Thursday, July 29, 2010

Taxation and Morality

Not long ago, I went to a local school board meeting in the town where I live north of New York City. The meeting was about the proposed school budget, which voters in our town get to vote on. Our district was spending $28,000 per student, and I got up to the microphone and suggested this was too high, and that high property taxes were starting to have a pernicious effect on the town.

Cue the disapproving shaking of heads. He wants to take money from our children!
The next woman got up to the mic and said that we needed large school budgets to protect our home values. Then she declared those of us in opposition as "greedy." What I wish I had then said was this:
This town has been unfailingly generous to the school system for decades. In fact, the growth in the school budget has been close to 8%, far outpacing inflation. And yes, while good schools help home values, there reaches a tipping point where high taxes hurt more than good schools help. We passed that tipping point long ago. Now, property taxes are crushing our home values. Just as importantly, they are changing the culture of our town. We are becoming a temporary residence for people with school age children. They stay as long as they have kids in school, then leave. Retirees, who had paid off their mortgages years ago, can no longer remain because of property taxes. The voraciousness of the school system is slowly destroying our town from the inside, and yet you call me greedy?
The point here is that there is a moral and social component to keeping taxes low - it's not simply about individuals wanting to keep more money in their pockets. This is an argument that, in particular, Republicans need to hear, because while they profess to like low taxes, they retreat into their turtle shells  every time a Democrat yells, "Tax cuts are for the rich!"
Republicans understand that tax moderation spurs economic activity. But not all possess the philosophical underpinning that gives one the confidence to fend off specious attacks. Many don't, in a nutshell, understand the morality of their own position. This makes them weak advocates.
My town is a great example. Taxes are driving away the elderly and actually breaking up multi generational families. The town is slowly losing its unique culture and institutional memory. Oh, and yes, our home values are getting crushed, but that's not an argument that the left is particularly concerned with. Playing on their pitch, though, they are supposed to be concerned with things like culture and population diversity. So they tell us, almost constantly. And yet their position on matters of tax runs counter to their own goals.
I remember Reagan's trickle down thesis being mocked, but history shows us over and over again that it is precisely how the world works, and thank goodness for that. Job creation - from CEO down to night janitor - doesn't happen without business creation. Business creation doesn't happen unless those that have capital (the rich!) can be enticed to remove it from the comfort of a bank account and risk it on some new enterprise. There has to be a reward in it, in other words.
That taxes affect economic behavior would seem to be straightforward enough, but policy makers rarely stop to consider it. Remember the Clinton era luxury tax? It was applied to expensive cars and boats, and the intent was to get more money out of rich people. Do you remember what happened? Rich people stopped buying. In particular, they stopped buying boats. The immediate and unintended consequence of this was that shipyards in Maine went out of business and lots of workers were thrown out of work. Rich people can do just fine without a boat, middle class workers cannot do fine without employment. Where's the morality in that?
There exists, I would suggest, a "taxation morality curve" that may look like this:

Sometimes concepts are understood most easily if one looks at the most extreme examples first. Zero taxation anywhere in society - the left edge of my graph - gets a score of "zero" morality. Government couldn't exist, and therefore there would be no property rights or assurance of liberty. Society would be dominated by well armed thieves. This is not conjecture, we can see it today in places like Mogadishu that have no functioning government.
The other end of the spectrum - full confiscatory taxation - produces the same result. At a 100% marginal tax rate, the entire economy would operate on the black market. Government couldn't exist since it couldn't collect anything. Thus, again, we would have a society dominated by thieves and violent anarchy. Justice would be a distant notion. I will also give this society a morality score of zero.
Since we know it is possible to construct a moral society somewhere in between, it therefore has to be that there exists a morality curve. This is interesting, because it is then a given that some taxation is highly moral. It pays for the things we need to preserve our rights and liberty. Rights are preserved, for instance, by the existence of our legal system, which must be supported by courts, public prosecutors, etc. Our liberty is preserved by a system of national defense as well as domestic law enforcement. These are not the only examples, but they are certainly the most important.
What's more interesting, though, is that after a certain point, marginal taxation necessarily decreases societal morality. If the curve ends up at zero, it has to go into decline at some point. As with property taxes in my town, taxation manufactures immoral outcomes. Those immoral outcomes fall hardest on the working classes, not the rich.
It is no coincidence that my graph looks a whole lot like the Laffer Curve, which postulates that after a certain level of taxation, revenues decline. The existence of the Laffer Curve - as well as the Morality Curve - cannot be in doubt. The open issue is the shape of these curves, i.e. at what point of taxation does revenue or morality decline? I believe the "real" morality curve (and Laffer Curve) looks something like this:

