Numbers and Feelings

November 5, 2017

How do numbers feel to us? Numbers are hard like rocks. Feelings are squishy. Numbers are left-brained. Feelings are right-brained. Deep in the vaults of our brains, tiny elves translate one into another. Here’s an example.

This past week, House Republicans released an initial proposal of tax reform. A feature of the plan is the limitation of state and local tax deductions (SALT) to $10,000. Under current tax law, taxpayers have been able to deduct state and local taxes without limit.

This will hurt taxpayers in high-tax blue states which are overwhelmingly Democratic. Wisconsin, a purple state, is the lone exception among the top ten states (Forbes ranking of state tax burden).

Expecting no votes from Democrats in passing a tax reform/cut bill, Republicans included few provisions in the bill that would pacify voters in Blue Democratic states. Republican congresspersons in those states are faced with a dilemma. One Republican congressperson in New Jersey, one of the top high tax states, claimed that the average SALT deduction in his district was $21,000, more than double the allowance in the tax reform proposal.

Knowing that the SALT limitation will hurt their constituents, do Republican House members vote with their party or in the interests of their constituents? Numbers can make politicians anxious.

For some taxpayers in those states, the feeling is anger. “I don’t want to pay taxes on my taxes,” one New Jersey resident growled.

That same N.J. congressperson claimed that incomes less than $200,000 were middle-class. According to this calculator based on the Census Bureau’s Current Population Survey, an income of $200K is in the 97th percentile of all incomes. Less than 3% of households have incomes greater than $200K. Hardly middle-class.

What is middle class? Some studies use the 25th – 75th percentile. Some use the 30th – 80th percentile. Using the latter definition, 2016 incomes from $24,000 to $75,000 were considered middle-class. These classifications use national data. Many coastal states have far higher incomes and living costs.

People living in some east and west coastal states feel middle class even though the income numbers do not classify them as such. Take for example, a household in Silicon Valley, where the median household income is almost $100K,  $40K more than the national median. They are rich, right?

Not so fast. The median price of a home in Santa Clara County (San Jose) is almost $1.2 million (See here ). Spending $40,000 annually for housing on an income of $95,000 feels middle class. The percentage of housing cost to income, 42%, is far higher than the 30% HUD guideline, and is more typical of poor working-class families.

Californians have counties with the highest incomes in the U.S. – and some of the poorest. The state has a median household income that is 12% higher than the national average.


But that’s not how it feels. That extra income is eaten up by higher housing costs, high car insurance premiums, and higher taxes at all levels. California sends about 12% more taxes to Washington than it gets back in various national programs. The additional federal taxes paid by higher income coastal states helps pay for benefits to those in lower income states, particularly those in southern states. Blue states subsidize Red states.

The Red states control the national agenda in Washington. The Republican tax proposal in its current form takes tax pebbles from the Red scale and puts them on the Blue scale. That feels spiteful.  Voters in those Blue states feel angry.

Interest groups around the country feel angry. The National Association of Home Builders claims that the SALT limit will lower home valuations, particularly in coastal states. They have promised a considerable effort and expense to defeat this version of the tax proposal.

When I recalculated my family’s 2016 taxes using the new proposal, we saved $752, a bit less than the $1200 average savings for a family of four. The monthly tax savings – the numbers – are relatively small. I feel neither angry or joyful. Those of us who are little affected by the proposal are unlikely to raise our voices in protest or support.

Angry people act. They call, they shout, they organize.

Joyful people – the CEOs of large corporations who will benefit greatly from this proposal – are not shouting. They calmly make claims that lower taxes will create more jobs, although the evidence is rather weak. They are organizing. They are calling talk shows. But most of all they are donating.

Political donations can speak more loudly than the shouts of angry people. In the political game of Rock, Scissors, Paper, cash covers a rock thrown in anger. Angry people must take up the more precise and patient tool of the scissors if they hope to best cash in a contest.

