Comments (30)

• Nick Bradley

  I'm sad to see that Mr. Brandly failed to mention the scam of the Alternative Minimum Tax:
  

  
  Basically, a taxpayer pays the AMT if he would pay more under the AMT than the regular income tax system. By reducing a upper-middle or upper income indiivudals' liabilities under the regular tax system, you simply make that taxpayer more prone to the AMT. The AMT also wipes out the dividend tax cut, as the AMT does not allow you to offset capital gains with capital losses.
  

  
  If Congress TOMORROW cut income tax rates to 0% without touching the AMT, taxes would stay the same or go higher.
  

  
  The only thing I can see here is that the AMT is an elaborate plot to replace the progressive income tax with a flat tax, which is what the AMT is:
  

  
  A two-tier tax bracket system (26% and 28%) with a large deduction. In addition, the AMT only allows for you to deduct your mortgage interest on your primary residence, not second homes, deflating the real estate bubble somewhat.

  Published: April 30, 2007 8:29 AM

• DC

  Doctored or not, that's a great photo.

  Published: April 30, 2007 8:33 AM

• mike

  Given that it was extremely difficult to get even such a limited tax cut passed, and is proving nearly impossible to keep it (as happened with the Reagan tax cuts during Clinton's term, when tax rates were raised to cover the budget deficit, but not lowered again when the budget went into surplus), what is the point of this article? How does muddying the definition of "tax" help this fight at all? Are you saying Congress should not have passed the tax cuts at all? that they provided no general benefit?
  Certainly there are a host of problems for the x-archist with the Bush Administration, but surely cutting tax rates is not one of them.

  Published: April 30, 2007 9:14 AM

• D. Saul Weiner

  New bumper sticker: "It's the spending, stupid"

  Published: April 30, 2007 9:54 AM

• RogerM

  Mike:"Are you saying Congress should not have passed the tax cuts at all? that they provided no general benefit?"

  As a staunch Republican, I would have to say I agree with the article. No, the tax cuts did not provide any benefit. I think Republicans are confused about economics in general and tax cuts in particular. The original idea behind supply side econ was that cutting taxes would increase tax revenue to the fed, but no one ever assumed that the function governing tax rates and revenue was linear; in other words, you can't cut tax rates to zero and get infinite revenue. It was always assumed that an optimum tax rate existed for raising the max revenue. If you go below that rate, revenue will decrease. I think we passed that point with Bush's tax cuts.

  At some point, the idea of maximizing revenues to the fed morphed into stimulating the economy, which is not supply-side econ, but Keynesian econ, which we all know is BS. It's impossible for fed tax cuts to stimulate the economy unless the fed cuts spending as well, otherwise the fed has to borrow money in the marketplace to cover the deficit. Fed borrowing raises interest rates to a higher level than they would have been without the fed borrowing and thus depresses econ activity. Also, fed borrowing increases the tax burden on our children.

  Republicans should be concerned with shrinking the size of the government, not stimulating the eocnomy. Politicians are without a doubt the very worst economists on the planet. They know absolutely nothing about economic development. They should leave that task to entrepreneurs and concentrate on reducing real taxes, which can only happen by reducing fed spending, and reducing regulation. Taxes, fed borrowing and regulation raise the cost of doing business and consequently reduce the money available for businessmen to invest in new plants and equipment.

  Published: April 30, 2007 9:56 AM

• Brad

  Where would the unfunded future promises fall? Not either an outright tax, or a more subtle tax like inflation, but it does cause a severe misallocation of property and resources.

  We have a nearly $50 trillion accrual basis debt, roughly $9 trillion of which is hard (borrowed) debt or the diverted positive cash flow from "human resource" programs like social security and medicare. The remaining tens of trillions are the present value of future promises made under these human resource programs, that too will have to repudiated or property will have to stolen from a third party. The misallocation comes in when people don't save/safely invest for their own future, but instead consume. It overheats the current economy (which is gravy for the government that gets the taxes flowing therefrom) as people consume inordinately leaving little for their own future. More alarming is that people are going further into debt personally on top of not building equity). So out of the one future production pie, there seems to be two claims, the individual providing for a basic household and paying off prior debt for consumables AND a government that is going try and pay for specific human resource programs. The illusion that you can two full divies from one pie is where the great misallocation is.

