The end of Herman Cain's candidacy

Last week, Herman Cain "retired" - or at least withdrew his bid for the Republican nomination for presidency.

Amen... and amen to his 9-9-9 tax plan either.

In case you missed it, Herman's tax plan, in short, proposed a 9% tax rate on individuals, 9% on corporations, and 9% sales tax.

That always seems so simple....

But alas.... as Michele Bachmann points out in the 999 upside down, the devil is in the details...

Certainly most people would embrace the simplicity of paying 9% of their income.  If you just earn a salary from an employer - your "income" is pretty easy to determine (assuming you give decide whether the exemption for  employer-provided health insurance should remain in place, and if you still get to contribute to a 401(k)).  But what if you are self-employed, and you have expenses related to your income?  Do you just tax 9% of your revenue?  Because if you always deductions for expenses - you open up a hornet's nest of complexity - starting off with depreciation, and when an item is deductible (when paid or when used up).  Those two issues alone consume hundreds of pages of IRS laws and rules.

I guess the one lesson that can be learned from this is as follows.  IF the tax system was so easy to fix, someone (or some group of people) would have figured it out a looooog time ago.

Tax reform committee crashes and burns up....

Well, belated Happy Thanksgiving - and the Tax Reform committee decided to punt a turkey to celebrate the holiday!

The "Super Committee" (of six Republicans and six Democrats) were charged with the task in August of 2011 of creating new tax laws (which could result in more tax revenue) and spending cuts at least equalled to $2.4 trillion over the next ten years.  Otherwise, automatic cuts would take place.

Well, get ready for the automatic cuts.

The problem is the Democrats simply won't move on without some new taxes - while the Republicans (not all, but a significant number), simply won't agree to any tax hikes.

I was hoping they both would stand back and think "outside the box" - like what if we eliminate a whole bunch of deductions (home mortgage interest, for example, which only benefits 1/3 of all taxpayers and gives nearly 60% of the benefit to the top 5% of income earners) - and decrease all the tax rates.

Ultimately, you could create more revenue for the Treasury - though it would not be clear that any particular income class has benefited or lost due to the change.

Unfortunately, that didn't happen.... oh well, like many sports fans say - "There is always next year!"

Excess cash

There was a couple of interesting quotes in a New York Times Business Section article last week:

1) “Companies are holding back on spending even though they have built cash reserves to 6 percent of their total assets, the highest level since 1952, according to Credit Suisse.

2) “The proportion of United States’ companies cash flow being spent on new equipment and other investments has not rebounded since the financial crisis and is stuck at the lowest level since the late 1950s, again according to Credit Suisse.

The New York Times is notorious for advocating a consistently liberal or left-wing bias - even in the Business Section.    But in this case, they are dead-on correct about picking on the Republican drum-beat of tax cuts.

Why cut taxes?  Answer - so investors (and consumers) can use the money to stimulate the economy in a more efficient manner than the government.

Hey, guess what?  As these quotes show - giving the money to businesses isn't going to do any good at this time.  It is only going straight to their bank accounts to earn .001% interest.

A consistent tax policy is ultimately the wrong policy at some point in time.  Economies change through the years - back and forth from good to bad (and even mediocre).

Warren Buffett's Hypocrisy and the Estate Tax

Last week, Warren Buffett, one of the world’s wealthiest men, “admitted” he was under-taxed and suggested that the US federal government should increase the tax rate for him and others at his level of income.

Many conservative columnists opined that Buffett should just write the US government a check for whatever “deficit” he feels he owes.

I merely want to point out Buffett's hypocrisy.

When Buffett suggests he is “under-taxed,” he is stating that the government has better uses for his money than he does (through his businesses, charities, or personal spending).  That may be true – or it may not be.  It really depends on the current condition of the world and US economy.  It is not always true that private businesses are more efficient with money than the government…or that private businesses will always be greater job creators than the federal government….(sorry Rick Perry, Sarah Palin, et al)... but it is true much of the time.

But back to Buffett.  OK, fine – he believes the government needs the money more than he or any other private organization does.

So let's take a look at Buffett’s estate planning. 

In the US, when you die, if you are worth more than $5,000,000, nearly 50% of your total net worth is going to go to the US federal government.

Now, don’t stay awake at night and worry about this.  In 2009, about 3 million people died in the US.  Of those 3 million, all of 15,000 owed the estate tax.

That’s right – only about ½ of 1 percent – or 5 out of every 1000 people who died owed estate tax.

Now, Buffett is estimated to be worth about $50 billion.  When he dies, his estate will owe between $20 to $25 billion to the federal government, unless he:

1)      gives it to his spouse (who then has to pay it when she dies) OR

2)      give it to a charity.

