Highgate Markets

Currencies, Economics, Politics

06 March 2009

I really  liked "Spend like you're French, but fund it like you're Californian" as a synopsis of Obama's policies, but I heard another one:

It's like noticing your car is on fire and you decide your top priority is to take out a loan to buy rust-proofing.

Hope somebody finds a fire extinguisher before the stock market goes to zero

27 February 2009

A monetary solution?

Can we devise a cohesive fiscal and monetary plan that both stimulates the economy and puts the US on sound footing going forward?

A successful plan must address the following:

Since there is apparently no appetite for cuts in discretionary government spending, there must be a combination of tax hikes and defense cuts that funds the old pre-crisis budgets of the Bush years.   Fortunately, solutions for these deficits are already in place.  First, all of the Bush tax cuts must expire (not just for the wealthy) and we should return to Clinton-era tax policies.  If the Republicans wanted Americans to keep those tax cuts then they should have spent less when they were in power (and that goes for Pelosi and Reid, who have been approving the budgets since 2006 and didn't object to spending increases in earlier years). Secondly, we must cut costs in Iraq and Afghanistan and scale back our presence in both countries.    Fortunately, the combination of restoring Clinton's tax policies and cutting our war expenses in half would have just about balanced Bush's budget back in 2006-2007 (at the peak of the economic cycle).

That is the good news-  there are measures in place to handle the pre-crisis Bush deficits and spending.   

The bad news is that this leaves us with some gaping holes

1) The TARP, son of TARP, the homeowner and the auto bailouts.  Essentially the crisis expenditures
2) The stimulus bill
3) The 8% spending increase in the recent supplemental budget passed by Pelosi/Reid
4) All of Obama's new spending ideas
5) Fixes for social security and medicare

What we need is a grand bargain combining fiscal and monetary policy.

1) Use the expiring tax cuts and declining war expenses to fund Bush's spending increases.
2) The Fed should monetize the debt (i.e. print money rather than issuing bonds) to cover the cost of the TARP and other crisis bailouts and also for any of the stimulus expenditures happening in 2009 and 2010 (this is much less than $787 billion).   This would generate at least $2 trillion in monetary stimulus (so a little less than 20% of the economy).   This would create a fall in the dollar and a short-term boost for inflation, but it must be a one-off event. Any future returns on TARP money (in the unlikely event our bank preferred shares ever get paid off) should go toward debt repayment.
3) Any new expenditures for 2009 and beyond must be fully funded with tax hikes.

If Obama wants to increase entitlements or add tax cuts beyond those temporary ones in the stimulus he will need to raise new tax revenues to pay for them.  His proposed income tax changes raise less revenue on a net basis than the simple expiration of Bush's tax cuts, and the revenues from the expiration of those cuts are already spoken for- they need to be used to reduce the Bush deficit.

Spend like a European but fund it like a Californian

Obama's budget strategy can be summarized as follows:

Spend like a European but fund it like a Californian.

In other words, increase entitlement and public sector spending in an aggressive and recurring way, but attempt to fund it narrowly on the volatile, cyclical and mobile earnings of a very few.

We know the California funding model doesn't work.  Combining a shaky, proven to fail funding model with the very expensive European social democratic spending model courts disaster. 

The European social democratic model runs at a deficit in good times despite taxing almost everybody for everything and despite failing to address their demographic time bomb of retiring boomers and fewer young taxpayers.  There is no country anywhere that has successfully funded this model only on the very rich.  In fact, there is no major country anywhere that is successfully funding this model even when taxing the poor and middle class much more heavily than in the US.   Resource-rich countries with tiny populations like Norway and Canada run social democratic systems that are well-funded, but the US isn't that type of country and even in Canada and Norway the middle class pays higher taxes than in the US in return for those higher benefits.

25 February 2009

Reflections on Obama's budget priorities

Nice speech, but what the heck does it have to do with the current crisis?

The stimulus package and now Obama's budget are essentially re-hashes of decades old Democrat wish lists.  There is precious little sign of any new ideas customized to our current predicament.  Does anyone believe his priorities would be any different if the economy was doing well?  The crisis only comes into play as an excuse to jam the old playbook through bigger and faster.  This is not genius nor is it the change we've been waiting for.  We could have elected Hubert Humphrey or Walter Mondale to do this if they were still around.....then at least we'd have the benefit of their experience and humility.  The stock market sees through this- Obama offers no real solutions to our current economic problems and yet with certainty business owners know that Obama's "Mondale plan" means they need to plan for higher taxes, more regulation and the government picking favorites.  

