My Tax Return Savings Account

It is interesting how the circumstances one finds oneself in can dramatically change their opinion of something.  For instance, 15 years ago, I was adamantly against tax refunds.  Not getting your money back, just the concept that people wouldn't pay enough attention to their finances such that they would receive thousands of dollars as a overpayment (or more likely an overwithholding) of taxes.  At the time it was obvious to me that it was much more profitable to scrutinize and adjust your withholding on a regular basis (every couple of months) so that at the end of the year you were as close to breaking even as possible.  I could put this money to work for me by investing it or at the very least put it in a savings account earning interest (as opposed to the interest free loan I would have been giving the government). I was pretty good at it for a few years, netting myself refunds of a couple hundred dollars or having to write a check for a couple of hundred dollars.

Then times changed.  I started making more money and my taxes became more complicated.  Now, at first glance one would think that making more money would be an incentive to implement my strategy above even more so.  Afterall, 15 years ago, I was only making about $25K a year.  My opinion on this issue has changed 180 degrees. Now, I would laugh in your face if you suggested the strategy above.

There are several factors that go into this.  While there is some profit to be made from investment, it doesn't come without it's own cost, namely the time necessary to adjust your withholding (or in the case of quarterly tax filers, the amount of time - ergo rigor - into estimating the taxes owed).  Couple this with exceedingly low interest rates and put a dollop of the ever changing tax code as politicians try to curry favor with this group or that group each year and you are left with a much more complicated task - so the rewards better be worth it.

In 2004 and 2005 I started a different job that had a significant amount of money made from bonuses and overtime.  Because of tax law, this income was withheld at a higher rate (remember withholding, tax owed, and tax paid are completely separate concepts and not necessarily related).  So, while my base pay was withheld at the legal minimum for federal income tax ($0), I was still being withheld on my bonus and overtime income.  And there was no way to not have it withheld.

My time was also more valuable, while as a college student I might jump at the chance to earn $10-$15/hour, I was making much more than that.  To put it in perspective, if my base rate was $30/hour and my boss wanted me to work overtime, he would have to compensate me for my time, usually at a rate of $45 per hour.  So, in effect my leisure time was worth $45 per hour.  On the other hand, if I wanted to make more money, I had to go and find that work and I might only be able to find something for $10-$15. 

The only "extra" work I ever did during this time was I was an usher at Texas A&M football games.  I was paid $50 per game (and I didn't have to spend $50 per ticket).  I was able to see most of the game - in particularly the 4th quarter since my shift was done at the end of the 3rd.  I did have to show up a couple of hours before the game, and the game was 3 hours, so figure about 5 hours total.  For $50-$100 of value (since I would have bought tickets to go to the game anyway).  And the first couple of hours, I brought a book or headphones to do what I normally would be doing at home.  This was a great gig.  To bad I didn't find out about it until my senior year.

So, only on rare occasions have I been willing to trade my leisure time for less than $25/hr.  When faced with a job that was out to defeat my tax philosophy, I decided to evaluate and determine if it was worth it to find some way around it.  Turns out, in my situation (and the vast majority of Americans situations), it's not worth it.

Let me illustrate.  For the last 8 years, I have been getting tax refunds of $3000-$7000.  Well above the national average of $2000 to $3000.  The question one has to ask is what would you do with the money if instead of getting it in one big lump sum, you got a little bit more in every paycheck?  Investing in the stock market historically has been the best performer.  I assumed that I get a refund of $5200 each year (it makes it easily divisible by 26 paychecks a year).  So each paycheck I would have a theoretical $200 to invest in the stock market (I'll use SPY the S&P 500 ETF).

	Value	$ Increase	% Increase	$/hr
2005 S&P	$5,355	$155	3.0%	$15.50
2006 S&P	$5,613	$413	7.9%	$41.29
2007 S&P	$5,177	($22)	-0.4%	($2.26)
2008 S&P	$3,814	($1,386)	-26.7%	($138.61)
2009 S&P	$6,265	$1,065	20.5%	$106.50
2010 S&P	$5,729	$529	10.2%	$52.85
2011 S&P	$5,184	($16)	-0.3%	($1.61)
2012 S&P	$5,375	$175	3.4%	$17.46
2005-2012 S&P	$42,511	$911	2.2%	$11.39

Basically, at the end of the year, hopefully you have more money than you put in.  Now, in order to game the tax withholding every couple of months you are going to need to go through and project what your tax return is going to look like at the end of the year (taking into account the money you have not yet made and the changes that the politicians have not yet proposed). Then you can adjust your withholding allowances/exemptions to change the amount that is withheld. Bear in mind that you probably want to err on the side of caution because while there is no bonus for having too much withheld, there are penalties for not having enough withheld.  So, I conservatively assumed 10 hours per year spent analyzing and adjusting your tax withholding to calculate how much per hour this is equal to.

You can see from the list above, there are only three of the eight years in which crunching numbers for 10 hours a year would exceed my $25 free time price.  Yours may be lower, but there were still three of eight years when the ROI was negative, so no amount of tinkering would have made it worth your time. Overall, $11.39/hour average doesn't sound too shabby - but remember, I make enough money to have $5200 refund each year, if you are only getting the national average of $2600, then cut this $11.39/hr in half and you have something that is less than minimum wage - in other words it would be more profitable for you to just go out and get a job at McDonalds for two days (five hour shifts) each year and then quit rather than try to monkey around with your tax withholding throughout the year.

But the 2005-2012 S&P line can be misleading.  This is calculated by just adding up each of the yearly amounts.  I did this since we plan our tax refund into our budget and mainly have it targeted to pay for big ticket items (replacing roof, buying car, etc.) that we know are happening in the next year.  What about if you plan on saving this for the long term, there could be a lot of good benefits, right?

	Value	$ Increase	% Increase	$/hr
2005-2012 S&P Yearly	$42,511	$911	2.2%	$11.39
2005-2012 S&P Combined	$48,765	$7,165	17.2%	$89.56

Well, the Combined column (assumes you don't spend it each year) is starting to look really good.  $89/hr is a heck of a lot more than I make.  Obviously, if the S&P 500 does average or even good in 2013, then this doesn't change the rosiness of this picture.  But what if instead 2013 becomes another 2008?

