Instafinance

Do Higher Taxes = Higher Tax Revenues?

2008-05-21T13:21:00.000-07:00

Tax collections have remained steady at about 18-20% of GDP since 1950. The government could certainly raise the top marginal rate back to the 70% rate of the 1970's, but they won't be likely to collect any more revenue. The proportional relationship between tax revenue and GDP has persisted with top marginal rates as high as 91% and as low as 29%. According to the data, the only way to increase tax revenue is to increase GDP. For a more detailed account of "Hauser's Law," follow this link:

http://www.theneweditor.com/index.php?/archives/8036-You-Cant-Soak-the-Rich.html

People off all stripes practice tax avoidance (both legal and illegal) as taxes get higher. And it's not just the domain of the uber-rich hiring tax lawyers to find obscure and complicated loopholes. If you are a cigarette smoker in New York, you know that the $3 per pack tax has made it more profitable for thieves to hijack a cigarette truck than an armored car. The black market is thriving as are cigarette sales in neighboring states. Why? Because nobody, rich or poor, wants to pay a tax rate that's confiscatory. It removes the incentive to work, produce and invest.

More evidence that markets are self-correcting...

2008-05-07T12:57:00.000-07:00

Drivers in Boston are trading in their SUV's for fuel efficient sedans....and it didn't take a single piece of government legislation. Consumers will mandate fuel efficiency standards much more efficiently than Uncle Sam. Read the whole thing.

http://www.boston.com/news/local/massachusetts/articles/2008/05/06/frustrated_owners_try_to_unload_their_guzzlers/

Energy Policy

2008-05-05T10:49:00.000-07:00

So here's what passes for energy policy from the remaining three presidential hopefuls:

Clinton/McCain: A "gas tax holiday" which would eliminate the 18.4 cent federal gas tax during the summer driving season. Think about the math for a minute. The average driver logs about 1,100 miles per month. Assuming average MPG of 19, that's 174 gallons of gasoline. Estimated tax savings for your average driver: $31.96 or 36 cents per day. McCain says this will give low-income Americans "a little break" over the summer. Little is a huge overstatement. If this policy proposal is influencing your vote, then your vote can be had for a daily 10-piece pack of juicy fruit.

Obama/Clinton: A windfall profits tax. Obama rightly calls the gas tax holiday what it is - pandering for votes. His idea (and Clinton's with a few differing details) is to take an additional 10% of oil company profits and redistribute them as the government sees fit. This is a very slippery slope. Microsoft made about $14 billion dollars last year. Is that a "windfall?" How about banks? Citigroup had over $62 billion in net income from 2004 to 2006. Why not take more of those profits, redistribute them, and make mortgages more affordable for everyone? In the long-term, any policy of this nature is self-defeating. If each dollar of marginal income is taxed at a higher rate, investment will inevitably decline. As investment declines, production declines and prices rise.

Politicians would be better served to start telling their constituents the things they don't want to hear. The era of cheap oil is over. We need to be thinking about ways to decrease demand and increase supply. Higher gas and oil prices are actually quite necessary to achieving this goal. With higher prices, new technologies become economically feasible. Consumers demand automobiles which provide the best combination of fuel economy, size and power. It would be nice if the government would enact policies that provide long-term leadership instead of myopic gimmicks.

Entitlement Programs

2008-03-07T14:45:00.000-08:00

If current trends persist, Medicare and Social Security will consume a whopping 76% of all federal income tax revenue by 2050. This is before a penny is spent on national defense or Medicaid (health care for the poor). Higher taxes are almost inevitable. How much higher is the million (or perhaps multi-billion) dollar question.

Congress isn't making the tough choices necessary to attack this problem, because to do so would almost certainly lead to lost elections. Americans are in favor of spending cuts in the abstract, but start talking about exactly what to cut, and it becomes a dicier proposition. It's almost impossible to imagine a politician running on a platform of raising taxes and reducing entitlement program benefits, but this is exactly what has to be done sooner or later. In the meantime, most pols are hoping beyond hope that we can somehow grow our way out of the problem. Good luck with that.

For folks at least 10 years from retirement, I would suggest a Roth IRA if you are eligible (after-tax contributions are after tax but withdrawals are tax-free). If you make too much money, consider a Traditional IRA with an eye toward converting to a Roth in 2010 when the income limit for conversion is lifted.

The Dreaded "R" Word

2008-01-15T12:50:00.000-08:00

The odds have grown that the economy will slip into a recession. At the beginning of last year, many economists put that chance at less than 1-in-3; now an increasing number says it has climbed to around 50-50. Goldman Sachs, the biggest investment bank on Wall Street even thinks a recession is inevitable this year. For its part, the Federal Reserve is not calling for a recession. It’s often repeated that economists have predicted 20 of the last 10 recessions. This is probably true to a certain extent given that many prominent economists have been calling for a recession every year since 2004.