OK, I get it.  Obama wants to move us toward a more European system of higher taxes and more government entitlements and intervention.  Well, that model already exists.  How is it doing?  Hasn't Obama realized that Europe is in crisis just as we are?  The UK has had a social democratic orgy of expanded benefits and spending for a decade, largely unfunded, in keeping with current Keynesian fashion.  Obama's plan may be different than Bush's but is very much like Gordon Brown's and there is no evidence that it averts or resolves the type of crisis we face today.  

It is interesting that Obama is "going European" at a time when most analysts have concluded that Europe's system of entitlements is unsustainable.   Replacing our current unsustainable system of overconsumption, deficit spending and unfunded entitlements with another proven unsustainable system is madness.   Now some say that Europe is actually worse off than the US because their demographics are horrible (fewer young taxpayers to pay for entitlement-sucking geezers) and their taxes are already about as broad and as high as they can go.  However, there is an area where the Europeans have an advantage- they are savers.  In 20 or 30 years time when they realize that the promised government benefits aren't really there, well at least they have a nest egg to fall back on.  

Americans need to remake our society to be less consumption oriented while at the same time providing incentives for business creation and employment.   Instead, Obama brings only old ideas proven to fail and promises more government benefits with the lie that someone else will pay.  We are going to end up in the same boat as Europe: higher sin taxes, higher gas and carbon taxes, cap and trade, a Federal VAT, high income taxes, crushing regulation and permanently high unemployment.  Everyone will pay through the nose, just as they do in Europe- not just the top 5%.  The question is- what will we get for our money?  I've lived in Gordon Brown's Britain and I can tell you the return on taxpayer investment is extremely poor, and in the future will be even worse:  fewer benefits and massive tax hikes (or national bankruptcy).  On a 10 year view some of Obama's plans may not look bad, but they'll be underfunded like every other entitlements program on the planet.   Out 20 to 30 years we will face disaster- similar to our current problem with Medicare except bigger.  The Dems have a solution for that, though, the same one used in Europe:  deny people the benefits promised, the same benefits they paid dearly for over decades.

There is a better solution.  We need to take responsibility for our own future expenses, rather than paying government to provide for us but fail.  We need politicians who can speak the truth to the American people

1) Healthcare is expensive- it must be paid for and saved for by consumers.  There is no free lunch.

2) Retirement is expensive- it must be paid for and saved for by consumers.  There is no free lunch.

Savings for healthcare and retirement must come FIRST, and then we consume out of anything that is left over.  Yes, that means smaller houses, cheaper cars, fewer clothes and no more $4 coffees.   We need to transform ourselves from consumers to savers and investors.  This also means a smaller trade deficit and less cancerous smog coming our way from Chinese factories and coal plants.  Rather the social democratic European solutions (which has failed in the current crisis and is unsustainable within a 30 year time frame) Obama should look to places like Singapore and Chile.

The government should force everyone to save 20% of their income for retirement and healthcare.  The forced savings would be put into government bonds and annuities based on government bond yields. In addition, everyone must purchase catastrophic healthcare insurance for themselves as well as a consumable/every day plan to cover their children.  Businesses that currently buy insurance for employees would convert those funds to salary.  The government would subsidize those who cannot afford the cost of a high deductible policy or provide a very basic HMO-type policy for those unable to work.  Social Security, Medicare and Medicaid would be eliminated over time.   Social Security would be replaced by a means-tested welfare plan for seniors offering food stamps, small monthly stipends and senior housing vouchers (designed to pay for the cost of living in cheap areas of the country like the Deep South, agricultural midwest and the rust belt).   Rather than selling its cars to old Americans, Detroit may house old Americans.

Even with a plan like this we would need to raise income taxes for all tax payers (while eliminating payroll taxes).  I also support raising capital gains taxes to the same level as income taxes.  There is no reason why speculation and investment should be taxed less than work.  The stock market bubble, private equity bubble and real estate bubble were fed in part by generous capital gains tax treatment.  Higher capital gains taxes will also eliminate the massive subsidy we extend to plutocrats like Gates and Buffet.  Currently, they donate to charities appreciated stock that they've never paid a cent of taxes on and use this to eliminate their income tax liabilities.  Working people earn money, pay taxes on their earnings and then get those taxes back if they donate to charity.    The plutocrats get deductions on funds they've never paid taxes on, and their donations are more often used to fund foundations that distribute precious little of that donated money annually, serving more as vehicles to employ the plutocrats family and friends and buy political influence.  This insanity has to stop.

