Minority Control

October 13, 2019

by Steve Stofka

On September 15, 2008 the trading firm Lehman Brothers declared bankruptcy. A small number of outstanding shares traded on the stock market that day. The SP500 lost almost 5% of its value. New Yorkers gathered in Times Square to watch the ticker tape display. A small number of people controlled the direction of the market and constructed a reality that they sold to the rest of us.

In politics, a few key people control the direction and fate of legislation. In the Senate, the Majority Leader decides whether to bring legislation up for a vote. Even if a bill makes it out of a Senate committee, the Majority Leader can stop it from reaching the full Senate.  Unlike the Majority Leader in the House, his position is practically impregnable. Legislation vetoed by the President can be overridden by Congress. There is no recourse to a veto by the Senate Majority Leader.

The current holder of the position is Sen. Mitch McConnell from Kentucky. He is up again for re-election next year. When Democrats held the Senate, Sen. Harry Reid ruled with a similar disregard for others in his own party as well as the minority.

In 2014, 800,000 voters chose McConnell. In effect, less than 1% of the country’s voters control the course of legislation in the U.S. Did the founders of this country intend that one person should control Congress? James Madison, the chief crafter of the Constitution, worried that a majority would overwhelm and take advantage of a minority (Feldman, 2017). Accordingly, the Constitution is structured so that a minority controls power. However, one person is a very small minority. What would the founders think of the current arrangement in Congress? If Americans wanted a king with veto-proof power, America would still be a colony of Britain.

Our method of electing a President is a 230-year-old compromise between republicanism and democracy. An electoral college composed of men not subject to the passions of the crowd would elect the leader of the country. It was an Enlightenment model of dispassionate rationality.

Even if they had Fox News and CNN on Election night at the time of the founding, all the thirteen states were in the same Eastern time zone. At a recent symposium on our election, former RNC chair Michael Steele pointed out the west coast states are mostly taken out of the Presidential election (C-Span.org, 2019). By 5 P.M. Pacific time, they are discouraged from voting because much of the action has already been called. The founders did not design a system for four time zones.

We have 50 states but the election for President takes place in eight to twelve battleground states. Most polling is done at the national level, not in the battleground states. Many polls do not accurately survey the sentiments of the critical minority of voters in the states that will decide the election.

A minority of people own and control much of the wealth of the world. They now pay a lower percentage of their income than the bottom 50%. That includes federal, state and local taxes. In the Triumph of Injustice, due to be released next week, authors Saez and Zucman (2019) tally up the tax bills for the rich and ultra-rich. The book is #1 bestseller at Amazon and it hasn’t been published yet.

In 1980, the top 1% paid 47% of their income in total taxes at all levels. Now they are down to 23% and below the rate paid by the bottom half of incomes. Two sets of rules – one set for the peasants and one for the castle royalty. The Constitution prohibits the granting of titles so the rich granted themselves the titles. This book is sure to get a lot of media attention. Like we need more controversy.

Notes:

Feldman, N. (2017). Three Lives of James Madison: genius, partisan, president. [Print]. New York: Random House.

C-Span.org. (2019, October 7). National Popular Vote Election, Part 2. [Video]. Retrieved from https://www.c-span.org/video/?464997-2/national-popular-vote-election-part-2

Saez, E. & Zucman, G. (2019) Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay. [Print]. Available for pre-order at https://www.amazon.com/Triumph-Injustice-Rich-Dodge-Taxes/dp/1324002727

Effective tax rates: If you make $100,000 and you pay $25,000 in federal, social security, state, sales and property tax, then your total effective tax rate is 25%.

Photo: WyrdLight.com [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0)%5D Page URL: https://commons.wikimedia.org/wiki/File:Bodiam-castle-10My8-1197.jpg

Unauthorized Tax Revenue

September 1, 2019

by Steve Stofka

This might be a sensitive subject for some – the amount of taxes that unauthorized immigrants pay. Homeland Security uses the term “unauthorized” (Note #1). Some people prefer the adjective “undocumented” but many immigrants have adequate documentation. Some prefer to use the adjective “illegal” but the only illegal act is being in the country without proper authorization. If someone is speeding but is obeying all other traffic laws, are they an illegal driver? In most cases, they are a legal driver committing an illegal act.

 Those who defend immigrants point out that they pay taxes, so they are contributing to our society. I was curious as to how much because I have not heard an immigrant advocate offer any data. I told my trusty hunting dog, Google, to go find them facts and bring them on back to me.

First the big picture. The total Federal, State and local taxes paid in 2016 was $5,300 billion, or $5.3 trillion (Note #3). What was the share that unauthorized immigrants paid? The Institute on Taxation and Tax Policy recently estimated that they paid almost $12 billion dollars in state and local taxes. The IRS says they paid $9 billion in payroll taxes (FICA) and almost $1 billion in income taxes (Note #4). The total is $22 billion.

How do they report? They get Federal ID numbers called ITINs. To encourage compliance with our tax laws, the IRS says they do not share this information with the immigration and naturalization folks in Homeland Security. I was amazed that unauthorized immigrants would file tax returns. They are not eligible for social security benefits or earned income credits available to low income families. They are not eligible for TANF – what most people call welfare. The only benefits they are entitled to are those directed toward children – free public education and school meals, child medical care and SNAP (food stamps).

So why file? If you follow that IRS link, you’ll find that an unauthorized immigrant who shows “good moral behavior” may have their deportation proceedings waived or be eligible to apply for citizenship after ten years of residence. What is one sign of good moral behavior? Paying taxes. What is a sign of bad moral behavior and might get someone deported? Not paying taxes. Good incentive to pay taxes.

Homeland Security estimated 12 million unauthorized immigrants in 2015. In the aftermath of the financial crisis, unauthorized immigration grew by a small 70,000 per year (Note #5). In the 2000s, the influx was almost 500,000 per year, and that was a decline from the record 1.4 million apprehended at the southern border in 2000. In 2019, the number of border apprehensions will approach one million (Note #6).