	Value	$ Increase	% Increase	$/hr
2005-2012 S&P Yearly	$42,511	$911	2.2%	$11.39
2005-2012 S&P Combined	$48,765	$7,165	17.2%	$89.56
One More Bad Year	$46,325	($475)	-1.0%	($5.27)
One More Bad Year Combined	$33,580	($13,220)	-28.3%	($146.89)

So, I calculated for one more bad year, assuming that you spend it every year and it is bad, but if you were using it as long term savings, then that $89/hr turns into -$146/hr.  In one year, of course the next year may be better than before. Or it could be worse.  You don't really know, so, I would suggest not using this as the basis to make a decision.  Don't get me wrong, I invest in the stock market and encourage others to as well. Its just not a place to put money that you may need in the short term.

So, let me look at something that is more stable, like bank interest rates.  I can count on this to always be positive. 

	Value	$ Increase	% Increase	$/hr
1% Savings	$5,227	$27	0.5%	$2.71
2% Savings	$5,254	$54	1.0%	$5.43
3% Savings	$5,282	$82	1.6%	$8.18
4% Savings	$5,309	$109	2.1%	$10.94
5% Savings	$5,337	$137	2.6%	$13.72

Nope, this certainly doesn't change things.  Unless interest rates are astronomically high, there is no sense in me using my leisure time to play with taxes.  In fact with some of these, I know my daughter has made more operating a lemonade stand.

So, for the last 8 years, my opinion has changed.  At one point in my life the $25 extra a year in interest I might have made sense, but I had a whole lot of extra time back then. Yes, I have been giving the government an interest free loan for thousands of dollars, but on the flip side, the actions I would need to take to not give them that loan are not worth it.  If there was no penalty for underpayment, then I wouldn't because it would make the decision easy (arrange to have nothing withheld and just write a check on April 15th).

Tax Hike Doesn't Increase Revenue

Greece has given us the latest example of something that has been obvious to people throughout time. Tax increases do not necessarily increase revenue.  Yes, it is true if tax rates didn't affect people's behavior and if no one took them into account, then increasing tax rates would increase revenue. But taking this logic to its extreme, a tax rate of 100% should bring in 100% of the revenue for the country.

This statement is true only if we consider "legal" revenue.  There are lots of other competing factors in any market (regardless of how much control the government has on it).  People don't work to support the government.  I haven't met one yet.  Warren Buffet and others may say they are not taxed enough, but they aren't beating down the doors of the Treasury department to give their excess money either.  Actions speak louder than words.

There is a cash economy that is completely untouched by federal taxes. This includes the kid who mows your lawn, your piano teacher, and even tipping at some restaurants. These people engage in legal business but don't report the income even though many of them are required to.  There is no way to track this money and the best that we can do is estimate how large it is. All of the estimates I have seen are in the hundreds of billions and in a few are $1-3 trillion (with GDP around $15 trillion, this is a significant amount).  Other than taxes these markets are relatively harmless.

Then there are the various black markets.  Markets of illegal activities. They exist for everything from drugs, guns, prostitutes, child porn, endangered species, etc. People in these markets are not subject to government regulation or the legal system to settle disputes.  They have lots of costs on society.  First, the law enforcement cost to find and prosecute these people, second the harm caused to people unrelated to the markets who are affected since there is no legal structure to insulate them.

Whenever tax rates/regulation changes money will flow to or from these other markets.  At a 100% tax rate, the black market would blossom (and probably involve more barter) and the cash economy would also flourish (although those who formerly received all of their income from this economy may take a significant hit because now nearly everyone would be involved in the cash economy). No one would want to work for "legal" money since they wouldn't keep any of it. So, traditional business would grind to a halt overnight.  This would not be good for the economy.

Changing tax rates (particularly targeted to wealthy people or on voluntary transactions) also can have large effects as their behavior changes. For instance, when the capitol gains tax rate was reduced, more capital gains were taken, so much so that the reduction in tax rate ended up generating more revenue than the higher rate did.  Conversely, luxury taxes on things like yachts did nothing but destroy the yacht building industry.  Sure the middle class and poor don't buy yachts, but they work for the yacht manufacturers.

Governments use a static model for projecting tax revenues. This is wrong.  Sure it would be a lot more complicated to use a dynamic model that actually takes peoples actions into account, but lots of things are difficult and complicated and we still do them.  We put a man on the moon for crying out loud. With slide rules.

Romney's Taxes vs. my taxes

Since tax season is coming up, I felt inspired to post this bit I had previously posted on Facebook.

I was thinking about how "awful" it is from the revelation that a) Mitt Romney makes millions of dollars a year, and b) he has an effective tax rate of less than 15% (because almost all of his income is from Capital Gains/Dividends not ordinary income). So I decided to take a look at my own finances, what is my effective tax rate?

To begin, let me iterate that I fall into the top 15% of wage earners based on reported AGI in table 488 ofhttp://www.census.gov/compendia/statab/2012/tables/12s0488.pdf . Lest you think that makes me a millionaire, the top 3% make $200,000 or more (so I wouldn't even fit Pres. Obama's definition of millionaire). So I have admitted that I make less than $200K. Now going back on my tax returns to 2001, I averaged my federal taxes (income and payroll), state taxes, and charitable contributions.

Why include payroll taxes (SS and Medicare)? Because in the end it is money going to the federal government to finance our nation. Mr. Romney probably pays nothing into SS and Medicare because (if you look at his return) he has no ordinary income (line 7 Wages, salaries, and tips). At 7.65% (5.65% currently), this is by far the biggest tax bite that workers in America pay (and if you include the employer portion, you can double that number to 15%). So, without refundable credits, you are automatically paying an effective tax rate of 7.65% if your income is primarily derived from ordinary income.

Anyway, my effective federal tax rate remained around 12% from 2001 to 2007. In 2008, it dropped to 7% (this would have been under Bush II). And then in 2009 and 2010 it was down to 6%. So, not only does Mr. Romney pay 2.5X an effective tax rate as me, he also pays about $3 million more than me. Can't say I have anything to complain about there. Besides, my tax return is only about 20 pages, not the 200 that Mr. Romney has to do. And I still do my own taxes, so I am not paying an accountant a few grand.

My state tax (when I lived in a state that has an income tax) has remained fairly stable at 4.5%. I have no desire to try and figure out what Mr. Romney's rate is. Nobody seems to care. They only care about his Buffet rate.

As for charitable contributions, mine have remained between 10% and 15%. This is right in-line with the 13.7% that Mitt donates to charity. So, maybe I should like Romney after all.