At the same time, corporate income taxes should be eliminated, killing the old "double taxation" argument, and replaced with a VAT (with deductions for US-sourced labor and material inputs). This will stimulate exports and US-based hiring.  Rather than borrow failed European ideas on entitlements, Obama should borrow the successful mercantile aspects of European VAT tax policies.   

The US needs to emerge from this crisis as the location of choice for global business.  We need to change our focus and become a country populated by savers, investors and prudent consumers.  We need to take responsibility for our own future expenses and have a government that rewards hard work, savings and employment.  Obama's "Mondale plan" converting us to a European social democracy does nothing to address the crisis or our over-consuming and speculative ways.    Instead, it just shows that Obama would prefer us to be sitting in the current crisis looking more like Gordon Brown's Britain than Bush's America.  Thanks, but I want no part of that sort of change.


03 November 2008

More on Taxes

I summarized my thoughts on coming tax changes for individuals a few days ago here.

Obama has also talked a lot about corporate tax reform and "closing loopholes".  What does he mean?  To get an idea of what may be in store, a Brookings paper written in 2007 by Jason Furman (Obama's economic policy director) and Larry Summers, makes interesting reading.  I summarize:

-Go after small businesses and sole proprietorships that underreport taxes through an increase in IRS audits and better reporting.  Now as someone who has largely earned W-2 paychecks and 1099 income and paid every cent of taxes honestly, I do sometimes resent the under-reporting and over-deducting that some small businesses seem to engage in and the conversion of taxable income to lower-taxed capital gains by LLCs.   Nonetheless, I fear an IRS witchhunt on small business, particularly if it is focused on hard-working sole proprietors rather than the ultra-wealthy LLC crowd (hedge funds, lawyers, private equity) that bankroll Obama.  Sounds like there will be a horde of government bureaucrats looking into every plumber's files.
-Go after large businesses and corporations that shelter earnings by increasing audits, closing tax shelters, taxing overseas income and disallowing depreciation for overseas investment. This is not good news for US multinationals.  If this happens, I would rather own stock in European or Japanese manufacturers that do business in the US than US companies doing business abroad.
-Impose a VAT to pay for universal healthcare.  While Furman admits a VAT is regressive, he posits that it is less regressive than payroll taxes (no cap) and manages to capture spending out of savings and investment by rich people and retirees.  Under a VAT, you not only pay taxes when you're earning income during your working life and then pay tax on interest and capital gains as you save, but you get to pay again when you're retired and spending out of your already twice-taxed savings!  Wonderful. Expect a VAT.  If we do get one early it might be good news for shorter-term TIPS (as a VAT temporarily pushes up CPI).
-Increase progressivity.  Obama will make income taxes more progressive, but Furman has data that shows that income tax cuts account for only 10% of the rise in inequality since 1960 (between the top 0.1% of earners and the rest of us). 90% comes from estate tax cuts, capital gains tax cuts and corporate tax subsidies and underpayments.  Expect capital gains and estate taxes to rise (though estate taxes may still end up lower than they were pre-Bush).

I also found a roundtable from early this year featuring Obama advisors Furman, Rubin and Rivlin talking about their ideas on stimulus.  Furman likes the idea of refundable tax credits, but says such stimulus must be temporary. Will Obama's refundable tax credit handouts prove as fleeting as his tax plans are fleecing?

