CASE FOR FREE CAPITALISM

 

The planet is in trouble, economies around the world are in trouble, and there seems to be no clear road map out of these troubles. For the planet we need a planet friendly model for building modern economies. For the economies in trouble we need a strategy for growth in this new era of resource and environmental constraints.

For advanced economies the strategy for economic growth has to be based on a planet friendly model because investments that add to their already high resource intensiveness are becoming increasingly unprofitable due to resource constraints. In developing economies, however, the effects of resource constraints on profitability are not as high, due to their low wages and other factors. Advanced countries are the ones that bear most of the brunt from the resource constraints. Remaining advanced in the new era will require finding new ways of growth and progress. Advanced countries have the necessity to invent.

This book proposes some radical changes in the financial system. These changes will help restructure economies to make them planet friendly and will also help advanced economies build many new and globally competitive industries. The proposed system will enable advanced economies to stat a new trajectory of growth that will last for generations. The current financial crisis will subside only after these or similar changes are made to the financial system.

Globalization and planetary and environmental resource constraints demand adaptability and responsiveness from the financial system that the current one does not have. The tenacity of current economic crisis is due to the absence of any mechanism in the current economic system to deal with latent or dormant resource constraints, those not fully reflected in prices, in a systematic manner. The flaws and deficiencies of the present financial system, which until recently were considered endurable, have started and will continue to cause major economic dysfunctions and weaknesses, particularly in developed countries.

The case for the proposed changes to the financial system, as laid out in the following pages, starts with a discussion and analysis of the current economic crisis followed by the role of the present financial system in perpetuating the crisis. The following is the Case for Free Capitalism.

  1. The current economic crisis
  2. Governmental efforts to recover from the crisis
  3. Antiquated economic system
  4. Recap of the Case for discontinuation of Interest
  5. Case for Asset Tax
  6. Potential benefits of Free Capitalism
  7. Dangers to the free world and free markets under old Capitalism.

 

The current economic crisis

The apparent cause of the US economic crisis is that traditional industries are migrating to developing countries and new industries are not being established to take their place. The US economy under competitive pressures from developing countries has lost many of its industries and is continuing to lose competitive edge in other industries. The gradual hollowing of the US industrial sector over a long period of time has robbed the US economy of its vitality and its ability to provide decent employment and incomes.

Globalization allowed populous countries like China and India to industrialize rapidly. After they started competing aggressively in the global markets, profits from a large number of employment-intensive industries in the US went down precipitously. The competitiveness of developing countries is not surprising because they have a huge cost advantage in labor. Most labor intensive industries started to migrate to developing countries to benefit from low labor costs or simply to survive. Employment and investment started moving overseas.

Returns in developing countries are relatively higher because they still have room for growth in traditional industries; and the proximity of huge markets of Asia also makes growth easier there. Their low wages and lower environmental standards enable them to expand globally through exports.

The huge difference in wages between the developed and developing countries will enable developing countries to keep profitable and growing at the cost of developed countries. Their wages and other costs have a long way to rise before they make developed countries competitive. The hollowing of the US industrial sector will only reverse if costs come down significantly.

Economic recovery in the US is a matter of costs, particulary capital costs because most planet friendly industries are very capital intensive. A significant reduction in costs, particularly capital costs, will certainly make US products globally competitive and will enable development of a multitude of new planet friendly industries.

 

Governmental efforts to recover from the crisis

Economists, however, are recommending fiscal stimulus of one kind or the other. The supply side oriented economists are advocating tax cuts while the demand side oriented economists are advocating more spending by government. Both kinds of fiscal stimuli have worked in one instance or another during the last century but they will not work any more;because the US does not have enough job creating engines, its industries, to be invigorated by the fiscal stimuli. If the cost structure of US business is uncompetitive; no amount of stimulus will make them profitable. Cutting taxes will not help enough to make the US competitive. Abolishing taxes completely is the kind of solution that might work at this time. This book suggests something equivalent.

Building roads and bridges will not have the same impact that it had in the 1950s and 1960s. New businesses, localities, and regions developed due to the infra structure built under the Highway Act of 1956. No such thing will happen now. The proposed power transmission grid will get results only if we have huge industries ready to take advantage of it, the way auto industry was ready for the highways. The windmill and solar panel industries don’t even have a secure business model. It is difficult to find enough industries or business that will take root or take off due to the proposed infrastructure spending.

During most of this century the US has injected growth in its economy through the housing bubble, the fiscal impact of two wars, and other fiscal stimuli like tax cuts. If fiscal stimulus had continued to work the US would not get into this crisis in the first place, Japan would not have lost decades and remain stuck in flat or negative growth for so long even after the Japanese government accumulating debt equal to 200% of GDP, the $168 billion fiscal stimulus given by the Bush administration followed by the $787 billion stimulus given by the Obama administration should have gotten the US out of trouble.

In fact the recent fiscal stimulus given by the US is working more for China than it is for the US because the increase in spending is finding its way to China through imports. In a New York Times article published September 9, 2010 titled “Trading Away the Stimulus” Alan Tonelson and Kevin L. Kearns write:

“For many people, the trade deficit seems unrelated to the nation’s continued economic crisis. But it is actually a central reason why American growth has lagged and President Obama’s stimulus hasn’t led to a robust recovery: since February 2009, the government has injected $512 billion into the American economy, but during roughly the same period, the trade deficit leaked about $602 billion out of it and into foreign markets.”

Government intervention through traditional fiscal measures will not make up for the sizable hollowing of the US industrial sector and will not address the weaknesses that caused it. The only way to refill the hollowing of the industrial sector is through creation of new industries. This book proposes a specific way to create new industries. Under the current circumstances the US should spur demand through improving economic potentials and creating new economic incentives and not through government spending and tax cuts.

If the US tries to spur demand through increasing money supply, most of the additional money will go to weaker credits and to speculators; and this will again result in credit losses and a speculative bubble. This will be a case of “doing the same thing and expecting different results.” Mainstream economists, like the proverbial generals, are fighting the previous crises (1929, 1970s, 1980s. etc.).