Having done my own taxes for my entire life, I would guess that the only people who are paying more than a 15% effective tax rate are those that fall into the 1% (according to IRS statistics those with income of about $350K) that the Occupy movement rails against. The exception would be single or married with two incomes who make between $100K and $350K. But even then, we are still talking about less than 7% of the population. If you make less than $100K and are paying an effective tax rate of more than 15%, you haven't figured out how to do your taxes. Get some advice from an accountant, and follow it.

So, have you ever bothered to figure out what your effective tax rate is? (Hint: It is not as easy as taking your paycheck withholding and dividing it by your income.)

Why Do We Still Have the Dollar Bill?

I've said in the past get rid of the dollar bill. While this is probably the 20th time in the last 50 years that Congress has looked at the proposal, perhaps we will have some sense this time and do it. Don't bet the house on it (when has Congress made a fiscally sound decision in the last decade), but I'm hoping for a long shot here!

One thing why you shouldn't get your hopes up - the Treasury is finishing up an 18 month study of this issue. Whatever money we spent on this study is a complete and utter waste. Several countries have gotten rid of their $1 bills, and not just third world banana republics - trading partners like Canada, England, and even the Eurozone have recognized for decades that the $1 bill was a money waster.

The fact that we are behind several third world countries who don't have reliable running water or electricity is an embarrassment. If we really need a study, we should have asked the Canadians for their 30 year old study and then relabeled it - total price $100K. If the study from 30 years ago showed that it was cheaper back when everyone carried money, it is going to be that much more cheaper now that hardly anyone carries money. 

If it is the metal composition, we are also behind the eight ball. Since we stopped putting precious metals in coins in the 60s, we should have immediately gone to the cheapest metals possible. No sense in trying to pretend like the money has melt value. Once again, several other countries (including many banana republics) have done this. While I am not too keen on steel from a collector's standpoint, it is very practical. I'd prefer a chrome steel or nickel steel alloy that doesn't rust. Cupronickel is good (what our nickels are made from) but expensive. If we wanted to stick with this then get rid of the penny, nickel and quarter and just have dimes and half dollars (then no one will get the dollar confused with the quarter). Several countries use a stainless steel alloy which remains nice and shiny decades later. 

So, if all of these other countries have been able to figure this out, why do we need to spend 18 months and millions of dollars on a study to come up with the same answer? And people wonder why we are adding $1 trillion in debt each year. Easy, just take this philosophy and magnify it by every item in the federal budget.

One area of the economy that would be affected is strip clubs.  I am not sure strippers would like to be pelted with dollar coins for their performance.  However, this could easily be solved by the strip clubs printing their own bills and then patrons can purchase a bundle upon entering. The workers would then turn in their gathered bills at the end of their work day for real money.  (Sure, this would eliminate a lot of the under the table transactions that probably go on, but that would mean more tax dollars - its a good thing!) Disney does this as sort of a souvenir gimmick (or at least they did 30 years ago).  I have Disney Dollars (with portraits of Mickey and Goofy) that can be used as real money in the Disney themeparks, but have no value elsewhere.

Tax Hike....Punt!

In case you haven't heard, President Obama is willing to make a deal on "tax cuts." Basically, when one looks at it, the deal is nothing more than a punt, for both Republicans and Democrats. To begin, what are some of the major economic negatives in our country right now:

1. Deficits in the trillions of dollars (few countries even have a GDP of 1 trillion, and we have a deficit of 1 trillion).
2. Unemployment of 9%+ (or 17%+ depending on which figure you want to use).
3. Anemic job growth (in spite of the stimulus spending which saved or created 3 million jobs).
4. Social Security in the red (i.e. it pays out more each year than it takes in).

So the Democrats and Republicans are worried about a tax hike, which they both contributed to 10 years ago. Funny how those things come back to bite you. And in an election year no less. At least they managed it in the mid-term election year rather than the presidential election year (then again, I'm not sure they had a choice in the matter). And after much bickering and whining we get this:

1. No increase in the base rates for two years (in other words, the vote will be to increase your taxes in two years). Why President Obama would agree to this (as opposed to a three year moratorium), I have no idea. Unless perhaps he is sick of the whole thing and wants to get back to being a Community Organizer. Two years puts the tax increase right back in an election year, except that this time, the Presidency will be up for grabs and the Senate in a big way (I think the Democrats will be defending 20+ seats in 2012, while the Republicans only have 10 seats to defend). If recent history is any judge, then having a tax fight in 2012 won't go any better than it did in 2010.

On the other hand the economy may turn around. Except that one of the reasons that the economy hasn't turned around is the uncertainty in the tax situation. What does a two year moratorium on the increase do? Not much. Businesses don't usually operate on a one or two year plan. In my current position, I have things planned out for 25 years. Hiring new employees (i.e. creating jobs) is usually a multi year commitment. You have to train them before you can begin to get your investment out of them. If they are not going to make your company more money than what you pay them (salary, benefits, and taxes), then you don't hire them. If you do, you are stupid and will be out of business soon enough.

So not only will the two year moratorium on tax increases just delay the fight until another election year, it is not going to do anything to spur job growth. But that is OK, because we have...

2. Extension of unemployment benefits by 13 months. I'm not sure of the details, but this may just be an extension on top of the 26 weeks that the States provide (at the direction of the federal government), or it may be an extension of the 99 total weeks that the States and Federal government had been providing. If it is the latter, then that means unemployment benefits are going to last for three years. If you know that you will get a check each week for three years, and you are just the slightest bit lazy, what incentive do you have to even bother being serious about looking for work during weeks 1 through 104 (i.e. first two years). As near as I can tell, this unemployment extension is not being offset by any spending cuts, so that means the deficit problem we had above is going to grow.

But Nancy Pelosi says that every $1 in unemployment returns $2 to the economy. Really? Where does that $1 come from in this case? Oh yeah, the economy. So if we get the $1 for $2, why not double the amount in each unemployment check? Oh there are diminishing returns? Why didn't you mention that. Does it work the opposite way? So if we cut unemployment in half do we get $4 returned to the economy for every $1 in unemployment? Why not do that? $4>$2. Do you mind showing me how you come up with the $2 figure anyway, and show how leaving that $1 in the economy in the first place wouldn't have created $2 or more by its own.