Nobody has a crystal ball, but history provides at least some clues as to how the market might behave if we do see a recession.

Stocks and Recessions:

The 90-91 recession probably looks the most like today – a bad housing market accompanied by bad loans hurting banks and a pro-active Fed cutting rates even before the recession began. In the three recessions between 1980 and 1991, market performance was the ugliest prior to the recession when investors panicked about the effects of a downturn in earnings.

The 2001 recession was caused by a combination of high stock-price valuations and a huge decline in corporate earnings. Prior to the 2001 recession, the P/E ratio hit an all-time high of 46 times earnings. This is encouraging given that the trailing P/E is currently about 16. At current price levels, it would take an earnings decline of 65% to achieve a P/E of 46 again. Additionally, sharp declines in earnings always have been temporary, caused by recessions or other special circumstances, and earnings as well as stock prices have rebounded subsequently. The average return in the 6 months following each recession since 1969 is 11.7%. Professional economists can’t even predict the start of a recession accurately let alone it’s length and severity. The best course of action, as always, is to stick to a carefully considered asset allocation plan. Even a seasoned trader like James Cramer will tell you that the only free lunch in the stock market is a well-diversified portfolio.

What to do in a Falling Market

2007-08-01T10:37:00.000-07:00

All the pundits are lining up this week with advice for investors in a falling market. Many suggested shorting financial stocks or hoarding cash until the "right time." For long-term investors, all this chatter matters little. It's hubris if not outright folly to think anyone knows the right time. If there is someone out there that can predict market moves with any degree of accuracy, I guarantee you that they are not sharing it with the masses. They are quietly making millions of dollars.

Whether you are making your own decisions or using an investment professional, your portfolio should contain investments that reflect your financial goals and tolerance for risk. If the market drop made you want to sell, you were not honest about your appetite for risk in the first place. If this is the case, it's time to rethink the stock-bond balance in your portfolio.

Dow 18000?

2007-05-25T09:19:00.000-07:00

Ken Fisher, Forbes columnist and founder of a $39 billion fund, thinks the market is undervalued by 40%. "The earnings yield (the inverse of the P/E rati0) for the S&P 500 is 6.7%. Companies can borrow at 3.8% after tax and buy back shares yielding 6.7%. At nearly 3%, this spread is historically huge."

This is the driver of all the share buybacks and private equity activity we've been seeing recently. As long as this spread persists, leverage will be the weapon of choice. Read the whole thing.

http://members.forbes.com/forbes/2007/0521/035.html

Oil and the Dollar

2007-05-24T12:30:00.000-07:00

Gas prices are once again north of $3, and politicians have wasted no time addressing the issue. Some blame "big oil" for price gouging. Others say it's the increased demand of the summer of driving season coupled with lower refining capacity. Still others point to a terrorism/war premium. Unfortunately, none of these politicians seem to understand enough about the oil market to identify one of the primary causes of oil's upward trajectory. Namely, the falling dollar.

The three current oil markers are all US dollar denominated: North America's West Texas Intermediate crude (WTI), North Sea Brent Crude, and the UAE Dubai Crude. The two major oil bourses are the New York Mercantile Exchange (NYMEX) in New York City and the International Petroleum Exchange (IPE) in London. As the value of the dollar falls, it makes perfect economic sense for OPEC producing nations to raise the dollar price of oil to make up for monies lost when dollars are converted back to local currency. Politicians can continue to blame all sorts of mysterious and unquantifiable sources for high gas prices. In reality, the weak dollar policies of the US Government- namely huge trade and budget deficits - are a primary and often overlooked cause of the problem.

The Price Earnings Ratio

2007-03-01T14:12:00.000-08:00

The price to earnings ratio on the S&P 500 is currently sitting at about 16, roughly equal to its long-term average. This means that investors are paying $16 dollars for every $1 of profits earned by companies in the index. To put this in perspective, the P/E ratio prior to the 1929 stock market crash was about 28. Prior to the dot-com crash in 2000, the S&P traded at an all-time high P/E of 42.

This doesn't mean the market can't go down. It simply means that by historical standards, the market is not the house of cards that some analysts would have you believe. Earnings would have to remain flat while stock prices dropped 40% before we see, for example, a P/E of 10. This type of market valuation hasn't been seen since inflationary pressures clobbered the economy in the 1970's (before being reigned in by Fed Chairman Paul Volcker in the early 1980's). Unless we see the return of the Misery Index (Unemployment + Inflation) on the front pages of the Wall Street Journal, I don't see a P/E of 10 arriving anytime soon.

