated taxes (as everyone else I guess) but also its complexity and the value they actually destroy.

This post is in the line : " I could create a country from scratch". We can do it with companies, with countries is, well, less frequent.

Taxes and death are the two things guaranteed in life.

An even the second with the advances of medicine may not be so in some decades. This side note observation I borrowed from Einstein: "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former". After you've read this blog I left you to decide to apply or not the Einstein note.

A New TAX System

Let's go directly to conclusions. Later I'll discuss the system.

Let's create a country where there are ONLY two taxes / contributions:

1. A Value Added Tax (VAT) for every single transaction. Amount: 15% of every transactions.
2. A Wealth Tax (WT) on wealth of Individuals and Corporations. 0.2% monthly (2,5% yearly)

Now a number of very important assumptions, no exceptions:

1. Every asset (individual or corporate) is electronically registered
2. There is no "physical" money. Every transactions, how small or large, had to be done electronically.
3. Every asset transaction is simultaneously cleared for funds transfer and ownership
4. Every (I mean EVERY) asset is registered in a stock exchange by a price that the owner establishes.
5. Anyone can go to the stock exchange and buy at any time any asset.

The TAX mechanics

Let's start discussing the economics. The WT is inflation. As time passes your wealth is diminished about 2.5% yearly. No more grandsons that do nothing because the grandfather worked all his life building an empire. After 40 years the WT would reduce the fortune to a "mere" 39%, and if there are about 6 grandsons. each will have around 6% of the initial wealth. If you grandfather had 10 million, 600K is still good, but doesn't allow you to not work an entire life.

The VAT is applied to every single transaction, either individuals or corporations, for every, I mean EVERY asset, good or service. The twist is that the VAT will be deductible both for corporations but also for individuals.

The State Budget will be a sum of the WT and the VAT.

Now here comes the radical stuff:

• No IRS, No Corporate Tax, No Social Security;
• No Deductibles, No Fiscal Incentives, No Fiscal Differentiation
• No Progressive IRS

No Corporate TAX ?

What NO CORPORATE TAX? Exactly! Remember every asset is registered in the stock exchange by a price established by owners (in case of a non public company). That means that anyone can buy any private company. In order for owners protected their ownership they will impose a price that is overvalued. The twist is that of course the owners will have to pay 2.5% yearly of the price of the company. To put this is perspective, as of 26-Aug-2014, 2,5% of Apple Cap will hold 15Bn USD, just sligtly above the current 13Bn that Apple registered as tax.

But what it means for SMBs? That means that no 25% to 35% tax. A SMB owner will valuate their business accordingly and that means that he will evaluate the probability of loosing his business (from a takeover) or paying more taxes. After all, his shares are indeed registered in a stock market open to anyone. No more disparities between multinationals fiscal planning versus pure domestic high rates.

Interesting enough the systems discourages the Scrooge approach. Because every single year the Scrooge will loose 2.5%. Thus, the systems penalizes the ones that do not reinvest money and take risks.

Taxing Home Loans ???

Now let's take a simple example. A Home Loan. You ask a loan of 180K loan and give a down payment of 20K to buy an house. You own 10% of the house, the bank will own 90%. Thus you pay a tax os 2,5% (yearly) of yours 10% of the price you think the house is worth. If you put our house undervalued, say 150K, you will risk that someone in the stock exchange buys the house (remember, every single asset is on the stock market). So because you wanted to save 2,5% x 10% x (200-150) = 125 bucks you end loosing an house and still have 50K in a loan you owe to the banks. Suffice to say that no way the bank would allow you to put 150K as the value of the house, since the bank owes 90% of the asset.

You see how this goes, you register goods above the market value to protect from a down spiral. It is like having a controlled bubble. It is a KIWI system embedded in the system. People increase the asset amount to protected against hostile takeovers and in return that have to pay more taxes.

But because the system is ultra liquid, when the bubble is about to burst, the deflation kicks in. But because the tax in an percentage people and corporations will not be insolvent. If people / corporations don't pay taxes (because they can't) the state will repossess assets automatically via stock exchange.