So guess what?  Buffett, who said last week he would rather give his money to the government than any other private organization, is giving nearly his entire estate of $50 billion to a charity.

http://money.cnn.com/2006/06/25/magazines/fortune/charity1.fortune/

Action speak louder than words, and Mr. Buffet's actions indicate that he believes the private sector, in this case, private foundations, can make more efficient use of his money than can the government. This, of course, isn’t the first time an extremely wealthy individual has decided he would rather have a private organization use his money rather than the US government.  Obviously, Bill Gates and his wife Melinda of Microsoft fame also made the same choice.  During the 20^th century, the Rockefeller, Ford and Carnegie Foundations are just some of the examples of very wealthy families getting out of paying a good portion of their estate tax by donating a substantial portion of their wealth to charity.

One very strong argument about keeping the estate tax in place (or “death tax” as its opponents like to call it) – is the ability to “force” wealthy individuals to give substantial portions of their wealth to charities. In fact, one study (by the non-partisan Congressional Budget Office) indicated repealing the estate tax would decrease overall charitable contributions by 30%.

Corporations are people too!

So Mitt Romney uttered the line “corporations are people” and liberals jumped all over him.

Would it have been better if Mitt merely said “corporations are a nexus of contracts” instead?

Frankly, part of the public’s misunderstanding (and hence mistrust) of the income tax system is exactly due to the lack of critical thinking that the liberals have shown here.

Democratic US Rep. Debbie Wasserman Schultz of Florida mocked Romney by asking “Does General Electric have human qualities?”

No, Rep. Wasserman Schultz – GE doesn’t have human qualities – but we don’t impose taxes on “human qualities” either.

Corporations really are made up of people.  You can argue that the corporate tax system (and regulatory system) sometimes allows really bad people to make large amounts of money at the expense of poor, under-educated individuals who have no control over their plight – but hey – at least allow the debate to be about who (as in people) get or are denied what because of the tax system.

The liberals here are engaging in a popular psychology ploy – describing the enemy in the most abstract terms – so people really don’t know anything about them – except they are “big, bad corporations.” Psychologists have found that the more you know about the other side, the more you may come to empathize, or at least understand, them and their motives.

Hollywood does a great job in many movies capitalizing on this psychology behavior in humans.  For example, in the movie “Independence Day,” the alien spaceship kills millions early in the movie through a huge explosive laser beam, but you really don’t feel their pain since you really haven’t been introduced to them in the story line.  After two hours of the movie, though, if Will Smith (who you now know) had been killed, that single death would have been personal and felt more than the millions to die previously.

In another movie, Die Hard 2, a group of terrorists overtake an airport’s air traffic control system.  First, they intentionally crash a plane.  The movie audience briefly (for 5 seconds) sees the airplane’s passengers as they are preparing to land.  As the plane explodes – you feel bad – but not terrible since you never “knew” anybody on the plane.

Liberals are doing the same thing now – maligning big bad "corporations" implies they are not made up of people.

Listen – corporations are made up of people.  When a corporation makes profits, the money can go to the government or to other companies or to shareholders or to employees - including those “already filthy rich executives.”

But the money is going to people.  In order to even begin a critical discussion of how much each of these entities is entitled to - and how, if and when the tax system needs to be involved in this distribution system – you need to at least acknowledge that fact.

My doctoral dissertation in economics at Notre Dame examined something similar – what is the effect of large management buyouts on various stakeholders to a corporation (by stakeholders, I mean the US government, employees, and current and future shareholders - all ultimately "people").

Basically, I found that these buyouts (where management takes a company “private”) benefits current and future shareholders tremendously – at the cost of hundreds or thousands of employees losing their job and the US government taking in less money from tax revenues than it would have otherwise.

In Mitt Romney’s old job, he was on the receiving end of these buyouts - to the chagrin of undoubtedly thousands of former employees – and the delight of thousands of shareholders.  He knows all about “people” involved in corporations.

But at least he is ready to engage in the conversation.

And as for Debbie Wasserman Schultz - don't look for her to announce that "labor unions are not people"  anytime soon.....

Stock market crashing, capital losses and tax reform

So yesterday, while I was returning from Denver (elevation 5,280) to Dallas (elevation 430 feet), the stock market decided to make a similar journey.

In case you didn’t know it, you can deduct your losses on tax return (Form 1040) to the extent of  $3,000, less any gains.

I think I already told you in a prior blog that they haven’t indexed that $3,000 for inflation in nearly 35 years (if they had, it would be worth around $10,000 now).

Today Obama again mentioned hopes of tax reform.  One way he could do this is to make this deduction “fairer” – and by fairer, I mean more helpful to the small investor that has lower taxable income.

The absence of the small investor right now (outside of retirement accounts) is partly to blame for the wild swings in the stock market during the past few years – many trades are being made either by hedge funds or big brokerage firms, who enter and exit the market much faster and more often than the small investor.

