Net Asset Tax White Paper (part 1 of 7)

[Jim Bowery]

A Net Asset Tax
Based On
The Net Present Value Calculation
and
Market Democracy

By James Bowery
The Coalition for Free Enterprise
619/295-8868

INTRODUCTION

In nature, predators benefit prey by feeding on the weakest members of
the population, thus strengthening the gene pool of the prey.
Parasites are far less discriminating than predators. Parasites are
careful to avoid killing their individual hosts by focusing on the
vital fluids, rather than killing for tissue. Parasites are
beneficial to neither the individual host nor to the host's gene pool.

In his opus, "The Discourses" Niccolo Machiavelli counsels the founder
of any new state to present tolerable challenges to the people at all
times, so as to strengthen their character. Either the founder should
locate in an austere land where nature herself will provide
discipline, or, if locating in a fertile area, the founder should
impose measured austerities on the people himself. Machiavelli
specifically mentions taxation, making virtue of necessity.

There is hidden morality in Machiavelli's apparent ruthlessness:

At each stage of life, you have passed beyond dependence on that which
raised you to that stage. If you continue accepting what was once
given to you, it weakens rather than strengthens you.

If we follow Machiavelli's wisdom and are consistent with the
ecological model of predator/prey dynamics, we should avoid parasitic
tax systems which drain off productivity in the form of income,
capital gains, sales and value added. We should instead look for a
tax policy that acts as a predator, applying disciplinary pressure to
the economy by measuring how effectively business entities are
utilizing their "living tissue" or net assets. We should do so
without violating nascent businesses and families, as these are the
fountainhead of wealth and value.

To that end, this white paper argues for the adoption of the following
policy reform:

The government should tax net assets, in excess of levels typically
protected under personal bankruptcy, at a rate equal to the rate of
interest on the national debt, thereby eliminating other forms of
taxation. Creator-owned intellectual property should be exempt.

The use of government-backed debt instruments as a baseline for the
calculation of asset value in the net present value formula indicates
the existence of a de facto negative tax on net assets pervading all
sectors of the economy.

This situation, which provides a form of "capital welfare", sets off a
familiar chain of events:

Centralization of net assets leads to corporate central planning and
monopolistic practices in the private sector with a drop in wealth-creating
entrepreneurial investment. The consequent loss of equity in
the general population, particularly in families with children and new
businesses, has a tragic and predictable result:

Structural economic decline and social decay.

This flaw in the capitalist system has been exploited by the enemies
of free enterprise throughout history. But the defenders of
capitalism have been disturbingly silent except to address the weaker
arguments of capitalism's detractors.

The economic policy described herein, including the above tax reform
and associated deregulation of financial institutions, repair this
flaw in the foundation of our free enterprise system.

Further, it provides immediate relief from the current economic
disease afflicting our society, in a virtually revenue neutral manner
(more than $1 trillion in tax revenue per year), while laying the
ground work for optimal economic growth far into the future.

CAPITAL WELFARE

"The rich get richer" is an old saying based on a widely used
mathematical formula in business economics:

The net present value formula:

AssetValue = Integral Risk(t)*Profit(t)/(DiscountRate+1)**t dt

where Profit(t) is the profit stream at some point in time
Risk(t) is the probability of realizing that Profit
DiscountRate is the zero-risk rate of return on money
typically linked to government debt instruments

Since risk is already discounted in the Risk(t) term, the DiscountRate
has no purpose other than to account for the rate of return that
society is expected to pay to the mere posession of wealth.

The net present value formula allows asset value to be calculated as
the size of a low-risk loan that one could pay off (amortize) with the
after-tax profit stream generated by an asset, adjusted for risk.
This means an asset's present value is proportional to the estimated
wealth it will generate in the future divided by the prevailing rate
of return on low-risk debt instruments.

For example, a patent might be expected to produce some profile of
royalties over a period of time -- ramping up as the technology comes
into full production and then declining to nothing as the technology
becomes obsolete or the patent expires. When multiplied by the
probability of achieving that expectation (adjusting for risk) this
royalty stream is equivalent to a series of payments on a low-risk
loan. The size of the low-risk loan that could be amortized by the
after-tax real profit stream is the patent's "net present value".

The most obvious indicator of pervasive de facto capital welfare is a
positive inflation-adjusted rate of return on government debt
instruments. The market compares private investments and their risk-
adjusted rates of return against the rates offered by the government,
backed by its fiscal and monetary authority. If a private asset isn't
obviously a better deal and wealth centralization has made the investor,
as in socialist central planning, is too far removed from the private
asset to make a well informed judgment about the investment's
viability, the investor will generally opt for investments that are
backed my a history of known profit -- resorting to U. S. Treasury
paper and their positive real interest rates, if all else fails. This
is equivalent to a welfare "safety net" for capital.

The widely used net present value formula, being based on these
government supported interest rates, indicates the real rate of
interest on the national debt is the rate of negative asset taxation
the economy pays to all wealth in society and therefore quantifies the
level of capital welfare pervading society.

