Posts tagged ‘taxes’

California…This Bud’s for You

I guess it’s time for Californians to dust off their bongs and break out the rolling papers because Proposition 19, the proposal to legalize personal marijuana consumption for adults in the Golden State, is coming up for vote next month. Judging by recent polls, the proposition is gaining steam…or smoke. 

Results show that 52% of voters are backing the proposition versus 41% opposed and 7% undecided. In fact, the data shows Californians are supporting ganja more than they are backing the state Senatorial and Gubernatorial candidates (Barbara Boxer, Dianne Feinstein, Carly Fiorina, Jerry Brown and Meg Whitman).

Proponents are fiercely battling the opposition in the remaining weeks before the big vote. Given all the controversy, I wouldn’t be surprised if pro-pot advocacy groups enlisted renowned rapper Snoop Dogg as a paid spokesman to support the cause. I can hear Snoop now, “Vote yes on ‘pot,’ but remember friends don’t let friends drive doped.” Alternatively, I’m sure Altria Group (MO), maker of the famous Marlboro branded cigarettes, wouldn’t mind getting into the profitable cannabis business. They could even hire ex-President Clinton, who could admit he “inhaled…and enjoyed it,” while consuming some cannabis legally in California.

Would Snoop and Bill Say Yes to Legalized Marijuana?

The Budding of Prop. 19

What was the genesis of Proposition 19? Well, this isn’t the first time the wacky weed debate has actually been put to a vote in California. Almost four decades ago a similarly titled Proposition 19 initiative showed up on the ballot. Was it a coincidence the same number was used…perhaps? On the bright side, more mature protesters will not have to break the piggybank to buy new Proposition 19 buttons and T-shirts. This type of recycling gives new meaning to the word being “green.”

From a broader political policy perspective, marijuana consumption is no small problem. An estimated $113 billion of pot is sold each year nationally, with more than 10% of that attributed to California weed smokers. A whopping 15 million Americans have admitted to using pot within the last month, according to one survey. Of all the marijuana smoked, around fifty percent of the illegal bud is said to originate from foreign sources, most notably Mexico, which is dealing with deadly drug cartels that are killing innocent civilians by the thousands and threatening our borders. Proposition 19 cheerleaders are quick to point out that the legalization of cannabis would remove valuable money from foreign criminals’ pockets.

Legalizing and taxing cannabis has the potential of raising billions for the state of California. We all know about the sad state of fiscal affairs for California ($19 billion budget deficit) along with the dismal financial shape of neighboring states – an estimated $137 billion in deficits over fiscal 2011 and 2012  (see The Next Looming Bailout). Contributing to the deficits is the overcrowding of our jails and prisons.  Ever since the “Just Say No” to drugs campaign, which started in 1984, prison populations have quadrupled – many of the prisoners being non-violent pot smokers.  So, why not collect some cash from the millions that are already smoking pot illegally and help reduce our damaging deficits and free up space for more violent criminals?

Calling All Sin-Consuming Hypocrites

I understand the opposition to cannabis legalization, primarily based on concerns relating to public safety, workplace productivity, and potential losses in federal funding, but if certain people are opposed to Proposition 19, I sure hope they are up in arms over the numerous other legal (but sinful) products and services that permeate our daily lives. If pot is deemed harmful and illegal by society, then where are all the picketers protesting this long list of other sinfully legal products and services?

  • Casinos/Gambling
  • Cigarettes
  • Lotteries
  • Alcohol
  • Prostitution (Nevada)
  • Guns/Hunting
  • Ho Hos/Twinkies/Sodas (Fat Tax)

The potential safety issue surrounding an increase in stoned drivers is a real one. However, if we have managed to reduce drunk driving, with the help of severe penalties, over the last few decades, I’m fairly confident we can keep slothful, Domino’s pizza (DPZ) loving, pot-smokers under control.

There is no shortage of controversy surrounding this political hot-button issue, but drastic times call for drastic measures. You may be against the legalization of marijuana, but if Proposition 19 passes in California, you may want to go long Domino’s, and short Nike Inc. (NKE).