3. A decrease in the payroll tax of 2% for 1 year. Why just 1 year? Oh, yeah, so we don't have to have this fight in two years during an election. Also, it appears that the cut will be in place of President Obama's signature making work pay tax credit which applied to most everyone equally, whereas the payroll tax "disproportionately" helps the wealthy. From a personal standpoint, I am all in favor of this. Social Security is a scam (government run mind you, but still a scam) and I don't expect to see any of the money that has been confiscated from me for it.

From an economic issue (particularly in regards to the problems listed above) I am torn. More money in the hands of consumers (all consumers, even the really rich ones) is a good thing. And Social Security is the largest tax payment that most Americans pay (particularly when you consider the "matching contribution" from your employer). On the other hand, Social Security proponents have prided the fact that up until last year, Social Security was a self sustaining program, it covered all of its expenses each year (and lent the excess to the goverment to spend at their leisure). Now we are going to take away 1/6 of the Social Security taxes (approximately $100 billion) in a year when Social Security is already in the red. That is going to decrease the solvency of the "trust fund" further, and add to the deficit. And since it is only for 1 year, it won't help create any jobs. (On the other hand, I may be able to convince my wife that I can use that extra $2000 in 2011 to go towards purchasing a Barrett .50 BMG or we could just put in a new shower in the bathroom. Tough choice!).

And then there is some other froo froo stuff. The funniest thing of all, if this passes. It will be in a House, Senate, and Presidency that is all controlled by the Democratic party. Since it has no provisions that will create jobs (it encourages stagnation), cut the deficit (actually it will increase the deficit), or shore up Social Security (it does the opposite) and it puts these same issues off to be fought over again in 2012, barring any major change in the world (which always seems to happen anyway), the Democrats will have voted on their own demise from the Senate and probably the presidency and solidify the gains that the Republicans made in 2010 in the House (although redistricting will accomplish most of that anyway).

Never let a crisis go to waste. But if your going to, make sure you waste it in spectacularly stupid ways.

BTW, I have no love lost on the Republicans punt of this issue. They have no power other than the filibuster, yet are still getting basically what they want.

How to Get Rich Quick!

http://www.foxnews.com/politics/2010/10/07/stimulus-checks-sent-dead/
So, all you have to do is register a bunch of dead/nonexistent people for Social Security (which has never happened before) and the money starts rolling in? And their excuse is that their deaths weren't reported to the Social Security Administration? Except for the 17,000 where it was the fault of the Social Security Administration for not properly processing the payments in the first place.

I have a more brilliant idea. Why not we just not have Social Security in the first place, then we won't have the screw-ups of sending payments to dead people? (Isn't it amazing how many of our government's problems/inefficiencies/waste/screw-ups are a direct result of the policies/regulations/laws of the same government).

But then all of the old people will starve to death?

Oh, yeah, just like they were starving to death for the first 160 years of our country before Social Security.

$73 Billion for Food Stamps?

40 million Americans are using food stamps. At a cost of $73 billion (with a B). Something is just wrong with this when 13% of the country leaches money to buy food. I am assuming that those 40 million don't have cars, dvd players, computers, iPods, and Playstations. Because afterall, food is a necessity and why would you want to spend your money on play things if you need to eat? Oh yeah, because our welfare state has bred it in to some people. Its disgusting!

Put $73 billion into perspective. For 40 million people, that is $1825 a year. About $150 per month, per person. Our family's food budget is just under $100 per month per person. And we eat out fairly regularly. And I wouldn't consider us anywhere close to poor. If this isn't a bloated government welfare program, then I don't know what is.

The stigma of using food stamps has all but disappeared too. At one point in our nation's recent history, people were for the most part ashamed to use food stamps and tried to hide it as much as possible. Since the adoption of debit cards, it has made it less obvious that anyone is using food stamps. Plus, the government has gotten into a large ad campaign to "encourage" people to sign up for food stamps. What irks me is that probably 75% of the people on food stamps don't need it or are there because of conscious choices they made.

Case in point, when I was going to college, there were quite a few couples I knew who were living in subsidized housing and getting food stamps. And they had chosen to do that by going to school that they couldn't afford and not wanting to lower their standard of living below what they were accustomed to in their parents home. Every now and then my friends would offer us milk and cheese that they got as part of their allotment because it was too much for their family. I don't think my wife and I ever took any of it, even though that sure would have helped our food budget at the time.

So what would I do? Scrap the whole program. Why should the government be in the business of providing food for people? But, but, but ... then people will starve .... Uh, no. They won't. They may get their priorities in order and not buy the latest movie on Blu-ray and instead feed their family for a couple of days. Perhaps they will cut back on the beer and buy Wheaties instead (their both made from the same stuff, one just has more nutritional value and you don't have the hangover the next morning). There are lots of charities that provide food for the poor, and can feed a family for a lot less than $150 per person a month.

So, am I a heartless cretin? If you rely on food stamps, you probably think so. However, in my mind (and in practice) I can separate what are legitimate roles of government (blowing things up, printing money, and building some roads) and what should be the role of private charities. Unfortunately, I only get to selectively choose which charities I donate to. I don't get to selectively fund government programs.

The Federal Budget - Federal Debt

This is one of a series. For the other parts click on the links below:

The Federal Budget - An Introduction

The Federal Budget - Spending Projections

The Federal Budget - Social Security and Medicare

The Federal Budget - My Budget

Debt is a big word in this country. Right now we are sitting on $12.5 trillion of actual debt (and another $10-20 trillion of defined benefit debt based on current law). Back in the 80's and 90's there was talk of cutting the debt in half. Now all we hear about is cutting the deficit in half. So let's start by defining those terms.

DEBT - the amount of money that the US owes.

DEFICIT or SURPLUS - the difference between receipts and outlays for a given fiscal year.

Now, some people think that the DEBT is calculated by adding up all of the DEFICITS (or SURPLUSES). If you are one of those, you would be wrong. That is because the DEBT is composed of two parts: public and intragovernmental. The PUBLIC DEBT is debt instruments that are held by parties outside of the federal government: Savings Bonds, Treasury Bills, etc. The PUBLIC DEBT is held by corporations, foreign governments, and individuals (like me and you). Pretty much anyone or organization in the world can buy PUBLIC DEBT.

INTRAGOVERNMENTAL DEBT are debt instruments held by other government controlled entities (like the Social Security and Medicare Trust Funds). Basically, excess receipts (above what is paid out for the year) in the government trust funds is loaned to the government (yes the same government), and in return a trust fund bond is received. Governments can do this since they have the power to print/create money. You and I and every corporation out there would go to jail for fraud if we tried such a thing with our trust funds.