  So not a "tax" or current spending just yet, but we have a greater amount of consumption as people think they are building something like equity, but being liened at $750,000 per working couple (the pro-ration of the accrual basis debt) any "equity" is merely a loan callable at any time.

  Published: April 30, 2007 10:42 AM

• jdavidb

  If Congress TOMORROW cut income tax rates to 0% without touching the AMT, taxes would stay the same or go higher.

  Nick, unless I misunderstand the AMT, and/or what you just said, that cannot be the case. AMT only kicks in if your regular tax is below what AMT requires. That means that taxes couldn't go higher if regular tax what cut to zero, because by definition AMT is already lower than what people are paying under regular tax, or else they are paying AMT.

  All taxes are a scam (and theft). I'm not sure there's anything that makes AMT particularly worse. We don't have to overstate the case to show how wrong taxation is.

  Published: April 30, 2007 10:53 AM

• lester

  bruce bartlett talks about some of this in "Imposter". the tax cuts accomplished more in the way of losing revenue than spurring any economic growth. I'm an amateur with economics, but bascially bartlett argues bush's tax cuts are not conservative but keynesian in nature. people didn't take their rebate and start new businesses or even buy something from a new business. they put it in the bank. and along with the spending, simply pave the way for an inevitable tax increase.

  Published: April 30, 2007 1:30 PM

• Brent

  Taxes are bad. Tax cuts are good.

  Like everythign else, though, it is a marginal good. Small tax cuts are wonderful compared to no tax cuts, but they are not monumental events worthy of being forever scribed into the history books.

  Published: April 30, 2007 1:39 PM

• Ike Hall

  Agreed, DC. I'm sure that's exactly how the millenialist dispensationalists see him. That photo just happened to catch the halo correctly for the rest of us.

  Published: April 30, 2007 2:22 PM

• lester

  well, bartlett would argue that a POLICY of consistantly cutting taxes is good, but a single tax cut is not neccasarily good, at least in terms of the economy over all. bascially, the government needs revenue and if you give up that revenue it should be for someting that will make more of it. it's doubly true if you have no intention of cutting spending

  Published: April 30, 2007 2:25 PM

• lester

  http://www.lewrockwell.com/tucker/tucker39.html

  
  something like a tax rebate is only a REAL rebate when it represents money the government hasn't actually spent yet.

  in a nutshell, real conservatism is good and fake nixonian machievellian conservatism isn't. and is more dangerous than it looks

  Published: April 30, 2007 3:58 PM

• atr

  Those who lend the government money are purchasing a promise to take someone's property in the future in order to repay the loan. If the securities that are issued are to be repaid, then the state is simply shifting tax burdens away from current taxpayers on to future taxpayers. We should recognize that there is a current burden from government borrowing and that is the opportunity cost of the resources the state commands due to the revenues resulting from the sale of securities. However, we must also recognize that government securities are simply promises to take someone's property in the future and give it to the bondholder. This future aggression against private property is a tax. Deficit spending is simply another way of shifting tax burdens.

  What about the case where the state incurs debt but later repudiates that debt? Suppose that the state borrows $100 from me with the promise to take $100 plus interest from someone in the future and use those funds to repay the debt. However, when the time comes, the state refuses to tax the future taxpayer and declares that the debt is repudiated. In this case, the state has taken $100 of my property as assuredly as if it had taken $100 from me in direct taxes. In fact, debt repudiation is another coercive non-contractual transfer of assets, in other words, it's a method of taxation.

  Is this right? If a thief asks for a loan using his future victims' assets as collateral, or promises that the repayment will come from future stolen assets, is the lender entitled to be repaid?
  
  Why don't we want the thief to stop stealing now? Yes, there is a chance that the thief will be unable or unwilling to pay in the future, but wouldn't it be better for the lenders to bear those risks than for the thief's victims to continue to suffer?