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper.  

www.Sidoxia.com 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MO, DPZ, NKE, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

October 6, 2010 at 1:10 am 2 comments

The Next Looming Bailout…Muni Bonds

Source: Photobucket

Government politicians and voters have made it clear they do not want to bail out “fat-cat” bankers in the private sector, but what about bailing out “fat-cat” state pensioners in the public sector? States and cities across the country are increasingly under economic strain with deficits widening and debt-loads stacking up. California’s statewide budget problems have been well publicized, but you are now also hearing about more scandalous financial problems at the city level (read about the multi-million dollar malfeasance in the city of Bell).

Why Worry?

Well if a 2010 $1.3 trillion federal deficit is not enough to tickle your fancy, then how does another $137 billion in state deficits over fiscal 2011 and 2012 sound to you (National Governors Association)? Unfortunately, the states have made no meaningful structural improvements. If you layer on general economic “double dip” recession fears with excess pension liabilities, then you have a recipe for a major unresolved financial predicament.

Despite the dire financial state of the states, municipal bond prices have generally survived the 2008-2009 financial crisis unscathed. With unacceptably poor state budget risks, muni bond prices have continued to rise in 2010. The downside…new investors must accept a pitiful yield of 2.75% on 10-year municipal debt, according to Financial Advisor Magazine.

One investor who is not buying into the strength of the tax-free municipal bond market is famed investor and CEO of Berkshire Hathaway (BRKA/BRKB), Warren Buffett. Here is what he wrote about munis in his legendary annual shareholder letter last year:

“Insuring tax-exempts, therefore, has the look today of a dangerous business…Local governments are going to face far tougher fiscal problems in the future than they have to date.”

 

Buffett has this to say about rating muni bonds:

“I mean, if the federal government will step in to help them [municipalities], they’re triple-A. If the federal government won’t step in to help them, who knows what they are?”

 

Safety Net Disappears

Source: Photobucket

Like a high wire artist dangling high in the air without a safety net below, the states are currently borrowing money with little to no protection from the bond insurance providers. The shakeout of the subprime debt defaults has battered the insurers from many perspectives, leaving a much smaller market in the wake of the financial crisis. In 2007 about 50% of new municipal bonds were issued with bond insurance, while today only approximately 7% carry it (UBS Wealth Management Research). With decreased insurance coverage, the silver lining for muni investors is the necessity for them to perform more comprehensive research on their bond holdings.

Defaults on the Rise

On the whole, less insurance will result in more defaults. Although defaults are expected to decline in 2010, non-payments totaled $6.9 billion in 2009, up from $526 million in 2007 (Distressed Debt Securities). Even though the numbers sounds large, the recent default rate only represents a 0.25% default rate on the hefty $2.8 trillion market. That muni default rate compares to a more intimidating corporate bond default rate of 11% in 2009.

Bigger Bark Than Bite?

James T. Colby, senior municipal strategist at Van Eck Global, understands the severity of the states’ budget crisis but he believes a lot of the doomsday headlines are bogus. Riva Atlas, writer for Financial Advisor Magazine, summarizes Colby’s thoughts:

“Even those states in the worst straits like California and Illinois have provisions in their constitutions or statutes requiring them to pay their debts. In California, the state’s constitution says bondholders come second only to the school system, so the state would have to empty its jails before it stopped paying its teachers.”

 

Certainly municipalities could raise taxes to compensate for any budget shortfalls, but we all know most politicians are reluctant to raise taxes, because guess what? Tax increases may result in fewer votes – the main motivator driving most politicians.

If the states decide to not raise taxes, they still have other ways to weasel out of obligations. For starters, they can just stick it to the insurance company (if coverage exists). If that option is not available, the municipalities can look to the federal government for a bailout. Irresponsible actions have their consequences, and like consumers walking away from payments on their mortgages, municipalities will effectively be preventing themselves from future access to borrowing. Either way, the bark is less than the bite for investors since the insurance company or federal government will be making them whole.

