Obama's Speech...and the Unseen

Let's see. It is August 2012. Here in the United States, we are gearing up for another presidential election, and president Obama just made a speech to the citizens in Roanoke, Virginia. In it, he outlines his vision for America if he is re-elected, and his plans to get us there.

Frederic Bastiat was an insightful economist during the 1800's. He has a famous saying that goes something like this: In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

In his speech, Obama explained his plan for economic recovery...the part he wants seen. In this small essay, I will also draw attention to the unseen. For if we want to make the best decisions individually and for the country, we should consider all the consequences.

Obama on taxing the rich:

Now, understand, the top 2 percent, folks like me, we're the ones who most benefited over the last decade from not only tax breaks, but also a lot of the money from increased profits and productivity went up to that top 2 percent. So the bottom line is, the top 2 percent doesn't need help. They're doing just fine.

And I understand why they wouldn't want to pay more in taxes. Nobody likes to pay more in taxes. Here's the problem: If you continue their tax breaks, that costs a trillion dollars. And since we're trying to bring down our deficit and our debt, if we spend a trillion dollars on tax cuts for them, we're going to have to find that trillion dollars someplace else. That means we're going to have to maybe make student loans more expensive for students.

Obama wants to increase the capital gains tax from 15% as it is now to 35%. He believes that the rich simply do not pay enough, and that if they did, we as a nation would be just fine. Forget about the fact that the United States is 14 trillion in debt, and we have at least 100 trillion in unfunded liabilities that simply cannot be paid, no matter what. The rich should just pay more.

In my profession, I meet some of the top 2% (I am a personal trainer), and I ask them what the story is from their perspective. Here are some things I learned:

• They get taxed quite a bit already. It is well known that the capital gains tax is 15%, but that is not the whole story. Businesses have to pay corporate taxes first before they pay dividends. How much is that? 35%. Then the owners of the company gets taxed another 15% for dividends. This totals to 50%. Quite tellingly, about a year ago, the corporate tax rate in America used to be the second highest in the world, behind Japan. We have since moved to first place.
• One of my clients does not own his own company, but he has been an executive for over 20 years. He does not get a tax break. He has to pay 38% of his income in taxes. He also has other tax obligations that I do not. All told, he paid over 45% of his income in taxes last year.
• When I asked him what would they do if Obama increases taxes, he said that the wealthy would simply not invest as much, and maybe not at all. In other words, they would just sit on their cash. As one of my other clients put it, exposing his capital is risky. He could lose it all, and if taxes are too high, the return versus risk is too simply too high to encourage investment.
• I asked my client who is an executive about who, then gets the "tax breaks" that Obama wants to get rid of. He said that it is the hedge fund guys that make the really big bucks, and get the breaks. What these guys do is they set up a corporation that then "manages" the companies the hedge fund guy buys. The hedge fund runs them for a few years and sells the company for a profit. They also charge "management fees" to the businesses they own through the corporation, which get taxed at the capital gains rate. When they sell the companies at a profit, they also only pay capital gains taxes as well. My client does think the tax law should be changed. He believes that the management fees should be taxes as income. I still do not think that may be the case, for after all, those corporations still have to pay the corporate tax before giving out dividends, so it would be the same situation I outlined above.
• Here is my 2 cents worth on the ones who have the real tax/wealth advantage. I believe it is the entities and individuals who are closest to the money spigot who get ahead. The Federal Reserve can, and does print money at will. So those companies closest to the federal reserve, such as big banks will get the money first before inflation sets in. They, therefore, have more purchasing power for assets than the rest of us. Other beneficiaries would be big businesses closely aligned with government, such as defense contractors. I do not think adding more taxes on "the rich" will address the problem. I believe we need to get back to sound money to balance out the playing field. Want to know more about this elite group? Read SUPERCLASS, by David Rothkopf.

The unseen consequence of Obama wanting to increase the capital gains tax to 35% is a drop off of business investment. The near term effect would not be too bad, but after a few years we would see lower productivity and lower employment.

Obama's plan for the housing debacle:

We’ve got to deal with home ownership, and the fact of the matter is that my opponent’s philosophy when it comes to dealing with homeowners is, let the market bottom out and let as many foreclosures happen as it takes. I don’t think that’s part of a solution -- that’s part of the problem.

So what I want to do is, I want to let every single person refinance their homes and save about $3,000 a year because you’ll spend that $3,000 on some of these stores right here in downtown. You’ll help small businesses and large businesses grow because they’ll have more customers. It will be good for you and it will be good for the economy. And that’s why I’m running for a second term as President -- because I want to help America’s homeowners.