  Published: April 30, 2007 4:17 PM

• Nick Bradley

  jdavidb,
  

  
  Here's an example:
  

  
  Under the regular tax system, Joint Filer A who makes $200k a year pays $20,000 in taxes. Under the AMT, Joint filer A also pays $20,000 in taxes.
  

  
  A tax cut is then passed that lowers the tax rate from $20,000 a year to $10,000 a year. Sounds great right? Well, that filer now just gets the pleasure of filing the AMT.
  

  
  Taxes actually go up only if you include preparation/compliance fees, which are much higher under the AMT. I should have clarified the fees are responsible for "higher" taxes.
  

  
  But that does not negate the point that Bush's upper-middle class tax cuts were a shell game, shifting tax revenue from the regular tax system to the AMT.

  Published: April 30, 2007 4:36 PM

• JIMB

  Deferred taxation is an asset offset by the obligation of future pay, and it depends on the calculation on both sides of the ledger whether the net is on one side or the other. If the return from available funds which would have gone to taxation is higher than the increased cost of the deferred obligation, it is a net gain which manages to overcome the cost of additional government -- but for that to be true, the government must not consume so many real resources that investment becomes unable to bring about the dollar volume of profits necessary and it must not impede trade which is the source of those profits as well.

  It also matters who ends up financing the deferral. Since foreigners have largely done this by selling the U.S. (underpriced?) goods while their central banks buy a (lot) of treasuries, this has offloaded the costs and the shrinkage of real domestic resources that would have normally occurred. But the U.S. government can grow to a certain size before it is consuming too much of the world's resources and there becomes an impossible situation... that's when the central banks as buyers of last resort create inflation.

  So it isn't how the deficit is financed (certainly a major source of uncertainty, however) that does us in, but the fact that the government consumes (and causes the consumption of) tremendous amounts of present goods which diminishes available savings and future real income and thus the tax base. And confiscation is not a solution : the government cannot in fact mass confiscate "wealth" because attempting to do so would collapse it faster than they could get it (imagine "confiscating" Microsoft -- the entire company and all it's assets, future cashflows based on productive earning power, would collapse).

  If, by financing a deficit, the real goods are still consumed which would have provided the investments to pay the future obligations, it is simply "forced consumption" to the detriment of everyone (including the government).

  Published: May 1, 2007 4:16 PM

• Juan

  the federal government owns a tremendous amount of property, including land. It owns 84.5% of the land in Nevada,

  I've been wondering what is the difference between socialism and laissez-faire and came up with this :

  In Russia the politicians owned 100% of the counrty. In the free world they only own 85% of it ? Isn't that uplifting ?

  Published: May 1, 2007 7:37 PM

• Gary

  Democrats tax us through our income.
  Republicans tax us through inflation.
  Mises Institute scholars usually condemn the former but defend the latter, so it is nice to see this article
  The Republicans' inflationary spending is even more perverted and degenerate than the Democrats'dreams of a nanny state since it imposes the burden of repayment and the consequences of negative real savings rates on unborn children.
  Now if you could just get the stomach to go after the corporate welfare bums at places like Boeing you might be onto something.

  Published: May 1, 2007 9:35 PM

• Nick Bradley

  JIMB, others:
  

  
  I would like to propose a scenario to you all. Currently, our federal budget is about 90% financed through taxes, and about 10% debt financed?
  

  
  Wouldn't we be better off? The Feds spend 30 - 40 cents on the dollar collecting taxes; wouldn't it be better if we collected that money by selling securities??? Lower transaction costs, right? ALL economic distortions from tax regulations are also pulled out of the economy.
  

  
  The 10% needed to service the debt can be collected from the states. With annual state spending at about $1.25T, a tax-exclusive tax on state treasuries of about 16% would do it.
  

  
  Sure, trillions in investment dollars would have to be re-directed towards the new debt, but the market would decide who buys the debt (and for how much). And the trillions in saved tax dollars would surely make up for the redirected investment.
  