VAT tends to ZERO

Let's go back to VAT. Because VAT is deductible a pressure will arise to keep goods, services and assets moving. Because VAT is deductible for Individuals, the best I can do for not paying VAT regarding a car I just bought is to sell something else. The velocity of transactions speeds up. The match of demand and offer is more liquid, thus reducing the asymmetry of information and reduce arbitrage.

Thus, the income from VAT tends to zero and it is shifted to the WT. In a stable system, after the transitory cycle it is expected that the VAT will be a fraction of the WT. VAT will be as we call in engineering a negative feedback to help stabilize the system.

The beauty of the system is that it tends to a single tax, the WT. Small enough yearly not to turn countries in communism (in which I completely do not believe) but large enough the penalize the "dolce vita" guys / corporations.

The world is Imperfect

In the following blogs, I'll explore the State Functions, Penal and Criminal Systems, Regulatory Functions, Smuggling, and Monopoly Control. Because the world is imperfect, we will need to take in account the exceptions in a way the system remains controllable and stable.

Improving Capitalism through a Pseudo Communist Idea

Since 2008 the World has lived difficult times. Until now Europe has been in a recession and US has been struggling. The several US programs like QEs have resulted in mixed economic results. On one hand the stock market has been beating records much helped by the liquidity that QEs offered, but that didn’t exactly translated in improving the living of the average American.

In Europe, a socialism driven continent, the pressure for increasing the minimum wage faces the mighty force of reality, where wages increase will even make the living of the SMEs more difficult, and only accelerate the migration of the multinationals for other geographies.

Nevertheless, around 27% of global wealth is in the hands of only 404 persons. And that imbalance only tends to increase.

Make no mistake, I’m a strong defender or meritocracy and only feel that socialism ideas only make the world worst. By socialism ideas I refer to the fact that we protect the ones that don’t (like to ) work through big unemployment welfare. By socialism I also mean redistributing wealth from the wealthiest to the poorest, just because the poor is poor (without putting forward policies to identify the ones that are just lazy).

However, building huge stock piles of money in the hands of a very few doesn’t do a lot for economy. Actually it hurts economy, since a poor middle class spends less thus pressuring economy into recession.

In a era where a single company, like Apple, has enough cash to bailout Portugal, Cyprus and Ireland together the question remains. For the Americans reader we could talk about California debt.

Thus, the socialists are coming up with the idea of increasing the minimum wage in Europe, but that is a “kicking the can” alternative. That is a winning lottery ticket for the lazy workers, and an huge headache for  companies that are just going by.

But it is reasonable for Apple to earn 2.3 million per employee and only paying them 100K? To those employees who actually contribute to such wealth, the vast majority of wealth is blocked.

I have a suggestion that can address an effective wealth distribution, and still manage well meritocracy:

a) Each time a company distributes dividends, a 20% amount should be distributed by the employees.

b) The amount should be distributed evenly, ie, each employee will receive the same amount.

Also noting that:

c) If an employee is lazy or incompetent, the management should have already fired that employee.

d) If a company distributes dividends it means that it can. And a company should only distribute dividends if that doesn’t hinder future growth or sustainability.

The policies in a) and b) will yield the results depicted below. Please note that results are for the medium, long term. Unfortunately our leaders aren’t able to play a multi round game. They don’t understand that increasing the tax on cars’ purchases will only reduce the number of cars bought, thus the overall tax collected cannot be extrapolated from the previous year’s cars purchases’ numbers.

The following results will yield:

1) The companies doing well will distribute 20% of dividends to the employees. That means that employees would be rewarded by their effort as a collective team, thus providing positive feedback and increasing team spirit.

2) A large amount of money would be reintroduced in the economy for each family. There is a limited amount of steaks that a person can eat per meal (in my case, one). Even billionaires will not be able to eat more than two or three steaks per meal which makes absolutely irrelevant if they have the ability to eat one thousand steaks per meal.