Numbers like these cause Americans to disagree strongly about policy choices related to immigration. In the 1980s, in the late 1990s and again in the 2000s, the numbers were high and we argued. This time is no different. These numbers don’t include visa overstays which make up 40 – 50% of the unauthorized immigrant population (Note #7). Let’s guesstimate the population at 15 million, about 4.6% of the population. That 4.6% is paying less than 1/2% of total taxes.

We can go look at unauthorized immigrants and say that they are leveraging their taxes – paying a small amount of tax to receive proportionately more in benefit. But that is the case for all low-income people, unauthorized or not. Low-income people buy less stuff, so they pay less in sales tax. They live in lower-valued properties, so they pay less property tax. They make less money, so they pay less income tax. Those are the three primary sources of tax revenue in the U.S.

When President Trump said he wanted higher quality immigrants, he meant that he is not anti-immigrant. He is anti-poor-immigrant. Like Trump, some say we don’t need more poor people; we already have too many poor people.  Some people anticipate that their taxes will go up to provide benefits for the growing number of poor people, documented or not. Few want higher taxes to pay for services to people who just arrived in the country.

When my grandfather came to this country more than a 100 years ago, there was no income tax, no social security tax and property taxes were relatively low. The only benefit for immigrant families was public education. There were no school lunches, no food stamps, no medical care for children. Despite that, anti-immigrant sentiment was strong enough to pass a bill in 1924 that cut off legal immigration for all except northern Europeans. Our grandparents and great-grandparents were far less tolerant of immigrants than we are today.

Let’s keep some perspective. People who are concerned that they will have to pay higher taxes for benefits are not evil or uncaring. Low-income people who are worried about competition for their jobs in the construction industry are not moral slugs. Whatever your occupation, imagine that the number of people available to do that kind of work doubled in your community. How would you feel? The more the merrier? Probably not. Those workers will compete for your job and that competition will hamper any future salary increases you can expect.

We all need to admit that immigration presents complicated moral, political and economic choices. History has taught us that we don’t know how to solve this problem in a way that satisfies most of us. Each time we have to choose which side of the rope tug we are on. Each side hurls insults and curses at the other side. This is not the new normal. This is the old normal. How about if we try the new normal, sit down and hash out the difficult details of a compromise?

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Notes:

  1. Homeland Security uses “unauthorized” to refer to those in the country without proper authorization
  2. Tax Policy Center calculation of total taxes paid to governments at all levels  
  3. Estimate of taxes paid by unauthorized immigrants – PDF
  4. IRS data on payroll and income tax paid by unauthorized immigrants- PDF
  5. Estimate of unauthorized immigrants – PDF
  6. Apprehensions at the border – CBP
  7. Visa overstays – Potitifact

The Homeowners’ Association

August 18, 2019

by Steve Stofka

Two quick asides before I get into this week’s topic. A cricket perched on the top of a 7′ fence. It drew up to the edge of the top rail, learned forward, raised its rear legs as though to jump, then settled back. It did this twice more before jumping 8′ out then down into a soft landing on some ground cover. How far can crickets see, how often do they injure a leg if they land incorrectly and do they get afraid?

The bulk of the personal savings in this country is held by the top 20% of incomes, and it is this income group that received the lion’s share of the 2017 tax cuts. It’s OK to bash the rich but that top 20% probably includes our doctor and dentist. Before you start drilling or cutting me, I want to make it perfectly clear that I was not criticizing you, Doc.

In 2016, the top quintile – the top 20% – earned 2/3rds of the interest and dividend income (Note #1). Due to falling interest rates over the past three decades, real interest and dividend income has not changed. Real capital has doubled and yes, much of it went to those at the top, but the income from that capital has not changed. That is a huge cost – a hidden tax that gets little press. The real value of the public debt of the Federal Government has quadrupled since 1990, but it pays only 20% more in real interest than it did in 1990 (Note #2). Here’s a graph of personal interest and dividend income adjusted to constant 2012 dollars. Thirty years of flat.

Ok, now on to a story. Economists build mathematical models of an economy. I wanted to construct a story that builds an economy that gradually grows in complexity and maybe it would help clarify the relationships of money, institutions and people.

Let’s imagine a group of people who move into an isolated mining town abandoned several years earlier. The houses and infrastructure need some repairs but are serviceable and the community will be self-sufficient for now. The homeowners form an association to coordinate common needs.

The association needs to hire lawn, maintenance and bookkeeping services, and security guards to police the area and keep the owners safe.  How does the association pay for the services?  They assess each homeowner a monthly fee based on the size of the home. How do the homeowners pay the monthly fee?  Each homeowner does some of the services needed. Some clean out the gutters, others fix the plumbing, some keep the books and some patrol the area at night. They work off the monthly fee.

How do they keep track of how much each homeowner has worked? The association keeps a ledger that records each owner’s fee and the amount worked off. The residents sometimes trade among themselves, but it is rare because barter requires a coincidence of wants, as economists call it. Mary, an owner, needs some wood for a project and Jack has some extra wood. They could trade but Mary doesn’t have anything that Jack wants. He tells Mary to go down to the association office and take some of her time worked off her ledger and credit it to Jack’s monthly fee. Mary does this and they are both happy (Note #3).

As other owners learn of this idea and start trading work credits, the association realizes it needs a new system. It prints little pieces of paper as a substitute for work credits and hands them out to owners who perform services for the association. These pieces of paper are called Money (Note #4).

The money represents the association’s accounts receivable, the fees owed and accruing to the association, and the pay that the association owes the owners for the work they have done. Then the association notices that there are some owners who are not doing as well as others. It assesses an extra fee each month from those with larger homes and gives that money to needy homeowners.  These are called transfers because the owners who receive the money do not trade any real goods or services to the association. In this case the association acts as a broker between two people. Let’s call these passive transfers. We can lump these transfers together with exchanges of goods and services.

Then some people from outside the area start stealing stuff from the homeowners. The association needs to hire more security guards, but homeowners don’t want to pay a special one-time assessment to pay for the extra guards.

Instead of printing more Money, the association prints pieces of paper called Debt. Homeowners who have saved some of their money can trade it in for Debt and the association will pay them interest. Homeowners like that idea because Money earns no interest and Debt does. The association uses the Money to pay for the extra security guards.

