A modest tax proposal

We have heard enough about what the candidate's tax plans are.  We know the current system is complex, and distorts economic decisions, and on some levels - unfair.  

Ideally, I think the 16th Amendment should be repealed.  Washington should not have been given the ability to tax income because it gives too much money, and thus too much power to meddle in our lives.    Ideally, a 10% VAT, excise taxes, and modest duties should cover the duties that are the prescribed powers of the federal government per the constitution.   But let's just admit that is not happening any time soon.  Sorry fair taxers, we're stuck with the income tax for a while.

So what principles do we want for an income tax system.  I would propose the following:

1. That it raise sufficient revenue to cover necessary government expenditures (sorry - this would probably mean a realistic downsizing of the Washington - i.e. no more department of education.
2. Not distort economic decisions - it should try all types of income the same - a person making $100K/year only as salaries should pay the same amount of tax as someone who makes $100,000/year on dividends.
3. Everyone should pay a de minimis tax.   I do not believe that people should not have to pay tax if their income falls below a certain level - citizens should all bear a minimum burden for the government they want so that they do not become detached from the costs of running it.   
4. Not be burdensome on those of modest means.
5. Simple to administer (this is tricky, you will still need a ton of volumes to define things, even a simple income tax needs to determine a lot of things).

So this is kind of what I came up with.

1. Income tax with one bracket of 20%.
2. All income taxed at same rate - interest, dividends, capital gains, wages...
3. Capital gains is determined with a CPI adjustment in order not to be taxed on inflationary changes in prices.  
4. Capital losses are 100% deductible immediately.
5. Only itemized deduction is charitable contributions - but with no income limitation.  No more deduction for state and local taxes (subsidizing those living in high tax states) and mortgage interest (no more distorting the housing market and putting renters at disadvantage).
6. Standard deduction of $10,000/filer and $5,000 per dependent.  Married filing joint with two children have $30,000 deduction.
7. Minimum tax is $250 - regardless of income.
8. Contributions to tax deferred retirement accounts deductible - no limitations.  However, early withdrawals subject to 15% penalty.

James Grant on the credit bubble - WSJ

James Grant is one of my favorite market commentators. Read his article in the Wall Street Journal on the confidence game that is the US dollar and credit markets. The key passage in my opinion:

But it wasn't the vigilance of monetary policy that facilitated the construction of the tree house of leverage that is falling down on our heads today. On the contrary: Artificially low interest rates, imposed by the Federal Reserve itself, were one cause of the trouble. America's privileged place in the monetary world was -- oddly enough -- another. No gold standard checked the emission of new dollar bills during the quarter-century on which the central bankers so pride themselves. And partly because there was no external check on monetary expansion, debt grew much faster than the income with which to service it. Since 1983, debt has expanded by 8.9% a year, GDP by 5.9%. The disparity in growth rates may not look like much, but it generated a powerful result over time. Over the 25 years, total debt -- private and public, financial and non-financial -- has risen by $45.1 trillion, GDP by only $10.9 trillion. You can almost infer the size of the gulf by the lopsided prosperity of the purveyors of debt. In 1983, banks, brokerage houses and other financial businesses contributed 15.8% to domestic corporate profits. It's double that today.

The dirty secret of Obama's job creation tax credit

So Obama is now proposing a temporary tax credit of up to $3,000 for firms that hire new workers.   I'll tell you why it is a scam, and is typical of the sound goods on the stump/sucks in reality:

1. The full credit doesn't kick in till $75K.   Most new jobs are well below that.
2. If they business is a S-corp/partnership - Obama's proposed income tax increase and FICA limit increases will not be offset by this credit.
3. If you are a Schedule C/S-Corp/Partnership - the credit in all likelihood will not be creditable against AMT.   Most tax credits are not good for AMT for individuals.  So, you might get the credit for regular income tax, but then it'll be taxed right back under AMT.

Basically - the credit is useless for small business.   When taxpayers normally talk about tax credits - they never work because the bulk of them are not creditable against AMT.

To John McCain: Campaign advice from Herm Edwards

There are opportunities in the markets

What I love about panics like this, is that there are some great companies now on sale.  I see many well run companies now at valuations where I can envision buying them.   I have become, though experience a Graham/Dodd value investor.   For those of you who aren't familiar - this is classic value investing - placing emphasis on a strong balance sheet and buying stock priced with a "margin of safety".

We have been due for a sustained bear market for a while.  We haven't had a real one since the 70's.   The media and most people do not remember what a sustained bear market is like, as most of us were too young or not born yet to fully grasp it.   It is a bit of a shock, as too many people have been conditioned to think of perpetual growth in the markets with minor dips here and there. 

Everybody needs to chill out, and just understand that it is not the end of the world.   The markets will eventually sort itself out as they find natural support levels and stabilize.   The best things people can do is save, pay off your debts, and start looking for investment opportunities in the markets.

To paraphrase the great emerging markets manager Mark Mobius - "the best time to buy is at the point of maximum pessimism".   Keep that in mind when watching the market.   Those who keep their heads on a swivel and have cash available will reap the rewards.

This is what I think Obama's Tax Policy will end up being

I've been a CPA for almost 6 years know, and in the financial services industry on and off for the last 15. Based on those experiences, I can say I have a good understanding of both items. Well this article about Congressional changes on pension plans show that there is no limits to the obtuseness of both Democratic Congressmen and academics. A brief passage:

“With respect to the 401(k), it appears to be a plan that is not really well-devised for the changes in the market,” Rep. George Miller, D-Calif., said.