3) Like Larry Page states, he has a problem knowing how to invest Google huge cash ord. He wants to do it, he just doesn’t know how to do it the best way. By deploying money to the families, we are actually contributing to increase the entrepreneur’s spirit.

4) Derived from b) (each employee gets the same), we are actually actively contributing to moving people out of poverty. That means those families will be able to have more kids (reducing aging problem in some countries), have more sanitary conditions (reduce money spent in healthcare), increasing kids grades (parents can afford better study conditions), less pollution (affording houses better built) and eating better and doing more exercise.

5) Derived from a), the policy will not hurt already struggling companies, that require a lower employees’ wage to deal with fierce competition in the market place. For SMEs and large companies in stress, distributing dividends should not be an option. Thus policy a) will not have the devastating effects that increasing the minimum wage will have.

6) Finally, policies a) and b) are done at micro-economy level. The only level where you can actually control meritocracy. Because a company is small and has visible owners, the employees that get the reward are those that management deem fit to get it, otherwise they shouldn’t be working at that company.

7) Because the employee dividend is equal to everyone, management can’t manipulate numbers. And because it is a percentage of dividends, if management or shareholders try to get money out of the companies, employees will get some of it too.

In short, making every single employee a virtual and automatic shareholder will only benefit the whole economy. For sure are more middle class persons are, the more iPhones are sold.

To Swap or not to Swap, that is one of the questions

Following the latest news about swaps contracts on state owned enterprises, I remembered a comment I read may years ago stating something like: "they are so smart at company X, they bought a future contract on Y [fuel, jet-fuel, or something else they needed for their operations] and as Y's price is going up that will improve their profit".

In my opinion the comment is just plain stupidity! 

If you really know that the price of something is going up (probably you just think it will...) just make a business of it - set up a trading company - and leverage as high as you can. The issue is that there's no such thing as the price of something going up in the future, only opinions (more or less informed) and most business are "real stuff" not speculative trading (more on this in a future post).

Taking that your business isn't speculative trading, you should indeed use a swap or future contract to minimize your operational risk, for instance:
 - an airliner sells plane tickets today, for a flight in 2 months and pays the jet-fuel 1 month after the flight, it's therefor exposed the fluctuations of the price of jet-fuel in the future, that can improve or decrease the expected profit of the plane ticket. As the business of the airliner is to fly passengers and not to earn money from jet-fuel fluctuations, it makes sense buy a contact to take out that risk (sort-of, no risk is completely taken out).
The future contract price should obviously be taken into it's cost structured and priced into the tickets. But here things become more interesting, if a company doesn't cover it's risk, it will have a lower cost structure and could improve profits!... not obvious as otherwise it will have an higher risk profile that may increase it's costs (of capital and goods).

So in reality the decision is, what's the risk profile of an enterprise? what do the managers and/or shareholders want it to be?

In the case of private owned long-term infrastructure projects that aren't easy to transact, it seems that the profile risk should be low - otherwise who would invest long-term in projects subject to go bankrupt due to market changes (for sure to occur in the medium-long term).

The recent news were indeed about enterprises with long-term infrastructure projects, but in this case they were state owned, so does it make sense to reduce the risk profile, namely in relation to interest rate fluctuations?
As governments have generally lower financial risk than other entities (they can tax their way out, while others have to persuade others to mutual benefit transactions) and state owned enterprises in question already needed a government guarantee of some sort to contract their loans, I personally don't think those swap operations made sense ! 
... the worst case for those enterprises would be to go bankrupt, but most already would be without state support !

(note: a big part of the current problem isn't reducing the risk profile but transferring cost into to the future, out of the balance-sheet and short-term P&L, that is a different story, to be addressed in a future post).

An important issue is, what should be the risk profile of the state itself? namely the liquidity risk associated with its debt (also to support the risk of its state owned enterprises)... but that will be for future posts!

How about everyone of us, what should the risk profile of a person? (more on that on a future post)

PS: getting started is always the most difficult part... in my first post I managed to leave leads to further 3 posts  :-)

What's with the 3% deficit ?

