Free Exchange: Zero Sum Debate - Assignment Example

? here) (Your here) (Type of assignment e.g. Test assignment) dropping the assignment) Article Analysis Zero-sum debate: Economists are rethinking the view that capital should not be taxed (The Economist). This article relates to policy making. Taxation is one of the major tools of fiscal policy. The policy makers consider the canons of taxation put forth by Adam Smith but some markets are so complex that it is almost impossible to achieve all the objectives of these canons: There are trade-offs. This article probes into the usefulness of tax on capital gains. Traditionally, taxes on capital gains have been low because of the belief that higher taxes would have an impact on growth. This article provides arguments against this view and suggests that taxing capital gains is a good idea. America’s current corporate-tax system is being blamed for the struggling economy. Currently, the tax rate on capital gains is 15% which is lower than in many countries. Since the 1970s and 1980s, many economics have believed that this tax must be made lower. Some argue that there should be no capital tax at all. Governments have to tax some part to restore equality and to fund public goods but there is an inevitable trade-off: taxes have an impact on consumption. Negative responses to taxation are harmful for the economy. Taxation has been dealing with inequalities that related to pay differences and these inequalities were addressed through taxation on labor. However, capital tax has more complicated implications because when tax affects the level of investments and savings, it has an impact on future growth and consumption. The economic sector has incessantly appealed the policy makers to cut the rate of capital tax and it was, in fact, brought down to more than half from 1950 to 1980. There is pressure for more and zero capital tax has been recommended by most economists. Messrs Piketty and Saez have argued that lower capital tax has brought more inequalities and lesser growth. They argue that taxing capital gains is not a bad idea because the capital markets are imperfect and it is appropriate to tax capital to provide social insurance against risks. It is commonly believed that capital investments are very sensitive to the changes in tax rates. In order to keep these investments running in the future, zero tax on capital gain should be employed. This belief is reputed by the argument that most of these taxes are paid by working-age adults who are saving for their retirement. Therefore, they are going to save regardless of the fact that their savings are being taxed. Some economics argue that the conventional view of taxes has been ignoring inheritances. Taxing hard workers who have earned their income due to their ability seems to be unfair as those who have done nothing to earn their income are exempt. Messrs Piketty and Saez found out that the capital-output ratios were very stable over time despite the fluctuating tax rates. They also mentioned that lower capital tax provides a major loophole to taxpayers who can easily avoid tax and no growth takes place. For instance, firms shift compensation from salaries to stock options and dividends hence cutting revenue without boosting growth. Emmanuel Farhi, Christopher Sleet, Ivan Werning and Sevin Yeltekin argue that the rising inequality is “a destabilizing political force” which would force the future Governments to raise revenue through heavy taxation. This threat might be detrimental to current savings and investments. Therefore, a progressive tax in the present might lead to more investment in the future as the firms would be assured that their wealth is safe over the long term. In my opinion, reforms are required in the American taxation system to make the economy strong. Tax revenue is one of the major tools of fiscal policy. Capital gains have been taxed at a lower rate so that there is no negative impact on savings and investments. But if the capital-output ratios have been steady with different rates of tax, it means that tax does not affect investments to the degree that is commonly believed. Principally, the policy makers tax those goods more which have inelastic demand. If the response of savings and investments is almost nothing in relation to tax, there is no harm in taxing capital gains. Taxation’s one of the primary concerns is inequality. Unequal distribution of income causes rich to get richer and the poor to get poorer. Government raises revenue from tax and uses it in such a way that the income is redistributed so that all the classes of the society benefit. It has been observed that capital gains create inequality. The lower rate of capital tax means that the difference in tax that the low-income group and the high-income group has to pay narrows. The high-income group benefits more and there is more inequality. Therefore, the rate of tax on capital gains must be increased and must also be made progressive to address the inequality. Low rate of tax on capital gain also gives more incentive to avoid tax. Tax avoidance is a legal activity but is still unhealthy for the economy. Government needs to “kill” the loophole that is created by low capital tax. I agree with the fact that there are many risks and liabilities in the lives of households and they cannot be insured against each and every one of them. Putting a tax liability on gains received from risks of investments is very fair. The taxation system must also consider bringing inheritances into tax bracket. Inheritance is a windfall gain and it must be taxed. Otherwise, it can be deemed to be an unfair and an unequal treatment of taxpayers because the taxpayers who work hard to earn their income are taxed and those who have done nothing are exempt. Therefore, reforms are required because with time, a stale tax system would only add to the inequalities that are already there. To fill this gap, tax system needs some changes and increasing tax rate on capital gains is one of the major steps. 