BABs and Taxes Add Fuel to the Fire

A glut of Build America Bonds (BABs) issued by municipalities, driven by demand from yield hungry pension funds, along with expected tax hikes for the wealthy have created a scarcity of tax-free munis.

In the first half of 2010 BABs accounted for more than 25% of municipal bonds issued, which was a significant contributing factor to the robust muni market. The BABs tailwinds aiding muni prices won’t last forever, as the bond issuance program is expected to expire at the end of 2010.

On the tax front, the wealthy are likely to see higher federal tax rates in the future – upwards of 36% – 40%. If you include the double tax-exempt benefits in states like New York and California, the relative attractiveness becomes even that much better. Combined, these factors have elevated muni prices.

Despite higher defaults, scarier headlines, and the lack of insurance, the municipal bond market remains robust. General interest rate declines caused by macroeconomic fears have caused investors to flock to the perceived “safe haven” status of Treasuries and Munis, but as we have all witnessed, the fickle pendulum of emotions never sits still for long.

Managing the Munis

As is evident from the municipal bond discussion, states and cities across the country have been plagued by the same deficit and debt issues as the country faces on a federal level. Tough structural expense issues, and revenue generating tax policies need to be scrutinized in order to prevent federal taxpayer bailouts of municipalities across the country.

From a municipal bond investor perspective, it’s best to focus on general obligation bonds (GOs) because those bonds are backed by the taxing authority of the municipal government. On the flip side, it’s best to stray away from revenue bonds or privately issued municipals because revenue streams from these bond channels are not guaranteed by the municipality, meaning the risk of default is larger.

While Congress sorts out financial regulatory reform with respect to banking bailouts and “too big to fail” corporations, our federal government should not lose sight of the widespread municipality problems our country faces today. If not, get ready to pull out the checkbook to pay for another taxpayer-led bailout… 

Read the Complete Financial Advisor Magazine Article: The Muni Minefield

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper.  

www.Sidoxia.com 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including CMF), but at the time of publishing SCM had no direct position in BRKA/B or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

September 27, 2010 at 12:47 am 1 comment

Sachs Prescribes Telescope Over Microscope

Jeffrey Sachs, Professor at Columbia University and one of Time magazine’s “100 most influential people” recommends that our country takes a longer-term view in handling our problems (read Sachs’s full bio). Instead of analyzing everything through a microscope, Sachs realizes that peering out over the horizon with a telescope may provide a clearer path to success versus getting sidetracked in the emotional daily battles of noise.

I do my fair share of media and politician bashing, but every once in a while it’s magnificent to discover and enjoy a breath of fresh common sense, like the advice coming from Sachs. Normally, I become suffocated with a wet blanket of incessant, hyper-sensitive blabbering that comes from Washington politicians and airwave commentators. With the advent of this thing we call the “internet,” the pace and volume of daily information (see TMI “Too Much Information” article) crossing our eyeballs has only snowballed faster. Rather than critically evaluate the fear-laced news, the average citizen reverts back to our Darwinian survival instincts, or to what Seth Godin calls the “Lizard Brain. ”

Sachs understands the lingering nature to our country’s problems, so in pulling out his long-term telescope, he created a  broad roadmap to recovery – many of the points to which I agree. Here is an abbreviated list of his quotes:

On Short-Termism:

“Despite the evident need for a rise in national saving after 2008, President Barack Obama tried to prolong the consumption binge by aggressively promoting home and car sales to already exhausted consumers, and by cutting taxes despite an unsustainable budget deficit. The approach has been hyper short-term, driven by America’s two-year election cycle. It has stalled because US consumers are taking a longer-term view than the politicians.”

On Differences between China and the U.S.:

“China saves and invests; the US talks, consumes, borrows, and talks some more.”

On Why Tax Cuts and Stimulus Alone Won’t Work:

 “Short-term tax cuts or transfers on top of America’s $1,500bn budget deficit are unlikely to do much to boost demand, while they would greatly increase anxieties over future fiscal retrenchment. Households are hunkering down, and many will regard an added transfer payment as a temporary windfall that is best used to pay down debt, not boost spending.”

On Malaise Hampering Businesses:

“Businesses, for their part, are distressed by the lack of direction….Uncertainty is a real killer.”

