Fiscal cliff deal analysis

Details of tentative deal averting 'fiscal cliff'

Highlights of the deal include:

—Income tax rates: Extends decade-old tax cuts on incomes up to $400,000 for individuals, $450,000 for couples. Earnings above those amounts would be taxed at a rate of 39.6 percent, up from the current 35 percent. Extends Clinton-era caps on itemized deductions and the phase-out of the personal exemption for individuals making more than $250,000 and couples earning more than $300,000.

This first highlight is one that I can get behind.  Of course, I’m not sure how much of a difference this will make in actually reducing the deficit.  There aren’t many wealthy people that actually pay 35 percent taxes on their income.  Capping itemized deductions will probably have a greater impact than raising the rate.  Of course, for many wealthy individuals, this won’t have much if any effect since a large portion of their income comes from capital gains and dividend income.

—Estate tax: Estates would be taxed at a top rate of 40 percent, with the first $5 million in value exempted for individual estates and $10 million for family estates. In 2012, such estates were subject to a top rate of 35 percent.

No problem here, as well.  I don’t understand how it is that the heirs of people who actually did build a large estate can feel such a sense of entitlement when it comes to their inheritance, and yet complain about the sense of entitlement that many feel about being able to buy food.  Something has got to give and, at least for now, this seems to be the right way to go.

—Capital gains, dividends: Taxes on capital gains and dividend income exceeding $400,000 for individuals and $450,000 for families would increase from 15 percent to 20 percent.

This one is a bit trickier.  Raising dividend taxes will likely result in changes to dividend policy by corporations.  Rather than pay dividends, more companies will likely opt for share repurchases, which is another way of distributing cash on hand to investors.  Then, the only time investors will have to actually pay taxes on that money is when they sell their investments.  Of course, the higher rate on capital gains should recapture the lost tax revenue from reduced dividend payments, but it may actually result in less realization of capital gains, with investors being less inclined to sell and take a gain.  I guess, if we carry this logic through, this would lead to an increase in the size of estates, which would eventually lead to an increase in estate taxes collected.  So, in the end, perhaps it will lead to higher revenues, but those increases will likely be further in the future.

—Alternative minimum tax: Permanently addresses the alternative minimum tax and indexes it for inflation to prevent nearly 30 million middle- and upper-middle income taxpayers from being hit with higher tax bills averaging almost $3,000. The tax was originally designed to ensure that the wealthy did not avoid owing taxes by using loopholes.

The alternative minimum tax is really kind of ridiculous.  The tax law provides people with a way to avoid paying taxes, so then our lawmakers turn around and pass this law to prevent people from taking full advantage of the law.  I’m not sure what the logic of leaving those loopholes that the AMT is supposed to help close available to middle and upper middle income taxpayers is.  And I’m not sure that middle and upper middle income people really need to be protected from an average tax increase of $3,000.  Somebody does have to pay the bills here.

—Other tax changes: Extends for five years Obama-sought expansions of the child tax credit, earned income tax credit, and an up to $2,500 tax credit for college tuition. Also extends for one year accelerated "bonus" depreciation of business investments in new property and equipment, a tax credit for research and development costs and a tax credit for renewable energy such as wind-generated electricity.

I really don’t see the benefit of the child tax credit, let alone any expansion of that credit.  I mean, really, do we want to encourage poor people to have more children?  And after all, Obamacare, the last I heard, requires health insurance to cover contraceptives.  This is just politics in action.  There’s no real sense to expanding the child tax credit.  If you can’t afford to have kids, then don’t; your insurance will cover the “don’t have kids” part, at everyone else’s expense.

The tax credit for college tuition was a bad idea from the very beginning.  We can see the result clearly now: skyrocketing tuition and a concomitant loss of worth in having a degree.

The accelerated “bonus” depreciation of business investments is a good thing, in my opinion.  It makes sense for businesses to depreciate assets over the life of those assets, but it doesn’t make sense to do that for tax purposes.  From a financial point of view, being able to expense business assets for tax purposes would result in more projects being worthy of investment, thus leading to increased business activity.  Really, I think this “bonus” depreciation should be made permanent.

A tax credit for research and development costs sounds like it might be a good idea; then again, it may encourage spending for research in areas that aren’t really likely to yield substantial benefits.  This is probably another example of an area where the government really should just butt out.  As far as tax credits for renewable energy goes… well, if those renewable energy sources were economically viable, there wouldn’t be a need to provide a tax credit to encourage development.