“We’ve invested $80 billion into subsidizing this activity,” he said, referring to tax breaks allowed for 401(k) contributions and savings.

With savings rates going down, “what do we have to start to think about in Congress of whether or not we want to continue and invest that $80 billion for a policy that is not generating what we … say it should?” Mr. Miller said.

Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds, suggested Teresa Ghilarducci, an economics professor at The New School for Social Research in New York.

When workers collected Social Security, the guaranteed retirement account would pay an inflation-adjusted annuity under her plan.

“The way the government now encourages 401(k) plans is to spend $80 billion in tax breaks,” which goes to the highest-income earners, Ms. Ghilarducci said.

That simply results in transferring money from taxed savings accounts to untaxed accounts, she said.

Where do I start on this? Needless to say, this really got me riled up. How this is so wrong:

1. The idea of retirement accounts and the corresponding tax deductions was to encourage people to save. Savings means capital for economic growth. The U.S. has one of the worst savings rate in the industrialized world. This would encourage consumption and deter investment. We complain now how all these Sovereign Wealth Funds are buying up all the companies and real estate in the U.S. They will own a lot more once Americans are deterred from saving.
2. The other part of 401(k) plans is that the taxpayer gets a deduction now, all growth in the account is tax free, but the catch is that all withdrawals from the account are taxable as income. Phasing out or eliminating the deduction for 401(k) plans would result in double taxation for many taxpayers.
3. Does Representative Miller mean that only 401(k) plan deductions be taxable? What about contributions by employees to big fat unionized defined benefit plans? If we are talking about taxing contributions to retirement accounts as a subsidy, shouldn't we throw in defined benefit plans, SEPs, IRAs, SIMPLE, Keogh plans as well?
4. The individual 401(k) limit is $15,500 if under the age of 49 and $20,500 if over 50 for 2008. An individual in the top bracket would get a reduction of income tax to the amount of $5,425 - but they would have to make at least $357,700 filing joint for the maximum bang. If someone is in that bracket, they are paying roughly north of $100,000 in federal income tax. I don't think this is such a huge "loophole for the rich"
5. Teresa Ghilarducci is a retard. Period. "Congress should let workers trade their 401(k) assets for guaranteed retirement accounts made up of government bonds" Hmmm.. hasn't Ghilarducci heard of social security? In case she hasn't it is essentially a guaranteed retirement account made up of government bonds (in theory, but I bet congress would raid your retirement account like it does social security). It is going insolvent in the next couple of years.
   
6. Government bonds have underperformed the stock markets historically. This plan would impoverish savers by limiting their returns to fixed income securities, even if you include this recent meltdown. Even though investors "lost" $2 trillion in the past month due to the stock market turmoil - most investors are in for the long term. They are paper losses until one sells. To reiterate - over the long run, stocks outperform bonds.

This is just wrong wrong wrong on so many levels.... cradle to grave! We're on the road to serfdom and the pedal is to the metal. Someone has to straddle this road and scream "stop"!

The End of the Beginning

With the passage of the rescue package by Congress, we have started the next phase of this contagion.   

I cannot say that this package will have any effect outside of psychological.  It might help settle the overnight LIBOR rate drop from its record highs as some confidence comes into the system.   The problem is, like a lot of things that get passed as legislation these days, is that rushed bills like this are like a condom - they let you feel good when in reality you're getting screwed.   Perhaps that is a harsh judgement, but the problem we have here is primarily about capital, not illiquid assets.

Let me put it to you this way, any institution who sells their toxic assets at a fair value to the Treasury for government bonds is only exchanging an illiquid asset for a liquid asset.  While this may help the liquidity of the institution in question, it does not address the problem that it is woefully undercapitalized.  Insufficient capital leads to bank runs, and the inability of banks to make new loans and extend credit.   In other words, we still will have a significant contraction of lending as banks still de-lever their balance sheets.

And we have not addressed how the "shadow banking system" of hedge funds and SIVs are going to get clobbered on this.  They, as it stands to the best of my knowledge, are not eligible for the rescue plan.  They will have to liquidate their positions as they lose capital to redemptions.  Hundreds, if not thousands, of hedge fund will be going bust as they face increasing redemptions, the inability to refinance on the commercial paper market, and with large illiquid toxic assets on their balance sheets.  This gradual unwinding of trillions of dollars of assets and liabilities will depress the stock markets for at least another year.

So, looking into the crystal ball, I see the following trends for the next year or two:

1. Several large banks will still fail and will be taken over by the FDIC.  Dozens, if not hundreds, of regional and local banks will be too.
2. The S&P 500 will drop below 900 points by the end of 2009.  We should expect a 25% decline in the markets as companies continue to de-lever.
3. Credit card and auto loan defaults will hit record highs over the next year.
4. Home prices, as measured in the S&P Case-Shiller index, will bottom out for most markets by Q1 2010.
5. Depressed demand will bring oil down to under $70/barrel.
6. Gold will be off its record high, but not much due to the debasing of the U.S. dollar that this rescue plan creates.
7. One of the big 3 automakers will not exist as a stand alone entity (either bought out or Chapter 11) by the end of 2010.