2. Stock Trading Is Still Falling After ’08 Crisis (The New York Times) This article relates to financial instruments and stock markets. It discusses the fact that America’s economy has not been reviving from the recent economic crisis. The expectations of investors play a huge role in the operation of the open market. An optimistic approach results in more investment and vice versa. The expectations of companies are also very important. A pessimistic approach by companies might make them resort to raising capital through bond markets rather than by issuing shares. This article discusses why it is difficult for the investors to trust the current economic situation. In the last three years, the American stocks have doubled in price but there has been no improvement in their trading. Instead, it has been experiencing a consistent decline. This April, the average of daily trades, 6.5 billion, in American stock was almost half of its peak in 2008, 12.1 billion. America faced economic shocks in 1987 and 2001 too but in those times, America managed to achieve the average number of trading in stocks within two years. This has not been the case after the 2008 economic crisis. Things are slightly different now due to the addition of new participants like high-speed trading firms which account for almost half of the activity in stock market. But even these participants are reluctant to participate more often. According to market experts, there is a sheer lack of optimism which has instilled a fear into the minds of the investors that the crisis would return with widely fluctuating markets. Stock market has caused big losses to many investors and they are afraid of trading heavily. The decline of stock trading by investors is showing in the slowdown of New York Stock Exchange’s activities. It has been reported that trading in New York’s bourse has fallen 23% from the year earlier in the first quarter. Also, major companies like Nasdaq announced that their revenues from stock market in the first quarter had fallen from a year ago. When such companies are able to raise less from the stock market, they resort to bond market to eliminate the deficit. Nasdaq has even made moves to capture such businesses which do not rely on stock trading because of the uncertainty that when the stock market is going to recover from the crisis. There have been many off-exchange operations which captured a larger proportion of all stock trades in recent years but their overall trading numbers have also been going down. This fall-off in trading is shocking because the volumes of stock trading have not declined for three consecutive years since 1960. As high-speed traders account for more than half of the stock trading activities, the market-watchers look at them for an explanation of the low trading volume. These traders use computers algorithms to take advantage of small price discrepancies and they have been regulated to make the markets less volatile. Also, they rely on transacting with slow traders like mutual funds. As these groups are pulling back, the high-speed traders are forced to do the same. At TD Ameritrade, stock trading now accounts for 16 percent fewer customer trades than it did in 2009. It has experienced this significant decline because many of the day traders have been scarred badly by the economic downturn. There are reports that there were instances where it seemed that the market was getting back on track as the clients started to return but then they left surprisingly. Trading by mutual funds has dropped due to the fact that they were drained of $400 billion at the start of 2008. Apart from the major companies, the individual investors are also shifting their investments to bonds rather than the stock markets. The departure of long-term investors has lead to decline due to which, small investors have stopped trusting the stock market. My take on this article is in the light of Keynesian economics. According to Keynes, “the amount of investment is determined independently by long-term profit expectations and, to a lesser extent, the interest rate.” In this article, it was reported that the volume of trading has declined even when the prices are stable. The participants of the market are actually willing to pay more. But the long-term expectations of the investors are very bleak due to which, they are reluctant to invest in stock market. Bonds pay a much lower rate of interest than the stock market. Even then, the major companies are resorting to the bond market to raise revenue and the investors are looking to invest in the same. Although the rate of interest is lower, it is very certain that it would be paid. The role of investor’s expectations is clearly dominant. It would be hard to restore the volume of trading in the stock exchange. Everything seems to be dependent on the other. There is a need for long-term investors to jump back into the market. That is probably the first piece of the puzzle. These investors have to be lured into the market. This is already being done as the current participants are willing to pay more. When these investors join in, the long-term investors that have left might also return. This would stabilize the stock market and the long-term expectations would get better. This might then encourage people to invest in mutual funds. This would increase the clientele of high-speed traders. As these traders move back in, the trading volume of stock would increase and the revival would begin. 