So how would this look in the real world. Let's say I make a promise to my kids to pay for their college. I get a job delivering pizzas to get the extra money. And, I get a piggy bank for them and put $9,000 in it a year (all of the pizza money is earmarked for my kids college). Since they don't have any college expenses right now, I then borrow that $9,000 from their piggy bank and put a piece of paper that says I will pay them back $9,000 +3% each year in interest. I have basically created $9,000 of INTRAFAMILY DEBT.

Let's go back to the DEBT and the DEFICIT/SURPLUS principle for a minute. Each year the big thing to talk about is the DEFICIT - mainly because the DEFICIT has gotten so large that it eclipse's the DEBT of the 80's (in 1984 the DEBT was $1.56 trillion, in 2010 the DEFICIT is projected to be $1.55 trillion). The goal Obama has proposed is to cut the DEFICIT in half, which would still make it larger than any year except Bush's last year budget (2009). DEFICITs have become the natural state of the American Government.

But what about Clinton's Surplus (or the Republican Congress' Surplus depending on how you look at it)? Again lets go to the definition. The SURPLUS happened because the US had less outlays than receipts. Now, in our personal world, we look at oulays and receipts as expenses and income (or revenue). This is where it gets a little hazy. The government (by law) has promised money to certain trust funds (for instance SS) and in some cases has even set aside taxes which (by law) can only be used for those trust funds. These taxes are part of the receipts. However, the excess for the year from the trust funds is loaned to the government (by law) and can then be used for whatever spending is wanted.

During Clinton's second term, the budgets showed a SURPLUS (less outlays than receipts) each year (1998-2001: I include 2001 since the fiscal year starts in October of the previous year). However, the DEBT went up, because a portion of the outlays were "financed" with the excess money of the governmental trust funds. In other words, the PUBLIC DEBT (selling of Treasuries and Savings Bonds) may have gone down, but the INTRAGOVERMENTAL DEBT (SS Bonds) went up by more than the PUBLIC DEBT went down. Hence, total DEBT still went up. In fact, total DEBT has gone up every year since 1940 except 5 ('47, '48, '51, '56, and '69).

How would this look in real life? Let's go back to our example. We'll assume that I have a $75,000 home loan and $45,000 of IOUs in my kids piggy bank (a total of $120,000), and I bring in $22,000 a year ($9,000 from pizza money and $13,000 from my regular job). My first kid just started college and needs $8,000 a year. So, I pay that and borrow the other $1,000 (increasing my IOUs to $46,000). This gives me with $14,000 ($13,000 + $1,000) to spend freely. If it was a Clinton year, I would only spend $13,500. So total outlays was $8,000 + $13,500 = $21,500. Therefore, I have a SURPLUS of $500 which I then apply to the home loan. So my total DEBT is now $75,000 - $500 + $46,000 = $120,500. Even though I had a "SURPLUS," my total DEBT went up because for accounting I am mingling the promised college fund (i.e. Social Security and other trust funds) with my regular finances (the rest of the budget).

Unfortunately, this is an Obama year, so the result is much different. Kid still needs $8,000, I still borrow the extra $1,000. However, I also need to take out a home equity loan of $17,000 to finance the remodeling that I am doing. So, at the end of the year I have receipts of $22,000 and outlays of $39,000 ($8,000 + $1,000 + $13,000 + $17,000). A DEFICIT of $17,000, although our total DEBT went up by $18,000 ($17,000 + $1,000). And if you want to have my numbers more closely reflect reality, just add seven 0's on to each one.

Now, can you really count the IOUs in my kids' college fund as debt? If you want to argue that no, it is fake anyway then look at the consequences. I tell my kids I am welching on the promise and they get all huffy. Since I am there dad, they can't get rid of me, however, they do eventually go off to college and work their tails off to pay for it. They don't ever trust me again, particularly with money matters and come to visit on the occasional Thanksgiving or Christmas. I grow old, and spend my lonely last years in a retirement home because my kids don't really like me and aren't going to pay for some nicer digs.

OK, so what about from a government standpoint. In theory, the government can just do away with the trust funds and make all of those IOUs worthless. In practice though, you would have to get 218 Congressmen, 60 senators, and a president to go along with it. None of these people would ever have a glimmer of ever holding public office again, and more than likely would face death threats if not actual assassination attempts (people get a little crazy when you take away their duely "earned income.") The chances of that happening are 0.

So what is going to happen? Well, when the second child goes off to college and I now need $16,000 a year, I can always get another job delivering pizzas. Except that there isn't not enough demand for that and all of the prime pizza delivering time is already being taken up by my 1st pizza delivery job. So eventually, I am going to have to start using my regular income. But we have already shown that is not enough, and so I'll have to take out another home equity loan.

Of course the bank isn't going to lend me money forever (just like investors will eventually stop buying US debt). At some point, they will say that my house isn't worth the risk of another loan. For them it is easy, they have a tangible point. For the real world, there is no known value that people will stop buying US debt, however, it is there somewhere as the debt grows faster than the economy, we get closer to it.

When that happens, the government still has another trick up its sleeve that I don't. It can print money. Now, with my laser printer and the right paper I could make an approximate facsimile of US currency and might even pass it off to the colleges as real money (kids DON'T try this at home - it is called counterfeiting and is illegal). Of course once they find out, the game is up and if they don't throw me in jail the minimum the college will accept is a certified bank transfer.

When the government continuously adds money to the supply, the hoi poloi eventually get nervous and inflation can happen. Rampant inflation. Not the late 70's type of inflation. We're talking Weimar Republic inflation right before its demise. Or Zimbabwe inflation. It is really the financial death spiral of a government. The paper money becomes nearly worthless, so more of it is printed until it gets to the point that the paper itself is worth more than the amount denominated on it. Lots of bad things can happen during this time.

So, let me introduce a term I made up: CUMULATIVE PRIVATE DECREMENT. The cumulative private decrement is a measure of the sustainable level of public debt (I exclude intragovernmental debt because it would make it look so much worse and all intragovernmental debt is funded by the private sector in the end). The % Private Decrement is first calculated by adjusting the % change in publically held debt and the % change in private GDP (GDP - government spending). The cumulative value is then added over a given period of time. I chose 1950 as my starting point since the budget figures for debt start in 1940 and I didn't want to start in the middle of a war (it tends to make the numbers look a lot worse since there is always massive spending during a war).