I never understood the rational behind the limit of 3% of deficit. As a matter of fact I didn't understand also the limit of 60% of debt.

Don't get me wrong, I'm not in favor of allowing deficits greater than 3%.

I'm in favor of prohibiting deficits. Period. Anything that is below 0% shouldn't be allowed.

For years the Euro Socialists (and others) were arguing that a country can't be managed like a household. Yeah, right! Results are there for everyone to see.

A country should be run just like a household.

And because, generally speaking, people seem unfit to run well their households, they cannot run well their countries.

In credit card terms, the deficit is the difference between what you spent that month and the credit you made to pay the credit card.

Likewise, the total debt is your current negative credit card balance.

Part I - The Deficit (as in income statement)

A deficit means you are spending more than you are earning. It is in corporate language, the net income. In case of a deficit is actually the net loss. Thus, it is the bottom line of an income statement.

I don't know any company that has recurrent, year after year, negatives net incomes, ie, deficits. Why not? Because those companies go bankrupt and cease to exist. Kaput!

The companies that have negative net incomes they will probably run out of cash. When they do, they must borrow, ie, start owing money to someone. Thus, they start paying interests.

Likewise, a country that has run out of internal funds, and have a 3% deficit (ie, 3% GDP of negative net income), that country would have to borrow at least 3% of GDP.

Now is where the economists enter the room and say I'm foolish, because if that country has an economy that grows, than it could sustain that deficit. I disagree, since that is true only provided some ranges of total debt and grow must be observed. I could prove otherwise but that discussion will be for another post. Irrelevant, though! Europe is not growing structurally if you remove the consumption based on acquired debt.

So now you understand that currently (since any country in Europe as a sizable amount of debt), any percentage point in deficit will require an equal percentage point increase in the debt. It is a vicious circle.

Thus, deficits should be prohibited. Period! Countries ought to be forced to build surplus. But that is not people's money? Yes, it is, and should be used wisely, in times of possible depression, to increase public investment. Wisely means spending a little bit of it, not all of it in year of elections to gain votes.  (However voters tend to be not so wise in the year of elections and vote for the guys that give them money that year even if those guys drive the country to ruin).

Part II - The Debt (as in balance sheet)

The debt is nothing more than the accumulated deficits during a period of time. Note that included in the deficit of the current year are included the interest we have to pay regarding the current outstanding debt.

People dealing with negative credit cards balance know this reality too well.

They know that even if you don't spend nothing during one month, you still have to pay interests regarding the current negative credit card balance. As the debt grows bigger and bigger, even your credit aren't enough to pay the interests alone. That's the time to call your parents and ask to move in because you lost your home.

That's why the Maastricht Treaty stipulated a 60% to GDP limit of total debt. To keep the debt under limits, so that countries could at least still pay their interests. 

Part III - The Irrational Stuff

As it should be clearer, as debt increases, the interest paid increase also. Thus, the deficit component that regards the interest increases. When the interest paid reaches 3%, that means the State cannot have any deficit regarding its current operations. In corporation terms, it means that the EBIT (earning before interest and taxes) must be zero or positive.

As you reach the 60% of the Maastricht Treaty, the deficit must be zero. Otherwise you must borrow, but that leads to increase the debt, and overtake the 60% limit. 

Ohhh nooo! Because the economy is growing so fast that it can actually accommodate that deficit. Yeah right! And I'm Santa Claus! Oh, wait, I'm not Santa Claus! Yeah, right, neither an European economy ever grew fast enough to absorb those 3%.

You see the irrational stuff. Even a kid in 6th grade can do the math.

Part IV - Even more Irrational Stuff

But wait, politicians didn't stop here. At some point in time they decide that Keynes is always right, so they kind of abolished the 60% debt rule.

As if... it was possible to unlink the 60% debt rule with the 3% deficit limit. The 3% deficit rule (already a stupid one, because it should be a 0% rule) now is not linked to anything. Thus, politicians continue to argue that is possible to have public finances stabilized with this rule.