Though extreme monetary measures taken recently may show some temporary results they will eventually cause inflation, business losses, credit deterioration, and other forms of economic crises. These measures have only prevented the US economy from falling off a cliff but will not help avert its long term slide because the fundamentals of the economy are taking it that way. Asset price inflation and speculative bubbles are building up again which may cause a reemergence of the financial troubles these measures are trying to address.

The stimulation of the economy through monetary and fiscal measures that the US continues to try has not only lost its effectiveness but is further weakening the economy, the credit markets, the currency, and the credit standing of the government. It is like giving vitamins and stimulants to a patient who needs immediate surgery. This book recommends surgery.


Antiquated economic system

The current economic system was built without any consideration for the environment; it was built when the planet was endless and the sky was limitless. Now we, humans, need to protect the oceans, heal the sky, and preserve the land.

Since the current economic system does not include planetary or environmental considerations, planet friendly industries are at a disadvantage in competition with fossil fuel based and other planet harming industries. We all know that we need clean energy industries but the deficiencies of the financial system don’t let these industries flourish and deliver their economic values and potentials.

Fossil fuel based economic activities spend earth’s energy reservoir; and pay little or nothing for polluting the environment. The price, e.g. of oil, currently paid by consumers of mineral resources is not the planetary cost of the mineral it is just the extraction cost, which is a small fraction of planetary costs. Planetary costs include the opportunity cost of not having the mineral when it will be in extreme short supply in future and the current environmental costs. The planetary cost mentioned here is also the economic cost of consuming fossil fuel.

The economic cost of using fossil fuel is therefore substantial because of its opportunity cost and the environmental costs. It is an irony that the current economic system ignores economic and opportunity costs in favor of accounting or extraction costs while allocating resources like minerals. The current economic system obviously needs to bring economic costs into the equation for allocating resources and minerals. Minerals and their pricing are discussed in detail in Chapter 7.

On the other hand the economic cost of using clean energy is almost zero, because of little or no opportunity cost and no environmental costs. In fact there is an opportunity benefit of investing in clean energy industries because the energy not harnessed from wind or sunshine is lost for ever. Additionally, in the absence of interest long term financial opportunity cost of investing in clean energy industries would be negligible because of the dismal future potentials of fossil fuel driven industries.

Since the environmental and opportunity benefits of clean industries and the environmental and opportunity costs of dirty industries are not being translated into economic terms, clean industries are at a significant disadvantage in competition with fossil fuel based industries. The inability of the economic system to translate economic costs into financial costs is depriving world economies of needed soundness and strength and also depriving mankind of a healthy planet.

Our failure to translate economic cost into financial cost is not only seriously degrading the environment, but it is also a generational robbery that we are committing against our future generations. Minerals that formed over hundreds of millions of years were used up in hundreds of years; without any consideration for future generations.

We need an economic system with an inbuilt mechanism that enables societies to translate economic costs of fossil fuel and other minerals into financial costs and also translate economic benefits of clean energy and similar industries into financial benefits, so as to bring financial costs in line with economic costs. This mechanism, e.g. asset tax, would help to protect the planet and its resources and create a range of new planet friendly industries and ways of life that will start a new trajectory of economic growth for developed countries and for the world.

Scarcity of resources was always part of economics. Environment and mineral resources are scarce and should be treated as one. The planet, along with the environment, has introduced itself into economics as another scarce resource. It is time for economics and the economic system to grow up and to include the planet within its framework. It is also time for economics to start translating longer term economic costs into financial costs.

Diminishing Utility of Fossil Fuel Model

The fossil fuel driven model of economic growth is not sustainable on a worldwide basis. The US and many European countries being the pioneers of the fossil fuel driven model have already derived the benefits that this model was capable of delivering. Now that the whole world has started adopting it; the model has become unsustainable for the planet and unprofitable for the developed countries. The world no longer has the unlimited amount of fossil fuel or the unlimited potential for further fossil fuel driven industrialization, as it did at the start of the industrial revolution.

Developing countries can still achieve growth with the fossil fuel model because they still have room for further industrialization and their wage and other costs and environmental standards are low. Even if oil supply constraints and global warming are ignored the fossil fuel model of economic growth is going to be far more helpful to developing countries like China than it is to the US. Increasing use of fossil fuel will help them get at par with developed countries and in the process achieve economic growth at the cost of developed countries and the planet. 

Therefore, the US and other developed countries need to move to the model of economic growth that is sustainable for the planet and profitable for them. Economies typically grow through building assets, there are not much assets to be built in developed countries if fossil fuel remains the driver of the economy. In fact the environmental problem is a blessing in disguise for the US; it will give the US a new path to grow. The US has to move away from fossil fuel to become profitable, competitive, and sustainable.

The world is entering an era when fossil fuel will be progressively replaced by clean sources of energy. The current, purely rate of return based, financial system will only let this happen if there is an extreme economic change, e.g. oil prices go up to $500 a barrel, or in the long run when for example, oil runs out. The interest based financial system certainly needs to be changed to allow gradual and peaceful transition to clean energy. Since clean energy does not produce high enough returns to support interest; interest has to go along with fossil fuel.

The proposal presented here suggests that planet friendly industries and life styles are not only a need of the future they are also the way to economic prosperity. Taking a lead on the environment is not only good for the future of humankind it is also good for the immediate economic growth and global leadership of the US. Future growth in developed countries can only come through a “planet friendly” model of economic growth, therefore a financial system that naturally supports that kind of growth has to be developed.

Negative Utility of Geometric growth model

The geometric growth in debt through interest exerts an unrelenting pressure on the economy to keep growing to accommodate the growing debt. It is a mathematical certainty that sustained exponential growth in any component of a system will overwhelm the system sooner or later. In nature the remedies for exponential growths include counteracting forces like predators, natural disasters, epidemics, limited space, sunlight or food, and a multitude of other factors. In the current economic system the natural remedy for exponential growth is breakdowns and crises, notwithstanding the remedies tried by central banks.