Lastly, this tax proposal further divides earners into groups. Income earners above the median will learn that this $1 is not the same as that $1 to the taxman.  According to an analysis done for the Wall St. Journal,
The $1 earned in wages and salary will be taxed more than
The $1 earned by the small manufacturer, which will be taxed more than
The $1 earned by the real estate investor, which will be taxed more than
The $1 earned by a stock or bond investor, which will be taxed more than
The $1 paid to an inheritor, who will pay $0.

Republicans criticize the identity politics practiced by Democrats. With this tax proposal, Republicans have stamped identities on the very $$$$ we earn. Those numbers don’t feel good.



An Interest-ing Debt

February 12, 2017

Republicans used to talk about the country’s debt load but such talk is so inconvenient now that they control the House, Senate and Presidency. Perhaps it was never more than a political ploy, a rhetorical fencing. Now there is talk of tax cuts and more defense spending, and a $1 trillion dollar infrastructure spending bill. 48 states have submitted a list of over 900 “shovel-ready” projects.

House Speaker Paul Ryan used to be concerned about the country’s debt. Perhaps he has been reading that deficits don’t matter in Paul Krugman’s N.Y. Times op-ed column. For those of us burdened with common sense, debts of all kinds – even those of a strong sovereign government like the U.S. – do matter. The publicly held debt of the U.S. is now more than the country’s GDP.


In 2016, the Federal interest expense on the $20 trillion publicly held debt was $432 billion, an imputed interest rate of 2.1%. Central banks in the developed world have kept interest rates low, but even that artificially low amount represents 11% of total federal spending. (Treasury)  It represents almost all the money spent on Medicaid, and more than 6 times the cost of the food stamp program. (SNAP)

The latest projection from the CBO estimates that the interest expense will double in eight years, an annual increase of about 9%. The “cut spending” crowd in Washington will face off against the “raise taxes” faction at a time when a growing number of seniors are retiring and wanting the Social Security checks they have paid toward during their working years.

In the past twenty years the big shifts in federal spending as a percent of GDP are Social Security and the health care programs Medicare and Medicaid. These are not projections but historical data; a shift that the CBO anticipates will accelerate as the Boomer generation enters their senior years. Ten years ago, 6700 (see end of section)  people were reaching 65 each day. This year, over 9800 (originally 11,000, which is a projection for the year 2026) per day will cross that age threshold.

CBO Source

A graph of annual deficits and federal revenue shows the parallel paths that each take. The trend of the past two years is down, promising to accelerate the accumulation of debt.


More borrowing and higher interest expense each year will crowd out discretionary spending programs or force the scaling back of benefits under mandatory programs like Social Security, Medicare and Medicaid. President Trump can promise but it is up to Congress to do the hard shoveling.  They will have to bury the bodies of some special interests in order to get some reform done.

[And now for a bit of cheer.  Insert kitten video here.]

We already collect the 4th highest revenue in income taxes as a percent of GDP. Canada and Italy head the list at 14.5%.
South Africa 13.9%,
U.S. 12.0%,
Germany 11.3,
and France 10.9 all collect more than 10%. (WSJ) Those who already pay a high percentage in income taxes will lobby for a VAT tax to increase revenues. Income taxes are progressive and impact higher income households to a greater degree. Poorer households are more affected by a VAT tax.  Cue up more debate on what is a  “fair share.” Many European countries have a VAT tax and the list of exclusions to the tax are bitterly debated.

Adding even more social and financial pressure is the lower than projected returns earned by major pension funds like CALPERS. For decades, the funds assumed an 8% annual return to pay retirees benefits in the future. In the past ten years many have made 6% or less. Several years ago, CALPERS lowered the expected return to 7.5% and has recently announced that they will be gradually lowering that figure to 7%.

Each percentage point lower return equals more money that must be taken from state and local taxes and put into the pension fund to make up the difference. Afraid to call for higher taxes and lose their jobs, local politicians employ some creative accounting to avoid the expense of properly funding the pension obligations. In a 2010 report, Pew Charitable Trust analyzed the underfunding of many public pension funds like CALPERS and found a $1 trillion gap as of 2008. (Pew Report) The slow but steady recovery since then may have helped annual returns but the inevitable crisis is coming.