Tick (60% debt), tack (63%), tick (67%), tack (81%), tick (86%), tack (92%), tick (100%), KABUM!

Portugal, Spain, Italy, Cyprus, Greece are already or near the final countdown. France and others are working hard to get there too. And they will succeed !

Part V - A Death Wish

A lot of European debt was spent in three major ways:

1) Building a lot of stuff: roads, bridges, more roads, more hospitals, more airports. Those in favor say we needed those things. My personal view is that we could live well waiting a little bit longer for those infra-structures and not borrowing money for building them. As it seems with too many TGV, HighWays and empty Theme Parks, we would be better off without some of them.

Europeans have 5,000 years history, we could have delayed 10 or 15 years some stuff and not destroy the next 30 years for our children.

2) Spending too much in health care, public schools, social care and so on. The unemployment subsidies only favored situations like Ni-Ni (ni estudia, ni trabaja). It isn't by any means a monopoly of Spain this phenomenon. But I think the "Ni-Ni" is the best I have seen in acronym land.

3) To give employment. The rational is that if the private sector don't create jobs, that the state will create them. Guys! Hello! If the private sector is at danger, don't create public jobs! Maybe, spend a little bit of money, following Keynes suggestion, and award the private sector some contracts.

Please note that the public sector is like a back-office of a company. It is the least of the two evils. Either you spend some money, or your company collapses due to the lack of support processes. But I never, never saw a back-office in a company to be a revenue center, it is always a cost center. And, as all costs, should be kept to a minimum.

So, as European governments did all three things at the same time, with very or few restrictions, I can only assume they had a dead wish. Well they succeeded.

Greece - done;

Ireland - done;

Portugal - done;

Spain - errr, the bailout that it isn't a bailout, but that looks like a bailout, but it is not assumed as bailout... you see what I mean.

Cyprus - oh, yeah, tomorrow we will see the next episode of the soap opera.

Italy - tick, tack, the bomb is still tick tacking, a good sign .... until it explodes.

You get the picture. Now a final quiz:

How many countries in the Euro zone have their debt below 60%?

Cyprus: Only Plan A, no Plan B, oooops, No Plan

"Those who fail to plan, plan the to fail", a common saying. Well it seems that the Euro Bureaucrats did it again!

How many times did we hear that there was no plan B? For the ones that thought it was some sort of pressure so that Cyprus would accept the bail-in, think again. They actually never had a plan B. That's all folks!

And only after a short while, already the ECB says that it will continue to provide liquidity to Cyprus. Aahahahhah! Merkel, who is saying that Cyprus should talk with Troika instead of Germany, is learning (at least we hope) what is a multi-round game. Yes, life is not a single round game, it is a multi round thing.

Well, now either Europe fulfills its promise and let Cyprus burn, or it helps Cyprus no matter today's decision. Either scenarios destroy Europe credibility and will increase the current crisis.

In the first scenario, for sure Cyprus will have to turn to non European funds, like..... russian money. No doubt Russia has a lot of money, as oil and gas continues to be pumped across Europe. A more troublesome idea would be turning to middle east. As we all now Cyprus history that would be unlikely, but desperate times mean desperate measures. As I often said, if Greece wasn't bailout out we risked intervention from uncommon capital sources. Remember that the principal buyers of portuguese recent privatized companies come from one single country, China, which is not by any means a near by neighbor (although the relationship of the countries has more than five centuries of history).

In the second scenario, we will actually wait for the ... third scenario, as I cannot see the incompetent European politicians to come up with a viable plan. Meanwhile, it is only probable that we will assist a bank run, precisely of the deposits above 100K, since depositors that have more than 100K have the knowledge, financial fire power and will to come up to alternative geographies. However, unwinding 60bn plus of foreign  investment (read; from russia) will certainly take a while. Whatever how it will play, any bank run will turn Cyprus banking system into a time bomb, with a very short fuse. If a bank run exists ( i would bet people with turn to their mattresses) , it is probable that it would be a fast one, mimicking the planned bank freeze, but this time is not for only a few days.

