Punitive Tax Rates of 90% Could Cause More Problems Than They Cure

By Martin Hutchinson
Contributing Editor
Money Morning

For lawmakers who believe that 90% tax rates would be an effective way of punishing the financial malefactors who continue to flourish as the rest of us founder, take careful note: Not only will you punish the innocent as well as the guilty, you could also extinguish the innovative spark we'll need to eventually make this moribund economy catch fire.

The U.S. House of Representatives voted Thursday to impose a tax rate of 90% on bonuses earned by wage earners of $250,000 or more who are working at banks that received more than $5 billion from the Troubled Assets Relief Program (TARP). The Senate is expected to vote this week on similar legislation, possibly extending the tax to institutions that have received more than $100 million under TARP.

OK, we get it guys: You don't like American International Group Inc (AIG).

Still, unless you just like 90% tax rates (probably true of about half the House Democratic caucus), you are punishing the innocent along with the guilty. Banks like Wells Fargo & Co. (WFC) and U.S. Bancorp (USB) have received more than $5 billion from TARP, but have yet to record a net annual loss.

The Saga of a (Highly Taxed) British Banker

For those who think taxing the rich at 90% may seem like a good idea, I can give you some practical experience of what happens when you do. Anyone who has paid a 90% tax in the United States is both quite old and quite rich - under the 1954 code, repealed in 1964, you had to be earning over $200,000 to pay tax at 90%, real money in those days, equivalent to over $1.5 million now. However, in Britain, 90% income tax rates lasted until 1979, and kicked in at 20,000 pounds, about $150,000 today. I never quite made that much, being in my 20s then, but I was paying 75% marginally, and it made a HUGE difference to my lifestyle and to those of my fellow bankers.

So, apart from making me feel poor, what did the high marginal rate do for me, as a young merchant banker?

Well, for a start, there were none of these 90-hour weeks you hear about on Wall Street. What the hell would have been the point? We got to the office each morning around 9:45 - not 6 a.m. - and we left at 6 p.m. (5:15 was the "official" quitting time, but we wanted to appear as keen up-and-comers, and figured the extra 45 minutes each day was time well spent).

Our workday was over, but we weren't exhausted: Every evening, in fact, I'd catch a bus to the British Museum Reading Room, which was open until 9 p.m., and get two-and-a-half hours of work done on my book about great conservatives in British history. Had the book been a best seller (it took me 25 years to find a publisher ... although it did get wonderful reviews), the 90% tax rate might have been justified, I suppose, but modest sales was what I saw.

Then there was lunch. Don't think now of the quick sandwich at the desk, or even the half-hour at the gym. When merchant bankers did lunch, they did it properly.  All banks had in-house dining rooms, where the food was of excellent quality and the wine was superb. You had to invite a client, of course, but there was no requirement that you ever actually did any business with that client, although usually one would spent five or 10 minutes over a very nice port, discussing the market - just in case.

Some of my colleagues found the wine so superb they were quite incapable of rational thought afterwards ... but that's why lunch started at 1 p.m., and not noon, so the firm got at least an hour or two out of them beforehand. Personally, I loved the haute cuisine, which is why I am the shape I am today - do you think I could sue?

The best lunches were the ones where I got Sir John Colville, one of our directors, to host - he had been Winston Churchill's private secretary, and as soon as the main course was served and the wine poured, he would begin: "When Winston and I were at Casablanca ..."

Lucky if you were back at your desk by 4.30 in the afternoon on those days, I can tell you - but it was worth it.

So if Congress wants to make bankers pay taxes at 90%, that's what they'll get: Lots of very good lunches, but not many deals. The bankers will be more dyspeptic, and the economy will be poorer, but what the hell: Civilized conversation and an in-depth knowledge of the better claret vintages will once again be the order of the day on Wall Street.

Why Not Spread the Pain?

It does, however, seem more than a little unfair to restrict the benefits of the 90% tax rate to bankers alone. We could, for example, extend it to members of the U.S. House of Representatives and the U.S. Senate. This wouldn't be, heaven forbid, on the salaries they earn as congressman and senators - the American public needs their finest efforts during that period. Instead, this new tax rate would levied on the period up through 10 years after they retire from Congress, on the lobbying income they pick up as "beltway bandits." And here it's clearly a case of addition by subtraction: The less productivity we get from lobbyists, the better off the country will be.

You could also extend the 90% tax rate to U.S. Treasury Secretary Timothy F. Geithner: Why should he not get the full joy of paying the taxes he imposes (and there'll be no forgetting about those tax payments this time around, Mr. Treasury Secretary!).

U.S. Federal Reserve Chairman Ben S. Bernanke could pay those higher taxes, too. And if that made him less eager to continue inflating the money supply after his current term ends in January 2010, well, everything has a downside!

Even President Barack Obama might enjoy them. Again, not on his presidential salary - but he's such a magnificent speaker, and so young, that you have to believe he will break all records for speaking fees once he leaves the White House. Indeed, 90% of his post-presidential earnings for a decade-long stretch might even make a noticeable dent in the budget deficits he will leave us.

So there you have it - a look at what the world might be like with 90% tax rates. If Congress goes ahead and implements them, I have an obvious stock tip, too: Put your money in one of the new tax havens, where relatively low taxes attract investment and entrepreneurship from all over the world - including such global economic powerhouses as France or Sweden!

[Editor's Note: When it comes to banking, there's literally no one better than Money Morning Contributing Editor Martin Hutchinson, who brings to the table the kind of high-level expertise that our readers have come to expect. In February 2000, for instance, when he was working as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians who had been stripped of nearly $1 billion by the breakup of Yugoslavia and the Kosovo War.

Experiences such as this have imbued Hutchinson with special insights in such areas as banking, the financial markets and fixed-income investing. Just last month, the financial Web site Seeking Alpha named Hutchinson to its "leader board" because of his quickly developing online following. And, in Money Morning, Hutchinson cut through the controversy about the health of the U.S. banking system, analyzed the Top 12 U.S. banks, and told readers which ones were "Zombies" and which ones were "Gems." The article was one Money Morning's most popular pieces of the New Year [If you missed the story, please click here to check it out. The report is free of charge].

Fans and followers of Hutchinson's work will soon be able to subscribe to a new product that focuses on income investing that will feature more of his - insights and essays. That should debut in about a month or so.

Hutchinson also writes regularly for our monthly newsletter, The Money Map Report, in which he and other Money Morning colleagues also make investment recommendations for subscribers. To find out more about The Money Map Report - including a special offer that includes The New York Times bestseller, "Crash Proof" - please click here.]

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