But there are not enough people who want to trade in their Money for Debt, so the association prints more Money to pay the extra security guards.

Let’s pause our story here to reflect on what the words inflation and deflation mean. Inflation is an increase in overall prices in an economy; deflation is a decrease (Note #5). Inflation occurs when the supply of money fuels a demand for goods and services that is greater than the supply of goods and services. Ok, back to our story.

So far so good. All the Money that the association has printed equals a trade or a passive transfer. Let’s say that the association needs more security guards and no one else wants to work as a security guard because they can make more Money doing jobs for other homeowners. The association makes a rule called a Draft. Homeowners of a certain age and sex who do not want to work as security guards will be locked up in the storage room of the community center.

Now there’s a problem. Because the association has taken some homeowners out of the customary work force, those people are not available for doing jobs for other homeowners, who must pay more to contract services. This is one of several paths that leads to inflation. To combat that, the association sets price controls and limits the goods that homeowners can purchase. After a while, the outsiders are driven off and the size of the security force returns to its former levels.

Now all the extra Money that the association printed to pay for the security force has to be destroyed. As homeowners pay their dues, the association retires some of the money and shrinks the Money supply. However, there is a time lag, and prices rise sharply (Note #6).

Over the ensuing decades, there are other emergencies – flooding after several days of rain, a sinkhole that formed under one of the roadways, and a sewer system that needed to be dug up and replaced. The association printed more Debt to cover some of the costs, but it had to print more Money to pay for the balance of repairs. Because the rise in the supply of Money was a trade for goods and services, inflation remained tame.

There didn’t seem to be any negatives to printing more Money, so the homeowners passed a resolution requiring that the association print and pay Money to homeowners who were down on their luck. These were active transfers – payments to homeowners without a trade in goods and services and without some offsetting payment by the other homeowners.

So far in our story we have several elements that correspond with the real world: currency, taxes, social insurance, the creation of money and debt and the need to pay for defense and catastrophic events. Let’s continue the story.

With the newly printed Money, those poorer homeowners could now buy more goods and services. The increased demand caused prices to rise and all the homeowners began to complain. Realizing their mistake, they voted on an austerity program of higher homeowner fees and lower active transfers to poorer homeowners.

Because homeowners had to pay higher fees, they didn’t have enough extra Money to hire other services. Some residents approached the association and offered to repair fences and other maintenance jobs, but the association said no; it was on an austerity program and cutting expenses. Some residents simply couldn’t pay their fees and the problem grew. The association now found that it received less Money than before the higher fees and Austerity program. It cut expenses even more, but this only aggravated the problem.

Finally, the association ended their Austerity program. They printed more Money and hired homeowners to make repairs. Several homeowners came up with a different idea. There is another housing development called the Forners a few miles away. They are poorer and produce some goods for a lower price. The homeowners can buy stuff from the Forners and save money. There are three advantages to this program:

  1. Things bought from the Forners are cheaper.
  2. Because the homeowners will not be using local resources, there will be less upward pressure on prices.
  3. The homeowners will pay the association for the goods bought from the Forners and the association will pay the Forners community with Debt, not Money. Since it is the creation of Money that led to higher prices, this arrangement will help keep inflation stable.

As the homeowners buy more and more stuff from the Forners, the money supply remains stable or decreases. After several years, homeowners are buying too much stuff from the Forners and there is less work available in the community. As homeowners cannot find work, they again fall behind in paying their monthly fees.

Several of those in the association realize that they don’t have enough Money to go around in the community. There is a lot to do, and the homeowners draw up a wish list: repairs to the roads and helping older homeowners with shopping or repairs around their home are suggested first. A person who is out of work offers to lead tours and explain the biology of trees for schoolchildren. The common lot near the clubhouse could use some flowers, another homeowner suggests. I could use a babysitter more often, one suggests, and everyone nods in agreement. I could teach a personal finance class, a homeowner offers. Another offers to read to homeowners with bad eyesight and be a walking companion to those who want to get more exercise.

Everyone who contributes to the welfare of the community gets paid with Money that is created by the association. What should we call the program? One person suggests “The Paid Volunteer Program,” and some people like that. Another suggests, “The Job Guarantee Program” and everyone likes that name so that’s what they called it (Note #7).

So far in this story we have two key elements of an organized society:

  1. Money – a paper currency created by the homeowner association.
  2. Debt – the amount the association owes to homeowners (domestic) and the Forners (international).

Next week I hope to continue this story with a transition to a digital currency, banks and loans.

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Notes:

  1. In 2016, the top 20% of incomes with more than $200K in income, earned more than 2/3rds of the total interest and dividends. IRS data, Table 1.4
  2. In 2018 dollars, the publicly held debt of the Federal government was $4 trillion in 1990, and $16 trillion now. In 2018 dollars, interest expense was $500B in 1990, and is $600B now.
  3. In David Graeber’s Debt: The First 5000 Years, there is no record of any early societies that had a barter system. They had a ledger or money system from the start.
  4. In the Wealth of Nations, Adam Smith – the “father” of economics – defined money as that which has no other value than to be exchanged for a good. This essential characteristic makes money unique and differentiates paper money from other mediums of exchange like gold and silver.
  5. An easy memory trick to distinguish inflation from deflation. INflation  = Increase in prices. DEflation = DEcrease.
  6. The account of the increased force of security guards – and its effect on prices and regulations – is the simple story of money and inflation during WW2 and the years immediately following. The process of rebalancing the money supply by the central bank is difficult. Monetary policy during the 1950s was a chief contributor to four recessions in less than 15 years following the war.
  7. A Job Guarantee program is a key aspect of Modern Monetary Theory.

View From The Top

July 21, 2019

by Steve Stofka

Several Democratic Presidential contenders have painted a target on the top 1%, claiming that they have not paid their fair share of taxes. After the 1986 Tax Reform Act, those in the top 1% paid 26% of their income in taxes. Thirty years later and they paid the same percentage, even though their incomes had grown 50% in real dollars, according to an analysis of IRS data from 2016 returns (Note #1).

Other high-income brackets have experienced modest income gains and small increases in their average tax rates. In 1987, the top 10% of incomes paid 20%. In 2016, they paid 21%.