With investors in Portugal, Spain and Italy already simulating and planning scenarios, things can eat up. (The Euro Bureaucrats are the only ones you have only a Plan A, every body else runs simulations and alternative scenarios). A Flight to Quality is already under way, and evaluating alternatives like Norway, Canada or Singapure are no more a far distant option. More trivial and fast to execute options like US or UK are already being executed.

Like Einstein said "Only two things are infinite, the universe and human stupidity, and I'm not sure about the former.". Not planning for the expected rejection in Cyprus's parliament for the total annihilation of the essence of the banking system has nothing to do with universe dimension.....

The Euro Bureaucrats pointed and fired a gun at Cyprus parliament. But surprise, surprise, and gun has no ammunition. They can reload the weapon. But who are they? ECB? EU? IMF? ECB already said that it will provide enough liquidity to Cyprus under the current rules, for whatever that means.....If only EU citizens would understand how good this soap opera is, we could save some money importing TV shows from Brazil and US.

Playing the Shutdown, Sleep on Economy

Shutdown and Sleep are techie terms. We are too familiar with Shutdown (and Reboot)  due to the constant Windows updates that forces us to wait helpless looking at a screen.

But now European Politicians discover that they like to play a different game: the "quasi-Sleep" game. Sleep is a Windows feature not as widely known as Reboot, that basically freezes the computer to save power and allow you to resume at the same state before you executed the Sleep.

However, unlike the real Sleep, the Cyprus bank freeze is like a "quasi-Sleep". And the "quasi" is the key word.

You see, what was to be a "sleep" mode during non bank business days, now we know only Thursday banks will open. During that time any bank transaction is blocked. So forget about going out for a meal,  go to the cinema, offer something for the Father's Day, or .... pay your suppliers. And if you don't pay your suppliers, you cannot sell your products and services.

The Bureaucrats seems to forget that you cannot actually freeze people lives. You still have to eat, drink and do a bunch of other stuff.

But technology is awesome, and now the Bureaucrats just discovered they can freeze an entire group of mainframes, SEPA infra-structure, debit / credit cards operations with a single click.

Today's world is controlled by software, and  a global software freeze has the capacity of global destruction.

What is really frightening is that those guys don't understand that freezing bits and bytes, aka "Money", they are actually destroying real goods and services.

Get Ready, Get Set, Go

Money, of course ! Money is getting ready to fly from Cyprus. Why?

Because I guess the people from Cyprus would like to keep the remaining capital.

ECB, Merkel or Schäuble may have a secret plan to capitalize the German banks. Flight to quality is happening, with german bonds hitting negative yields.

Now, the not so trivial question: if you were a cyprus citizien would you put your remaining cash in a german bank, the same banks that pressured for a deposit levy on your money. Would you help even more the enemy of your capital ?

The deposit levy, and the way it was conducted, it is a "no return" atomic bomb.

First, we already are seeing the "not me" show. Schäuble is saying that he is not responsible. Merkel says that she must explain to the voters why Germany has to save everybody, but now it is under fire internally and had to reassure that the german deposits are guaranteed.

Second, I really don't get the deposit levy rates. At current amounts Cyprus will not be able to repay the debt for a long, long time. The problem is that the reforms were not done. Taking money from people that have very few doesn't solve the problem. And the 20bn of Russian money will be a hot patato as Putin is already showing. Getting some money are providing the bailout only mean that in short time a second levy will be necessary.

What should be done is gaining control over the Cyprus financial system, ie, the banks. By controlling the banks, but guaranteeing the deposits, the respect of the depositors will happen. It is idiotic to make each small depositor a sharehold of the cyprus bank. A much more effective way would be to deliver those shares to Merkel ..... and from that point on, the Cyprus banks would be german banks, no bank runs, financial discipline, and more important, Germany would become committed to the solution.