Basically, what this means (if I did my math right) is that public debt has increased 465% more than the economy as a whole has since 1950 (and really since 1970). From 1950 to 1970, debt growth was actually slightly less than the growth of the economy. This is sustainable. A government can increase its debt indefinitely as long as the means to service that debt (growth of the private sector) is also increasing at the same or faster rate. However, since 1970 the US has steadily increased its public debt at a rate that exceeds the economic growth of the private sector. The disappointing part is that the budget outlook for the next five years continues this trend. Public debt is expected to increase faster than private GDP. In other words, the situation is only going to get worse. And that's before you add in my less rosy predictions from The Federal Budget - Spending Projections.

Where the tipping point is, I don't know. I don't have plans to sell off the US Savings Bonds that I have. Then again, I don't have any plans to buy more in the immediate future either.

Taxes and the US Postal Service

It's December. And one of the times of the year when two government agencies particularly draw my ire. The US Postal Service and the IRS. It's a good thing Christmas is here this year so that I can have a breath of good cheer in the air.

With winter comes snow. With snow comes the drudgery of shoveling out the driveway. And as I found out the first year in Iowa, also making sure that the area in front of the mailbox is cleared. If not then I will undoubtedly get a nasty gram from the mailman telling me that I need to clear it or he won't deliver the mail. Now, mind you. I own my house (and the land that it is on). The city owns the sidewalk, but I am responsible for clearing it. The street/cul-de-sac that I live on is owned and maintained by the city. I don't even have a say in who does the plowing.

So, when the plow truck came by that first year and deposited three feet of snow and ice near the curb (in front of the mailbox), I get a nasty gram. After about the third time, I finally started snow blowing in front of the driveway and mailbox so that there was less stuff to be deposited. After reassessing the situation this year, I think I will just leave a nasty gram myself to the postman if he leaves one for me. "Dear sir, Thank you for your concern about getting my mail to me. However, if you leaf through it you will find over the course of a month there is only 1 or 2 letters that are actually worth opening. The rest goes in the recycle bin. So, please hold my mail until spring. I don't need it."

I am amazed that there is still individual house service by the US Post Office. Earlier this year when they knew they were going to be losing billions (again), there were whispers of maybe cutting service on Saturdays. However they weren't going to make a decision until the September board meeting, more than 6 months away. Doesn't that sort of defeat the purpose of whining about losing money if you aren't going to take any action for 6 months? So I came up with a plan if I was given control over the US Post Office to turn it around.

First, no service on Tuesday or Thursday. Also, I would cut service on every other Saturday. Postal workers would work 12 hour days on Monday, Wednesday, Friday, and every other Saturday. Second, no more individual mailboxes for each house. There would be a community mailbox area like I have seen in most new neighborhoods. My street has about 2o houses. These could be served by a single station with 20 boxes at the beginning of the street. I would be willing to bet that you could eliminate half of the delivery workforce just by doing this. Third, no more package delivery to the door. There could be a few large boxes at the community station for packages or they can be held at the post office. Fourth, rural delivery routes would occur once a week. No sense in wasting all that driving to deliver coupons from Bed Bath and Beyond (why don't they just lower all of their prices by 20% rather than sending me a coupon every single week?). Fifth, eliminate the franking privileges of elected officials. We pay them enough and provide enough for their office budgets that they can buy their own stamps. Some quick back of the hand calculations make me believe that these 5 suggestions would cut the postal expense by 75%. If you can't meet your budget after cutting 75% of your expenses, there is no help for you.

The US Postal Service is becoming an anachronism. Sure for 150 years, there was no other economical option to get documents from point A to point B if they were separated by more than 50 miles. However, there are several package/document companies that will do it for you now and overnight. Furthermore, if it weren't for monopolistic government regulations which require them (private companies) to charge more than the US Post Office, than their prices would be very competitive. Email and online bill pay has nearly eliminated the need to send checks through the mail. Frankly, the junk mail people are the only thing keeping the post office afloat. I send out more Christmas cards, than I do all other mail combined. And if there is ever a private company that will deliver them for 50 cents to a dollar a piece, I would use them. Even digital photography has made it so that you can share pictures with family without the mail. So, let's see if we can't get rid of the US Post Office in the next 25 years. Don't worry, private companies will come in to pick up the slack for less money, with better service, and faster.

So the next subject of my ire this time of year is the IRS (and subsequent state department of revenue). Every December, I do an estimate of my taxes to see how much I owe or how much I get back. This is so that my wife and I can budget out the next year. The last few years have been wacky, resulting in thousands of refunds. My work has always had a significant portion of my pay in the form of bonuses and overtime which is automatically withheld at 25% even though I claim enough deductions on my W-4 so that very little is taken out of my regular paycheck.

One of the results of the convoluted federal and state tax systems is that I have paid more SS tax than state income tax than federal income tax. In fact last year, once all of the credits were added in, I had zero federal income tax liability (Note: I am not foolish enough to believe that if I get a refund I don't pay taxes, what I am saying is that my federal refund was equal to or more than the total amount of federal income tax that was withheld). And I make a decent amount of money. The states that I have lived in that charge an income tax (Iowa, New York, South Carolina, Oklahoma) always seem to get more than enough. And while the federal return has enough deductions and credits to eliminate my tax liability, the states don't.

For instance, Iowa allows you a $40 tax credit for each person claimed on your taxes. $40! Compared to the federal child tax credit of $1000 + the $3650 per person exemption of income (which translates into $360 to $1200 of taxes depending on your marginal rate). The $40 is more like an insult than anything else. Why bother even giving it? Times like these, it makes moving back to Texas (with no income tax) look real promising!

The other thing I don't understand the logic for is underpayment penalties. Basically, both the state and federal systems are set up so that if you don't have enough withheld from your paycheck. In Iowa, the penalty is 5% of whatever your underpayment is. However, on the reverse side, if you overpay (i.e. get a refund) they don't tack interest on to it. So, the system forces you to overpay your taxes. Frankly, I'd be happier if we just had to write one check a year. So far our elected officials don't seem to care how much money comes in, they spend 10% to 50% more each year. Any complaint that the government wouldn't have a steady income flow is laughable.