The average tax rates of the top 25% of incomes has increased from 16.5% to 18.5% in thirty years. As a group, the effective tax rate of the top half of incomes has increased from 14.6% of income in 1987 to 15.6% in 2016. While the top half has gone up a percent or two in the past three decades, the bottom half of incomes have paid a decreasing share of their income – falling from 5% to 3.7%.

The lesson? Changes in tax rates occur very slowly. A candidate who promises big changes quickly is facing formidable odds.

How much income does it take to get into the top half of incomes? Only $40K (Note #2). I was surprised how low the amount was and it hasn’t changed much in the past thirty years. In 1987, the income threshold to be in the top half of incomes was $17,768 – $38,500 in inflation adjusted dollars.

Want to be part of the upper class? All it took in 2016 was $81K, 9% more than it did in 1987, to be a part of the top 25%. How many workers making modestly good incomes in Los Angeles, San Francisco, New York City or Boston feel like they are upper class? After tax income is about $56K and rent in a middle-class neighborhood of L.A. can be 45% of that disposable income. That’s two paychecks toward rent. One paycheck for bills. One paycheck for food and miscellaneous. Ooops, just ran out of paychecks, didn’t you? Welcome to the upper class.

The threshold to get into the top 1% has increased a lot – from $302K to $480K in real dollars – a jump of more than 50%. Those are the people who are still paying the same percentage of their income in taxes. Their share of the total income pie has risen from 12% to 20% in thirty years (Note #3).

In the past thirty years, incomes have stretched upward by 50% for those at the tippy top. As a group their share of income taxes paid has kept pace with income growth, increasing from 24% to 37% of total personal income taxes collected (Note #4). The top 1% can say, “Yes, we are doing better, and we are paying proportionately more.” Can one of the Presidential contenders convince the Congress to get more out of that top 1%?

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Notes:

  1. At the top of the analysis is a link to the Tax Foundation’s summary tables. Table 8 of that summary shows effective tax rates of the various income brackets. Here’s a link to the summary tables themselves.
  2. Table 7 from the summary tables.
  3. Table 5.
  4. Table 6.

Tax Reform Winners and Losers

May 26, 2019

by Steve Stofka

Φ * π Σ (y-c) / (σ ỹ)

Did your head just explode? That’s how the tax code appears to many of us. This spring, many taxpayers sat down with their tax accountants and were informed that they were among the losers created by the tax reform act that went into effect for the 2018 tax year. Among the losers were employees who claim business expenses. In the western states, many in the construction trades may take a temporary job that is located a few hours from home. Instead of driving home every day, they share hotel rooms or live in campers during the work week and travel home on weekends to be with their family. Some employers pay per-diem expenses, but many smaller employers don’t. Under the old tax laws, an employee could deduct meals, lodging and ordinary living expenses away from home. Under the new law, employee business expenses are subject to a threshold that equals 2% of gross income (Note #1).

An employee with business expenses who has a family of four has discovered that they are the losers this tax filing season, the first one under the new tax law. Under the old law, that family of four used to get $12K standard deduction and $16K in personal exemptions. Now they get a $24K standard deduction and no personal exemption (Note #2). If they have employee business expenses that meet the threshold test, it may not be enough to exceed the new higher standard deduction. Some tax accountants report that their clients are shocked when they learn how much they owe in this first tax year under the new law.

In the future, some workers may be able to negotiate higher pay on these away jobs. Some will have to turn down such jobs.   

Corporate America was a big winner in the tax reform bill. In addition to lowered tax rates, low interest rates during the past decade have helped many publicly held companies buy back their own stock. The stock buybacks have accelerated this past year, with a record 25% of companies in the SP500 buying back their own stock, according to a Wall St. Journal analysis published this week. 

Don’t companies have a better use for the money? Apparently not. When companies buy back stock, they reduce the number of shares outstanding and increase the profit per share reported. In the first quarter of 2019, these buybacks lifted per-share profits by 4%. The share buybacks have distracted investors from the fact that corporate profits have flatlined since 2012.

Corporate profits flatlined during the Reagan administration in the 1980s. Investors bid up stocks on the promise that trickle-down policies and tax reform would break the cycle. Before profits did start to rise again, stock prices shook off their speculative pricing on Black Monday in October 1987. Let’s hope we don’t have a similar phenomenon this time.  

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Notes:

  1. Workplace expense deductions
  2. Tax law winners and losers.

Taxes – the Necessary Good

Taxes shall be levied according to ability to pay. – Franklin D. Roosevelt

August 19, 2018

by Steve Stofka

In the aggregate taxes are necessary and beneficial to everyone. Because Federal taxes act as a drain from the economic engine, they are different from state and local taxes. How those taxes are levied is a matter of policy debate, but they are necessary for the survival of a nation’s government and its economy. Revenue from natural resource production that is owned by a national government acts as a tax. Failing to understand that concept weakens and cracks governments around the world.

The inability to create money constrains state and local governments (Note #1). Taxes paid act as income for goods and services received from those governments. The Federal government has no such constraints. It does not need tax income as such. Rather, it must drain taxes to offset the amount of spending that it pumps into an economy. Inflation, the chief measure of extra money in an economy, rises when the Federal government doesn’t drain enough in taxes. As inflation rises, people turn to goods and service exchange that is not recorded and not taxed. The underground economy tries to offset the hidden tax of inflation.

As Venezuelans flee the runaway inflation in their country, they are running from too much spending and not enough taxation. Yes, it is counterintuitive. Venezuela owns the world’s largest reserve of oil. The net revenue from that oil competes with the taxes that a private oil company would pay to the government. The national government “owes” itself the tax revenues that it would have collected from a private company. Oil production has declined from 2.4 million barrels per day in 2008 to 1.2 million barrels in 2018 (see Note #2). Corruption and incompetence are the chief causes of the decline. Net oil revenue has declined by 95% from the bull market levels of the mid-2000s. Because the national government has not been paying their taxes, inflation has exploded the economy.