  
  The mounting debt would not rise in relation to the economy as a whole, but rather shrink (due to reduced compliance costs and regulations).
  

  
  Furthermore, the market can influence the federal government on its fiscal policy. If they don't bite on offered securities, the Feds will have to reduce spending. And since states are being taxed, they will pressure the federal government to control spending as well.
  

  
  The only sad part is that the current system is so bad a crazy system like this would be FAR preferable.

  Published: May 2, 2007 8:33 AM

• JIMB

  Nick - It wouldn't be better because the government is typically an immediate consumer (even when it pretends to 'build capital') and the debt is usually longer term than the assets. Over time there's an accumulation of debt unmatched by economic assets remaining in the economy. This leads to default (by inflation) as the central bank then 'socializes' these losses across all dollar users.

  Published: May 2, 2007 9:02 AM

• Scott D

  Gary:
  "Democrats tax us through our income.
  Republicans tax us through inflation.
  Mises Institute scholars usually condemn the former but defend the latter..."

  I'm not sure where you got this impression. Please do a search on "inflation" on this site for evidence to the contrary. Maybe you are mixing up LvMI with one of the many neo-con-in-libertarian's-clothing organizations? Mises and Rothbard spent a considerable amount of time describing the harm of inflation.

  What you will find some disagreement on is the relative harm of current account deficits, in which inflation and budget deficits appear to play an important role.

  Published: May 2, 2007 9:11 AM

• Nick Bradley

  JIMB:
  

  
  "It wouldn't be better because the government is typically an immediate consumer (even when it pretends to 'build capital') and the debt is usually longer term than the assets. Over time there's an accumulation of debt unmatched by economic assets remaining in the economy."
  

  
  But that wouldn't be the case. Assets that would have been confiscated by taxes remain in the economy. In addition, the hundreds of billions of dollars that tax regulation destroys every year would still remain.
  

  
  If all of the tax savings, saved compliance costs, and the economic efficiencies that would result from a total elimination of federal taxes were factored in, the debt-to-asset ratio would be going down, i.e. assets are growing faster than debt.
  

  
  If the debt:asset ratio went up, the bond markets would force interest rates up as well. Higher interest rates would force the Federal Government to produce less debt, and lower spending amounts.
  

  
  If states had to service the debt, they would have a great interest in limiting federal spending as well.
  

  
  The federal government is currently paying out about 4.6% in interest for every dollar of debt ($400B+/yr.). If we ran up another $2T in debt this year, that would add $90B - $100B to the annual interest payment.

  Published: May 2, 2007 12:08 PM

• JIMB

  Nick - Think about what you said "assets that would have been confiscated by taxes remain in the economy". But that is opposite of the facts.

  Consider: I buy and consume $1000 of goods from income ** OR ** I buy and consume $1000 of goods from debt. Aren't the goods gone either way? THOSE are the assets ...

  On the one hand I have less present income and the cost is reflected correctly in my lifestyle. On the other hand (taking on debt) what ** appears ** as higher valued financial assets lose their direct connection with the goods markets because it is government that is doing the 'investing' and they have no incentive (and no losses) that they care about: it's your life and your dime they are putting at risk.

  Then it's party time for the politicians ... at least for awhile. Then when the 'correction' comes, the financial markets get marked back to their real values. How is that better?

  Published: May 2, 2007 12:52 PM

• Nick Bradley

  JIMB:
  

  
  1. Your consumption of goods analogy doesn't really hold. The transaction costs involved in the government collecting "income" are about 50 cents on the dollar when compliance costs and distortions are factored in. So that $1,000 of income buys about $500 worth of goods.
  

  
  If you instead bowwored the money, you would get $1,000 worth of goods, or very close to it. On top of that, you can keep your income and invest it; as long as you got a higher rate of return than what you paid out on your credit card, you make out better.
  

  
  This is the same reason why it is absolutely asinine to buy a vehicle in cash. At an interest rate of 5% over 60 months, your annualized rate is only 2.5%. You can get TWICE that in a CD!
  