 

On 5-Point Plan to a U.S. Recovery:

1)      Increased Clean Energy Investments: The recovery needs “a significant boost in investments in clean energy and an upgraded national power grid.”

2)      Infrastructure Upgrade: “A decade-long program of infrastructure renovation, with projects such as high-speed inter-city rail, water and waste treatment facilities and highway upgrading, co-financed by the federal government, local governments and private capital.”

3)      Further Education: “More education spending at secondary, vocation and bachelor-degree levels, to recognize the reality that tens of millions of American workers lack the advanced skills needed to achieve full employment at the salaries that the workers expect.”

4)      Infrastructure Exports to the Poor: “Boost infrastructure exports to Africa and other low-income countries. China is running circles around the US and Europe in promoting such exports of infrastructure. The costs are modest – essentially just credit guarantees – but the benefits are huge, in increased exports, support for African development and a boost in geopolitical goodwill and stability.”

5)      Deficit Reduction Plan: “A medium-term fiscal framework that will credibly reduce the federal budget deficit to sustainable levels within five years. This can be achieved partly by cutting defense spending by two percentage points of gross domestic product.”

Rather than succumb to the nanosecond, fear-induced headlines that rattle off like rapid fire bullets, Sachs supplies thoughtful long-term oriented solutions and ideas. The fact that Sachs mentions the word “decade” three times in his Op-ed highlights the lasting nature of these serious problems our country faces. To better see and deal with these challenges more clearly, I suggest you borrow Sachs’s telescope, and leave the microscope in the lab.

Read Full Financial Times Article by Jeffrey Sachs

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper.  

www.Sidoxia.com 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

July 30, 2010 at 2:18 am 3 comments

Dividends: From Sapling to Abundant Fruit Tree

Dividends are like fruit and an investment in stock is much like purchasing a sapling. When purchasing a stock (sapling) the goal is two-fold: 1) Buy a sapling (tree) that is expected to bear a lot of fruit; and 2) Pay a cheap or fair price. If the right saplings are purchased at the right prices, then investors can enjoy a steady diet of fruit that has the potential of producing more fruit each year. Fruit can come in the form of future profits, but as we will see, the sweetness of a profitable company also paying dividends can prove much more fruitful over the long-term.

Investing in growth equities at reasonable prices seems like a pretty intelligent strategy, but of late the vast majority of fresh investor capital has been piling into bonds. This is not a flawed plan for retirees (and certain wealthy individuals) and should be a staple in all investment portfolios, to a degree (some of my client portfolios contain more than 80%+ in fixed income-like securities), but for many investors this overly narrow bond focus can lead to suboptimal outcomes. Right now, I like to think of bonds like a reliable bag of dried fruit, selling for a costly price. However, unlike stocks, bonds do not have the potential of raising periodic payments like a sapling with strong growth prospects. “Double-dippers” who are expecting the economy to spiral into a tailspin, along with nervous snakebit equity investors, prefer the reliability of the bagged dry fruit (bonds)… no matter how high the price.                     

How Sweet is the Fruit? How Does a +2,300% Yield Sound?

Not only do equities offer the potential of capital appreciation, but they also present the prospect of dividend hikes in the future – important characteristics, especially in inflationary environments. Bonds, on the other hand, offer static fixed payments (no hope of interest rate hikes) with declining purchasing power during periods of escalating general prices.  

Given the possibility of a “double-dip” recession, one would expect corporate executives to be guarding their cash with extreme stinginess. On the contrary, so far in 2010, companies have shown their confidence in the recovery by increasing or initiating dividends at a +55% higher clip versus the same period last year. Underpinning these announcements, beyond a belief in an economic recovery, are large piles of cash growing on the balance sheets of nonfinancial companies. According to Standard & Poor’s (S&P), cash hit a record $837 billion at the end of March, up from $665 billion last year.

The S&P 500 dividend yield at 2.06% may not sound overwhelmingly high, but with CDs and money markets paying next to nothing, the Federal Funds rate at effectively 0%, and the 10-Year Treasury Note yielding an uninspiring 3.11%, the S&P yield looks a little more respectable in that light.