30 October 2008

Taxes- what's in store

We're going to have a trillion dollar deficit in 2009 (even before Obama's huge spending plans). Federal spending has been out of control since 1998 and appears poised to move from excess to insanity, using the financial crisis as cover.  We know we're all going to have to pay.  Here is what I expect to see in the next Congress' first term:

 1) Federal gasoline tax hike in 2009 (assuming gas stays below $3/gallon into early '09).  I expect to see 20-50 cents added to the current tax.  Obama will sell this as a conservation measure and a way to fund his planned investments in "green" energy.   The far left has always favored higher gasoline taxes and the Blue Dog Dems will be looking for ways to pay for some of Obama's new initiatives.  The Dems will look to substitute a broader carbon tax for the gasoline tax once the economy recovers.
 2) Windfall tax on oil companies.  While this is a stupid idea (see also: Carter) and hurts US companies at the expense of foreign producers, it is red meat to the Dem base and may be used to help sell the gas tax ("you the motorist will be paying more at the pump for 'investment' and conservation, but don't worry- the oil companies will be paying, too").  
 3) Eliminating the income cap on social security for the employer portion.  Obama will likely apply the 6.2% employer tax to all income over $200,000.   For a high-earning employed person this means no direct tax hikes- instead your employer pays more (meaning over the long run they will find ways to pay you less).  This will probably be sold as a way to punish companies for excessive executive pay.  This will be extremely painful to traditional self-employed small business people, but generally they aren't Obama supporters.  The LLC lawyer/hedge fund/private equity crowd that Obama depends on for campaign cash will have ways around it (by converting salary income to capital gains).  I don't see Obama going after carried interest in his first term.
 4) Capital gains/dividend tax hikes-  certainly back to 20%, likely to 28% for high earners.  In order to cushion the impact on the market these hikes may be phased in over several years.  Increased ability to deduct capital losses from income in 2009 may be thrown in as a sweetener.  Capital gains revenues will be tiny in 2009 (who has gains?), but by raising tax rates in 2010/2011 the government will be poised to collect big on the inevitable market rebound.
 5) Income tax hikes.  Back in 2000, Clinton's last year, the 39.6% bracket started at $288k for a couple.  Due to inflation indexing the top bracket for a couple in 2008 began at $358k with a Bush tax cut rate of 35%.  Obama is talking about reinstating the 39.6% rate at somewhere at or below $250k in joint income.  After inflation, this is the equivalent of lowering the threshold for Clinton's 2000 top bracket to about $200k for a couple.  Clearly, Obama is not just talking about a repeal of Bush's upper income tax cuts but new tax hikes that go further than Clinton's did.   A more interesting question is the fate of the 33% bracket (which was the 36% bracket under Clinton).  Back in 2000, this bracket started at $161k or a couple, and currently starts at $200k.  However, as Obama's new top bracket ($250k) comes in below Clinton's old (non inflation adjusted) number of $288k, I expect that we could see the 36% bracket come in somewhere at or below the old Clinton threshold of $161k for a couple.  Could this have been what Joe Biden was talking about when he let $150k slip as the new definition of rich?
 6) Targeted corporate tax hikes (elimination of subsidies for Republican-associated industries to be replaced with subsidies and credits for Dem-favored industries and activities).  I expect the net revenue contribution here to be negative.

The scary part is that all of the above plus a $100 billion cut in annual defense spending (assuming we quickly scale back in Iraq) wouldn't even balance the 2008 budget, let alone pay for any of Obama's new initiatives.  I suspect that Obama and Pelosi are comfortable with the idea of $300-400 billion deficits once the economy recovers and the defense budget normalizes (say in 2011).   I believe that plan will be to finance the current level of spending through the above tax hikes and defense cuts and then spend $300 billion on top of that (in today's dollars). Refundable tax credits (or social security tax "refunds" for lower income workers), infrastructure boondoggles, healthcare and aid for unionized industry and "green" industry will all be high on the spending agenda, though these will have to compete with spending requests from individual US States, many facing bankruptcy as tax revenues fall while a decade of spending at twice the pace of inflation needs to be funded.  States will be looking for at least $100 billion of budgetary assistance in 2009, and a wholesale bailout of states and the muni bond market would dwarf the recent Wall Street rescue.

Eventually, the $300 billion or so in new annual spending will have to paid for, as well as the 2 trillion or so in new national debt we'll accumulate in 2009/2010 as well as the debt accumulated during the Bush administration.  This will require not only regressive consumption-based taxes (higher gasoline/carbon taxes, VAT) but also dramatically higher taxes on middle income earners.  At the end of the day, European-style Social Democratic spending levels require European-style taxes.  If a social democratic paradise could be built off the backs of the rich alone then some country would be doing it somewhere.   It seems we need to re-learn the lessons of the 1970s.  There is no such thing as a free lunch, and "change you don't have to pay for" is an empty promise.