  
  Even with a home mortgage it is STUPID to buy with cash: a 30-year mortgage @6% works out to only 3.8% a year in interest. Factor in a tax deduction at a 25% rate and it's only 2.9%. That's FAR under the rate of inflation in any period.
  

  
  Even if you don't factor in inflation, a time preference of 4% per year is nothing. That's probably far below society's actual decision point. Somebody would have to pay over 10% on a 30-year mortgage to may more in annualized interest than the average return in the stock market (7%); No wonder we're awash in debt.
  

  
  2. If we say it costs 25 - 50 cents on the dollar to collect taxes, that's $600B - $1.2T annually lost to the tax code. Adding that to our GDP alone constitutes 5 - 10% GDP growth. If you factor in 3 - 5% GDP growth on top of that, you're looking at 8 - 15% GDP growth annually. Interest on the debt is only 5% a year; Asset growth is far outpacing debt growth.
  

  
  As long as you can get a better return in the stock market than your credit card interest rate, you're in the clear.

  Published: May 2, 2007 1:53 PM

• JIMB

  Nick - Good point, but not quite.

  First people find it in their interest to endure many of the compliance costs (they could just pay the max tax rate and greatly reduce compliance costs). So the total cost are not quite the gross figure you believe it to be. Even at a generous 400B out of a 2T budget, that's 20% (not 50%), and it is likely that the difference is only about 10%. The economy (we are talking only tax compliance) loses $1.10 for every $1 the gov gets, indicating the drop in total gov spending (if possible at all) would be $1/$1.1 or about 9%. A gain in government spending could be counterproductive depending how it is spent (more warmaking, for instance).

  Even if we assume that works out ok, there is still a problem. The gov does not match the term of debt with the term of the assets they intend to acquire. In other words, the benefit you note is diminished and reversed over time by the government borrowing longer term for it's yearly consumption (politicians don't want to pay the principal if they can avoid it).

  Since the 'benefit' is close to 1 year (mostly consumption), but the debt is going to be longer than 1 year, the debt grows larger and larger as formerly unpaid principal accumulates.

  There's another issue as well. Part of the way the government creates demand for fiat currency is by taxation (along with capital gains tax for any non-government-money transaction). You can bet the idea that they finance the ops only by borrowing will not ever see the light of day ... that's why the income tax was passed right on top of the creation of the Fed in 1913.

  And another: the government uses round robin financing structure, sometimes using inflation, sometimes selling to foreigners, sometimes selling bonds domestically (sometimes deflating). This tends to maximize the extraction of wealth as there are always a percentage of people in the populace that believe things are going to go the same direction at switching points, and they lose value to the government as it takes the 'other side of the trade' (example: holding dollars during an inflation benefits the govt).

  Published: May 2, 2007 7:52 PM

• JIMB

  Nick - BTW your example of a car is really bad: most people buying a 40K car will pay around 700 per mo and would need to save an additional 600 on top of that to own their next vehicle (they must pay not only the debt, but save enough for a new car at the same time).

  The after tax cost of debt is 75% of the interest rate if the tax rate is 25%. I've no idea where you are getting 3.8%. What's worse is the '1%' rates offered for cars. Basically new car financing is very close to an unsecured loan (it immediately depreciates so there is no collateral). Buying a car on that type of financing means the buyer is paying capitalized interest in the price of the car and has no ability to avoid the interest charges. It's far better to negotiate the price of the car lower and pay a higher rate so a person can accelerate their payments.

  Published: May 2, 2007 7:59 PM

• Nick Bradley

  JIMB:
  

  
  1. The 50 cents on the dollar figure represents combined compliance costs and distortions to the economy caused by tax regulation. If think that is quite accurate
  

  
  2. Yes, the assets that the USG would purchase with debt is pretty much wasted, but tax receipts are also wasted today;
  

  
  3. Using debt instead of taxes wins out because of the saved compliance costs and eliminated regulatory burden. The economy would be far more efficient if there were no tax code, correct?
  

