Money Tutorials at thismatter.com: Fundamental Tutorials on Personal Finance, Investments, and Economics

Bitcoins and Cryptocurrencies Will Never Be Major Currencies

Another form of payment receiving media attention recently is through the use of bitcoins or other cryptocurrencies. Some of the main advantages advanced for bitcoin are that:

• the supply is strictly limited and not controlled by the government
• bitcoins can be subdivided into smaller payments, allowing for micro-payments, and
• the cost of transactions is extremely low

However, some of these advantages touted for bitcoin result because it is an entirely electronic form of money. If the United States dollar or the euro was made entirely electronic, then those currencies can be subdivided indefinitely to allow for micro-payments. Most fiat currencies have a lower limit for value because they are represented by coins and paper currency, which cost money to produce. Indeed, the US penny and nickel cost more to produce than their represented value. On the other hand, the value of electronic money can be reduced, virtually without limit, to form smaller payments.

That transaction costs for bitcoins are usually lower than using other electronic payment systems, such as credit cards or debit cards, is also artificial, since transaction costs are generally set by banks and other payment service providers, such as MasterCard and Visa, who are reluctant to lower prices that constitute a major source of profit. The transaction costs for current methods of payment could be much lower, but the lack of competition and government control has kept these transaction costs higher. When money becomes entirely electronic and the government institutes reforms to take advantage of electronic payments — which I believe is inevitable — then all the advantages of electronic payment, such as enabling micro-payments and lowering the cost of transactions, will become available to that currency.

That the supply of bitcoin is limited is actually a major disadvantage, since the value of bitcoin varies widely over short spans of time because supply cannot be increased or decreased to meet changing demand. The problem with bitcoin and other cryptocurrencies, or for that matter, any other means of payment, such as gold, where the supply cannot be controlled, is that it cannot satisfy the the primary functions of money, as a unit of exchange, as a unit of account and as a store of value.

Although cryptocurrencies can be used as a unit of exchange, it is very risky to do so. Imagine if Walmart or Amazon.com accepted Bitcoin for payment. What would happen to these companies — or any other company — if the value of Bitcoin suddenly dropped to half its value or more, as it has already done? In December, 2017, the price of 1 Bitcoin reached almost $20,000. Shortly afterwards, near the start of 2018, the price of Bitcoin was less than $9,000 (USD)! The pay rate for employees would have to change every single week and prices paid to suppliers, likewise. This would be a managerial nightmare!

It cannot serve as a unit of account, because the variation in its value, even within a short time, makes its exchange value for goods and services unpredictable; price comparisons would be impossible because these cryptocurrencies vary in value by the minute, so any prices that you would see may be stale prices, reflecting the value that Bitcoin had at an earlier time. Likewise, it cannot serve as a store of value, since it can lose value very quickly, as has already occurred several times with bitcoin and many times with gold. Additionally, using methods common in business and investments, such as calculating present value or future value of projects or investments or even calculating many forms of financial risk, becomes almost impossible. Calculating present value or future value is only meaningful if the value of the currency is stable. Even though most currencies decrease in value because of inflation, inflation is usually low and predictable, so it is easier to account for inflation.

Hence, in my opinion, bitcoin or any other types of money where the supply cannot be controlled will never serve as a major currency, or even as a co-currency. Instead, bitcoin will remain as it is, a novelty currency that can be used as a medium of exchange for those businesses or individuals who are willing to assume the risk of a widely fluctuating currency, or to profit from speculation, where profits are contingent on the greater fool theory. Because the intrinsic value of Bitcoin and other cryptocurrencies is 0, that is the price that I believe it will fall to, eventually, although it may take many years, possibly until 2025 and beyond.