 If the stock market yield doesn’t enthuse you, how does a +2,300% yield sound to you? That’s roughly what a $.05 (split adjusted) purchase of Wal-Mart (WMT) stock in 1972 would be earning you today based on the current $1.21 dividend per share paid today. That return alone is mind-blowing, but this analysis doesn’t even account for the near 1,000-fold increase in the stock price over the similar timeframe. That’s what happens if you can find a company that increases its dividend for 37 consecutive years.

Procter & Gamble (PG) is another example. After PG increased its dividend for 54 consecutive years, from a split-adjusted $.01 per share in 1970 to a $1.93 payout today, original shareholders are earning an approximate 245% yield on their initial investment (excluding again the massive capital appreciation over 40 years). There’s a reason investment greats like Warren Buffett have invested in great dividend franchises like WMT, PG, KO, BUD, WFC, and AXP.

Bad Apples do Exist

Dividend payment is not guaranteed by any means, as evidenced by the dividend cuts by financial institutions during the 2008-2009 crisis (e.g., BAC, WFC, C) or the discontinuation of BP PLC’s (BP) dividend after the Gulf of Mexico oil spill disaster. Bonds are not immune either. Although bonds are perceived as “safe” investments, the interest and principal payment streams are not fully insured – just ask bondholders of bankrupt companies like Lehman Brothers, Visteon, Tribune, or the countless other companies that have defaulted on their debt promises.

This is where doing your homework by analyzing a company’s competitive positioning, financial wherewithal, and corporate management team can lead you to those companies that have a durable competitive advantage with a corporate culture of returning excess capital to shareholders (see Investing Caffeine’s “Education” section). Certainly finding a WMT and/or PG that will increase dividends consistently for decades is no easy chore, but there are dozens of budding possibilities that S&P has identified as “Dividend Aristocrats” – companies with a multi-year track record of increasing dividends. And although there is uncertainty revolving around dividend taxation going into 2011, I believe it is fair to assume dividend payment treatment will be more favorable than bond income.

Apple Allocation

Growth companies that reinvest profits into new value-expanding projects and/or hoard cash on the balance sheet may make sense conceptually, but dividend paying cultures instill a self-disciplining credo that can better ensure proper capital stewardship by corporate boards. All too often excess capital is treated as funny money, only to be flushed away by overpaying for some high-profile acquisition, or meaningless share buybacks that merely offset generous equity grants to employees.

So, when looking at new and existing investments, consider the importance of dividend payments and dividend growth potential. Investing in an attractively priced sapling with appealing growth prospects can lead to incredibly fruitful returns.

Read the Whole WSJ Article on Dividends

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper.  

www.Sidoxia.com 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and WMT, but at the time of publishing SCM had no direct positions in BAC, WFC, C, BP, PG, KO, BUD, WFC, AXP, Lehman Brothers, Visteon, Tribune, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

June 27, 2010 at 10:55 pm 2 comments

EBITDA: Sniffing Out the Truth

Financial analysts are constantly seeking the Holy Grail when it comes to financial metrics, and to some financial number crunchers EBITDA (Earnings Before Interest Taxes Depreciation and Amortization – pronounced “eebit-dah”) fits the bill. On the flip side, Warren Buffett’s right hand man Charlie Munger advises investors to replace EBITDA with the words “bullsh*t earnings” every time you encounter this earnings metric. We’ll explore the good, bad, and ugly attributes of this somewhat controversial financial metric. 

The Genesis of EBITDA

The origin of the EBITDA measure can be traced back many years, and rose in popularity during the technology boom of the 1990s. “New Economy” companies were producing very little income, so investment bankers became creative in how they defined profits. Under the guise of comparability, a company with debt (Company X) that was paying interest expense could not be compared on an operational profit basis with a closely related company that operated with NO debt (Company Z). In other words, two identical companies could be selling the same number of widgets at the same prices and have the same cost structure and operating income, but the company with debt on their balance sheet would have a different (lower) net income. The investment banker and company X’s answer to this apparent conundrum was to simply compare the operating earnings or EBIT (Earnings Before Interest and Taxes) of each company (X and Z), rather than the disparate net incomes.  