Long-Term Market Perspective

2007-03-01T13:14:00.000-08:00

Tuesday's 3.86% decline in the S&P 500 left pundits from all corners listing the reasons for the sharp decline. The primary explanations:

Alan Greenspan uttered the word "recession." Never mind the fact he said he didn't actually expect a recession. He simply declined to rule one out. Has there ever been a time in the history of US economy where a recession in the upcoming year could be "ruled out?"
The sub-prime mortgage market meltdown is about to spill over into the broader economy.
Corporate earnings are moderating. Solid explanation, but didn't investors know this already?
We are simply "due" for a correction. Why? Well, according to many analysts the bull market has simply gone on too long by historical standards.

Nobody really knows where this market is headed with any degree of certainty. As my grandfather used to say, "a broken watch is correct twice per day." As a long-term investor, you simply need to ride out the volatility. You can't avoid the down days, and you can't afford to miss the up days. The 3 best days in the market over the past 5 years provided 75% of annual returns.

What Social Security Problem?

2007-01-03T21:19:00.000-08:00

George Gilder, senior fellow at the Discovery Insitute, makes the case for an open U.S. economy in Tuesday's Wall Street Journal. A few excerpts:

The key is keeping the economy open to oustide investors as our population ages and as the productive center of the global economy shifts to Asia. Social Security can become a crisis only if we try to stop this process by raising taxes and regulations, debauching the dollar and enacting gimrack spending cuts that focus on defense.

His prescription: Lowering taxes on paryolls and incomes and pursuing the opportunities of global economic growth. Although it's politically expedient to enact policies designed to "protect the American worker," I have to agree with Mr. Gilder. There's no turning back the complex machine that is the global economy. Any efforts to the contrary will only stifle growth and excacerbate any future Social Security shortfall.

The Power of Buy and Hold

2006-11-17T09:22:00.001-08:00

When speaking with clients, there is a common perception that the market can and should be "timed." While dollar-cost averaging is a wise long-term strategy, unsystematic timing of the market will only cause you to miss the big up days that provide a bulk of returns in the first place. The article below from the Motley Fool illustrates this point nicely. The author calls a 5-standard deviation move "5-sigma." Quick statistics refresher: A 2-standard deviation move covers 95% of all observations in a normal distribution.

In a standard normal distribution, an event that occurs five standard deviations or more from the mean has about a 1 in 3,488,555 chance in happening -- fairly unlikely, in other words. Yet plenty of stocks have seen more than their fair share of these lightning strikes.

Over the past 56 years, the S&P 500 has seen 52 days with 5-sigma or greater movement, and three days in 1987 with changes that were 10-sigma or greater. Over the past five years, if you had invested in the S&P and held on to it, you would've seen a 23% return, or roughly 4% annually, not exactly something to get excited about. But if, instead of holding, you were jumping in and out and managed to miss the eight 5-sigma days (two of which were negative) over that time frame, then your annual return is slashed to 1%, a certifiably terrible performance.

Read the whole thing:

http://www.fool.com/Server/printarticle.aspx?file=/news/commentary/2006/commentary06110931.htm

Reagonomics at 25

2006-08-17T13:51:00.000-07:00

Twenty-five years ago, Ronald Reagan signed the economic Recovery Tax Act, slashing income tax rates by 25% across the board. The top tax rate in the US in 1980 was an astonishing 70%. Dividends were taxed at 70% and capital gains at 50%. I doubt anyone under 50 remembers that US tax policy used to be virtually confiscatory. Whatever politics you practice, I doubt you would want to pay Uncle Sam more than two-thirds of your gross pay. Keep that in mind next time you visit the polls. Make sure you know the fiscal policies that your potential Congressman or Congresswoman supports.

401K/Pension Legislation Passes

2006-08-17T13:48:00.000-07:00

It took federal lawmakers almost two years of debate, half a dozen stabs at earlier legislation and an end-of-session deadline to finally agree on a law designed to shore up company pension plans.

But buried in the 900-plus pages of the Pension Protection Act of 2006, signed by President Bush Thursday, are several tax provisions that will benefit individuals who do their own golden years saving.

The aim of the law is to boost the 30,000 defined-benefit plans run by employers that are now underfunded by an estimated $450 billion. Those plans must reach 100% funding, up from the current 90% requirement, in seven years. That could save taxpayers from funding a multibillion-dollar bailout of the federal agency that insures pension plans.

Read all the details.... http://articles.moneycentral.msn.com/RetirementandWills/PlayingCatchUp/BigChangesForYour401kRetirement.aspx?GT1=8473

College Education

2006-08-15T13:36:00.000-07:00

Good news for for those who use 529's or Education IRA's to save for their children's education. Congress made the tax breaks associated with these accounts permanent. They were slated to expire after 2010.