Windbags

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In WSJ article, 3/26/09 Rebecca Smith writes: “The electric-power industry accounts for nearly half of all water withdrawals in the U.S., with agricultural irrigation coming in a distant second at about 35%. Most of the water used by the utilities is returned to the rivers or ground water. In the arid western states, water supply has become an important factor in favor of alternative energy systems. Solar and wind energy require no water.”

Where is the largest wind farm in the world? Texas, of course, the land of the largest. If they installed a wind turbine in front of the speaker’s podium at the House Of Representatives, it would generate enough power to light up all of Washington!

Taxes

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What percentage of your income do you pay in taxes? At the beginning of March, I heard a working class person complain that Obama was “soaking the rich” at 35%. Presumably this person was complaining on principle. By another principle, that of self-interest, a working class person might also cheer that Obama is “soaking the rich.”

What is rich? For 2006, IRS data shows that the top 1% of tax returns had an AGI (Adjusted Gross Income) above $389K. I would say that the top 1% qualifies as rich. Yet, some rich people don’t feel rich.

In the 4/16/09 WSJ weekly “Currents” feature, Gary Fields spoke with several of the rich and near rich, those in the top 1 and 2% income tiers. The owner of a human-resources company in Silicon Valley, California and his wife make about $400K but feel like they are barely getting by. San Jose, CA mayor Chuck Reed calls a family making $250K in Silicon Valley “upper working class,” unable to afford a home in the area.

What did this top 1% pay in Federal income tax? Just under 23%. Wait a second.. what happened to the 35% rate? That is the marginal rate, not the average rate.

If someone is in the 35% tax bracket, that doesn’t mean they pay 35% on all of their income, only on the portion of income that is above the 35% bracket threshold. A person making a $500K salary still only pays 10% tax on the first $16K of that salary. In the 2008 tax year, if someone made $357,701 they paid 27% or $96,770 on the $357,700. They paid 35 cents on the extra dollar.

Warren Buffett once wryly remarked that he paid less in taxes as a percentage of his income than his secretary did. How do the top 1% cut their average tax rate? Many have a significant portion of their income in capital gains, which are taxed at 15%, the rate for middle class taxpayers earning less than $65K.

In a history of the capital gains tax, the Tax Policy Center reports that “The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) cut the top tax rate on long-term capital gains from 20 percent to 15 percent, the lowest level since World War II.” Obama’s budget proposes to restore the 20% tax rate on those families making more than $250K. For some historical perspective, this level is more favorable than the recommendations of a 1997 Congressional Joint Economic Committee Study.

There is an old saying: “The poor fight the wars, the rich pay for them.” Former President Bush, together with his party, had a novel idea on this centuries old maxim. Why not have the poor fight the wars in Iraq and Afghanistan and not have the rich pay for it? Instead, the U.S. would charge the war expense on its “credit card”, the U.S. Treasury. It was an interesting idea that didn’t work out so well as the “credit card balance”, the national debt, of the U.S. grew from $6.2T in 2002 to over $10T in 2008.

Defense spending has almost doubled since 2002. To keep our country strong, the rich need to do the noble thing and pay for it. Defense spending is an insurance policy on one’s assets.

President Obama and his wife paid over $700K in taxes last year on $2.7M in income, most of it from the sale of Obama’s books. They didn’t complain about paying that much in taxes and I promise that I will be noble and won’t complain if I make $2.7M next year.

Drug Dealin’

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If I were the head of a large network of illegal drug distribution in the U.S., I would want a political and legal environment that promoted my business.

I would donate to the campaigns of conservative politicians who would vote to continue to keep those drugs illegal. Better that the profits go in my pocket than to state and Federal treasuries in the form of taxes.

I would donate to the campaigns of politicians of a moderately liberal bent who would vote to lessen penalties for small time users. When my customers are in jail, they don’t buy my product. I shun the more liberal politicans who want to legalize any of these drugs and eat into my profits.

I would donate to politicians who favor stricter, but not too strict, security measures at the border because this will make it more difficult for my less sophisticated competitors to get product into the U.S. I would prefer more moderate conservatives for this task.

In short, the political and legal environment in the U.S. is pretty close to optimal for a well run illegal drug distribution network.

What A Fool Believes

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Thirty years ago, in April 1979, the top song on the Billboard charts was “What a Fool Believes” by the Doobie Brothers.

On April 16th, 1979 the Dow Jones average was 857. In 2009 dollars that was 2502, using this handy inflation calculator. Today, April 14, 2009 the Dow closed at 7920. That is a 7.7% annual return. The yield on a 30 year U.S. Treasury bond in April 1979 was 9.08%.

Do bonds have consistently better returns than stocks over the long run? Not according to Jeremy Siegel who researched owning stocks versus bonds for various periods in his book “Stocks for the Long Run.” Mike Piper, who has written several introductory books on accounting and taxes, reviews some of the details on his Oblivious Investor blog.

As convincing as Siegel’s case for stocks may be, should a person put all their savings in stocks? No. Only a fool believes that the next 30 years will be like the last 30 years. For most of us, the safest answer is to diversify among a range of investments.