At some point the geometrically growing pools of available credit becomes too big for the economy either because the economy is not growing fast enough in real terms by itself or the pool has grown too big for the system. Since the requirement to earn a certain minimum return cannot be met for all the available credit, money is diverted into speculative activities where it seems to make more than a certain minimum return as long as the speculative frenzy is on. The geometrically growing financial capital will either help in building new assets or will bid up the price of existing assets. In speculative bubbles it does the latter.

We have all observed in financial and other markets that even after prices are unreasonably high sellers manage to find buyers at even higher prices; this is primarily due to pressure from geometrically growing money, or available credit, to be lent or spent. These episodes of speculative frenzy usually happen after a period of sustained geometric growth in the pool of available credit.

Recent lack of real investment opportunities and relentless pressure from the geometric growth in debt through interest, compounded by easy money policies of Central Banks and higher savings rate in developing countries, created a frenzy of speculative activities which materialized into massive asset bubbles and credit bubbles in many developed countries. Usually speculative bubbles are accompanied by credit bubbles because the geometrically growing funds have to be lent first for the borrower to participate in the speculative bubble.

The gigantic mess of the US mortgage market including risky lending, unscrupulous packaging and securitization of loans, sloppy or nonexistent documentation, overpriced collaterals, look the other way regulation, superficial securities or bond ratings, and similar other lapses and excesses were in most part the result of the pressure of geometrically growing pools of money to find a borrower.

As stated in the section on “Speculative Bubbles” (previous chapter) that the current financial system would allow capital to be wasted in speculative activities and credit bubbles, rather than allowing investments in sustainable industries with low returns. As explained earlier, the reason for this perverse behavior of the financial system is the existence of interest.

If there was no minimum requirement for returns from interest, and no myopia, then investments would flow into low yielding sustainable industries and create real value and real growth. There would be investments even at zero percent return and investors would be happy that their capital remained in tact.

Interest based financial system, under the current economic conditions in developed countries, has become counter productive: it is destroying capital. The last major global episode of capital destruction was the great depression which eventually took the destruction of the Second World War to bring economies to the point where they could earn high returns again to accommodate interest. The tenacity of the current economic crisis is a result of the destructive phase that the interest based financial system is currently going through in developed countries. This destructive phase may be more intractable than the one associated with the great depression because of the addition of resource and environmental constraints in the mixture.

Given the extreme difficulties that the interest based system is currently causing in developed countries there is really no point for developed countries to continue with the interest based economic system. It is time for interest to go.Ironically, as the interest based system succeeds in destroying capital the scarcity justification for interest increases.

 

Recap of the Case for discontinuation of Interest

The “Case against Interest” was extensively made in the previous chapter. Here is an excerpt from its concluding paragraph.

The compelling reasons for discontinuation of interest are as follows:

-                     Interest will not let most developed countries to recover economically

-                     Interest is a threat to globalization and to free markets

-                     Interest is a threat to the environment, the planet, and to global peace

-                     Interest will destroy the US sovereign credit, and its fiat money: the US dollar

Interest has become economically unsustainable. Interest is a very inefficient and costly way to allocate capital and therefore needs to be replaced with an efficient method of allocating capital. If that method also allowed environmental priorities to be made an integral part of the economic system it would help address the existential challenge of our time.

 

Case for Asset Tax

The proposed system, Free Capitalism, has an annual asset tax, which applies to most assets including cash. It has no interest, and no income tax. Asset tax replaces two costs: interest and income tax; it will perform the function of both interest and income tax. Currently capital gets allocated amongst businesses that can pay interest; similarly capital will get allocated amongst businesses that can pay their respective asset tax. Asset tax will also be a source of revenue for the government, a function performed today by income tax.

Asset tax rates will be different for different assets. It is as if there were different interest rates for different assets. Since assets would be classified according to their industries or their uses asset tax rates would generally apply to respective industries, the use the asset is put to, the environmental impact of the asset and similar other criteria. Asset tax can be precisely targeted to assets, industries, regions, uses, etc. Asset tax system will allow the government to factor in broader and long term needs and trends of the economy in setting the asset tax rates for different industries or assets. Asset tax rate will act as the hurdle rate for respective industries, and will accordingly influence capital allocation to those industries or types of assets.

Asset tax and the environment

Due to their low financial returns industries harnessing natural energy have been unable to attract much investment. Even ambitious and well funded programs like that launched by the billionaire T. Boone Pickens for national energy independence did not make much progress for lack of returns relative to financial costs. Interest cost is the single factor standing in the way of clean energy.

Clean energy industries, like wind and solar, don’t use earth’s energy reservoir, therefore, their rates of return on capital are low compared to fossil fuel based energy industries. Another way of looking at the financial returns of clean energy is that they are low because a major part of their returns accrue to mankind, to the environment, and to the planet. In essence clean industries offer a tradeoff: less private and more public returns or benefits. We therefore need a mechanism to translate public benefits into private profits.

Asset tax would be generally lower for environment friendly industries or assets and higher for environment damaging ones. An appropriate Asset tax structure will translate public benefits into private profits. It can also systematically translate environmental costs into economic costs and environmental benefits into economic benefits for each asset, industry or activity.

The world can have an environmental revolution if it gets rid of interest. Asset tax will replace interest.Asset tax can therefore be a potent toll for protecting the environment and for addressing global warming.

Investment in environment friendly and other socially desirable assets can be promoted by setting their asset tax rate lower than or similar to that on cash. Lower asset tax in essence means cheaper capital for the industry, which in turn will make them competitive. The right asset tax structure can help clean energy compete with fossil energy.

Asset tax is a costless and a powerful way of allocating capital

Asset tax is more efficient than interest because it will increase production and employment and also because it will reduce cost of production and tend to make the US globally competitive. Asset tax will also enable societies to protect the environment and other planetary resources. It will enable governments to efficiently manage the economy. It will allocate capital with no allocation cost.

Asset tax does not add an additional cost for the function of allocating capital. It allows markets to play their role in allocation of capital through sharing of an existing cost, tax. The sharing of asset tax between the borrower and lender will allow the markets to play their role in the allocation of capital. The asset tax rate structure will set the general allocation preference of the society and the sharing of asset tax will let the market conditions play their role.