But back to the process. How, exactly, does taxation create immorality? If you have been following these letters, you know I have looked extensively at state-by-state fiscal and taxation comparisons. Many states like New York, California, and Illinois are in dire straits and need to close enormous budget gaps. Many want to raise marginal rates, particularly on top earners. This is a bad idea with a highly immoral outcome.
Witness the recent experience of Maryland, where the state legislature raised the top rate on millionaire households to 6.25% from 4.75%. Using static analysis - which postulates that behavior is never affected by rate changes - they estimated that they would collect an extra $106 million in revenue. Instead tax receipts from rich filers - wait for it - fell by $257 million.
The number of millionaires filing fell by a whopping 30%. Certainly, some had income declines, but fully 12% didn't file, suggesting that most had just up and left. I'm guessing Florida is the beneficiary. (See: You see, the people who have the most resources - and pay the lion's share of the taxes - are precisely the ones that can leave the easiest. In all likelihood, they already have homes in other states. Rush Limbaugh moving to Florida is costing New York close to $50 million over the life of his contract. How many dock workers or bus drivers do you need to cover that loss? LeBron James not coming to New York cost the state $12 million.
I'm not asking you to feel sorry for LeBron, Rush, or any of the other rich folks. Yes, it's immoral that they have to decide where they live based on something as ridiculous as tax rates, but they'll get along somehow. What's really immoral is what happens to the people who don't have the same ability to live where they want. If you run a hedge fund, you can do it from anywhere. If you depend on others for your employment, you can try to move, but you'd have to find someone else willing to hire you. Good luck with that right now.
Businesses are also much more mobile than in the past. Once upon a time, if the state of Michigan raised taxes on the auto industry, they could count on GM (et al) to swallow hard and pony up. Now, they can outsource. Take a look at Detroit and tell me that's not exactly what happened:

But more to the point, today's businesses are more information based. Why does an internet company need to be based in New York? It can move tomorrow.
So what happens is that the lower rungs of the economic ladder are left holding the bag. Taxes spiral upward and services are systematically cut. Poverty and crime escalate, people suffer. If we accept that human misery is a form of immorality - at least, when we know we could have prevented it - then you understand how high levels of taxation are immoral.
This is a message that all Republicans need to internalize. Only then will they become effective advocates. (Incidentally, I'm not being partisan here. I welcome Democrats to internalize it, too. I'm just not holding my breath.)

Website of the Month

This is somewhat out of left field, perhaps, but for years in the letter I send to clients I always include a "website of the month." Since it has proved popular, I have decided to blog about them here as well. These sites run the gamut from humorous to useful to ridiculous.

The cost of living in New York is nuts. This leads a lot of people to fantasize about living elsewhere. The line of thinking goes something like, if I sold my home and cashed in all my chips, I could live like a king in [fill in the blank].
Well, I had a friend who, a couple of years ago, followed through. He was tired of Wall Street, didn't like his prospective cost curve, and so he moved his family to Boulder, Colorado. Why Boulder? I asked. Friends? Relatives? None of the above. He went on a website called "Find Your Spot" that suggests where you might want to live based on your personal preferences:
I went to the site to see where my "spot" is. They ask you dozens of question about your preferences on things like activities, culture, religion, climate, etc., and then - presto! - they rank the top 25 places in America where you should live. Here are my top five:
1. St. George, Utah (never heard of it, but now I want to know more)
2. Greenville, South Carolina (you can't go home again - or was that Ashville?)
3. Tulsa, Oklahoma (really?)
4. Clarksville, Tennessee (see: St. George, Utah)
5. Kent, Washington (a Seattle suburb - do they know I don't drink coffee?)
It's actually a fun exercise - try it yourself when you are looking to kill half an hour.

Wednesday, July 28, 2010

Free Food, Anyone?

So, why do you suppose a grocer would give away something for free? Past the expiration date? No, doubt it. That sounds like law suit city. My guess is that this stuff isn't selling and that the cost of removal (something small) exceeds the cost of giving it away (zero).

Hat tip to Freakonomics on this one.

Friday, July 23, 2010

Tri-State Smackdown

After I began to analyze the various financial situations of our 50 states (see: Where Should I Live Where I Won't Get Crushed?), it dawned on me there was an incredible opportunity in the Tri-State area (New York, Connecticut, and New Jersey). All three are basket cases, and no sane person should move to them unless they have to. (Connecticut is slightly less awful than the other two, for what it's worth).

But there is an incredible concentration of wealth and industry in the area. Yes, it has been slipping away, but it's still there. The opportunity is if just one of these three states gets it economic act together - reduces public debt and taxation - it would hit the ball out of the park. People - particularly the successful ones who pay taxes - would move in droves.

Which is why I found it interesting that Connecticut's governor, Jody Rell, has scheduled lunch next week with a number of successful New York hedge fund managers. The agenda: move here and we won't hose you as badly as New York!

Mayor Bloomberg responded by saying that this is what New York should be doing, i.e. making itself attractive for people and businesses. Albany has other ideas, though. New York will be the likely loser in this game. The question is, who will be the big winner? Rell or New Jersey's Christie?

Fairfield Greenwich - They Guessed the Wrong Scam

Irving Picard is now going after various Fairfield Greenwich entities as well as many of its principals personally. He believes they were in on the Madoff scam, or at least knew it was happening. I agree with this - sort of.