Mark To Market Debate

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The tribe needs meat. The antelope, gazelle and wildebeest have already passed through your area on their annual migration so the easier game is gone. Off in the distance you and your buddies see a lone bull elephant, whose meat would feed the tribe abundantly well. The problem is that all you have for weapons are some sharpened sticks, some rocks, and some rock flakes tied to sticks. Big problem, and a big payoff if you can solve it.

Mark to market accounting is like that.

At a recent Future of Finance Initiative seminar sponsored by the WSJ, Stephen Schwarzman, head of the investment firm Blackstone Group, said “If [a bank] made a loan in the old world . . And you didn’t think it was impaired, you kept it on your books at par. Now, if loans are trading at $70 [per $100 and] you make that loan, you lose $30 just for making the loan.”

He concluded, “Even though there is a lot to be said for complete mark-to-market in a system that can take it, I don’t believe that the financial system, as currently organized with its current rules, can really take the full hit of it.”

Robert Shiller, professor of Economics at Yale U., countered with “The first thing is to make sure that we preserve the integrity of our accounting. People know that this country stands for high integrity, and so anything that looks like we’re allowing people to doctor the books, I think we shouldn’t do that.”

Social Security Decrease?

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Social Security recipients saw almost a 6% increase in their monthly checks in 2009.

The Consumer Price Index (CPI) is calculated from October to September every year. In 2008, the spike in gas prices during the summer overinflated the CPI. If the Social Security Administration had calculated the CPI on a calendar basis in 2008, the swift decline in gas prices in the fall and winter would have resulted in a truer CPI index and a lesser increase in monthly check amounts to retirees.

Because of the overinflation in the preceeding period, the current period Oct 2008 to Sept 2009 will probably show a decrease in the CPI. So, will SS recipients see their monthly checks decrease? No. By law, the SS benefit portion can not decrease from year to year.

In her weekly WSJ “Ask Encore” feature, Kelly Greene notes that “the Bureau of Labor Statistics has developed an experimental consumer-price index for Americans age 62 and older, referred to as the CPI-E.” This is weighted more heavily toward medical care and housing than the currently used CPI-W index for urban consumers. In the 25 years ending 2007, this CPI-E index has risen faster than the CPI-W.

Estimates are that Social Security recipients, including children and the disabled, will increase from 51 million today to 89 million by 2035. At the end of 2004, it was about 48 million. For the next 20 years, 10,000 people a day will become eligible for SS benefits as the baby boomers retire. According the U.S. census clock, there are an estimated 306 million people living in the U.S. The population rose by 8 while I wrote this paragraph.

In Jan. 2009, the Bureau of Labor Statistics counts a bit over 140 million working. That’s a ratio of a little under 3 contributing workers to 1 SS recipient, who also may be working at least part time.

It is a ratio of approximately one worker to one non-worker in this country. If someone, a hundred years ago, had predicted that over half of the population would not be working, everyone would have laughed. The productivity gains of the past century have been a remarkable synthesis of individual and community ingenuity and spirit.

Robert Ball was commissioner of Social Security under Presidents Kennedy, Johnson and Nixon. In a 2005 brief he made the case for returning the Social Security “cap” to the original design of 90% of the maximum annual earnings base: “over the past twenty years the earnings of the higher paid have been rising much more than average wages—so an increasing proportion of earnings exceeds the maximum earnings base and thus escapes Social Security taxation. Today [2005], only about 83 percent of earnings is being taxed.”

Ball recommended that the cap be raised slightly more than inflation, gradually getting back to the 90% target goal.

Budget Buster

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In his weekly WSJ Capital column of 4/9/09, David Wessel reviews the CBO projections for President Obama’s proposed budget.

“The issue isn’t today’s deficit. Deficits are supposed to widen at times like this. The issue is the size of the deficit .. when the recession is past.” A CBO graph of U.S. debt, the deficit, is not pretty going forward. In 2007, the deficit was a little over a third of GDP. It is projected to go to 54% of GDP.

Rising health care cost have become the primary concern of budget projections, as the Director of the CBO notes. “Over the past 30 years, total national spending on health care has more than doubled as a share of GDP.” That doubling is not double the cost, but double the percentage of GDP. GDP has grown six-fold, meaning that health care costs have risen by a factor of 12.

This CBO graph from January 2009 of Debt Held by the Public as a Percentage of GDP from 1968 to 2010 is interesting. (Scroll down a few graphs to get to this one) Now look at a comparison of the January projection and the revised projection based on Obama’s budget. By 2012, projected Federal revenues will be about 18% of GDP and continue at that level for 7 years, till 2019. Spending will be 23% of GDP and climb to almost 25% of GDP.

Wessel notes that “Republicans, such as Wisconsin Rep. Paul Ryan, counter with proposals that combine tax cuts with spending cuts so severe that even a Republican Congress probably wouldn’t pass them – and still show significant deficits through 2019. So either taxes as a share of GDP rise or spending on those popular benefit programs (or everything else) is throttled back.” Wessel concludes his article with a sobering summary: “For 15 years, the Americans people have been told they could have it all. They deserve to be told that they can’t have it all in the future.”