Because national politicians begin their careers in local politics, they regard a nationalized resource (NR) as a source of income, not an economic drain. That drain must be kept open through spending in oil infrastructure, training and transportation. In Venezuela, 2016 gross oil revenues were 20% of GDP and a net of less than 5% (see Note #3). Inflation taxes 100% of an economy. Because NR revenue acts as a pressure relief on inflation, that 20% portion of GDP affects 100% of the economy. A lack of understanding of the nature of a NR led to the crisis and decline of Great Britain in the 1970s, China in the 1960s and 1970s, and Zimbabwe in 2008.

How should a national government levy taxes on the taxpayers within the economy? FDR suggested “ability to pay.” For the past one hundred years we have measured ability to pay by income. Is that a good measure? French economist Thomas Piketty suggests that assets are a better measure. Local governments use this method to collect property taxes. Consider a retiree with $500K in liquid assets, who is taxed on $10K in interest and dividends earned each year. Clearly, the retiree’s assets are a better indication of his ability to pay. Should Congress abolish the income tax and tax people and corporations a multiple of what they pay in property taxes on their primary residence or business locations? Those living in high tax suburban and ex-urban areas might move toward lower-taxed urban areas. Would suburban areas actively recruit businesses to widen their tax base and lower property taxes? An intriguing thought.

Tax levies are the subject of endless debate because people cannot agree on what constitutes a fair tax. In the aggregate, the pressure reducing function of taxes benefits everyone, but is especially beneficial to those with less income. Should a national government impose a head tax on everyone? It could. That would amount to $15,000 per person this year, more than some families make. How does a national government extract tax money from its poor? It doesn’t. From 1958 – 1962, China forced taxes out of poor farmers in Mao’s Great Leap Forward (Note #4). Millions starved as a result.

Everyone should contribute equally to shared benefits, but practicality triumphs over principle. The survival of the national government becomes paramount. Some form of redistributive taxation must ensue. How to shape that redistribution? A government could take all the wealth of the ten richest people in America and still be short $3.8 trillion (Note #5). All the debate falls between total equality and total unfairness, and neither accomplishes the task of draining enough taxes out of the engine. A government could spend nothing: no defense, no research, no border or shore protection, no pension, medical or education spending. That’s a government in name only, and not for long. Other governments will want to capture control of that country’s resources.

The vast middle of the debate is an endless variety of proposals of “fairness” in both taxing and spending, a debate that has changed little since Cicero argued for his proposals in the Roman Senate in the first century B.C.E. What is not debatable is that a nation’s taxes must be roughly guided by its spending. A nation like Venezuela, which taxes half of what it spends, was headed for an economic tsunami of high inflation and inevitable collapse.

The debate is important. Just as it did in Rome two thousand years ago, consolidated party power corrupts. Because the current Presidency and House are held by the same party, we can expect a strong growth rate of net input, spending less taxes, and the data confirms the prediction. Net Federal input in the first full year of the Trump administration, April 2017 – March 2018, grew at a record-breaking annual pace of 19.6%, far above the sixty-year average of 8%. However – because Federal input has been so low this decade, the Federal government must continue this torrid pace of input in 2018 and 2019 just to reach the 8% average.

Republicans have held the House for the majority of the past three decades. Neither party agrees with the other party’s priorities, so the Republican strategy has been simple. They talk fiscal discipline and curtail Federal spending during Democratic administrations so that Republicans can spend big on their priorities when they have the Presidency. The Democrats did this for forty years when they held the House from 1954-1994 and will do so again when they have their next Congressional “run.”

To sum up: taxes are good, in general, but bad in the particular. No nation’s leader has stood on the world stage and said, “To tax or not to tax, that is the question.” For a nation and its economy, “to tax” is synonymous wtih “to be.”

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Notes:

1. Before the Civil War, each state controlled banking within its border (National Bank Act). For a deeper dive into state financing, try this Brookings Institute article.

2. A background paper on Venezuela oil (PDF). Crude oil production in the first quarter 2018 fell to 2.19 million barrels, a thirty-year low (Reuters). The Venezuela government spends more than 40% of GDP but collects only 20% in taxes (Statistica). During the 1997-2006 oil bull market, net revenues to the Venezuelan government averaged $20B per year (background paper above). Last year it was less than $1B. On August 20th, Venezuelans will lose their gasoline subsidies and pay a competitive price for gasoline (PDVSA article).

3. Gross oil revenue in 2016 was $48B, 20% of GDP of $236B (Reuters article). Exxon Mobil had a net profit of 6.5% in 2011. Venezuela would greatly benefit if the oil production was owned privately and paid 25-30% in income and other taxes.

4. Frank Dikotter was one of several historians afforded access to People’s Party records of the Great Leap Forward. He wrote an exhaustive account of human folly in Mao’s Great Famine .

5. Richest people in America  – Wikipedia 

Miscellaneous

Gold is down more than 10% in the past few months. BAR is a gold ETF launched in the past year. As an alternative to GDL and IAU, it has the lowest expense ratio at .2%. Here is a June 2018 article on the ETF.

Taxes – A Nation’s Tiller

Printing money is merely taxation in another form. – Peter Schiff

 

August 12, 2018

by Steve Stofka

The Federal government does not need taxes to fund its spending, so why does it impose them? Taxes act as a natural curb on the price pressures induced by Federal spending. Taxes can promote steady growth and allow the government to introduce more entropy into the economic system.

During World War 2, the Federal government ran deficits that were 25% of the entire economy (Note #1) and five times current deficit levels as a percent of the economy. Despite its monetary superpowers, the government imposes a wide range of taxes. Why?

Using the engine model I first introduced a few weeks ago (Note #2), taxes drain pressure from the economic system and act as a natural check on price inflation. During WW2, the government spent so much more than it taxed that it needed to impose wage and price controls to curb inflationary pressures. Does it matter how inflation is checked? Yes.

When price pressures are curbed by law, people turn to other currencies or barter. During WW2, the alternative was barter and do-it-yourself. Because neither of these is a recorded exchange of money, the government collected fewer taxes which further increased price pressure in the economic engine. After the war was over and price controls lifted, tax collections relieved the accumulated price pressures. As a percent of GDP, taxes collected were 50% more than current levels.