The government has to be financed by the people, so what better way to price capital than through asset tax, which will allocate capital and finance the government as well. Asset tax serves two purposes: revenue to the government and socially and economically efficient allocation of capital.

The government is the producer of money and has the responsibility to maintain its value and availability; it should therefore have the power to fix a price on liquidity through asset tax on money. Since it also has to mange the economy, maintain employment levels, and protect the environment it should be allowed to have the versatile and powerful instrument of asset tax to implement economic policies and exercise strategic choices.

Asset tax will lighten fiscal weight

Asset tax is easy on the economy; since it replaces income tax it has no additional weight on the economy. Interest is an additional and needless weight on the economy. Asset tax will allow governments to get a big portion of their taxes from the money that would have otherwise gone towards interest. The government will get another big portion of its tax revenues indirectly from fossil fuel and its usage without significantly increasing energy prices because asset tax will also make clean energy competitive.

A combination of changes in asset tax rates can be structured to help government achieve almost any of the macro economic and policy objectives (like increasing employment, economic growth, developing infra structure, education etc.) that they currently achieve through subsidies, interest rates changes, money supply manipulations, tax rate changes, and similar other government initiatives involving expenditure. The fiscal weight of the government will therefore be very significantly reduced.

Asset tax and economic management

Asset tax can be narrowly targeted to assets or activities and is therefore a precise tool compared to interest for economic management of the economy. There is no need to slow down the whole economy to fight inflation because asset tax can be targeted to relevant sectors of the economy. The whole economy rarely overheats; it is usually a segment of the economy that overheats. The concept of the whole economy overheating (inflating) or slowing down is an illusion resulting from monetary flows created by interest. While a big segment, e.g. real estate, of the economy was inflating wildly during the early part of this century there were huge parts of the economy, e.g. manufacturing, that were depressed and folding.

Inflation can be addressed on an industry, area, or asset basis. If there is speculative fervor in real estate then only real estate need be addressed through higher asset tax; likewise if a particular group of industries need help tax rates can be reduced for them. Tax breaks or other concessions can be easily made because the revenue belongs to the government. The same is not true with interest because interest earnings belong to banks and other lenders.

In Free Capitalism the government does not need to spend money, assume credit risk, or commit to incur expenditure, e.g. interest payments, bond trading, assumption of credit risk, lending to banks, etc., to manage money supply. Small changes in the asset tax rates and some adjustments in government borrowing programs will achieve the same effect as that of managing money supply. Since there won’t be any interest payments involved government borrowing will not require any expense.

Asset tax is a better tool because it enables governments to mange the economy segment by segment as it really is; and not a homogenous mass as interest presupposes.

Asset tax will maximize employment and production

Maximum employment and production can only be achieved if all the rewards of economic activities are distributed amongst the factors actually contributing towards production. If all the rewards from production activities are given back to the participants actually involved in production then, only then, maximum production and employment can be achieved. Lenders are not actually involved in production, they don’t work nor do they take business risks. We can only maximize work (labor) and risk assumption (entrepreneur) if we give back all that is earned to those involved in producing the reward. More rewards for workers and entrepreneurs will make more of them work.

Interest diverts economic rewards away from production functions into allocation function. Asset tax can perform the allocation function without any additional cost. Interest will therefore generally keep production and employment below the level otherwise possible. In other words interest is a source of macro economic inefficiency. Amongst all the reasons, interest is the biggest reason for the difficulty economies regularly face in achieving full employment.

Simply: interest causes unemployment.

Asset tax will increase prosperity

Discontinuation of income tax will significantly increase the relative size of the middle class in society which in turn would increase demand, employment and general prosperity. Individuals and businesses will need to save more than the sum they want available at a particular time in future because of asset tax; not less as is the case with interest. Asset tax will increase savings and asset buildup not only because of higher incomes but also because it will increase the net incentive for savings.

Few people increase their saving because of higher interest rates and few will reduce savings because of asset tax. Since the ability to save will be much higher due to higher incomes and absence of income tax and interest and the need for savings also higher to cover asset tax expenses, savings will be higher under free capitalism. Investments would be higher not only because of higher savings but also because there will be plentiful investment opportunities in absence of interest.

Asset tax and incentives for lending

Asset tax will create a strong incentive to lend. The lender’s inducement to lend will include sharing all or part of asset tax liability with the borrower. The sharing ratio will be determined by the market; or through negotiations between the borrower and the lender. If the demand for loans is high lenders may be able to transfer all of the asset tax liability to the borrower; if lenders are able to charge more than the applicable asset tax rate it will be a market signal that applicable asset tax rates, particularly on cash, need to be increased.

Compensation for assuming credit risk will continue to be paid; it will be charged more like an insurance premium rather than as an addition to interest payment. Borrowing will continue to have a price, asset tax and credit premium, and therefore an inducement for early repayment and for economic employment of resources.

Assets tax works in two ways: it can increase the penalty for not lending by increasing asset tax on cash and it can incentivize borrowing for specific purposes by reducing effective asset tax on particular assets, like houses, wind mills, IOUs from students, etc. Asset tax will make credit available even under difficult economic conditions because it can increase pressure to lend and also increase incentives to borrow both at the same time by varying relative tax rates.

Asset tax and chances of bankruptcy

Financial assets or liabilities are said to become toxic if their presence causes further losses and significantly increases the chances of failure or bankruptcy. Interest, as stated in the previous chapter, is a major contributor to toxicity. Since asset tax is a periodic charge similar to interest it can contribute to some toxicity of loans and assets at individual and corporate levels; but no government will let it become toxic for the whole economy. Asset tax will be structured to minimize the potentials of toxicity, with appropriate exemptions, minimums and moratoriums.

A numerical example of asset tax assessment

For the sake of simplicity let us assume that:

Asset tax on cash is 2%

Asset tax on Wind turbine farm is 1%

Asset tax on Coal power plant is 4%

A wind farm borrows $1,000,000 and has $1,000,000 of equity. This wind farm has $200,000 in cash and $1,800,000 in other assets. No income no loss recorded.

