Monday, December 31, 2012

Fiscal cliff deal analysis

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.

Saturday, December 29, 2012

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.

Thursday, December 27, 2012

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.  

Monday, December 24, 2012

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.

Saturday, December 22, 2012

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.

Friday, December 21, 2012

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.

Sunday, December 9, 2012

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.