(I think another factor propping up the prices of cryptocurrencies far beyond their intrinsic value is micro-demand. Because cryptocurrencies can be subdivided into ever smaller amounts, I believe many people are getting these small amounts to experiment with these novel currencies. When the demand for these micro-amounts are totaled over the entire global population, the result is significant demand. Eventually, people will realize that cryptocurrencies really offer no added value over traditional forms of electronic payments, nor are they spendable at most places, so, it is still my prediction that the value of all cryptocurrencies will drop to their intrinsic value of 0. Blockchain, of course, has great promise, but this is used only to record transactions. Although Bitcoin and other cryptocurrencies depend on blockchain, blockchain does not depend on the cryptocurrencies.)

How to Save Social Security and Medicare

There has been much press lately about the trust funds for Social Security and Medicare running out of funding, that they soon will both be broke. Of course, the Republicans want to decrease payments as a solution, but that would deprive much of the poor and middle-class of funds that they sorely would need in their old age. And employment taxes are already high enough to hurt the poor significantly and to lower the standard of living for the middle class. Here's a solution that can greatly increase funding without raising the employment tax rate.

For the self-employed, employment taxes are referred to as self-employment taxes, which constitutes about 14.13% of income earned from work for those who earn less than the Social Security wage cap. For employees, the employer pays ½ of employment taxes for their employees, and the employees pay the other half. Economists generally agree that employees pay a larger share of the tax through lower wages, what economists refer to as the tax incidence. In other words, employees get paid less because the employer must pay their share of the employment taxes, so the employees pay additional employment tax through lower wages.

So how can the Social Security and Medicare trust funds be saved? By increasing the minimum wage, by taxing all earned income, such as the compensation earned by high income employees through stock options, and as a clawback from people who receive more in Social Security and Medicare payments than what they paid in, by subtracting it from their estates before the unified tax credit is applied. Adjusting the minimum wage for inflation would also help to increase tax revenue to cover Social Security and Medicare payments, since both payments are adjusted for inflation annually.

The federal minimum wage in 2018 is $7.25 per hour. The last time it was raised was July 2009. Inflation since then has eroded the purchasing power of that minimum wage, but even back then, it was inadequate to earn a decent living. Increasing the minimum wage to $15 or $20 per hour would greatly increase employment tax revenue, and it will have other desirable effects as well. Increasing the minimum wage will stimulate the economy, because giving more income to low-income employees will stimulate their spending, which, in turn, stimulates the economy. Moreover, the increased cost to employers will become less and less of a factor in the final price of the product or service, as automation makes each worker more productive. Although the microeconomic effect of a higher minimum wage would reduce the demand for labor, the stimulatory effect of allowing poor people to earn more money will more than compensate, with the macroeconomic effect of greater spending exceeding the negative effect of higher prices of labor on employment. Not only would this increase employment tax revenue for the government, but it would also increase tax revenue in general, since working income, what the tax code refers to as earned income, is also subject to marginal taxes.

Some highly compensated employees are paid through stock options, and if the employer follows the tax rules, the compensation earned through the employee stock options, even though such income is earned from work, is not subject to employment tax, and is only subject to the lower marginal tax rate applied to investment income. Another way highly compensated employees can avoid Social Security and Medicare taxes is by forming an S corporation and declaring part of their income as dividends, which are not subject to self-employment tax. Likewise, for carried interest, which is income earned by some fund managers, some of whom make hundreds of millions of dollars annually. These fund managers earn carried interest by working for it, since they are not investing their own money, but, nonetheless, the tax code has a special provision, allowing them to designate a substantial portion of the compensation as carried interest. Carried interest is subject only to long-term capital gains rate and is not subject to employment taxes. So why allow highly compensated employees to pay less tax on their earned income than low-income employees?

Another possibility is that employment taxes can be applied to all income rather than just employment income. After all, why should employment taxes only be applied to employment income? That they do is why they are called employment taxes, but there is no reason why these taxes cannot be applied to all income, including gratuitous transfers. Applying employment taxes only to work just increases the taxes on people who earn most of their money from work, because the tax revenue must be earned from a smaller base. If the tax rate was applied to all income, then the tax rate could be lower, since it would apply to a much larger tax base. Additionally, more people would qualify for Medicare and Social Security.