For a historical perspective, take a look at CBO projections in 2003, forecasting an approx $16B GDP in 2009 and an unemployment rate of 5.2%. Recent, and more accurate, projections for 2009 are $14.2B in GDP with an unemployment rate of 8.3%.

As we can see, projected deficits for the coming years look bad and those projections do not take into account unpredictable events like another attack on the U.S., an escalation of violence in Iraq, a continuing cascade of business failure leading to unemployment above 10%.

Every year the Social Security Administration sends each of us a statement of projected monthly benefits when we retire. Don’t count on getting all of that.

The Tax Man Cometh

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In a 4/10/09 WSJ op-ed, Nina Olson, the national taxpayer advocate at the IRS, presents her case for a simpler tax code.

Her office estimates that taxpayers and businesses spend 7.6 billion hours complying with IRS tax code. This does not include state and city tax codes. That amount of hours would make tax compliance one of the largest in the U.S., requiring 3.8 million full-time workers.

Her office calculates that taxpayers spend the dollar equivalent of 14% of the income tax collected to meet tax code requirements.

Her recommendations as guiding principles for tax reform:
Don’t create traps for the unwary.
Simple enough that a single form can be used to report tax liability.
Anticipate areas of non-compliance and make it less inviting.
Some choices, but too many are confusing.
Refundable credits should be simpler to understand, apply for and administer.
Incorporate a periodic review of the tax code.

I have a better idea. No Federal income taxes. Politicians are wanna be car mechanics. As long as they breathe, they will want to amend the tax laws in order to “fix” something.

If there are no income taxes, how to replace the $1.4T – $1.5T in personal and corporate income taxes? Tax stock and bond trades.

In the five day period ending 2/18/09, daily average total notational volume was $229B on 10 million shares traded per BATS. This volume included the Chicago Options Exchange, NYSE, Nasdaq, Boston Exchange, International Stock Exchange. That is $229B traded in one day. 1/2 of 1% (.005) of that trading volume would be $1.145B. There were 250 trading days in 2008 = $1.145B per day * 250 days = $286B. For an individual making a $10,000 stock purchase, that would be a $50 fee.

The volume of bonds sold dwarfs that of the stock market. Construct a smaller percentage fee structure for the bond market. Financial institutions who buy and sell securities with the savings deposits of their customers would pass the cost on to their customers in the form of lower interest returns. Those institutions who traded less would incur less cost and theoretically be able to offer their customers a slightly higher return.

While there will always be the issue of non-compliance, the problem will be greatly reduced, thereby enhancing revenues. Inevitably, there will be investment banks who will construct legal dodges but the IRS should be able to deal with these much more straightforwardly than they currently do with the complexity of the tax code.

Under this simple system, we would implicitly be taxing those who have more than others. That is essentially what this country does with all the complexity of its tax code. Let’s admit it and at least make it simple.

Three Days of the Condo

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Like Robert Redford’s character in the movie “Three Days of the Condor”, some condo developers may feel like they went out to the deli to get a few things and, when they got back, found that the world had changed drastically.

Fannie Mae, the quasi-government agency that backs a majority of the mortgages in the U.S., announced that, effective March 1st, it would stop “guaranteeing mortgages in condo buildings where fewer than 70% of the units have been sold”, according to the weekly Property Report in WSJ, 3/18/09. The previous minimum was 51% units sold.

A N.Y. real estate firm “estimates that 93,000 new condo units will be completed this year, a 28% increase in new inventory from last year.” At the end of 2008, there was a 14 month condo supply, a decade long high. Some developers are turning their buildings into rental apartments. There is demand for the condos but a lack of financing. Some buyers, who put down deposits on unfinished condos, are walking away.

We interrupt this broadcast to bring you an important message from History, a sponsor of our show, the Present:
“Sales of apartment buildings to condo converters reached a record $13.3 billion last year, up from $3 billion in 2003, according to Real Capital Analytics.” This was reported in a NY Times article in May 2005.

The article notes that “the trend is driven by low mortgage interest rates that have encouraged renters to become homeowners, leaving landlords in many areas with falling occupancy rates and forcing them to lower rents and make other concessions to keep their buildings full.”

Office Vacancies

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Thought the housing market was bad?

WSJ reported 4/3/09 that the office vacancy rate for the U.S. rose to 15.2% for the first quarter of 2009, up from 14.5%. Three years ago, in the first quarter of 2006, it was 7.1%, according to Reis. The vacancy rate has been rising for almost two years.

In 2006, Reis analyzed construction and absorption of newly constructed space, as well as economic and demographic trends, and predicted an 11% vacancy rate in 2009. However, their predictions were that vacancy rates would be falling from a high of 12% in 2007.

2008 turned out to be the “rare event”, that event in any series of events that throws off all projections. Job layoffs have been responsible for the glut of supply of office space being dumped on the market. If U.S. companies shed another 1.5 million jobs in 2009, the supply of vacant office space may push the vacancy rate to 20%.