—Unemployment benefits: Extends jobless benefits for the long-term unemployed for one year.

At this point, I don’t think it would be a very good idea to just allow unemployment to end for so many people.  The problem, as I see it, is that unemployment benefits should never have been extended so long to begin with.  Unemployment seems to be becoming a retirement plan.  It wasn’t meant to support people for so long; it was meant to provide a bridge between jobs.  It needs to get back to that point as soon as possible.

—Cuts in Medicare reimbursements to doctors: Blocks a 27 percent cut in Medicare payments to doctors for one year. The cut is the product of an obsolete 1997 budget formula.

I don’t know enough about this to even comment, other than to say I don’t see why everything seems to be patched together and if we don’t keep passing new laws then the law will revert to some antiquated method.  We could avoid this kind of thing by making permanent changes.

—Social Security payroll tax cut: Allows a 2 percentage point cut in the payroll tax first enacted two years ago to lapse, which restores the payroll tax to 6.2 percent.

This is a bad idea.  For lower income people, this means 2 percent less to spend, and for many of them, they’re already only spending what they need to spend to survive.  This is, in fact one of the ways that the government can actually remove money from the economy, making it smaller, resulting in recession.  I realize that, if we’re going to have Social Security, it needs to be funded.  I’m just not sure Social Security is a great idea to begin with.  Regardless, a big part of this tax increase will actually come from money that would have otherwise been spent, so I don’t see why we want to do this now.

Most of what I see here doesn’t seem to really address the real problems that our economy is facing.  If the result is that we are supposed to be reducing our deficit, then why are so many special interest tax credits a part of the deal?  Taxes should be reduced for the people that would spend that money, while taxes should be increased on people who would just be adding to their personal cash stash.

Of course, things may be significantly different now, since the talks are proceeding as I'm writing this.  And, of course, from what I see here, there really hasn't been much progress towards actually reducing the deficit.

 

Someone's trying to scare us

Wall Street Week Ahead: Cliff may be a fear, but debt ceiling much scarier

Um, yeah.  Since you weren't worried enough about the fiscal cliff, let's see if you'll get worried about this.  I'm not positive, but I'm pretty sure that every time the debt ceiling has been reached, it's also been raised.  I guess the thing that we should really be worried about is that the government will come up with some way to avoid the fiscal cliff and raise the debt ceiling again, because it's fun to spend trillions.  At least, I think it is... I sure wouldn't mind having a shot at it anyway.

The government needs to just give up

Wall Street rebounds on House session, but off for 4th day

The story says that the market recovered most of its early losses because the House said it would work over the weekend.  I'd be more optimistic if the government just gave up trying to fix anything.  

I forgot to mention...

In my last post about the real reason for the market tanking last Friday, I forgot to mention one thing: Because so many analysts and journalists jumped on the lack of action towards a resolution of the fiscal cliff, many investors will now believe that to be the reason for the drop on Friday, and with continued inaction on the part of the government, these investors will also sell.  So, we have a case here of a faulty analysis becoming a self-fulfilling prophecy.

Retirement planning

There's plenty of advice around about how to invest for retirement, so I may as well throw my 2 cents in as well.  I'll be honest, there's not a lot of great places to stash money right now, but I won't go so far as to say you shouldn't set anything aside.  Instead, I'm going to propose that you stock up on whiskey.

For example, a bottle of Jim Beam retailed for $14 at the beginning of 2007, but at the end of November 2012 was priced at $19, an annual increase of 5.2%.  Not a huge return, but consider the alternatives.  The S&P 500 began the same time period at 1416 and ended at 1416.  A home purchased in 2007 for $190,000 would now only be worth about $125,000.  Gold, would, in fact, have been a great investment in 2007 when the average price was about $695 an ounce.  Today, gold is trading at $1,650, which would have given you an annual return of about 15.5%.  Unfortunately, it appears that the gold rush is over, and I expect to see gold prices decline as the inevitable interest rate increases become imminent, and quantitative easing comes to an end.

I suggested whiskey here because it has a history as a store of value.  But, you could use just about any consumable product that has an indefinite shelf life.  Just make it something that you would use, and if you never resell it for a profit, you can still just use it, so you're not really out anything, unless the price actually drops, a scenario that I don't think is likely for many things.  And if enough people did it, perhaps it would provide the boost our economy needs.