The Advantages of EBITDA

Although there is no silver bullet metric in financial statement analysis, nevertheless there are numerous benefits to using EBITDA. Here are a few:

  • Operational Comparability:  As implied above, EBITDA allows comparability across a wide swath of companies. Accounting standards provide leniency in the application of financial statements, therefore using EBITDA allows apples-to-apples comparisons and relieves accounting discrepancies on items such as depreciation, tax rates, and financing choice. 
  • Cash Flow Proxy: Since the income statement traditionally is the financial statement of choice, EBITDA can be easily derived from this statement and provides a simple proxy for cash generation in the absence of other data.
  • Debt Coverage Ratios:  In many lender contracts certain debt provisions require specific levels of income cushion above the required interest expense payments. Evaluating EBITDA coverage ratios across companies assists analysts in determining which businesses are more likely to default on their debt obligations.

The Disadvantages of EBITDA

While EBITDA offers some benefits in comparing a broader set of companies across industries, the metric also carries some drawbacks.

  • Overstates Income:  To Charlie Munger’s point about the B.S. factor, EBITDA distorts reality. From an equity holder’s standpoint, in most instances, investors are most concerned about the level of income and cash flow available AFTER all expenses, including interest expense, depreciation expense, and  income tax expense.
  • Neglects Working Capital Requirements: EBITDA may actually be a decent proxy for cash flows for many companies, however this profit measure does not account for the working capital needs of a business. For example, companies reporting high EBITDA figures may actually have dramatically lower cash flows once working capital requirements (i.e., inventories, receivables, payables) are tabulated.
  • Poor for Valuation: Investment bankers push for more generous EBITDA valuation multiples because it serves the bankers’ and clients’ best interests. However, the fact of the matter is that companies with debt or aggressive depreciation schedules do deserve lower valuations compared to debt-free counterparts (assuming all else equal).

Wading through the treacherous waters of accounting metrics can be a dangerous game. Despite some of EBITDA’s comparability benefits, and as much as bankers and analysts would like to use this very forgiving income metric, beware of EBITDA’s shortcomings. Although most analysts are looking for the one-size-fits-all number, the reality of the situation is a variety of methods need to be used to gain a more accurate financial picture of a company. If EBITDA is the only calculation driving your analysis, I urge you to follow Charlie Munger’s advice and plug your nose.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing had no direct positions in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 6, 2010 at 11:00 pm 1 comment

Short-Termism & Extremism: The Death Knell of our Future

In recent times, American society has been built on a foundation of instant gratification and immediate attacks, whether we are talking about politics or economics. Often, important issues are simply presented as black or white in a way that distorts the truth and rarely reflects reality, which in most cases is actually a shade of grey. President Obama is discovering the challenges of governing a global superpower in the wake of high unemployment, a fragile economy, and extremist rhetoric from both sides of the political aisle.  Rather than instituting a promise of change, President Obama has left the natives restless, wondering whether a “change for worse” is actually what should be expected in the future.

Massachusetts voters made a bold and brash statement when they elected Republican Senator Scott Brown to replace the vacated Massachusetts Senate seat of late, iconic Democratic Senator Edward Kennedy – a position he held as a Democrat for almost 47 years. Obama’s response to this Democratic body blow and his fledging healthcare reform was to go on a populist rampage against the banks with a tax and break-up proposal. Undoubtedly, financial reform is needed, but the timing and tone of these misguided proposals unfortunately does not attack the heart of the financial crisis causes – excessive leverage, lack of oversight, and irresponsible real estate loans (see also, Investing Caffeine article on the subject).

With that said, I would not write President Obama’s obituary quite yet. President Reagan was left for dead in 1982 before his policies gained traction and he earned a landslide reelection victory two years later. In order for President Obama to reverse his plummeting approval ratings and garner back some of his election campaign mojo, he needs to lead more from the center. Don’t take my word for it, review Pew Research’s data that shows Independents passing up both Republicans and Democrats. The overall sour mood is largely driven by the economic malaise experienced by all in some fashion, and unfortunately has contributed to short-termism and extremism.