The asset tax on the borrowed money will be $20,000 ($1,000,000*2%).

The asset tax on the equity portion of the assets will be $10,000 ($1,000,000*1%)

There will be no asset tax on cash because it has already been accounted in the tax on borrowed money.

The asset tax on the $800,000 of assets that are financed by debt will be $8,000, but since asset tax on cash has been accounted for these assets, and is higher than asset tax on wind farm assets, there will be no additional asset tax for this portion.

The total asset tax on the wind farm will be $30,000 ($20,000 + $10,000).

The total tax would have been $22,000 if all the assets were financed by equity: ($18,000 for $1,800,000 assets and $4000 for $200,000 cash).

A rebate can be given on the tax on debt financed portion. The amount of the rebate would be less than $8,000 because that would be the saving if the entire asset had been financed by equity ($30,000 – $ 22,000). The total tax would be somewhere between $22,000 and $30,000 after rebate.

There could be a fixed part (fiscal side) of the rebate and a varying part (monetary side) of the rebate depending upon the budgetary, money supply, macro economic, and other conditions at the time.

The $20,000 asset tax on borrowed money will be the liability shared between the lender and the borrower. The recovery however should be from the entity that has the use of the money, in this case the wind farm.

If the borrower was a coal plant with exactly the same capital structure

The asset tax on the borrowed money will be $20,000.

The asset tax on the equity portion of the assets will be $40,000 (4%*1,000,000)

There will be no asset tax on cash ($200,000) because it has already been accounted in the tax on borrowed money.

The asset tax on the $800,000 of assets that are financed by debt will be $32,000, but since asset tax on borrowed money of $16,000 has been accounted for these assets there will be only $16,000 more asset tax for this portion.

The total asset tax will be $76,000 ($20,000 + $40,000 + $16,000). Double counting has already been eliminated.

The total tax would have been $76,000 if all the assets were financed by equity: ($72,000 for $1,800,000 assets and $4000 for $200,000 cash).

There is apparently no benefit for financing through equity as was the case in wind farm. If the government wants to favor equity financing in a coal plant it can either give rebate for equity financing or add a penalty on debt financing.

Subsidized borrowing

If, for example, the borrower is a student or an individual buying his first residential house, potential candidates for government support, the asset tax would be charged as follows:

  1. Charged from the borrower
  2. Would be traced from the lender and the asset e.g. house, car, cash etc.
  3. The effective rate would be less than that on cash and more than zero.

Borrowings for credit card and other short term consumer loans would probably have an asset tax rate same as that on cash, traced and charged from the lender’s assets, who can pass it on to the borrower.

Asset tax and inflation

In Free Capitalism money will tend to retain its value. Asset tax scheme will help prevent inflation due to the following reasons:

  1. The cost structure in the economy would be lighter, it would not have the burden of interest to bear.
  2. Absence of interest will help increase investments and production. Higher production is anti inflationary.
  3. Debt will not grow exponentially, as it does with interest. Exponential growth in debt after a certain point creates inflationary pressures in asset prices (asset bubbles) and subsequently in goods and services.
  4. Money supply increase will not be used to spur demand; therefore chances of monetary policy induced inflation will be minimized.
  5. Governments wouldn’t have to spend most of the money they currently spend on economic and social programs because asset tax will give them the power to achieve those social and political goals without spending money. Chances of fiscal policy induced inflation will be minimized.
  6. Governments will be able to borrow interest free; therefore instances of spiraling budget deficits induced inflation will be rare.
  7. Reducing money supply will have no interest cost and therefore easy. Governments can easily and freely reduce money supply by borrowing money on low or zero asset tax.
  8. Asset tax on assets will tend to prevent speculation, asset hoarding, market manipulation, asset bubbles and asset price inflation.
  9. Asset tax can help target particular areas where there is rapid price increases. Inflation control on a segmented or localized basis has fewer unintended consequences.
  10. In old capitalism inflation serves to transfer wealth from lenders to borrowers. Since borrowers are already advantaged under free capitalism there won’t be any justification to transfer wealth to them.

Unless a government is really irresponsible or wants inflation for some reason there won’t be any inflation until full employment is achieved.

Asset tax and negative interest

Asset tax will create an economic equivalent of negative interest rates. Taxing cash holdings at bank is like applying negative interest. Negative interest rates are necessary for offsetting the ability of wealth or money owners to hoard money and therefore create a necessity for interest. In other words, negative interest rates are needed to get rid of interest. Instituting the possibility of negative returns on cash is necessary to induce investment in industries of the future, most of which yield low financial returns. It will also provide a tool to deal with the freezing of credit markets the way economies regularly face in crises.

Negative interest rate was also suggested by Silvio Gesell, an economist of the early 20th century. The esteemed economist John Maynard Keynes agreed that the idea of negative interest (stamped money) was sound but did not agree with Silvio’s proposed mechanism. Free Capitalism, which is quite different from Silvio’s plan, suggests a robust mechanism of asset tax to achieve an economic equivalent of negative interest rate. Judging from his detailed writings on the subject I am certain that Lord Keynes would have agreed with the mechanism of asset tax. One of the later chapters of this book is devoted to the views and suggestions of John M. Keynes and Silvio Gesell on the subject of negative interest and on the proposals in this book.

Asset tax and global resource constraints

Fossil fuel are internationally priced commodities, their rising prices will gradually drive developed countries’ businesses out of existence, while allowing developing countries to use their low wages as a cushion against rising fossil fuel prices. Part of the gain of developing countries due to their low wages will come from the failure of businesses in developed countries. Their low environmental standards also allow them to keep their effective energy costs low. Their increasing industrialization will take away industries from developed countries.

The limits of the planet lend some “zero sum game” like characteristics to fossil fuel based industrialization. If developed countries don’t change the financial system soon developing countries will expand their use of fossil fuel, take most of the portable jobs and in the process ruin the environment.