This idea sounds good, but I have one question. What about the people that would have been able to buy a house if the market did reach bottom? Actually, I have 2 questions. What about the people that get the handout as well? Truthfully, getting the handout does not help them out in the long run. I am willing to bet that in most cases, if someone is struggling to make ends meet paying the mortgage, it would not be much better with a mortgage reduction. There is still property taxes, insurance, and maintenance that needs to be tended to. Also, since the government would be helping all these people, the market cannot correct, meaning, for one thing, that housing will not appreciate for a long time, if ever because the homes are still overvalued. I might also ask, where is Obama going to get the money to help these folks? Either by raising taxes or by the printing of money.

I can personally relate to this. I bought a home and I could not make payments after the recession. I had the option to restructure my debt, but I chose not to. Why? Because my mortgage and maintenance burden would have still been too high. I filed for bankruptcy and had to start all over. Since the house went into foreclosure, the bank sold it for less than I bought it (good for the new owners), and I found place to rent. Guess what? For the first time in 10 years, I am finally able to save money. On my balance sheet, I am much better off now than I was 4 years ago because the debt is wiped away, the assets I owned are in better hands, and everybody is better off. Consequently, this only took 3 years all in all.

The unseen point of Obama wanting to help homeowners out is that potential new homeowners will have a harder time buying. All those families carrying excessive debt will still be carrying excessive debt and not able to get ahead, home values will not appreciate, and most likely taxes would go up and/or we will see more inflation.

Obama and the General Motors agreement:

On almost every issue, you've got the same kind of choice. When the auto industry was about to go under, a million jobs lost, and my opponent said, "let's let Detroit go bankrupt," what did I say? I said --

AUDIENCE: No!

THE PRESIDENT: I said I'm betting on America's workers. (Applause.) I’m betting on American industry. And guess what? Three years later, GM is number one again and the American auto industry has come roaring back. (Applause.)

So I believe in American manufacturing. I believe in making stuff here in America. (Applause.) My opponent, he invested in companies who are called “pioneers” of outsourcing. I don’t believe in outsourcing -- I believe in in-sourcing. (Applause.) I want to stop giving tax breaks to companies that ship jobs overseas; let’s give tax breaks to companies that are investing right here in Roanoke, right here in the United States of America. (Applause.) Let’s invest in American workers so they can make products and ship them around the world with those three proud words: Made in America. (Applause.)

Before I examine the unintended consequences of the General Motors deal, I want to make a couple of observations. First, General Motors does look healthy. I checked out the balance sheet, and as of 2011 they are running at a profit. They show a profit of over 8%. This is good. It is in line with what a healthy company should do. Secondly, I need to point out that President Bush actually started the negotiations for the General Motors bailout. Obama moved it forward. Thirdly, I like the idea that he wants to give tax breaks to companies to invest right here, but I think he is only half way there. Why not tax cuts all across the board, along with a roll back on tough to overcome regulations for business start ups? Tax breaks alone to try to keep jobs in America is not enough. If regulations are too high, and employee wages too high and non-negotiable, companies will still ship jobs (and open their headquarters) overseas. We simply need a more business friendly environment, period.

Now, let us take a look at how the General Motors deal went down. I will let Paul Gregory of Forbes magazine explain the details:

The White House ran the auto bailout from start to finish. The Treasury provided $30 billion to see GM through its reorganization. The White House then proceeded to fire GM’s CEO and to strong-arm secured creditors. Most importantly, Obama’s auto task force did not use section 1113 of the bankruptcy code to renegotiate GM’s $55 per hour labor union labor contracts (New hires earn much lower wages under the agreement). GM’s white-collar (non-union) employees took the hardest hits.

The UAW pension fund received 17.5 percent of the new GM. Shareholders were wiped out. Contrary to established law, the Treasury allowed the new GM to carry forward $50 billion of losses, at an eventual taxpayer cost of around $15 billion.

There is more:

The courts had little choice but to approve the Treasury’s prepackaged reorganization plan. After all, all the parties had signed off, whether under duress or not. The bankruptcy court must have marveled at the sweetheart deal for GM.

What happened is that the established rule of law was basically upended to do this deal. The older union workers got a good deal, at the expense of the bondholders. Obama put his man in charge of General Motors, a czar, and General Motors gets tax breaks for lost monies before the bankruptcy. I can't help but wonder if General Motors would be doing so well if it had to pay it's taxes like the rest of the car companies.