For the past fifty years, Federal tax collections have ranged from 10-12% of GDP, but they are not an isolated statistic. What matters is the difference between Federal spending and tax collections, or net Federal input. During the past two decades Federal input has become a growing share of GDP.

FedSpendLessTaxPctGDP

During the past sixty years, that net input has grown 8% per year. The growth rates have varied by decade but the strongest rates of input growth rates have occurred when the same party has held the Presidency and House. Neither party knows restraint. The lowest input growth has occurred when a Republican House restrains a Democratic President (Note #3).

FedNetInputGrowth

Let’s compare net Federal input to the growth of credit. As I wrote last week, the Federal government took a more dominant role in the economy in the late 1960s. By the year 2000, net Federal input grew at an annual rate of 10.3%, over one percent higher than credit growth. During all but six of those years, Democrats controlled the House and the purse. During those forty years, inequality grew.

FedNetInputCreditGrowth

During the 1990s and 2010s, government should have increased its net input to offset the lack of credit growth. To increase input, the government can increase spending, reduce taxes or a combination of both. When GDP growth is added to the chart, we can see why this decade’s GDP growth rate has been the lowest of the past six decades. It’s not rocket science; the inputs have been low.

FedNetInputCreditGrowthGDPGrowth

A universe with maximum entropy is a still universe because all the energy is uniformly distributed. At a minimum entropy, the universe exploded in the Big Bang. Too much clumping of money energy provokes rebellion. Too little clumping hampers investment and interest and condemns a nation to poverty. As an act of self-preservation, a government adopts redistributive tax policies. Among the developed nations, the U.S. is second only to France in the percent of disposable income it redistributes to its people (Note #4).

A nation can either tax its citizens directly, or add so much net input that it provokes higher inflation, which taxes people indirectly through the loss of purchasing power. Of the two alternatives, the former is the more desirable. In a democracy we can vote for those who spend our tax dollars. Inflation is both a tax and an unmanaged redistribution of money from the poor to the rich. How so? Credit is money. Higher inflation rates lead to higher interest rates which reduce access to credit for lower income households, and give households with greater assets a higher return on their savings.

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Notes:
1. Federal Income and Outlays at the Office Management and Budget, Historical Tables

2. The “engine” was first introduced in Hunt For Inflation, and continued in Hunt, Part 2 , Engine Flow , and Washington’s Role.

3. Federal spending less tax collections grew at a negative annual rate during the Clinton and Obama administrations. Both had to negotiate with a hostile Republican House in the last six years of their administrations.

4. “U.S. transfer payments constitute 28.5% of Americans’ disposable income—almost double the 15% reported by the Census Bureau. That’s a bigger share than in all large developed countries other than France, which redistributes 33.1% of its disposable income.” (WSJ – Paywall) The OECD’s computation of the GINI coefficient is based on disposable personal income, which is calculated differently in the U.S.

Miscellaneous:

Average GDP growth for the past sixty years has been 3.0%. The average inflation rate has been 3.3%. The 60-year median is 2.6%. The average inflation rate of the past two decades have been only 2.1%.

A good recap of the after effects of the financial crisis.

 

Sacred Cow

October 22, 2017

Moo. One of the sacred cows of tax law has been the mortgage interest deduction. There is talk that the proposed Tax Reform law will erase this deduction. Who benefits from the deduction? Before I look at that, here’s some groundwork.

Two months ago the IRS released aggregated income tax data for 2015. Pew Research analyzed the data and produced this  chart of who pays how much in individual income taxes.   I took the liberty of marking up  their chart.

TaxAnalysis2015Pew

The Tax Reform bill that is being tortured to death in the back rooms of Congress proposes to double the standard deduction, making the first $50K that a couple earns tax-free. About 50% of tax returns will pay little or no federal income tax. That leaves the other half to pick up the tab for the 5% of taxes paid by the lower half of incomes. 1% of tax returns paid 40% of taxes in 2015 and they will argue that they are already paying their fair share.

As the Congress tries to craft a Tax Reform bill, one of the hot button topics is the mortgage interest deduction. According to IRS analysis of 2015 tax data, 33 million returns, about 20% of total returns, took the mortgage interest deduction totaling $304 billion, averaging over $9000, or $770 a month. The annual cost to the Treasury is about $70 billion in taxes not paid.

The bulk of this tax giveaway goes to wealthy families, but the program is popular among middle class families in expensive housing markets, particularly on the east and west coasts. The Tax Reform package proposes to double the standard deduction.  For many married couples, this would exclude another $25K of their income. This $25K is far more than the $9K average mortgage interest deduction.  However, there will be about 8 million returns, mostly wealthier Americans, who will pay more.  Those 8 million will certainly raise a campaign of alarm and outrage as they try to convince the vast majority of Americans that this reform is so un-American. Those in the real estate sector will claim that this will cripple a recovering homebuilding sector and prevent many American families from owning a home.  It won’t.  Each sector of the economy wants to preserve their tax carve outs because their business model has come to depend on it.

Notice that the analysis included effective, not marginal, tax rates. What is the difference? The effective rate is the net tax divided by adjusted gross income. It is the average tax paid for all the income received. For those who use tax preparation software, the program calculates the effective rate and prints it out on the summary page.

The marginal rate is the highest tax rate paid on the last dollar. When we hear someone complain that they are in the 33% tax bracket, for example, we think that the person pays 33% on all their income. They don’t. A two-earner family making $130K, filing jointly, two deductions, would be in the 25% bracket in 2017, but their effective tax rate is 12.89%, almost half of the marginal rate. (Dinky Town calculator)

Why is this important? Let’s return to the difference between effective and marginal tax rates. Let’s say our hypothetical couple making $130K wants to buy a new house for $300K. After $60K down, they will pay about $7800 per year in interest for the first 20 years of a 30-year mortgage (Zillow mortgage calculator). What they tell themselves is that they are “saving” over $160 per month, almost $2000 per year, because they are in the 25% tax bracket.

What is the fallacy? The couple assumes that the first dollars they earn buy the groceries, buy clothes for the kids, or make the car payment. It’s the last money earned, the money that is taxed at a 25% rate, that they will use to pay the mortgage. It’s sounds silly, but it’s effectively what we do when we use the marginal rate to analyze costs. Real estate salespeople sometimes use this technique to upsell a couple into a more expensive house, one that earns the salesperson a higher commission. If our couple uses the effective tax rate of less than 13%, the savings on that monthly mortgage payment is only $83. Many financial decisions are made “at the margin” but this is not one of them.