In December 2009, I first noted a Financial Times Future of Finance article which quoted Raymond Baer, chairman of Swiss private bank Julius Baer. He warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”
That warning is two years overdue. Sure hope he’s wrong but … here’s the global government debt clock. The total is approaching $70 trillion, $20 trillion of which belongs to the U.S.  We have less than 5% of the world’s population and almost 30% of the world’s government debt.  As Homer Simpson would exclaim, “Doh!”

Correction:  Posted figure for 10 years ago was originally 9000.  Current figure was originally posted at 11,000.  Projected for the year 2026 is 11,000.)


Market Valuation

Comments by President Trump indicating a “sooner than later” schedule for tax cuts helped lift the stock market by 1% for the week. The Shiller CAPE ratio currently stands at 28.7, just shy of the 30 reading on Black Tuesday 1929. (Graph) Since the average of this ratio is about 16, earnings have some catching up to do. Today’s reading is still a bargain compared to the 44 ratio at the height of the dot com boom. Still, the current ratio is the third highest valuation in the past century.

The Shiller Cyclically Adjusted Price Earnings (CAPE) ratio
1) averages the past ten years of inflation adjusted earnings, then
2) divides that figure into the current price of the SP500 to
3) get a P/E ratio that is a broader time sample than the conventional P/E ratio based on the last 12 months of earnings.

The prices of long-dated Treasury bonds usually move opposite to the SP500.  In the month after the election, stocks rose and bond prices went lower.  Since mid-December an ETF composite of long-dated Treasury bonds (TLT) has risen slightly.  A number of investors are wary of the expectations that underlie current stock valuations.

The casual investor might be tempted to chase those expectations.  The more prudent course is to stick with an allocation of various investments that manages the risk appropriate for one’s circumstances and goals.


Gimme More Government Limits

Many companies do not want limited government.  A smart company dumps as many costs as it can into the public sector, thereby increasing its profits.  WalMart is one such smart company, going so far as to provide their many low paid employees with literature on government social programs that will help the employee cope with the low wages WalMart pays.  Smart companies crusade local governments to upgrade their fire departments and the delivery pressures of their water systems in order to save the company money on its business insurance.  The cost is shifted and spread out to the public and the owners of companies in the upgraded area put the profits in their pocket. Smart established companies like regulations which establish a barrier to entry for their competition, particularly in businesses that have low capital requirements to start up.  Smart companies lobby local and state governments for more licensing laws which present one more cost and regulatory hurdle for small businesses trying to gain a competitive foothold in an industry.  Smart companies argue that licensing is needed for public safety.  Would you want an unlicensed fishing guide?  Of course not!  Here is a partial list of occupations requiring a state license in my state.

The IRS is now requiring most tax preparers to be licensed as a Registered Tax Return Preparer, which includes “competency tests for all paid tax return preparers except attorneys, certified public accountants (CPAs) and enrolled agents who are active and in good standing with their respective licensing agencies.” (IRS Source)  How many independent tax preparers who do tax returns for a few months a year will bother with the cost and time to establish and maintain their credentials?  Many low income workers, especially those with marginal reading skills, feel more comfortable having a tax preparer fill out the amount of their W-2s and do the relatively simple calculations required to file the short form 1040A.  The IRS could have exempted those preparing 1040As, but it didn’t.  Did the IRS enact these regulations in response to a law passed by Congress?  No.  Surely the IRS must have studied this problem for several years before issuing these new regulations?  The IRS spent all of six months before issuing these rules.  One can only wonder who and what prompted such a swift review and enactment of these regulations.  The logic is the oldest one in business:  reduce the supply of preparers and those that remain can charge higher fees.

I am not a tax preparer so I don’t have a dog in this fight.  I’m sure there are instances of tax preparers filing more complex tax returns which the preparer does not have the knowledge to prepare.  But why use an axe when a paring knife will do?  The only solution may be tax reform, the holy grail of simplicity and practicality that continually eludes our elected representatives.