Asset tax implementation in the US

Free Capitalism can be easily implemented in the US because the huge amounts of monetary wealth in the country and in dollar denominated assets globally don’t have many non-dollar alternatives. The US dollar will attract international savings even at zero percent or lower because there is no suitable alternative to the US dollar for large international savers. The US will also continue to attract international investments because of the enhanced potentials of the economy and significant reduction in business and credit risks.

US deficits as a source of revenue

The US provides the world with an important service: liquidity in the form of US dollar and dollar denominated assets. The dollars US owes gives the world money to do business with and to save. The US dollar that others around the world hold should be a source of revenue for the US not a source of expense. Under Free Capitalism US dollar will become a source of revenue (asset tax) for the US; not a source of expense (interest).

It may be necessary for the US to maintain a negative balance of payments position so that the rest of the world can have dollars to do business with and save in. The US trade deficits support the global role of the US dollar as a reserve currency. The US should not be paying in the form of interest for providing the world with a currency. Free Capitalism will let the US charge for this service in the form of asset tax. This point is discussed in detail in later chapters.

Benefits from the reserve status of the US dollar

The benefits of having a strong and dependable system of government should translate into economic benefits. The ability of the US economy and the US government to attract savings even a zero percent is the reward for providing the world a reliable place to keep or to invest their savings. The institutions, traditions and systems the US has in place to protect private property rights cannot be matched by any competing player on the global stage. There is nothing quite like the US dollar on the world stage.

Developing countries have low wages as a competitive advantage the US can have low capital cost as an advantage.

Asset tax will help promote conservative economic policies

Asset tax will help the US implement conservative economic policies. It is a trade off that will protect most other conservative traditions in economics. If there are going to be taxes; it should be done in a fashion that will help businesses, create jobs, and enhance competitiveness. The social welfare or the socialistic model that had shown good results in Europe seems to have outrun its course. The government debt problem of countries like Greece, Spain, and Portugal is just the beginning of the unraveling of the model that Europe has been following. This is certainly not the time to start following the European model.

Asset tax is the tool that will make it unnecessary to use government money to achieve social, environmental, and other policy objectives. Asset tax will allow governments to be liberal in social policies while being conservative in economic policy.

Social security and other social policies

Asset tax will not let social security and other programs for the elderly become a heavy burden for the younger generation even when the baby boomers retire. Older segments of the population will also be paying higher asset tax because of their larger accumulation of assets. Tax exemptions and other methods will be used to maintain the integrity of the social safety net that social security is. Since the economy would be much stronger it will be better able to absorb the deficit in social security. Higher employment may mean higher contributions to social security as well.

Higher incomes and better employment opportunities may incentivize a significant proportion of people eligible for retirement to delay their retirement, which would help substantially to alleviate the entitlement problem. Elimination of income tax may also provide some room to ask for higher contributions from younger generations. Government can also borrow interest free to cover the deficit.

The spiraling health care costs can also be controlled using the tools provided by free capitalism. Zero asset tax, zero interest and zero income tax can dramatically change the cost structure of healthcare. As a result the premiums of the current insurance based healthcare system will become affordable for a larger number of people.

Significant reduction in healthcare costs will enable some buyers to pay for some services themselves. Reduced overall costs can help create a healthcare system where most buying decisions are made by consumers of healthcare services; and healthcare providers have to compete in free and buyer driven healthcare markets. A free, competitive and efficient healthcare market can evolve if the buyers are also the payers.

A safety net program can also be put in place for the most vulnerable through a combination of philanthropy, zero taxes, and government help. Zero asset tax healthcare savings accounts and zero asset tax health insurance programs will further help buyers prepare for healthcare costs. Free Capitalism will help develop a humane and efficient healthcare system.

Asset tax offers a means to solve the growing entitlement problem in the US budget without adding any generational tension.

Social reasons for Asset tax

Wealth is power enough by itself. It does not need any additional power to multiply itself. People will not consider wealth less worthy in any meaningful way if it didn’t have its self multiplying powers. In fact it will make wealth more meaningful, satisfying, humane, natural and moral.

Wealth should be produced by participating in production of goods, services or other objects of value. Additional wealth should not come out of wealth itself; as it does with interest. Wealth should not become an extortionary tool and charge toll just for allowing production to take place.

Wealth should not do any harm to the economy or society. Because of interest it does harm: it burdens the society with interest costs, inhibits production and investments, and makes people consume minerals and other resources unnecessarily.

Interest based system also provides the economic foundation for extracting interest from other assets, particularly land, and adds to the cost of productively using those assets. Interest provides a minimum base for return expectations and therefore pushes return expectations upward for other assets. It is natural for any asset owner to expect a rent or return from his asset that is higher than interest. Wealth because of interest slows down the economy and reduces its productive capacity; it robs economies and societies of their economic well being.

The main philosophical reason for asset tax is that wealth, besides benefiting the owner, should also benefit the economy and the society; Free Capitalism will make that likely. Asset tax puts an annual cost on ownership so that owners have a pressure or an incentive to allow wealth to be used for productive purposes. Asset tax makes it economically necessary for owners either to use the assets themselves or to let someone else use it. Wealth will not have the power to multiply itself; it will be earned through actual participation in the production process.

Asset tax and income tax

Asset tax is fairer than income tax because it taxes people according to their wealth. Wealth is far better measure of ones ability to pay tax and can better determine their fair share of tax than income in a particular year. Under the current income tax system there are many examples of millionaires and even billionaires paying less tax than many middle class individuals. Income tax tends to keep the poor poor and by comparison keep the rich rich.

The great philosopher and thinker Plato said:

When there is an income tax, the just man will pay more and the unjust less on the same amount of income. The Republic

Interest and income tax act like a social and economic locking mechanism. They tend to perpetuate the class structure of a society. Under asset tax system it will be far easier to become rich and wealthy; however, it may not be as easy to stay wealthy because of absence of interest and presence of asset tax. There will be greater upward mobility for most people in the asset tax system. Free Capitalism will not help perpetuate the class structure of a society, the way income tax and interest does.