  
  4. There is nothing wrong with the car loan example. With a 5-year, 6% car loan for $40,000, monthly payments are $773.31 a month. over 60 months, $46,380 in payments are made, or $6,380 in interest. That's 15.95% paid in interest over FIVE years, or less than 3.2% annually (I don't have an annualization calculator).
  

  
  Nobody needs to save an extra $600 a month. Who needs a second car; most people sell their current car when they buy a new one. If it depreciates 50% over five years and they then buy another $40,000 car, they'll just get another loan with an annualized interest rate of less than 3.2% for $20,000.
  

  
  5. There's nothing wrong with my numbers for the mortgage example either. A $300,000 loan at 6% over 30 years is about $1,800 a month. That's $648,000 in payments over 30 years, or $348,000 in interest payments. That's 116% in interest on $300,000 over 30 years, or less than 3.86% annually. With a 15-year loan, it's less than 3.45% annually.
  

  
  Actually, I just found a rate of return calculator online and that 30-year loan is only 2.6% annualized and compounded! Add the tax write-off on top of that.
  

  
  The tax deduction works too. 75% of 3.86% is 2.9%.
  

  
  Credit cards work too. If you make the minimum 2% monthly payment on a card with 9.99% APR, it takes you 65 mos. to pay it off; that's an annualized rate of 5.54%. With a sky-high Credit Card rate of 20%, that's an annualized rate of 12.88%.
  

  
  There is no reason to pay off personal debt, other than to make yourself feel good or increase your credit score, to be honest.
  

  
  If you had $40,000 to buy a car, you'd be much better off getting the loan and plunking the $40k down in the S&P 500. It has gotten an inflation-adjusted return of 7% annually over the past 80 years. That would give you $56,100 after 5 years, while you would only make $46,380 in payments.
  

  
  If you want to get even more accurate, let's throw inflation in the mix (3%). Historically, the S&P grows 10% annually if not adjusted for inflation. That would turn your $40,000 into $64,400 after five years. Subtract your $46,380 in loan payments, and you have $20,000 left over. If you want to adjust it back to present-day dollars, that gives you a return of $17,100.
  

  
  You may be asking yourself why any bank in the world would loan out money at such paltry rates. Well, they have a license to steal; they are loaning out money that doesn't exist. If the government allows me to loan out millions of dollars that don't exist, I'll take that low return; It's free money!

  Published: May 2, 2007 10:22 PM

• JIMB

  Nick - Assuming you're right, you still have a couple of things to explain: 1 - how more gov spending wouldn't be worse than the waste we have now (gov can do really bad things with more money), 2 - how carrying more and more principle over time wouldn't negate any benefit and make it worse. At 5.5% interest cost it would not take long before the 'benefit' is gone, and I suppose the orgy of gov new spending (and additional off-balance-sheet promises and entitlements) during that time would make the final adjustment far, far worse.

  Interest is paid on the outstanding balance. You are assuming that the balance stays steady over 5 years and 40K is left so you are dividing 6398 by 40000. But the balance declines over time, so you must divide each interest payment by the outstanding balance as it is each month and bring the sum to the present -- that is btw a yield of 6% -- that's why the loan is 6%.

  Your home mortgage example suffers from the same errors as well.

  You must save the principal of a new car in addition to paying the current debt minus any residual value in the 5 year old vehicle which I assumed at zero (for conservatism as you don't know if after 5yrs your car becomes irrepairable) before you can 'get out of debt'. The residual value of 5 year old cars most definitely is not 50%, it is perhaps 20% based on 15K mileage per year, which is pretty low mileage. Example: Taurus new today is 24K, 5Y good condition trade-in is 4800 which is 20%. The residuals of Toyotas are among the highest. A 5 Year old Camry (year 2001 compared to 2007 model price) is 5825 (compared to 19K+tax+other fees for new) which is 28%. I assume this understates the loss as I have not computed the 'real price' of the historic actual price paid for Camry's - I assume they've fallen in real price. Most people don't think this thru and end up borrowing for life...