3. CREDIT MARKETS: Companies Maintain Debt Pace Amid Haven Trade. This article relates to the capital markets and financial instruments. It explains the chain reaction that has originated from the current political stalemate in Greece that has caused an uncertainty. The companies have started to avail the benefit of raising capital through bonds and securities. They are offering these at low interest rates and less risk and the investors are willingly accepting this. This article looks at the current trend in trading of Treasury bonds, debt-issues, municipal bonds and mortgage-backed securities. It further discusses the interrelation among the trading of these bonds and securities and what the investors of today are looking for. Due to the recent political situation of Greece, many investors started to invest in Treasury bonds to gain less but guaranteed gains. The investments were made in such amounts that the 2012’s losses of TBs were obliterated. The party that acquired the most number of votes has threatened to renege on the recent bailout deal from the European Union and the International Monetary Fund. This has caused great uncertainty among the investors as now there is a risk of instability in the region. The investor’s interest shifted significantly to the bond market. Therefore, the prices of municipal and agency mortgage-backed securities also rose with Treasury bonds. However, the prices of MBS were raised too much which made the investors wary and they curtailed their buying. As the buying of Treasury bonds increased, there was a significant decline in its yield. It hit as low as 1.814%. Now, the yield trades below the 1.876% posted at the end of last year. The investors have become circumspect as the uncertainty relating to economic growth has increased and a lot of it owes to the political conditions of Greece. Euro market has also been experiencing fluctuations to a great degree. If this market shows any signs of stabilization, the investors might start selling the Treasury bonds as their yield is too low. The fact that investors are still willing to buy Treasury bonds indicates the level of uncertainty that is there in the European markets. Besides Treasury bonds, many other bonds of different durations have also been issued by companies like International Business Machines Corp. (IBM). IBM issued seven-year bonds with a 1.875% coupon hence becoming the first ever company to sell such a bond under 2%. Following the lead of IBM, Berkshire Hathaway Inc. (BRKA, BRKB) and Diageo PLC (DEO, DGE.LN) also announced debt-issues of their own. Many other companies also expanded their deals to be a part of the new trend. Southern Co. (SO) unit Georgia Power and Motorola Solutions Inc. (MSI) expanded their deals of $500 million to $750 million. The excess of such low-rate bonds has resulted in a low yield of high-rated bonds. Barclays U.S. Investment-Grade Index finished at 3.25% last week. This is its lowest level in almost 40 years. The increasing trade of Treasury bonds has also caused a boost in the prices of top-rated municipal bonds. Yields on triple-A rated municipal bonds went down but the bonds maturing in 30 years hit a record-low yield of 3.09%. In primary market, $419 million in transportation bonds were sold in Massachusetts. It was observed that for bonds maturing in 10 years, the deal was received the best. Investors are reluctant to buy mortgage-backed securities far above their par value due to the rallying Treasury bonds. The MBS usually offer high carry and the investors are looking for the same. This is why the prices of MBS are rising. However, there are investors of such disposition that they are satisfied by the fact that this sector is backed by the Federal Reserve. Therefore, it can be deemed that these investors are looking for safe investments. The experts are saying that the rising of prices is understandable because “the market came into the current session at all-time highs in terms of dollar price for most liquid coupons.” There were also some deals in Negotiated bonds but they were very small in size. From this article, it can be suggested that restoring the investors’ confidence in taking brave risks in unlikely in the near future. The investors have been bruised financially by the recent economic crisis and the situation of Greece is redirecting the investor’s interest to making investments in low-risk and low-yielding bonds and securities. The moves made by huge conglomerates like IBM are a testament for the fact that the current financial situation is too unstable to reward high risks. But sometimes, companies are forced to go along with the expectations of the investors. Once again, the role of expectations of the investors is dominant. The shift towards the capital market from the stock market has been of such a magnitude that many of the bonds and securities are now yielding at their all-time lows. Their previous lows go back to the 1980s. These trends show the level of pessimism that is prevailing right now in the minds of the investors. But the situation is not very bad for the Government because it can raise a lot of revenue while offering low yields. However, even the Government needs a stable market for its financial operations. Hopefully, the political situation of Greece would get better soon. When the threats by the dominant political party to renege on bailout deal with IMF and EU are taken back, the stormy waters of shaken world of the investors would calm down. When Greece becomes stable, the investors might come out from the shelter of Treasury bonds and be willing to take high risks in a stable market. References Emmanuel Farhi, Christopher Sleet, Ivan Werning and Sevin Yeltekin. "Non-linear Capital Taxation Without Commitment", Review of Economic Studies, January 2012. "Free Exchange: Zero Sum Debate." The Economist 05 May 2012. Print. Jones, Dow. “CREDIT MARKETS: Companies Maintain Debt Pace Amid Haven Trade.” The Wall Street Journal 08 May 2012. Print. Popper, Nathaniel. “Stock Trading Is Still Falling After ’08 Crisis.” The New York Times 06 May 2012. Print. Thomas Piketty and Emmanuel Saez. "A Theory of Optimal Capital Taxation", NBER Working Paper, April 2012. Read More