Technology has flattened the world and accelerated the exchange of information globally at the speed of light. Any action, recommendation, or gaffe that deviates from the approved script immediately becomes a permanent fixture on someone’s lifetime resume. Our comments and decisions become instant fodder for the worldly court of opinion, thanks to 24/7 news cycles and millions of passionate opinions blasted immediately through cyberspace and around the globe.

Short-termism and extremism can be just as poisonous in the economic world as in the political world. This dynamic became evident in the global financial crisis. Short-termism is just another phrase for short-term profit focus, so when more and more leverage led to more and more profits and higher asset prices, the financial industry became blinded to the long-term consequences of their short-term decisions.

Solutions:

  • Small Bites First: Rather than trying to ram through half-baked, massive proposals laced with endless numbers of wasteful pork barrel projects, why not focus on targeted and surgical legislation first? If education, deficit-reduction, and job creation are areas of common interest for Republicans and Democrats, then start with small legislation in these areas first. More ambitious agendas can be sought out later.
  • Embrace Globalization: Based on the “law of large numbers” and the scale of the United States economy, our slice of the global economic pie is inevitably going to shrink over time. How does the $14 trillion U.S economy manage to grow if its share is declining? Simple. By eschewing protectionist policies, and embracing globalization. Developing country populations are joining modern society on a daily basis as they integrate productivity-enhancing innovations used by developed worlds for decades. In a flat world, the narrowing of the productivity gap is only going to accelerate. The question then becomes, does the U.S. want to participate in this accelerating growth of developing markets or sit idly on the sideline watching our competitors eat our lunch? 
  • Hail Long-Termism and Centrism:  Regulations and incentives need to be instituted in such a fashion that irresponsible behavior occurring in the name of instant short-term profits is replaced with rules that induce sustainable profits and competitive advantages over our economic neighbors. Much of the financial industry is scratching and screaming in the face of any regulatory reform suggestions. The bankers’ usual response to reform is to throw out scare tactics about the inevitable damage caused by reform to the global competitiveness of our banking industry. No doubt, the case of “anti-competiveness” is a valid argument and any reforms passed could have immediate negative impacts on short-term profits. Like the bitter taste of many medicines, I can accept regulatory remedies now, if the long-term improvements outweigh the immediate detrimental aspects.

The focus on short-termism and extremism has created an acidic culture in both Washington and on “Main Street,” making government changes virtually impossible. If President Obama wants to implement the change he campaigned on, then he needs to take a more centrist view that concentrates on enduring benefits – not immediate political gains.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

Article first submitted to Alrroya.com before being published on Investing Caffeine.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds but at the time of publishing had no direct positions in securities mentioned in the article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 3, 2010 at 12:01 am Leave a comment

Plucking the Feathers of Taxpaying Geese

“The art of taxation consists in so plucking the goose as to get the most feathers with the least hissing.” ~Jean Baptist Colbert

With exploding deficits, multiple wars, healthcare reform, and a sluggish economy, there are two logical immediate choices on how to improve our current financial situation:

1)      Cut spending. This is not a desirable option for politicians since benefit cuts to voters are not appreciated come re-election period.

2)      Raise Taxes. Not desirable from a voter standpoint either, but the Obama administration has chosen to target the rich – the smaller voting population. This can of course backfire, when many of these wealthy individuals are campaign contributors or have ties to lobbyists who are backing the President’s agendas.

The tax-paying geese are getting fatter, but before the goose can be put in the oven, the feathers need plucking with the goal of minimizing hissing. Sure, I am an advocate for tax cuts like most taxpayers. I’m even a larger proponent, if Congress had the political gumption to cut spending to fund the tax drops. Unfortunately, politicians view expense reduction as suicide because cutting programs or benefits will only lead to fewer reelection votes. Congressmen are perfectly fine letting taxpayers live high on the hog for now, and just saddle future generations with our mounting debt problems.