Also on the cutting board is a reduction in the amount of pre-tax contributions a person can make to a 401K retirement program.  Higher income earners would be trading in that tax break for lower tax rates, but the finance industry is sure to balk.  They make billions of dollars in administrative and trading fees for these retirement programs. In addition to the taxpayers who receive the benefits directly, tax breaks have protectors who benefit indirectly from the break. Together, this minority fights for their interests.

Soon after the last tax reform was passed in 1986, members of Congress began adding tax exclusions. Republicans may be able to pass a reform bill under a Budget Reconciliation rule in the Senate, which requires only a 50-vote threshold. Their slim majority in the Senate and a lack of cooperation from Democrats means that passage of a reform bill is vulnerable to just a few Republican defections. This is how health care repeal or reform was defeated earlier.  It can happen again.

Income Distributions

February 7th, 2016

Updates on January’s employment report and CWPI are at the end of this post.  Get out your snowboards ’cause we’re going to carve the political half-pipe! (*v*)
(X-Game enthusiasts can click here)

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To Be Rich or Not To Be Rich

Every year the IRS takes a statistical snapshot of the almost 150,000,000 (150M) personal tax returns it receives.  There are some interesting tidbits contained in these tables that will put the lie to many a politician’s claim in this election season.  The IRS lists the number of returns for each of some twenty income brackets.  They also list the exemptions claimed for each of these income brackets and let’s turn to that for some interesting insights.

From Table 1.4 we learn that there were 290M exemptions claimed in the 147M tax returns filed in 2013, or almost two exemptions per return.  In 1995 (Table 1, same link as above) the number of exemptions claimed was 237M for 118M returns, exactly two exemptions per return. Exemptions are people that need to be fed, clothed, and housed.

Census Bureau surveys (CPS) over the past few decades show that households are shrinking.  Conservatives assert that median household income has stagnated simply because there are fewer people and workers in households today compared to the past.  If this were true, IRS data would show a greater decrease in exemptions over an 18 year period. We can’t say that one or the other data source is “true,” but that averaging data from the two sources probably gives a more accurate composite of income trends in the data.  Census data probably overcounts households while the IRS undercounts them.  Conservatives who advocate less government support will ignore IRS data that conflicts with their beliefs.

30% of the exemptions were claimed by tax returns with adjusted gross incomes (AGI) of less than $25,000, or less than half the median household income. (AGI is earned income and does not include much of the income received from government social programs.)  Only 2M exemptions, or 2/3 of 1%, were claimed by tax returns with an AGI of $1M or more.  Out of 315 million people in the U.S., there are only two million “fat cats” with incomes above $1,000,000.

Presidential contender Bernie Sanders tells his supporters that he is going to tax the rich to help pay for his programs.  IRS data shows just how few there are to tax to generate money for ambitious social programs. Mr. Sanders says he will get money from the big corporations.  Corporations with lots of well paid lawyers are not going to give up their money peacefully.

Instead, Mr. Sanders’ plans will rely on taxing individuals who can not erect the legal or accounting barricades employed by big corporations.  11% of exemptions were claimed by those making more than $200,000, a larger pool of potential tax money. Doctors, lawyers and other professionals will “Feel the Bern.”  It is not unusual for a middle class married couple in a high cost of living city like New York or Los Angeles to make $200K.  Mr. Sanders has his sights on you.  You are now reclassified as rich.

Here is a well-sourced analysis of the net cost to families.  Most will save money.  Unfortunately, Mr. Sanders made the political mistake of admitting that he would raise taxes, but…  No one paid attention to the “but.”  Should he win the Democratic nomination, Mr. Sanders will “feel the Bern” as Republicans use the phrase against him.  He might have used a phrase like “my plan will lower mandatory payments” to describe the combined effect of higher income taxes and no healthcare insurance payments.

The author calculates that the top 4% will spend a net $21K in extra taxes less savings on health care premiums.  The author probably overstates the effect on those at the top because he uses an average instead of a median, but we could conservatively estimate an additional $10K for those with AGIs in the $200K-$300K range.

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Earned Income Tax Credit

The Earned Income Tax Credit (EITC) is  a reverse income tax for low income workers, who get a check from the federal goverment.  For the 2014 tax year, over 27 million returns received about $67 billion from the government for an average of $2400 per receipient (IRS).  In inflation adjusted dollars, this is up 50% from the 2000 average of $1600.  The number of receipients has expanded 50% as well, growing from 18 million to 27 million.  Although Democrats often tout their support for the poor, it is Republican congresses that are largely responsible for expanding this support for low income families.  Republicans may talk tough but are more than willing to reach out a helping hand to those who are giving it their best effort.  There is a practical political consideration as well.  An analysis of IRS data by the Brookings Institute found that, in the past fourteen years, the poor have shifted from urban areas largely controlled by Democrats to the outlying suburbs of metropolitan areas, where Republicans have more support. In short, Republicans are taking care of their voter base.

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Constant Weighted Purchasing Index (CWPI)

The manufacturing sector, about 15% of the economy, continues to contract slightly, according to the latest Purchasing Manager’s Survey from ISM.  The strong dollar and a slowdown in China have dragged exports down.   Extremely low oil prices have impacted the pricing component of the manufacturing survey, which has reached levels normally seen during a recession.

 

For some industries, like chemical products, the low oil prices have boosted their profit margins.  Most industries are reporting strong growth or at least staying busy.  Wood, food, beverage and tobacco manufacturers and producers report a sluggish start to the year, as reported to ISM.

The services sectors have weakened somewhat in the latest survey of Purchasing Managers, but are still growing, with a PMI index reading of 53.5.  Above 50 is growing; below 50 is contracting.  The weighted composite of the entire economy, the CWPI, is still growing strongly but the familiar up and down cycle of the recovery is changing.  Both exports and imports are contracting

The composite of employment and new orders in the non-manufacturing sectors has broken  below the 5 year trend.  It may turn back up again as it did in the winter of 2014, but it bears watching.