  Depending when you bought, the S&P500 could have yielded zero, a negative amount, or a positive amount. In the recent case, the SP500 has yielded nothing over the past 5 years as dollar depreciation has negated the gains. Hedonic adjustments and substitution changes also have understated inflation for the past 10 years (computed on an old CPI basis, for example, inflation would be roughly 3% higher - in other words, if people eat dirt because meat is too expensive, the brilliant analysists in the gov say "dirt is free so there's a drop in costs of food" although steak is in fact more expensive).

  Over the last 80 years, the composition of the SP500 has completely changed, less than 5% of the original composition remains. Only recently have instruments been available for a person buying the SP500 'versus a car' been available (i.e. the buy the SP500 instead was factually impossible and likely a lot of the recent gains are from trading capability - a one-off event).

  If you have 40K to buy a car it would prove better if you bought a used car and invested the remaining in real estate in San Diego then sold in 2005 - if you want to talk 20-20 hindsight. Or perhaps simply bought MSFT 20 years ago.

  Banks have a cost of funds based on depositor yields and their cost of operations. No bank can make a spread on 1% (their ops cost is higher than 1%) even though they do create money.

  Published: May 3, 2007 8:21 AM

• JIMB

  Nick - One correction:

  "But the balance declines over time, so you must divide each interest payment by the outstanding balance as it is each month ** and that is the yield for that month. If you wish to calculate the total yield, you must discount each payment by an interest rate ** and bring the sum to the present ** so that the discounted sum is equal to the loan amount ** -- that is btw a yield of 6% -- that's why the loan is 6%.
  

  Published: May 3, 2007 11:25 AM

• Nick Bradley

  JIMB:
  

  
  "Interest is paid on the outstanding balance. You are assuming that the balance stays steady over 5 years and 40K is left so you are dividing 6398 by 40000. But the balance declines over time..."
  

  
  1. I understand how the bank calculates the 6% rate. But in reality, you're paying $6,400 in interest on a $40,000 loan. I understand that the bank gives you back some principle every month if its fully amortized. But to the consumer, it's 3.2% in interest per year.
  

  
  2. 50% in depreciation may have been a stretch. It's anywhere from 20% - 50%, with Honda Accords and Civics on the high end and SUVs on the low end. So let's use 25%: The car is worth $10,000 after five years. Throw in the $10,000 in gains (minus interest on the loan) off the $40k made from buying SPDRs (S&P tracking funds), and you only need a $20,000 loan to buy a brand new car.
  

  
  The same thing works for a home loan: $348,000 in interest payments over 30 years on a $300,000 loan; 116% in total interest. If you used the $300,000 in cash to buy SPDRs, your would have 2.8 million dollars from that investment over time.
  

  
  3. The composition of the S&P is irrelevant; it's quite easy to buy a tracking fund that buys everything in the S&P. Pretty simple.

  Published: May 3, 2007 11:45 AM

• JIMB

  Nick - To the consumer and to the lender, the interest rate is the same. The consumer pays the rate on the outstanding balance -- the rest is a reduction of the amount of the obligation. The consumer did not pay 6398 for a 40000 dollar loan, they paid 200 the first month for using 40000, then 197 the 2nd month for using 39428, etc. etc.

  To 'invest the borrowed funds in the SP500' is really bad advice. The obligation is fixed and the investment returns are variable. Worst case you could suddenly take a loss of 20% or 30% at the end of the loan period leaving you far underwater. Doing that type of structure over and over again is really foolish, unless you've the financial power to withstand the drawdown out of non-essential cash. In my view, over time, that behavior results in growing long-term obligations offset by shorter and shorter assets, especially if it is 'successful'.

  I think your best argument here, is if a person is in an inflation leveraged industry (so their income rises with inflation), that their assets and obligations should balance in maturity, so that they aren't hurt so badly by rising prices. It's a natural hedge.

  The comment on SP500 funds was to note they haven't been available until recently, so the 'data period' where SP500 rises faster than inflation (definitely not in the late 70s and 80s) also includes the same period where those funds did not exist. It's bad practice to use data from a period that factually excludes the possibility of doing what you say, as you are comparing two different markets.

  Published: May 3, 2007 4:59 PM