Asset tax is more in line with the wealth need cycle of human life: you pay less taxes when you are young and accumulating wealth and need a higher portion of your income for building and enjoying life, you pay more when you have accumulated wealth. It is fair and convenient. Social side of asset tax is discussed in detail in the chapter on asset tax.

Asset tax and democracy, interest and plutocracy

No healthy society, particularly a democratic one, should try to make its rich even richer. Interest is an instrument to actually make the rich richer; and income tax does the same in relative terms.  Interest and income tax provide a way for the wealthy to lock in their economic position or power. The current trend of money and moneyed interests polluting the democratic process is certainly helped by interest and the current financial and tax system.  Interest and income tax are helping to gradually convert democracies into plutocracies.

Interest and income tax should, therefore, be replaced by asset tax, a people, planet, and democracy friendly way of allocating capital.

Free Capitalism and the planet

Since the old model of digging holes in the ground, or ocean beds, for energy and other resources and then building the whole economy and society around consuming the find does not seem to have much future; we need a new model to build economies. The era of basing economies on exploiting resources is over. We now have to use and harness planetary resources in a way that does not rapidly deplete the remaining resources nor harm the environment.

Businesses and industries that have a promising future provide more than financial rate of return; they also provide sustainability for the planetary resources. In other words they have large “public” or “planet” component in their returns. Under old capitalism these “public” components don’t translate into financial return. The private sector therefore currently lacks economic incentive to venture into these promising industries or businesses. Free Capitalism by translating “public” components into financial returns will provide incentives for establishment of industries and businesses that serve the planet.

It is obvious that the economic system for promoting planet friendly business and economic activities have to be different from the one that promoted exploitation of the planet. Free Capitalism is different from the old capitalism in exactly that way. There are significant positive “public” or environmental components in the economic activities that will be pursued under Free Capitalism whereas under old Capitalism the said components are negative. Free Capitalism is good for the planet and old capitalism bad.

Free Capitalism and the rising human population

The increasing resource scarcities require investments for creating new resources and protecting existing ones. Growing human population and rising standards of living will over time keep driving consumption demand ever higher, which could only be met on a resource stretched planet if higher levels of the right kind of investments are made earlier. Investments increase the economic ability to consume in future. Free Capitalism by increasing investments will prepare us to meet the needs of the future population.

Machines have been replacing human labor for a very long time and with the advent of computers the trend is likely to continue for the foreseeable future. Growing human population however increases demand for jobs. Labor being replaced by machines and the rising human population are fundamentally at odds with each other. Free Capitalism by makingcapital free and freely available will tremendously increase investments. A planet friendly economy will add a large range of new products which in turn will help absorb increasing investments. Rapidly increasing investments and a significantly enlarged and sustainable product mix will employ the growing pool of labor in spite of replacement of labor with machines.

The replacement of labor by machines will continue because increasing scarcity of resources will require higher efficiency, and increasing demand for product and services will require higher production. Free Capitalism will create a planet friendly economy which will be larger, absorb more labor, create additional resources, and continue increasing efficiency and productivity through replacement of labor by machines. Free capital will create a virtuous cycle where higher level of investments will make more capital available for even higher investments which in turn will keep employing more labor and producing more sustainable goods and services. Free Capitalism will resolve the conflict between labor being replaced by machines and the growing pool of labor.

 

Some benefits of Free Capitalism

Free Capitalism will free capital for a wide range of economic activities. New businesses and industries will spring up every where. With no interest, and no income tax, it is easy to imagine a thriving economy. Free Capitalism will open up many new and sustainable industries, endeavors, or areas for investments. The growing wealth or capital levels around the world can only keep growing if employed in planet augmenting, and resource and potential developing, economic activities. Resource exploiting investment activities cannot employ the amount of capital already available or becoming available around the world.

Free Capitalism will help start a new era of economic growth and development, which may be called the environmental revolution. The amount of work that needs to be done to incorporate environmental considerations in our daily lives and its physical structures and surroundings is so huge that it will keep the global economy occupied for generations. Examples of the work involved include: restructuring of houses, factories, towns, and cities in addition to producing a very large range of environment friendly products and services and de-carbonizing an even larger range of products and services. The impact of the environmental revolution will be no less than the industrial revolution.

Free Capitalism will enable us to harness ocean tides and air currents for energy needs of the future, and also for addressing global warming. Cultivation of oceans for food, energy, and for addressing global warming is already a technological possibility, but the right economic incentives, infra structure, and global agreements are needed to make it a commercial possibility. Free Capitalism will help create that possibility. Once the oceans are considered for developmental and commercial investments the global economy won’t be short of investment opportunities for a very long time and therefore won’t have to stimulate consumption, on an already resource stretched planet, to keep the wheels of our economy moving. Stimulating consumption through economic stimulus is counter productive for the global economy and for the planet, certainly in the long run. Stimulating investments will be a healthier and more sustainable way to stimulate the economy.

Free capitalism will bring space and related industries in the mainstream through zero asset tax, which allows investment possibilities with very long time horizons to become attractive. Space will provide investment opportunities for the growing wealth levels around the world. Free capitalism will create economic growth by having people look into the distant future for return and investment opportunities. Saving the earth and going to the moon are not just lofty goals; they are now pressing economic needs. Going to the moon or mars will help us create jobs, build economic potential, put our savings and production capacity to peaceful work, and unite the world. It is the vision and the possibilities that will drive investment; not just consumption.

Space offers us answers to the epic challenges we face in this age. Space shows us the bright side of overcrowding of the planet. Space will bring unity and provide common purpose for mankind, it will usher in an era of global peace and harmony, and it will provide food for thought, imagination, art, and intellect. It will make our best and our brightest cool again. Space will give some practical meaning to life as well. Life on this planet will become exciting again!

Benefits for the US

Being a country where people and governments from around the world want to keep their savings, the US is in a position to make long term investments in assets, technologies, potentials, industries, research and development, and in projects of global significance.