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Employment

Each month theBureau of Labor Statistics  (BLS) surveys thousands of businesses and government agencies to compute the number of private and public jobs gained or lost during the month.  The payroll processing firm ADP also tallies a change in private jobs based on paychecks generated from thousands of its client businesses.  If we subtract government jobs from the BLS total, we should get a total number of jobs that is close to what ADP tallies.  As we see in the graph below, that is the case.

Economists, policy makers and the media look at the monthly change in that total number of jobs.  This change is miniscule compared to the 121 million private jobs in the U.S.  A historical chart of that monthly change shows that BLS survey numbers are more volatile than ADP.

I find an averaging method reduces the monthly volatility.  I take the change in jobs as reported by the BLS, subtract the  change in government employment, average that result with the ADP report of jobs gained or lost, then add back in the BLS estimate of the change in government employment.  This method produces a resulting monthly change that proves more accurate in time, after the data is subsequently revised by the BLS.  Based on that methodology, jobs gains were close to 175K in January, not the 151K reported by the BLS or the 205K reported by ADP.

There was a lot to like in January’s survey.  The unemployment rate fell below 5%.  Average hourly earnings increased by 1/2%.  Manufacturing jobs added 29,000 jobs, the most since the summer of 2013.  This helped offset the far below average job gains in professional and business services.  Year-over-year growth in the core work force aged 25-54 increased further above 1%.

The bad, or not so good, news: job gains in the retail trade sector accounted for 1/3 of total job gains and were more than twice the past year’s average of retail jobs gained.  Considering that job growth in retail was near zero in December, this may turn out to be a survey glootch.  Food services were another big gainer this past month.  Neither of these sectors pays particularly well.  The jump in manufacturing jobs probably contributed the most to lift the average hourly wage.

The Labor Market Conditions Index (LMCI) is a cluster of twenty or so employment indicators compiled by the Federal Reserve.  December’s change in the monthly index was almost 3%.  In the forty year history of this index, there has NEVER been a recession when this index was positive.

We are innately poor at judging risk.  We derive indicators and other statistical tools to help us balance that innate human weakness with the strength of mathematical logic.  Still, people do not make money by NOT talking about recession.  NOT talking does not pay commissions, does not generate the buying of put options, expensive annuities, and other financial products designed to make money on the natural gut fears of investors.  Next week I’ll look at the price stability of our portfolios.

Re-pricing the Market

January 31, 2016

In the closing moments of one of the “big ape” films, the very large gorilla Mighty Joe Young saves the girl, placing her on a boat as an island in the Pacific, broken by a volcano, falls back into the sea.  The bandaged hand of the big ape reaching out of the roiling waters is the last we see of the movie’s star.

On Friday morning, the Bank of Japan (BOJ) surprised the world by cutting it’s funds rate to a negative .1% from a positive .1%, vowing to fight the deflation and lack of growth that has plagued the Japanese economy for two decades.  As the island’s economy collapses under the weight of its aging population and lack of immigration, the bank thrust its arm above the Pacific waters to save – well, the entire Japanese population.  Could be the script of another big ape movie or a Godzilla sequel.

The first estimate of fourth quarter GDP was released Friday morning and the news was not good, which meant that the news was good, get it?!  GDP growth for the last quarter was positive, not negative, but less than 1%, so traders figured that the Fed will not raise interest rates again in March.

#3 in the combination was positive earnings surprises from Microsoft and Facebook, among others. Thursday was the busiest day of the earnings season.  #4 The price of oil continued to climb above the near rock-bottom benchmark of $30.  All of these factors were the impetus for a stock market surge of 2-1/2% on Friday and helped soften a really bad start to the year.  For the month, the index fell 5%.  During the month, revisions to earnings estimates for 2016 fell about the same amount – 4.7% (Fact Set).  In short, the stock market re-priced itself.

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Taxes

As the primary season approaches and millions of Americans receive their W-2 earnings record in the mail, Americans turn their attention to the cheery subjects of incomes and income taxes.  Here’s a Heritage Foundation chart of the effective payroll tax rates and income tax rates for the five quintiles of Americans based on income.

Those in the lowest quintile making less than $25K pay a combined rate of 2.1%.  Those in the next quintile making less than about $47K pay a combined rate of 6.6%.  Those in the next higher quintile making less than $80K pay 12.2%.  The top two quintiles pay 14.7% and 21% respectively.  It is easy to understand why many in the upper quintiles feel that they are already paying their fair share of taxes.

The fault in these calculations is that they neglect the employer’s portion of the payroll tax which is paid indirectly by the employee in the form of a lower wage.  Including that portion would add another 7.5% to 8% to the lower quintiles, a bit less to the top two quintiles.  Here’s a chart showing the total payroll tax burden since the Social Security Act was passed in the 1930s.

Should the rich pay more in taxes?  Yes, says Democratic Presidential contender Bernie Sanders.  Many Americans do not realize that we are in the top 10% of global incomes, the world’s fat cats.  Should Americans pay a global fairness tax of 10% or so?  This money would then be redistributed to poorer people around the world.  That is the world that Mr. Sanders is aiming toward.

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Consumer Problem Survey

Over the past several thousand years people have developed numerous tools to predict the future.  Reading chicken bones, tea leaves and other forms of augery have given way to mathematical and statistical modeling.  The folks at Georgetown have developed a predictive tool to estimate consumer spending. Using a survey methodology researchers ask consumers what problems they have and which ones they are planning to solve in the coming months. These can be the payment of taxes, needing a new computer, iPad, or cell phone, the purchase of new home, etc.  Based on these responses, the researchers compile a Problem Driven Conumption Index (PDCI).  In the spring and early winter of 2014, the predictive index badly under-estimated retail sales.

However, the approach brings an essential understanding of the challenges American families face.  In a 2013 survey, respondents reported having many problems for which they see no solutions.  We learn that men and women have a few problems in common but confirm the axiom that each sex really does see the world differently.  The researchers are able to chart the shifting patterns of problems as we age.  This problems based approach is another statistical tool in the field of behavioral finance.