Dividends are another big gripe. In case you didn't know, when a company reports earnings, that is the amount they are taxed on. To the tune of 35%. Then, the company pays out dividends (which have already been taxed at the corporate level), and the individual getting the dividends pays taxes on those (15% or 25% although for the next couple of years some of them are 0%). Double taxation at its finest.

I've blogged before about the federal budget. I support the Fair Tax. Is it perfect, no. But it is a heck of a lot better than the system we have. Now, I need to go look at some retirement properties in Texas, Washington, Alaska, Florida, Nevada, South Dakota, and Wyoming. I may work in an income tax state right now, but when I no longer am tied to a location for a job, you can bet I won't be living in a state where I have to pay income taxes.

The Land of Outrageous Profits! - Part 2

Walmart is a different story. Where oil companies that are involved in exploration, production and refining can move some operations around (i.e. only explore and produce in certain regions of the world, refine in others), retailers have to do business in the country they sell stuff in. Looking at Walmart's numbers $255 billion of revenue is US producing $18.5 billion in earnings (7.2%), while their overseas operations have $98.6 billion in revenue and $4.9 billion in earnings (5%); or operations in the US are almost 50% more profitable than overseas. This may be partly due to the newness of the overseas markets, but if you delved into the numbers I think you would find that the majority is due to the US having the largest population of middle class with income to spend at Walmart. Furthermore, as long as market saturation hasn't occurred (yet another discussion), Walmart would be wise to continue expansion on the more profitable US market.

The bottom line is that the DOW stocks had earnings of $373 billion in 2008 and paid 31% of that in income taxes. So, that $373 billion for the companies to "give back" to the people is now $257 billion. It turns out that $111 billion is "given back" in the form of dividends. Of course these are the wrong people receiving the money according to some. Dividends go to shareholders. Not only that, within a class of stock, shareholders all get the same amount. So Sam Walton's heirs get paid the exact same amount as I do. They just own a larger percent of the company than I do. And the shareholders do deserve that $111 billion. In many cases that is the reason they bought the stock. Remember Rule #1! The business is in it to make money. Turns out, the investor is in it to make money as well. When investors buy stock, all of their money is at risk. If Walmart went bankrupt, I would lose all of my money invested in it. There is no protection. As such, investors expect to get a return, either in the form of increased stock value or dividends (or both).

So, governments got 31% of the earnings of the DOW, investors got 30% of the earnings, that leaves 39% of earnings to figure out where they are and if the providing higher wages or health care would have been better. There are three major categories that this money can be spent on. First, operations. Paying off loans on equipment and buying more inventory. Both of these can be good things. Paying off loans can reduce the financing expense which will increase profits later. Increasing inventory in a growing business is important to stay ahead of orders (having more orders than one can fill is a bad thing, because customers don't like having to wait to get what they ordered). Second, investing. This can be capital expenditures (new equipment) or investments (stocks, bonds, real estate, etc.). Both of these are good things too. Capital expenditures are used to increase productivity and generate more earnings (plus, that equipment is bought from another company which affects their bottom line). Investments provide capital to other companies such that they can spend it on one of the three categories. Third, financing activities. Dividends actually fall into this category. As does buying stock. All of the stock that a company gives to its employees has to be bought from the market (so, yes, many companies own a portion of themselves). A company cannot just snap its fingers and make new shares of stock. It has to tell the market it is going to make new stock and how much (which usually results in a decrease in the current price of the stock such that the market capitalization remains roughly constant. Additionally, if a company doesn't have earnings or left over money from previous years, then it can borrow money. Borrowing can be a good thing as long as the return on that money exceeds the finance costs.

So, in a nutshell, the left over earnings are used to expand the company (i.e. generate more earnings the next year). This is exactly in line with Rule #1. A company does not exist to provide jobs or health insurance. They exist to make money. If it is necessary to provide jobs or health insurance in order to make money, then the company will do it.

So what would be wrong with raising wages or providing more health care with the extra earnings? Well, to begin with, you would need to take that money from one of the other two uses: dividends to shareholders or re-investing in the company. Let's look at these two options.

Let's use Walmart as an example. Walmart had after tax income of $13.4 billion. Roughly $3.75 billion was paid out in dividends and $10 billion was reinvested in the company. Walmart has 2.1 million employees. We could probably assume that 2 million of these are the stockboys, cashiers, etc, that are usually championed as the poor who Walmart is walking all over. $13.4 billion divided evenly among these 2 million would be $6700 more for wages or benefits (which includes the necessary taxes that have to be paid - sorry you can't short change Uncle Sam). Since Walmart is usually chastised since it doesn't pay a wage that will support a family of 4 (that the positions it has were never intended to support a family of 4 is irrelevant), lets look at what benefit an employee would get.

For a moment let us pretend that Walmart is going to give everyone a $3000 raise and provide health insurance for the other 50%. Assuming that all 50% are providing for a family of 4. Health insurance from employers for a family costs on average $13000 a year. There is only $3700 per person left over after the raise so, the employee would have to pay $9300 - $5000 more than the raise that Walmart gave them! Even if the employee is single, the cost is $7200, requiring him to fork out $3500 almost as much as his raise. If you are relatively healthy and you got to choose whether you had health insurance (which you may not use) or $3500, which would you choose? I actually had the opportunity to make this choice. I chose the cash.

In the end, whether the employees would "benefit" from having these profits is meaningless. They have no claim on them. Employees have essentially made a contract with the company for X wages and Y benefits in exchange for Z work. Regardless of how profitable (or unprofitable) a company is, all that is owed employees is X +Y as long as they provide Z. The investors on the other hand, have complete claim on the earnings of the company. They own those earnings. The shareholders elect the board of directors which ultimately decide how that money is reinvested. So, if you are an employee and believe you are being unjustly treated you have a couple of options:
1) Quit. Why are you working for a company that treats you like garbage? (Oh, maybe they really don't your just jealous and greedy and want something that you don't deserve).
2) Buy stock. Now you own the company. At the next meeting, put forward a proposal to distribute earnings to the employees rather than the shareholders. I'm sure that will be well received.
3) Continue to whine. This is usually the option that is chosen.

The Land of Outrageous Profits! - Part 1

Welcome to America! The Land of Outrageous Profits! Our companies are so rich that people have time to complain about how rich they are. Michael Moore, after making millions through the quasi capitalist system, has made a recent movie about how horrible capitalism is. Protesters at the G-20 conference complain about the horrible things a capitalism has done. And my personal favorite is when people complain about the evils of WalMart or Exxon or any other Big Bad Company. The reason it is my favorite is because most of what they say is wrong, meaningless, or both. And they don't even have a clue that they are wrong, meaningless, or both.