Free Capitalism will enable the US to attract capital for these investments because of the long term potentials for profit and an inflation free and stable economic environment that the US will offer. Elimination of interest and a sound and robust economic system will deliver a low risk (low price volatility) environment to investors from around the world. Free capitalism will enable the US to start a new trajectory of economic growth that will last for generations.

The solid credit standing of the US, its superior capital markets, its huge markets, and the reserve status of the dollar, will further enhance the ability of the US to attract capital. It just needs the right economic incentives in place to convert its capital market advantages into investments. Asset tax will provide the tools to put the right incentives at the right place and time. The US will be able to direct massive amounts of investment towards new and promising industries.

Investments in clean energy will make the US energy independent. Its dependence on foreign oil will be minimized and its national security conditions will significantly improve. Cheap clean energy will improve its international competitiveness. Eliminating interest will also tend to make the US globally competitive because it will enable it to offset part of the low wage advantage other countries have. The US balance of trade will improve significantly.

Benefits for US leadership on the environment

Since the US would have a huge and growing clean energy sector and an environment friendly infra structure and way of life it will be able to meet very ambitious emission standards on a per capita and per square mile basis. Using historical pollution to justify future pollution is insincere and would result in waste of time and opportunity. As long as the US and other developed countries try to use historical standards there will be no real global consensus and action on climate change. The longer the world waits to implement strategies to tackle climate change the more difficult it will be to implement them because fossil fuel based assets are being built at frantic pace in developing countries.

The US will create a new economic system that the world will eventually follow. If there is a good and planet friendly economic system in place other countries would have to adopt it; since there is none other. Since skies are common to all countries; no country can get away with excessively polluting the atmosphere for long, after there is a demonstrated way to avoid it. Most important of all: the new economic system will give the US the ability to set environment and resource protection standards on a global basis because it will be able to meet those standards.  

Environment is the challenge of our time.  The nation that leads in environmental protection will lead the world in the most meaningful way possible at this point in time. There is no global cause that comes close to the environment in its importance, in the enormity of its challenge, and in its effects on the future. Leadership on the environmental front will again give the US the leadership role that it has since the Second World War.

This new economic system will not only help the US in addressing global warming and global economic crisis but will also enable it to love its future generations and leave some minerals for them as well. Free Capitalism will help the US pioneer life styles that sustain, protect, and respect the planet. The US will lead the world in ideas and in action.

 

Dangers to free markets under Old Capitalism

Economic distress in developed economies is necessitating major government interventions and bail outs. After rescuing the financial sector and supporting the housing sector the next unavoidable step to keep the economy going will be to create employment in government financed economic programs in education, clean energy, infra structure building and similar other projects and programs. This will happen because of continuing lack of good investment and business opportunities in developed countries. If governments have to subsidize a major part of the economy to achieve environmental, employment, growth and other economic targets the US and other developed countries will end up with a predominantly government run economy.

No government, or a combination of them, can address the current economic crisis along with global warming only through government programs and subsidies; they will have to gradually take over most of the economy because they would need revenues to be able to spend and they would need more control to achieve “desired” results. It may start with, for example, a huge super tax on mining industries and may advance to nationalization. Developed countries are already approaching the limits of taxing and of deficit spending.

Given the recent experiences with government run economies it is easy to see the disastrous consequences of government intervention. Government bureaucracies have never been good at running businesses and economic enterprises. Large scale intervention of the government in the economy will destroy the efficiency, inventiveness, risk taking and other beneficial part of the free markets and leave us with moral hazards, agency problems, entrenched interests, and other vulnerabilities of the free market system.

Free markets need a financial or monetary system that incorporates planetary considerations in everyday business and economic decisions. The task of incorporating planetary and similar considerations is so extensive and so economic in nature that if the political machinery is employed do it directly, through subsidies, free markets will shrink to their toy sizes. Free market economic system has to find an efficient and sustainable way of translating environmental costs into economic costs. It cannot survive without doing its new job: efficiently allocating environmental and planetary costs of economic activities to economic units.

If environmental costs are not translated in financial terms, and the investment horizon is not extended far into the future developed countries will continue to face shortage of good business and investment opportunities which in turn will keep them mired in this economic crises. Extended period of economic crises will create doubts about free markets and about capitalism. The interest based financial system because of its inability to incorporate planetary constraints has become a threat to the free market economic system.

If the US does not make the suggested or similar changes to its economy; command economies like that of China will start to have advantage over the US economy in allocation of capital to industries that are required for modern living in the environmental age. The US certainly should not want to get to a point when China’s economic system looks like an example for the US to follow.

 

Dangers to free world under Old Capitalism

Following the collapse of the Soviet Union and the opening up of global markets; billions of people joined the global work force. The global economy requires massive amounts of non-polluting and productive work to accommodate the industrialization of two billion people, in addition to the one billion already industrialized. The fossil fuel driven model of economic growth cannot productively employ all these people without destroying the planet.

The current economic system, because of its dependence on fossil fuel, short time horizon, hurdle mechanism (interest), and other deficiencies, will not allow enough employment and production to meet the needs of the growing world population with its rising standards of living, in a planet friendly and peaceful way. If these billions of people don’t obtain peaceful employment they could easily be sent back to jobs in industries of war and repression. Environment, oil and other resource constraints, and old rivalries are already pushing countries in that direction.

The world is facing increasing competition for resources and for markets; historically these have been causes of major wars. Given the relationship between the great depression and the Second World War some countries may think that the way to solve the current economic crisis is through a devastating world war. We, humans, need to solve the crisis before it leads us to a devastating war. Interest is one of the biggest threats to global peace in the coming years and decades.

World war will change the economic and other realities to suit the interest based economic system; the solution proposed in this book will change the economic system to suit emerging economic and other realities.

 

Conclusion

Interest works against both the needs of the time: employment and environment.

We need an economic system that creates jobs and prosperity and does not degrade the planet. Free Capitalism will help us achieve both of these objectives.

In short, we need an economic system whose priorities are employment, environment, and rate of return; and not rate of return, rate of return and rate of return.

 


Chapter 4

Table of Contents