The Best Monetary Policy to Stimulate the Economy is a Fiscal Policy: Lower or Eliminate Taxes on the Poor

To stimulate the economy, money must have velocity: people must spend it repeatedly. If money is just hoarded, then it will have no impact on the economy, regardless of its quantity. The best way to increase the velocity of money is to use it to offset taxes on the poor, who are hurt most by recessions and depressions, and who will quickly spend the money. As it is done now, QE merely makes the rich richer, who are far less apt to spend it. Lowering interest rates, even if it worked, would merely serve to increase the debt load of the public, which would eventually result in less spending, since the debt will have to be repaid. This is why QE is not effective either in the United States or in Europe. On the other hand, lowering taxes on the poor will increase their spending, which will increase business, which will increase money flowing to the middle class, who, in turn, will increase their own spending, and eventually, even the wealthy will benefit. Lowering taxes on the poor will benefit everyone! That is the way the economy works! Additional benefits to lowering or eliminating taxes on the poor include:

• import prices remain steady
• currency wars are avoided

Of course, central banks use quantitative easing because that is a monetary policy tool that they can implement. Because lowering taxes on the poor is a fiscal policy, only Congress can change it, and since Congress is beholden to special interests, especially the rich, that is unlikely to happen soon. Working income, what the tax code refers to as earned income, has always been the most highly taxed form of income — at least in recent decades — and is an effective means of keeping a higher tax burden on working people rather than on the wealthy, who receive much of their income from investments and inheritance. Nonetheless, as already argued, lower taxes on the poor and the middle class will benefit everyone, including the wealthy, and is the best method of stimulating the economy.

Helicopter Money for the Poor

Helicopter money, a term coined by Milton Friedman in his 1969 book, The Optimal Quantity of Money, is a distribution of money by throwing it out of a helicopter, where the people below will grab it and spend it. Friedman envisioned that helicopter money would increase inflation, but would not increase real economic output. Ben Bernanke, a former Federal Reserve Chairman, argued that helicopter money might be a better solution than lowering interest rates to stimulate the economy in a deflationary environment, especially when there is a large economic output gap. The resulting increased spending will simply narrow or close the output gap rather than causing inflation.

In my opinion, helicopter money would be much more effective as an economic stimulus in a deflationary environment if it were distributed only over slums, because as I have argued above, giving more money to the poor would directly stimulate the economy. Indeed, there is no need to print any more money: taxing the rich more and the poor less would stimulate the economy, without causing hyperinflation. The rich would still benefit, because the money would eventually return to them, through their businesses and investments, and the government would collect more tax revenue from the growing economy and the higher velocity of money. Hence, everyone benefits! I should even call this the Utilitarian Tax Policy, since it is the best tax policy that I think will maximize the happiness of everyone, the primary goal of Utilitarianism.

A Tale of 2 Government Handouts

Some people consider the child tax credit to be a government handout, as evinced by the fact that the Additional Child Tax Credit has an explicit work requirement. I do not know if the Republicans have a unified view of the child tax credit, but since they oppose abortion, they should, at least, help people to afford those children. However, governments — federal, state, and local — put most of the tax burden on working people. Indeed, the Republicans do not want to tax investment income or gratuitous transfers at all! So that leaves taxing only work. They want working people to pay all the income taxes, so it is natural that they should espouse hard work, since somebody must pay for government. The Republicans just don't want it to be the rich. The tax burden on work is one reason why inequality is increasing, and why it is so difficult to move up in society by simply working for it.

In this light, it is interesting to compare the child tax credit with another very generous tax credit that benefits the wealthy: the unified tax credit, used to eliminate the estate tax on more than $5 million of gratuitous transfers, i.e., gifts and bequests.