That's not why the market tanked

Everywhere I look, the conventional wisdom is that the market tanked today because of the government's inability to act to avoid the fiscal cliff.  The problem with this explanation is that by now most people should realize that the government isn't going to act until they've milked this latest "crisis" for all the political gain they can get from it, and so the lack of action should have come as no surprise to anyone.  I think the real reason for the drop is much more subtle and complex than that.  In a nutshell, though, today's market action had more to do with the upward revision of GDP as well as the unemployment figures.

Why?  A while back, the Fed announced it would be buying $40 billion a month in MBSs.  More recently, the Fed announced they would buy another $45 billion a month in long bonds.  This is effectively driving all the low risk investment returns down to such low levels that the only rational thing for anybody with some money to invest can do is to invest in riskier assets, like stocks.

The Fed has said that it will keep easing until unemployment gets down to 6.5 percent, and unemployment has remained stubbornly high, so it may seem a bit premature to be worried about the end of quantitative easing.  But I suspect that the smart money is already pulling some out, to avoid the last minute rush when it becomes apparent that we have reached the end of easing.  Unemployment has been edging down, and if GDP growth is even a little better than expected, the drop in unemployment could happen relatively quickly.

The take-away from all of this is that I would expect to see more of the same irrational investor behavior as we say before the Fed started the recent rounds of easing, i.e. rallying on bad economic news and and falling on good news.

Term for the Day

Going public: The act of selling stock to the public at large by a closely held corporation or its principal stockholders.

Profit from the Fed and ECB

Last week, the ECB announced that it would spend as much as needed to contain borrowing costs in euro-area countries ifthey sign up to bailout conditions first.  At first glance, it sounds a lot like the ECB is going to turn on the printing presses, which should weaken the euro.  But, that isn’t what happened at all.  Instead, the euro has strengthened rapidly against the U.S. dollar, as investors have apparently rushed in to take advantage of the higher yield on euro bonds that now seem to be a whole lot less risky.  The ECB even remarked today that it may not need to buy any bonds, but of course, that depends on whether the market continues to buy.

Subsequent to the ECB announcement, the Fed announced its own version of unlimited buying, the target being mortgage backed securities, with a somewhat different result.  The markets for risky assets have surged, while the dollar continues to slide against the euro.  What one might have expected is a drop in mortgage rates, but that isn’t really the case, since mortgage rates are already low.  Instead, it appears that investors are moving money from relatively safe, low yield, investments into riskier investments.  The Fed has artificially raised the investment demand for mortgages, which would lower the yields on those investments, except that other investors then, seeing the low mortgage rates, choose to invest in some area where the returns are higher.  The result: a big pop in stocks, for one.  It is somewhat like the Fed is investing indirectly in the stock market, effectively “crowding out” other investors from relatively safe investments into more risky assets.

The longer term effects of both these actions are hard to quantify, but I think the result will be a continuing surge in stock prices here in the U.S., assuming we don’t actually enter into a recession, and a continued weakening of the dollar against the euro.  The reason for the weakening is clear: the Fed has said it will buy $40 billion in mortgage backed securities until the employment situation begins to pick up.  The ECB, on the other hand, has actually said that they may not need to do any actual bond purchases.  So, the Fed will be turning on the printing presses, while the ECB may never need to, although in the longer term, they too will likely need to if economic conditions don’t improve in Europe.

So, the question that needs to be answered is, “How can investors profit from these actions?” Just considering these two actions, the best thing to do is to invest in European companies that are not dependent on exports, particularly to the U.S. since European goods are going to become significantly more expensive here in the U.S., while the opposite is true for U.S. goods in Europe, at least in the near term. The best investments here in the U.S., in my opinion, are in companies that have significant exports to Europe, since the exchange rates are moving in a way that is favorable to U.S. exporters.

Apple and the Wall Street Journal

If I were to make a guess, I'd have to say that someone at the Wall Street Journal owns Apple stock,or at least has a vested interested in Apple.  It's really simple.  The front page of today's paper has an article about Apple's earnings release with the headline: "Rare Miss For Apple As iPhone Sales Cool."  And at the top of the page the description of what's in the Personal Journal section: "Why One Phone Isn't Enough."

On further reflection...