The unseen consequences of this action are:

• People who have money to invest will now be less likely to do so, for they may get wiped out to support employees or whatever the government deems important. It increases investment risk.
• It set a rather uncomfortable precedent: big companies deemed "too big to fail" can be nationalized. In a roundabout way, that is what happened.
• Most likely, General Motors will have to borrow more money from the government at some point because they cannot get financing through the private sector any more. This creates the problem of moral hazard. Since the government will most likely back up GM, no matter how poorly they run the company, it will struggle with innovation and profitability.

Obama and health care:

I am running because I still believe that you shouldn't go bankrupt when you get sick. We passed that health care law because it was the right thing to do. (Applause.) And because we did, 30 million people who don’t have health insurance are going to get help getting health insurance. (Applause.) Six million young people who didn't have health insurance can now stay on their parent’s plan and get health insurance.

Seniors are seeing their prescription drug costs go down. And, by the way, if you've got health insurance, you’re not getting hit by a tax. The only thing that’s happening to you is that you now have more security because insurance companies can’t drop you when you get sick. (Applause.) And they can’t mess around with you because of some fine print in your policy. If you’re paying your policy, you will get the deal that you paid for. That’s why we passed health care reform.

I do agree that one should not have to go bankrupt if one gets sick, but this is not a good way to go about it. Health care costs have gone ballistic in the United States over the last 40 years. The reason? The health care system has been slowly taken over by government. Tom DiLorenzo clarifies:

Some years ago, the Nobel-laureate economist Milton Friedman studied the history of health care supply in America. In a 1992 study published by the Hoover Institution, entitled "Input and Output in Health Care," Friedman noted that 56 percent of all hospitals in America were privately owned and for-profit in 1910. After 60 years of subsidies for government-run hospitals, the number had fallen to about 10 percent. It took decades, but by the early 1990s government had taken over almost the entire hospital industry. That small portion of the industry that remains for-profit is regulated in an extraordinarily heavy way by federal, state and local governments so that many (perhaps most) of the decisions made by hospital administrators have to do with regulatory compliance as opposed to patient/customer service in pursuit of profit. It is profit, of course, that is necessary for private-sector hospitals to have the wherewithal to pay for health care.

The government cannot do a good job of efficient resource allocation. It does not subscribe to the profit and loss mechanism that the private sector has to do to stay in business. In the private sector, if the company runs at a loss, it has to make adjustments, and fast, to stay in business. In other words, good performance is rewarded, while poor performance is penalized. This is not so with the government. More often than not, when the government fails at producing the desired result, more money is thrown at the problem. So it has been with health care in the past, and with Obama's new health care reform, we will see more of the same in the future.

One other point worth mentioning about government run healthcare: supply and demand gets out of kilter. Once again, Tom DiLorenzo pontificates:

All government-run health-care monopolies, whether they are in Canada, the UK, or Cuba, experience an explosion of both cost and demand — since health-care is "free." Socialized health-care is not really free, of course; the true cost is merely hidden, since it is paid for by taxes.

Whenever anything has a zero explicit price associated with it, consumer demand will increase substantially, and health care is no exception. At the same time, bureaucratic bungling will guarantee gross inefficiencies that will get worse and worse each year. As costs get out of control and begin to embarrass those who have promised all Americans a free health care lunch, the politicians will do what all governments do and impose price controls, probably under some euphemism such as "global budget controls."

He goes on to demonstrate how long waiting lists are for health care in countries that have "free" health care. In Canada, for example:

• If an individual suffers third-degree burns in an automobile crash and is in need of reconstructive plastic surgery, the average waiting time for treatment is more than 19 weeks, or nearly five months.
• The waiting time for orthopedic surgery is also almost five months.
• For neurosurgery it's three full months.
• It is more than a month long wait for heart surgery.

The unseen consequences of Obama's health care plan is that over the long run, we will see more demand for health services, a lower supply of these coveted services, and ultimately a rationing of health services determined by a government bureaucracy.

President Obama is a good orator. I put him up there as one of the best speakers at motivating his audience. His proposals appeal to the masses, for they are quick fix solutions to problems people struggle with on a daily basis, but as with any economic plan, there is more to be considered than just the immediate need. We must examine the long term outcomes of any action taken in the present. We must consider the unseen. In this essay, I outline what may come from the implementation of Obama's ideas. In summary, we will be witness to slower economic growth, lower quality of health care, and an erosion of our liberties. Is that what we really want?