So, to begin let me give some disclosure about myself. I have never taken an economics class in my life, neither high school nor college. I have not read an economics textbook, ever. The same with Finance. In fact the only business classes that I had was a Management for Non-Business majors in college. So who am I to talk about business, finance, and investing? Well, I started seriously learning about investing in 4th grade and have closely followed the US stock markets since then. Pictures of myself in my early years show that I understood money was important as early as 2 years old. My parents can testify that I started analyzing complex money issues (with my allowance) and was much better at saving during my teen years than my bothers. In high school, I started to learn and follow the commodity markets.

In college I started investing the money I had. Since that time I have invested in a variety of things. I have made money investing in stocks, bonds, and real estate. I have also owned and operated an S corporation with some college friends. Each of my investing endeavors has contributed to my education about money and finances. Do I consider myself an expert? Not by a long shot, but I feel confident in explaining the basics.

Before I get too far, let's go over Rule #1 of business: The primary goal of all businesses is to make money for the owners. This rule is what distinguishes businesses from charities. While all businesses play a political/social game of saying that safety or the customer or employees or something else is most important, they are not. All of these other factors are weighed against making money. For instance, safety may be important. If a company has a dangerous job to do, it has several options:
1) Allow the company to do the job without mitigation of the danger.
2) Provide extra safety equipment or training to the employee.
3) Compensate the employee at a higher rate for taking the risk.
4) Decide not to do the job.
In each case, the company has weighed the cost of injury (medical, bad publicity, wages, etc.) to the benefit of the job being completed (increased efficiency, prestige, etc.). For businesses, all decisions are financial. Some people aren't comfortable with that concept. (Even the most "socially conscious" businesses make their decisions based on money.) Now that we have Rule #1 out of the way, let's get on with it.

First, let's look at how big some of these companies are, after all, we are told that Big "Insert BoogeyMan Here" are the cause of our problems. I'll use the Dow Jones Industrial Index as an example. Thirty large cap stocks make up this index. While the overall diversity is lacking (it has improved in the last decade), the index has been a very close approximation of the market as a whole (the market being made up of 5000+ publically traded stocks).

Three ways of looking at the size of company give different results. First, revenue. This is the total amount of sales of goods and services that a company has. The top five in the DOW are Exxon ($477 billion - a perennial favorite bad guy), Walmart ($405 billion -another favorite), Chevron ($273 billion - part of the Big Oil Cartel), GE ($182 billion - usually you don't hear too much bad about them because everyone thinks they are an manufacturing company - actually, almost half of their business is in the financial services sector), and finally Bank of America ($124 billion - does anyone not think this company is the embodiment of Satan by now). So clearly, those companies who bring in a lot of money are evil, evil, EVIL!!!!

Oh, wait, I am suppose to be for capitalism. So, let me say, none of these companies are evil. In an effort of full disclosure, I own a large amount of Walmart stock. I also own all five of these companies through various retirement funds and ETFs. The major reason why these five large companies bring in so much money (notice I said bring in, not make) is because they sell products or services that millions use. Oil and gas are the fuel of our economy. Walmart is the middle & low class shopping haven, GE has their hands in so many things you can't not buy GE products, and we all like to keep our money safe in a bank.

Second, market capitalization. This is the value of the stock that has been issued. The top five are: Exxon ($319 billion), Microsoft ($222 billion), Walmart ($189 billion), Proctor & Gamble ($165 billion), and JP Morgan Chase ($164 billion). Two are the same but three are different although all have been villified to some degree or another. Another way of describing market capitalization is the perceived value of the company by investors. This perceived value includes the sum of assets and liabilities, as well as the future earnings potential based on past experience, market conditions, and personnel the company has. Market capitalization is the most fluid of the three valuation types because it flucuates whenever the stock is being traded.

Third, earnings. This is the actual money that is earned (and thereby taxed) by the company. The top five are: Exxon ($82 billion), Chevron ($43 billion), Walmart ($21 billion), AT&T ($20 billion), Microsoft ($20 billion). A lot of the same characters, now we have AT&T (communications giant). Earnings are a sign of how companies have used resources, labor, technology, and capital to accomplish Rule #1.

All of these lists are in absolute numbers. The 30 DOW stocks combined had a market capitalization of $3.2 trillion, revenue of $2.8 trillion, and earnings of $374 billion. Now a lot of the criticism that companies get is due to people not understanding how financials work together. Some are focused on only a small component (Walmart's low wages or lack of health insurance, Exxon's "largest profits in history", Microsoft's monopolistic practices, even AT&T not limiting use of its phone lines). The common theme is that these companies are making billions in earnings and should be using them for something else.

The earnings that I mentioned above are before taxes. A large chunk of this is used to pay taxes. The corporate tax rate in the US is 35% . Now because of different tax laws and where the companies "earned" the money, they may be paying more or less than this. The top five earners of the DOW paid the following amounts in income taxes in 2008: Exxon - $36.53 billion, Chevron - $19.03 billion, Walmart - $7.15 billion, AT&T - $7.04 billion, Microsoft - $5.25 billion.

For those of you who are math challenged, even though the corporate tax rate in the US is 35%, Exxon and Chevron (those oil companies who do nothing for us) are paying out 45% of their taxable earnings in income taxes. (Most of this is due to the number of other governments that they paid income taxes to and the various tax liability in those locations). Take Exxon for a moment, $36.53 billion in income taxes. $3.8 billion of that went to the US or state governments. The rest went to governments of other countries. Before anyone cries foul, only $10 billion of the $82 billion in earnings was related to operations in the US. So, $3.8 billion is rather fair. What it more interesting is that of the $477 billion in revenue, $121 billion was from US operations. Basically, what this tells me is that operations outside the US are far more efficient at generating earnings (10/121 = 8.2% for US vs 72/356= 20% for international). So, even though there is effectively a higher tax on the earnings outside of the US (3.8/10=38% vs. 32.73/72=45%), because of the increased efficiency in generating earnings, the majority of operations occur outside of the US. Furthermore, any expansion of operations would make more sense to be outside the US since that maximizes income. In other words, if the US wanted to lure more of the operating dollars to the US (thereby being able to tax them), they would have need to lower the corporate income tax rate (I'll have to write another post on that one!).