Follow the Money to Real Growth, Not Tax BreaksThis week, David Cay Johnston, former tax reporter for The New York Times, published a stimulating thought experiment titled How Would You Invest $1 Billion Under the Current Tax System? It's premised on the idea that if we use tax policy to boost demand, we can find more profitable ways to invest that proverbial $1 billion.

It's a premise I reject. Based on research for Capital Rising, co-authored with Srini Rangan, I believe that capital will flow toward growth, and growth can be found in emerging markets. In a nutshell, I don't think there is enough tax policy on the planet to fill a thimble compared to the torrent of demand that can be derived from bringing a large country out of the Third World and into the First World.

Johnston, who's now teaching at Syracuse University Law School, reviews the domestic investment horizon and comes to the conclusion that right now, there's no place to invest that offers an attractive return at a reasonable risk. He uses historical statistics to point out the futility of investing in the S&P 500, U.S. utilities, manufacturing, petroleum and coal companies. He then points out the money-losing ways of retailers and the futility of making money buying out-of-favor real estate. What's an investor with that $1 billion burning a hole in his pocket to do?

Johnston's proposed solution is to change the tax structure to boost domestic demand. In my opinion, he is going off the rails with this. First, I don't think people ought to make purchasing decisions just because they can save some money on taxes. When they do, as we saw in the case of the home buyers tax credits that expired this spring, all that is accomplished is to shift future demand into the period before the credit expires. This helps explain June's 27.2% drop in existing home sales.

Send Money Where the Demand Is Real

Simply put, tax policy cannot create demand where it doesn't exist. For real demand, you need an economy that meets real economic needs. Consider Chile. Its economy is growing at 6.5%, and as I wrote in an Aug. 22 article on DailyFinance, the iShares MSCI Chile Investable Market Index Fund (ECH) -- a good proxy for the Chilean stock market -- is up 22.8% so far this year.

What's driving demand in Chile now are the efforts to rebuild from the Feb. 27 earthquake. Bloomberg reports that the quake caused $30 billion in damage, but that Chileans increased consumption following the disaster, and the nation's output is almost back to pre-quake levels. Retail sales spiked 18% in June, 19% in May and 22% in April from the previous year. I don't know how sustainable that growth rate is, but economists expect Chilean GDP to rise 5% in 2010 and 6% to 7% in 2011.

Rather than try to boost domestic demand through tax policy, I would look for countries like Chile that are enjoying rapid economic growth that has not been fully recognized by investors. If Chile's market keeps growing at the 23% it has already spiked in the last year, it would take about 3.5 years to double that $1 billion.

Admittedly, there's no guarantee that's going to happen, but I'd much rather take that chance than wait for Washington to pass enough tax incentives to get the U.S. economy back to growing at 6%.

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Wake up,stand up let's put all the cards on the table! Mismanagement accross the board from City's,States& federal agencys is the culprit .. Let's start with The Lottery's aka ( poor man's tax) Unaudited!! were is the money really going??? Bridge & Tunnel Toll's Unaudited let's call them ( Ali Baba &the 40 theive's) , How did you feel when siting in an emergency room waiting hours for comfornation of your medical insurance, Sign this, sign that. ,while non-citizens of this country get in and out before you, and we're paying for them too.

December 25 2012 at 10:21 AM Report abuse rate up rate down Reply

Americans are not even close to being over taxed

August 31 2010 at 4:20 PM Report abuse rate up rate down Reply


August 31 2010 at 3:13 PM Report abuse rate up rate down Reply

The key to the Chilean story is "rebuilding infrastructure." If we continue to do that here with road and bridge projects, it will employ construction workers, who will then demand food shelter and shoes for their kids = real demand. Compare that to the Bush $300 tax rebate and you will not need a computer model to tell you which approach will generate real long term effective growth.

August 31 2010 at 2:55 PM Report abuse rate up rate down Reply

While I appreciate your calling my Tax Notes thought experiment "stimulating" and giving it wider attention, I think you have seriously misread my column. And, seriously, earthquakes as a basis for investment policy? Talk about going off the rails.... I did NOT call for tax breaks to stimulate demand, as you assert. Indeed, in previous Tax Notes column I have been critical of the car and house tax credits as producing illusory benefits and only moving some demand forward in time, so I agree with you on that point. Your readers would not know that, however. What I raised is the question of how tax policy can address the huge imbalance between supply and demand, as evidenced by the surfeit of idle cash flowing into government debt and $1.8 trillion of cash (equal to $6,000 per American) held by corporations, while 14.5 million people are out of work and another 12 million or so have quit looking or want more work than they can get. Supply becomes more valuable when there is demand for the goods and services. I wrote: "What is needed is a tax policy that will put that capital to work. And the way to do that is by adopting tax policies that will increase demand, just as we created a boom in capital through tax policies." That does not mean tax breaks, though it could. Maybe it means taxing idle capital. Or spending our taxes in ways that facilitate growth. The question was open-ended. What might those policies be? Maybe our tax policies cannot affect the future value of current investments. I seriously doubt it, but this is a thought experiment after also its worth considering. Fostering growth in undeveloped countries is a sound idea, but what is the tax component in it? What tax policies will make your American billion dollar windfall more valuable?

August 31 2010 at 2:50 PM Report abuse rate up rate down Reply
1 reply to davidcayjohnston's comment

What about the good old excess retained earnings penalty? That should get the corporate money moving (or at least tart a shell game).

August 31 2010 at 2:58 PM Report abuse rate up rate down Reply