In my last post here, I proposed that the government should dramatically crank-up the borrowing and spending, while the fed began raising interest rates as a method to help straighten out the economy.  Of course, we'll never know if that would work, since no one will do that, at least not without the excuse of another world war, or something similar.

But, there is another possibility: the government goes ahead and drives our economy right of the "fiscal cliff" everyone is talking about, and... it turns out to be a good thing, instead of the cataclysm economists think it will be.  After all, economists thought that the end of World War II was going to turn out economically terrible, but it just didn't happen.  And if it does turn out good, I'm sure all the politicians will be patting themselves on the back for their inaction.

The economic fix

I read an article this morning, and I have to say, I've finally found someone that I somewhat agree with when it comes to the current state of the economy, and how the federal government should deal with it.

Let me begin by saying that I don't think there is any really quick fix for the economy.  We are in a situation that has been created over a long period of time, and I think we are looking at a long period of time to correct the situation.

The aforementioned article is actually an interview with Richard Duncan, author of  The New Depression, so my references to what the article states are, of course, statements made by Mr. Duncan.

The article states that the federal government "should borrow "massive" amounts of money at the current low interest rates to invest in new technologies like renewable energy and genetic engineering."  I actually don't understand why the government isn't borrowing more than they are.  Interest rates will likely not be this low again for a long time, so why worry over how much the government is borrowing?  It could be argued that the interest rates on government bonds is effectively zero, or even negative, which is a good thing for the government, if not for the investors.  Without going into specifics, I think the government should go on a huge buying and hiring spree, funded with money borrowed at ridiculously low rates.

I also think the Fed should have their mandate changed.  It has always puzzled me why the Fed should have the dual mandate of controlling inflation and encouraging growth.  The two goals are opposing; in order to increase growth, the Fed would lower interest rates, while controlling inflation requires raising interest rates.  And normally, this results in a situation where the Fed has to make a somewhat subjective judgement over which (inflation or growth) poses the greatest risk to the economy.  So, I propose that the Fed instead have the mandate of controlling the amount of outstanding private sector debt.  Growth and inflation would be the concern of the federal government, as it should be.  After all, we all blame the government when those are bad, and politicians are quick to take credit when those are good; let the government have sole responsibility for them.

The idea that I'm getting at here is to create a situation similar to the situation around the time of World War II.  When the U.S. entered the war, the government started a massive buying program.  Of course, at the time, who would complain?  The Japanese had just destroyed most of our Navy, and we needed to replace those ships.  We "hired" soldiers, and we limited the goods that consumers could buy, either through rationing or through direct control of the use of materials on the part of the government.  At the end of World War II, many economists claimed that we were destined for a huge recession due to the huge decrease in government spending, and the increase in unemployment resulting from the soldiers returning home.  While GDP did, in fact, decrease by approximately 11 percent in 1946, we were entering a period of great prosperity for the U.S., and depending on how you define "recession," it can be argued that there was no recession.  Certainly, all the gloom and doom that economists were forecasting didn't happen.

This same article quotes , "If this credit bubble pops, the depression could be so severe that I don't think our civilization could survive it."  I'm not sure what that is supposed to mean, but I think it sounds a whole lot more dire than what we are facing.  However, I do think that current circumstances, if not somehow controlled, could lead to another global conflict, which in the end would serve the same economic purpose as the actions I am proposing here.  My preference would be to attempt to create similar economic conditions as World War II did, without having to actually have a World War III.

In the end, I actually believe that the economy will work itself out, no matter how badly it is handled by our government.  And I'm sure that whoever the politicians are that happen to be in office at the time that this happens will be more than happy to pat themselves on the back for a job well done.  Unfortunately, I also think it will take a long time for the economy to work itself out, and I think the current actions of the Fed and government will just prolong the pain.

So, in short, and perhaps in oversimplification, the fed should start raising interest rates to deflate the bubble in private sector debt, while the federal government should borrow and increase spending and hiring to lower inflation and maintain aggregate demand while consumers are adjusting to higher interest rates and, at least theoretically, buying less.  Once we have decreased private sector debt to an acceptable level, the government can concern themselves with balancing the budget, paying off its debt, and decreasing the size of government.

More of the same

It's midday again, and the market is rallying on the bad news that China's GDP growth slowed more than expected, while here in the U.S. consumer confidence sagged to it's lowest point in seven months.  Oh yeah, we certainly have reason to celebrate.