But the small investor has little reason to come back – including the fact that the $3000 loss deduction is seriously benefiting high income taxpayers and not "middle" America.

The reason why is that the tax costs of the gains versus the tax benefits of the losses are not symmetrical. Because of that, high income taxpayers get a much better deal on their losses than low income taxpayers.

Let’s start with the first item – symmetry.  If your taxable income is $500,000 per year, you’re in the 35% bracket.  If you have an additional gain on sale of stock – say a $3,000 gain – it is taxed at 15%.  So you pay $450 more.

Now suppose instead you have a loss of $3000 at 35%.  You end up paying $1050 less in taxes. 

That’s right – UP and you owe $450 to the government, DOWN and you get back $1050.

Suppose your taxable income is $30,000.  You get a gain of $3,000 – you pay tax on it at 10% - $300.  Down and you pay $300 less in taxes as well.

Let’s see – UP and you owe $300 to the government, DOWN and the government owes you $300.

Just another reason why you would rather make $500,000 a year than $30,000.

Instead of correcting disparities like this, presidential candidates (former Governor and 2008 Presidential candidate Mike Huckabee of Arkansas comes to mind) become obsessed with these “pie in the sky” ideas like FLAT TAX (!!) (as if the Flat tax is going to fix all the problems – but I will cover that in a future blog).

FAA tax, my trip to Denver and I am bummed out....

I am bummed out.

In case you haven’t been following this – the Federal Aviation Adminstration tax (which is about 10% of your airline ticket cost) was “suspended” on July 22 due to disagreements between the HofR and Senate.  This tax pays for the construction of new airport expansions.

If you paid for your ticket before July 22 (which I did for my Dallas to Denver flight), and flew both ways BEFORE Congress reinstated the tax, you might be able to petition the IRS for a refund (Delta and United were both offering simply to refund the tax on your credit card).

Unfortunately, before I got back to Dallas from Denver next week, the tax was reinstated… so no refund for me... in fact, Obama signed the bill into law today, painfully while I was in the air to Denver....

You can read about it here:

http://www.reuters.com/article/2011/08/05/uk-congress-reaches-deal-to-end-faa-shut-idUSLNE77400A20110805

An interesting tax “phenomenon” occurred when the tax was dropped two weeks ago.

Typically politicians will say that instituting a tax hike will penalize consumers with higher prices. 

This whole FAA tax suspension proved that is not necessarily true by proving the reverse.

When the tax was suspended, you would have expected prices of airline tickets to drop.

For example, if the price of the ticket was $300 before the suspension (based on $270 for the flight and $30 for the tax), you would have expected the price to decrease to $270.

Guess what happen?  Airlines simply all raised their fares $30 – so they were still collecting $300 per ticket.

A tax cut – or a tax hike – does not mean that the consumer will pay less or pay more.  In this case, a strong oligopoly (few companies controlling most of the airline tickets) could coordinate their action to insure they got all the money from the tax cut.

Cutting taxes doesn’t always mean more money for consumers – corporations could simply keep the money and increase their net income (or pay workers more, or reinvest in operations more, or pay more to shareholders). 

Raising taxes doesn’t always mean higher prices for consumers – corporations might be forced to keep prices the same and pay the tax themselves – thereby reducing their net income.

Similarly, if Congress were to increase the gas tax, or increase the taxes paid by oil companies on their income – it doesn’t necessarily mean that consumers would pay higher prices at the pump – corporations could simply make less income.  It all depends on the supply and demand forces working within that sector of the economy at the time.

In four words – “well, it all depends….”

Denver, Colorado here I come this weekend!

Off to Denver this Friday for the American Accounting Association's national meeting - where nearly 3000 accounting professor will all be in one place at one time.

One of the luncheon speakers is Paul MacCartney's sister - Ruth - who will speak on "The Role of Social Media in Education."

And who said accounting profs weren't cool?!!

Debt deal ready for passage - absent a shock - next few months interesting.

The bill (soon to be law) contains requirements for additional spending cuts, plus some elements of tax reform.

That should make for some interesting discussions on this blog for the next few months.

One thing to point out though - Obama didn't fail to increase taxes on the wealthy.  He failed to increase taxes on people whose taxable income exceeded $200,000.

The headlines always say "raise taxes on the rich" or "fails to raise taxes on the wealthy" - but that isn't the case.  The federal government doesn't tax wealth (unless it's the estate tax which is such a small portion of tax revenues, it can be ignored for this discussion).

The federal government taxes taxable income.  Period.

Now, of course, you can argue that wealth and taxable income are heavily correlated - and you're probably right most of the time.

But it is a smart tax-literate person who can figure out how to disconnect the two. (It is usually done through years of savings, squirrelling away money into investment vehicles that don't pay current taxable income, and reaping returns on investments which produce income that is not currently taxable - think some stocks, real estate, etc.).

