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Solution to Sovereign Insolvency, Part 2

It is mathematically impossible to have income taxation without giving the ultra-wealthy a free ride.

VANCOUVER (TheStreet) -- In Part 1, I explained how our system of income taxation was a horrible mistake -- nothing more than an unfortunate accident of history. I introduced readers to the concept of a "wealth tax," and pointed out how that formed the basis of a much more equitable system of taxation, using an Islamic principle as an example.

Before I go on to explain the virtues of wealth taxation in detail, I will spend some time demonstrating why it is impossible to ever have "fair" income taxation. You will see that is impossible to have income taxation without giving the ultra-wealthy a free ride. More than that, I will demonstrate why no system of income taxation can be economically viable over the long term.

To do this requires nothing more than some simple, numerical examples. For this analysis, let's assume that everyone's assets (i.e., their wealth) appreciate at an identical rate: 10% per year. Note that very few of these assets actually become "more valuable." Instead, this rate of "appreciation" is, in my opinion, nothing more than the rate at which bankers are diluting our purchasing-power through their excessive money-printing. While this may be a high estimate of asset-appreciation at the moment, if the unprecedented money-printing of Western bankers continues, this will be a low estimate of future inflation.

Let's begin with a hypothetical individual who is very wealthy. The individual has $1 billion in net wealth, and one of the highest salaries on the planet: $10 million per year. Indeed, the average billionaire has a smaller annual salary than this (meaning this analysis will be a slight understatement of the under-taxation of billionaires).

The first point to note here is that with total wealth of $1 billion, even the huge $10 million salary of this individual only amounts to 1% of this person's wealth -- an insignificant amount. Meanwhile, the wealth of this individual increases by $100 million a year, just through the appreciation of assets (10 times the amount of incremental wealth generated from income). In other words, even if this individual was taxed (on income) at a 100% rate, his increase in net wealth would only decline by 10%.

Now let's take an average person, who has an annual salary of $50,000 and net wealth of $500,000 (an above-average level of wealth for people in this income bracket). The first point to note is that this person's income is equal to 10% of his or her total wealth. Put another way, income is 10 times as important to this individual -- meaning that taxing income has 10 times the impact on this individual. Equally important, this person's wealth increases incrementally by $50,000 per year, identical to the increased wealth from income.

What this means is that if we were to tax this average person at 100% on his income, we would reduce his incremental wealth by 50%, five times the impact of that rate of taxation on a very wealthy individual. We would have to reduce this individual's tax rate to less than 20% in order for such taxation to have an equivalent wealth-effect on these two individuals.

Now let's take an equally common example: a person in a low-wage, service sector job that pays $30,000 per year. We'll assume (for purposes of this example) that this individual has net assets totaling $100,000 (again, this estimate is on the "high" side). For this individual, annual income represents 30% of his total wealth, or 30 times the level of the billionaire with the $10 million salary, and every dollar of income tax paid by the low-wage earner has 30 times the impact on this individual (if taxed at 100%).

With little in the way of assets, his wealth only appreciates by $10,000 per year. Thus, if we were to tax 100% of this person's wages, we would reduce his increase in wealth not by a mere 10% (like the billionaire) but by 75%. Of greater relevance, the appreciation of assets only represents 25% of this person's increase in wealth, compared to 90% for the billionaire.

In short, in an income taxation system, even a 100% tax-rate has only a trivial impact on the very wealthy, while tax-rates far below that level have a very punitive impact on the average person. And in absolute terms, if we taxed the $30,000 a year worker at 0%, his total wealth would only increase by $40,000 a year, while if the billionaire was taxed at 100% (on his income) that person's wealth would still increase by $100 million per year.

Simply, it is mathematically impossible to have income taxation without giving the ultra-wealthy a "free ride" -- and concentrating more and more wealth, in fewer and fewer hands, every year.

Worse still, as I pointed out in Part 1, there is nothing more detrimental to an economy (as a whole) than allowing most of a society's wealth to be concentrated amongst a tiny portion of the population. Thus, income taxation is not only a system that inevitably and unjustifiably makes the obscenely wealthy even more obscene, but it also steadily weakens our economies in the process.

This concept can be illustrated by the chart above, which shows how incomes in the U.S. became horribly concentrated among the ultra-wealthy -- and then came the Great Depression. Looking ahead to today, we see that (once again) incomes have become shamefully skewed in favor of the wealthy, and (once again) we are faced with the imminent threat of "Greater Depression."

Note that while wealth was horribly concentrated 80 years ago, it was much less concentrated than it is today. Following eight (more) decades of income taxation funneling all of our societies' wealth into the pockets of the top-1%, average individuals are far less able to cope with the coming "Greater Depression" than they were the first time around.

Compounding this economic catastrophe, our governments, themselves, have become indebted to the point of obvious insolvency (in the case of the U.S.) or near-insolvency (in the case of most other Western economies). In other words, while our "leaders" were busy destroying all of our "economies" (on an individual basis), they have been equally busy destroying our overall economies.

With ordinary individuals taxed-to-the-max, while our economies are drowning in debt, clueless commentators do nothing but yammer on and on about the "inefficiency of government." Clearly, what is monstrously "inefficient" is our taxation system.

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Certainly there is "bureaucratic waste" in government -- the same inefficiencies that we can find in every one of the corporate behemoths that have been allowed to grow into such unhealthy, unwieldy conglomerates. Strangely, not one of the critics of "big government" express the same animosity toward "big business."

What should be crystal-clear following my analysis is cause and effect. With a taxation system that automatically cripples its own tax-base (by funneling ever-increasing hoards of


wealth into the hands of the ultra-wealthy), our current fiscal nightmares became inevitable the day we adopted the systems of income taxation.

After more than a century of the

worst, possible taxation system

, we have been left with the following parameters:

1. Our governments are drowning in debts, and cannot avoid sovereign debt-defaults without finding large, new streams of revenues.

2. After being "squeezed" by our own governments for decades, the average citizen cannot possibly contribute one, extra penny in taxes.

3. After more than 100 years of getting a "free ride" from our tax systems, the ultra-wealthy have amassed gigantic hoards of wealth that would be the envy of any "king" of the Middle Ages, or even the most despotic, Third-World tyrant.

Clearly, there is only one possible way to restore solvency to our governments (and economies). In Part III, I will explain how governments can claw back the illegitimate fortunes of the ultra-wealthy -- in both a fair and equitable manner.

--Written by Jeff Nielson in Vancouver, British Columbia.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.