What’s Fair?

The current strategy is based on taxing the wealthy to fund deficits, healthcare, wars, debt, etc. Since the rich represent a smaller proportion of voters, from the egotistical politician standpoint (reelection is paramount), this wealth distribution strategy appears more palatable to incumbent legislators. Democrats would rather focus on squeezing a narrower demographic footprint of voters versus an across the board tax increase, which would impact all taxpayers. Merely taxing the rich can certainly backfire however, especially if the wealthy demographic getting taxed is the exact population paying for the politicians’ reelection and lobbying agendas.

Source: Alan’s Money Blog (U.S. has high corporate tax rate)

But at what point is taxing the rich unfair and counterproductive?  Currently the top 10% of the nation that earns more than $92,400 a year, pay about 72% of the country’s income taxes. Ari Fleischer, former G.W. Bush Press Secretary compares the current tax policy to an “inverted pyramid scheme” in a Wall street Journal Op-Ed earlier this year. Like an upside spinning top, the whirling pyramid is supported by a narrow, pointy pinnacle.

Fleischer goes onto add:

“According to the CBO, those who made less than $44,300 in 2001 — 60% of the country — paid a paltry 3.3% of all income taxes. By 2005, almost all of them were excused from paying any income tax. They paid less than 1% of the income tax burden. Their share shrank even when taking into account the payroll tax. In 2001, the bottom 60% paid 16.3% of all taxes; by 2005 their share was down to 14.3%. All the while, this large group of voters made 25.8% of the nation’s income. When you make almost 26% of the income and you pay only 0.6% of the income tax, that’s a good deal, courtesy of those who do pay income taxes.”

 

Cheaters Should Not Be Exempt (See Celebrity Tax Evader Article)

Certainly loopholes and undeserving credits for multinationals and the wealthy should be removed as well. The House of Representatives recently approved a $387 million boost for the IRS to fund a high-wealth unit focusing on trusts, real estate investments, privately held companies and other business entities controlled by rich individuals (read Reuters article). The IRS is also opening new criminal offices in Beijing, Panama City and Sydney to focus on international enforcement of tax cheaters. At the center of the IRS’ offshore effort is the legal cases against Swiss banking giant UBS (stands for Union Bank of Switzerland), which resulted in UBS agreeing to turn over almost 5,000 client names and pay $780 million to settle tax evasion charges.

Taxes in 2010 and Beyond

When it comes to future taxes, a lot of details remain up in the air. What we do know is that the 2001 Bush tax cuts are set to expire in 2010 and the Obama administration has indicated they want to raise taxes on the rich (those earning more than $250,000) and keep the cuts static for those in the lower paying tax brackets.

  • Healthcare: If healthcare reform will indeed pass, those benefits won’t be free. The Obama administration is backing a House bill that creates a 5.4% surtax on income over $500,000 for single filers or $1 million for couples.
  • Income Taxes: On the income tax front, Obama and some Democrats are pushing to have the two highest tax brackets revert back to the pre-2001 levels of 36% and 39.6%.
  • Capital Gains: If the Obama administration gets its way, capital-gains tax rates would go back to 20% for wealthier individuals and qualified dividends would be taxed as ordinary income up to the top rate of 39.6%.
  • Estate Taxes: The House passed a bill earlier this month that makes the 2009 estate tax provisions permanent (i.e., a  45% top marginal rate on estates larger than $3.5 million or $7 million for married couples). If the Senate were not to pass the bill, current law has the estate tax rate reverting to a 55% rate on estates worth more than $1 million after next year.

Given the exploding deficits and weary economy, which is recovering from a severe economic crisis, getting our tax policy situation back in order is critical. Having politicians make tough tax policy decisions runs contrary to their partisan reelection agendas, however our country needs to pluck more feathers from our taxpaying geese to face these monumental economic challenges…even if it requires listening to irritating hissing from our citizens.

Ari Fleischer WSJ Op-Ed From Earlier This Year

Article on Tax Policy Issues for 2010 and Beyond

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in an security referenced, including UBS. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 21, 2009 at 1:45 am 4 comments

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