The child tax credit:

• is not adjusted for inflation;
• has an income limit;
• has a work requirement; and
• the maximum credit is $1000 per child, although the full credit may only be claimed if there is sufficient earnings from work.

By contrast, the unified tax credit:

• is adjusted for inflation;
• has no income limit;
• has no work requirement; and
• the maximum credit in 2016 is worth $2,125,800 that can be used to offset $5,450,000 of gratuitous transfers from each individual, so parents can give $10,900,000 of their wealth to their children tax-free, and that's not even considering the many tax loopholes that allow even more wealth to be transferred tax-free.

The unified tax credit is very generous, indeed. For instance, the 2016 unified tax credit is worth more than most people are ever going to earn (adjusting for inflation) in their entire lives. A person who works for 40 years, averaging $50,000 a year, will only earn $2 million over his working lifetime, and would pay an enormous amount of taxes on that income over those years. On the other hand, a child receiving $10.9 million from his parents does not have to pay any federal tax at all on that income — and no! — he doesn't have to work for it.

Remember, too, that it seems that the tax code for the child tax credit has been carefully crafted to minimize any actual refund to low income taxpayers, by only allowing the credit to offset payroll taxes, so that the government's net credit to the taxpayer does not exceed what it has collected through payroll taxes. The Additional Child Tax Credit increases by 15% for each dollar over the $3000 minimum, which closely tracks the total payroll liability for an individual taxpayer. Of course, if the taxpayer also qualifies for the earned income credit or the premium tax credit or even the American Opportunity Credit, then the taxpayer's refund from these truly refundable credits will be increased by the child tax credit. Although this is a rather complicated explanation, it does explain why the calculation for the child tax credit is so complicated, and why the child tax credit is not simply a $1000 refundable credit per child. Moreover, not everyone can work! And if they had children? Too bad, I guess! This is just 1 illustration showing how the tax code strives to limit payments to the poor, while being very generous to the wealthy, as demonstrated by the inflation-adjusted unified tax credit of over $2 million!

If the government truly wants to promote work, it would be more successful by taxing it less, instead of taxing it the most, as it is now, especially considering the fact that the deadweight loss of taxation on employment is greatest while the deadweight loss on taxing gratuitous transfers is 0. States and municipalities also tax work more than other forms of income.

Under the tax code, as in other things in life, the rich really do have it better!

Note: As noted in the news item above, the new tax package doubled the maximum child tax credit to $2000, with $1400 of it being refundable. However, the only reason why this was added to a tax package immensely beneficial to the wealthy is because Marco Rubio insisted on it, and without his vote, the rich would not have gotten their big tax breaks. As for the wealthy, among the many other goodies that they have received, the unified tax credit has been doubled, so now the wealthy can pass $22 million to their heirs without any tax liability. But since the government costs so much money, if the wealthy don't pay their fair share in taxes, then they will have to increase taxes on everybody else! While the new tax package did lower taxes for many lower income Americans, it achieved this by greatly increasing the deficit, exactly at the time when taxes should be raised rather than lowered, since the economy is peaking right now. After all, what is the government going to do when the next recession arrives, as it always does, since the economy continually moves in cycles. Without government spending, the economy will sink lower than it would otherwise.

Eventually, these taxes will have to be paid back. For years, the Republicans have been screaming about the deficit, and now that they are in complete control of the government, they have greatly increased the deficit to benefit their political donors. What this means is that the Republicans were not really concerned about the deficit, only that not enough wealth was being transferred from the lower classes to the wealthy! Eventually, the Republicans will argue that taxes must be raised on everybody, mostly the poor and middle-class, and that so-called "entitlements" — Social Security and Medicare — needs to be reduced or even eliminated. Of course, working people have been paying heavy taxes for these entitlements all of their working lives, but the Republicans still call them entitlements. On the other hand, the unified tax credit is a free gift to the wealthy, and unlike the child tax credit, has no onerous requirements!