Take as an example, Mr. Miser's portfolio of assets totaling $2,200,000 (and assume he has no debt):

Non-dividend paying stock     $1,000,000
401(k)                                         $500,000
Land holdings                             $300,000
Personal residence                      $400,000

Suppose Mr. Miser's salary from his job last year was $100,000, and each of his investments listed above grew 10% for the year. 

How much taxable income does he have?  Easy - just his salary of $100,000 (less some deductions). None of his investments listed above will appear on his 1040 tax return since none produce taxable income in the current year.

How much did his assets grow?  Well, his total assets listed about were $2,200,000, so he "made" another $220,000 on that - but none of that is currently taxable.  Total income - $320,000.

So Mr. Miser is wealthy - he is a multi-millionaire - he made over $300,000 last year - but his taxable income is "only" $100,000 (less some deductions) - and he won't register on Obama's "tax increase on the wealthy" list.

And no, the tax reform you're going to see over the next few months isn't going to change any of those rules.

9AM CDT Sunday and a deal may be near

I am surprised there are no taxes increases being discussed.... I can't believe the Republicans could pull that off - especially since one of Obama's central pledges in the 2008 election was increasing taxes on families making more than $250,000.

Of course, every year there are tax increases on most US taxpayers just due to inflation and yet the lawmakers seems to ignore that problem (or simply are enjoying the "flexibility" of increased spending potential).

The taxability of social security benefits comes to mind.  In 1983, social security benefits became taxable for single filers earning (a modified adjusted gross income) more than $25,000 ($32,000 for married filers).  In 1993, the taxability of higher income taxpayers increased even more.

Has this amount been indexed to inflation?

Nope.

So as wages, interest, dividends and of course, social security benefits, have increased just due to inflation every year, what do you expect would have happened?

That's right - the portion of social security that is "taxable" increases each year.  It will happen again certainly in the next couple of years (2012 or 2013) despite the "no new taxes" pledge of 240 Republicans.

Just checked the IRS Statistics of Income to give you an example.  In 1996, $53 billion of social security benefits were taxable.  In 2008, $151 billion (a 300% increase) was taxable.  That extra $100 billion in taxable income provides the US Treasury with an extra $20 billion a year or so.

The problem of ignoring certain threshold adjustments because of inflation for decades is a common problem with Washington.  The rental real estate loss limitation for taxpayers with income greater than $100,000 was set in 1986, the capital loss limit of $3000 was created in 1977.

So it looks like no tax increases on this debt deal...well... maybe a few tax increases...

A lesson about the US tax system

Oops.. and I violated this just yesterday in my post.

Rule: Don't use absolute dollar amounts when discussing issues.  Cite things as a percentage of something else.

For example, don't say "$2 trillion" - say 16 percent of Gross Domestic Product. 

Don't say (as Boehner said yesterday) - a trillion dollars in cuts over 10 years (that works out to $100 billion in cuts a year to a $3 trillion dollar US government budget..peanuts basically....)

Which sounds like more is being done: 1) a trillion dollars over 10 years!!  2) a 3% cut!!!

From yesterday's debate - they were the same, sadly.....

The popular press (and Obama) are great at doing this (heck, any politician or news organization does this ad nauseum).

For example, there are 300 million or so people in the US - and with that 140 million "taxpayers" (many tax returns have multiple people on it - mine has 4 - me, my wife and our two daughters.)

So Obama points out that "50 million Americans are without health insurance!"  He doesn't say that 17 percent of Americans are without health insurance, or even worse for him, 83 percent of Americans have health insurance.

No, he used absolute amounts which make it seems worse.

But on the other hand, he wants to raise taxes on only the top 5% of US taxpayers.  Doesn't seem like much.

But how about "I want to raise taxes on 7 million tax paying households!"  That sounds like more.

And when you consider that the 7 million households represent about 30 million Americans - how about "I want to raise taxes on 30 million Americans!"  Now that sounds a lot worse than 5%!

So - to be "tax literate" - remember to always base your discussion on government revenues and expenditures as a percentage of something else - not absolute dollar amounts.

Boehner's plan passed, shot down by Senate

Maybe Saturday will finally bring a compromise.

I love how the Republicans point out that tax hikes will hurt an already weakened economy.

Hey - you thinking spending cuts won't? Last time I checked - slashing government spending meant firing people to some extent...

Of course, the spending cuts are minimal - like $25 billion this year for the current House plan, $30 billion for the Senate plan - according to an article on politico.com today.

Heck - they are going to do another one year "patch" on the Alternative Minimum Tax in December this year for the tax year 2012 - that is going to cost them at least $70 billion.

Debt debate July 21, 2011

Seems like a good time to start blogging about taxes.... 11 days or so until the "supposed" countdown to US government bankruptcy...

Of course, I don't exactly believe that August 2, 2011 is the "drop dead" date - but we shall see.