ASSET DISTRIBUTION

A primary function of the market is to place assets under the
ownership of those whose unique skills, knowledge, courage,
intelligence and enterprise will maximize the assets' profitable use
and minimize the risk of waste or idleness. This happens when people
contending for the use of assets estimate the net present value of the
assets.

Those perceiving the greatest value in the asset use their capital or
credit to purchase the asset. If they underestimate the risk and/or
overestimate the profit, they lose some capital or credit and
therefore are less likely to grab assets and make poor use of them in
the future. However, if they are right, they gain capital or credit
at a greater rate than competitors. Thus, the market strives to
maintain an optimal match between the particular qualities of owners
and those of the assets they own as reflected in the owner-specific
net present value calculation.

We eliminate the market equilibrium in asset ownership when,
independent of any particular qualities of the owners, our policies
not only protect the inflation-adjusted value of assets, but actually
provide a net return, including capital gains, on ownership. In such
an environment, society pays a negative asset tax which amounts to
welfare for capital, creating debilitating incentives similar to
welfare for labor. In both cases, nonperformance is rewarded over
enterprise. When combined with taxation on income, capital gains,
sales, value added, inheritance, gifts, etc., (all market activities
that reallocate resources within the economy), the disincentives
placed on productive investment are greatly compounded.

Just as important, capital welfare severely distorts the optimization
of asset ownership in society by placing, as a matter of public
policy, ever more assets under the control of those who already have
the most assets. Capitalism expresses its worst potentials when
capital welfare debilitates the character of the wealthy while it
gives them ever more economic authority. This asset centralization
impoverishes the population at large, ending with a collapse in
consumer demand. Supply-side theory fails to predict this collapse
because it fails to deal with the fact that the wealthy are just as
prone to character erosion by welfare as are the poor. It is even
more destructive than welfare for the poor because it corrupts the
decision makers in the economy. In the face of collapsing consumer
demand and capital welfare, acquisition of more capital assets is
promoted over the productive use or investment of those assets.

Political rhetoric defining "the rich" or "the wealthy" as those with
high levels of income or capital appreciation, focuses public
sentiment against the most productive members of society and away from
the centralization of net assets as the underlying problem.

The incentive for productivity in the economy, left after the
disincentives of capital welfare are subtracted, is the long-term
economic growth rate minus the interest rate on the national debt.
When the interest rate being paid on the national debt equals the
growth rate of the economy, the fruits of all productivity are being
confiscated to pay capital welfare and the incentives for productive
investment and labor disappear. When the incentives for productivity
become negative due to capital welfare in excess of the economic
growth rate, wealth is structurally centralized at the expense of
others in the economy. The absolute level of net assets owned by the
general population actually decreases so as to increase the net assets
of the wealthy. This not only removes all incentives for production
and entrepreneurial investment from the economy, but consumer demand
collapses as credit is liquidated to pay for necessities. Depression
ensues. It is under these circumstances that demands for socialist
intervention in the economy via "public investment" take on an air of
urgent legitimacy.

In such a desperate environment, Marx's arguments in "Das Kapital"
appear as rational and appealing as any made by Schumpeter, Laffer or
even Adam Smith. It is therefore critical to understand to what
extent socialist criticisms of capitalism are valid so we can credibly
argue against their fallacies -- particularly when they are promoted
during obvious manifestations of capitalism's flaws.

THE APPEAL OF COMMUNISM

Communists advocate the emergence of a "scientific state" in which all
revenues and all functions of society are subsumed by government
planning and execution. In updated terminology, Marx predicted that
ultimately science would advance to the point that there would be no
role for labor or enterprise -- only scientifically optimized systems
of automated planning and production. In this situation, there would
be no free market to sustain the masses since they would not own the
automated means of production, and, labor being worthless, would,
therefore, have no income. Although Marx predicted a "withering away
of the state", the communist interpretation of Marx's dilemma was that
the state should confiscate ownership of the automated means of
production and distribute the products to the masses based on social
need. Since science would have removed all uncertainty as to the most
optimal way in which to plan and operate these facilities, there would
be no need for the incentives of the market to optimally allocate
assets.

Clearly, communism touched a chord with this vision of an automated
future in which laborers could not feed themselves or their families
while capitalists, who controlled vast production facilities, had no
incentive to operate them. The communist movement dominated the
politics of the 20th century. Adolf Hitler exploited a related idea
when he attacked "international Jewish bankers" in his national
socialist movement. When such profoundly destructive movements run
their course, it behooves us to do more than merely condemn their
evils in moral outrage. Analysis of this recurring political disease,
why we are susceptible to it and what can be done to prevent it in the
future is just as great a moral responsibility as is condemnation of
its manifest evils.

The appeal of communism (and an appeal of fascism) is that it
addresses a truth which capitalists exploit and typically resist
acknowledging in a material way -- that nature and civilization
provide common assets of knowledge, resources, infrastructure and
defense of legal rights which enhance and secure the productive value
of private assets. It is precisely this pervasive influence of common
assets, attributable to natural and historical heritage rather than
the merits of any person or operating corporation, that provides the
definition of government's proper function, and, therefore, its proper
level and source of revenue.