Fairfield's due diligence was, indeed a joke. I blogged about this in detail here:

Fairfield Greenwich

But I am quite convinced that the executives at Fairfield didn't suspect that Madoff was running a Ponzi. I believe they thought he was running a different sort of scam, one known as front running.

Madoff also owned a reasonably successful brokerage firm, which meant he was dealing with a lot of order flow. Front running involves trading in front of your clients, and it is quite illegal. It would have enabled Madoff to provide the incredibly consistent returns that he did simply by crediting over profitable trades (to his investment arm) as he needed them. There had been talk around the Street for years that this was going on. I had heard it myself, and clearly Fairfield did as well.

Think about the difference. In a Ponzi, the game always ends, and the money is gone. Fairfield would have known their doom was inevitable, and nothing about their behavior suggests this. On the other hand, if Madoff had been running a front-running scheme, the money would have been real, and the risk entirely Madoff's. If the SEC had come along and busted him, presumably Fairfield would have pleaded ignorance, gone home with their assets (less, possibly, an SEC haircut), and not shared in culpability. This explains why they hardly ever did any due diligence on Madoff. They didn't want to know anything. They needed plausible deniability.

When the true nature of the scam became known, it must have rivaled history's great "Oh, crap" moments.

There is one other Fairfield matter that seems to have escaped the regulators, which is their close relationship  with Union Bancaire Privée, a Swiss bank that had its own Madoff feeder fund. Apparently, three of Fairfield’s other funds-of-funds - the ones that theoretically had nothing to do with Madoff - had money in this feeder. Huh? Fairfield had direct access to Madoff, so why would it pay someone else for access? One guess is that it was some kind of quid quo pro arrangement; Fairfield and Bank Privée did business on a number of levels, so perhaps they were getting a fee break somewhere else, perhaps on advisory services their management company was receiving from Privee. This, in effect, clips client returns and re-directs the money to Fairfield management. Very bad.

Another possibility is that this was a way to quietly channel money to Madoff from other Fairfield funds without letting this fact be completely clear to investors (i.e. ones that had possibly taken a pass on the direct Madoff feeder). Also very bad.

Thursday, July 22, 2010

Financial Reform - Be Afraid

This is supposed to be a blog (mostly) about investment theory and practice, although really it admittedly wanders off-piste.You may have noticed it has veered more and more into the political realm of late. Sadly, this is because politics and the economy (and therefore investing) have become inextricably linked as the government continues to extend its reach almost everywhere.

Which brings me to the Dodd and Frank's "Wall Street Reform and Consumer Protection Act." It is 2300 pages long, and almost assuredly no one other than a few congressional lawyers and staffers have read it. As readers of this blog know, Johnston's Law asserts that unintended consequences rise with the square numbers of pages in a bill. And, already, on Day One we see our first, and it's a doozy: the shut down of the ABS market.

The Asset Backed Securities market is what funds car loans, credit card loans, and small business loans. It is vital to the functioning of our economy. It seems that the bill forces ratings agencies to accept liability for the quality of their ratings. Mind you, a rating is very clearly only an opinion, but the agencies will be placed in harm's way nonetheless (harm, in this case, being from the devil's minions in the plaintiff's bar).

So, the ratings agencies are simply saying, "screw this," and are refusing to rate ABS. The problem with that, though, is that many forms of ABS are required by law to be rated. Rut roh! This has led to an overnight shut down of the ABS market. Ford has already pulled a large auto loan offering.

Interestingly, the ratings agencies had no idea this was in the bill. It apparently wasn't in an earlier version. This underscores the fact that no one knows what's in it. Obama, who doesn't know the first thing about finance, certainly doesn't. Dodd and Frank? Please.

If Day One has led to the unexpected shut down of the ABS market, what will Day Two bring? Day One Hundred?

Tuesday, July 20, 2010

E-Books Outselling Hardcovers at Amazon - By Wide Margin

This is reported by the New York Times here:

E-Books Outselling Hardbacks

I bought an iPad when they came out but was skeptical I would like reading long books electronically. I hate reading on computers. Turns out I like it a great deal. Just finished Atlas Shrugged, a long book if there ever was one. (Unrelated note: Atlas Shrugged, a book published 53 years ago, is #42 on Amazon).

I will miss bookstores. Libraries will hold on, I think, but not as places to go get books.

Wednesday, July 14, 2010

Hong Kong and the Flat Tax

Check out this excellent piece on Hong Kong's flat tax system on Clusterstock:

I lived in Hong Kong for three years. When I was getting ready to leave, I realized I had never paid any income taxes (the government doesn't clip your paycheck there). I figured I'd better settle up so I looked up the number for Inland Revenue (their IRS) and dialed it. A woman answered and I explained my situation. She asked me my ID and I told her. For about 20 seconds, I heard the sound of a computer keyboard. Then she told me exactly how much I owed. She didn't even have to transfer the call. I sent in the check. Bam, done!

Now contrast that to the annual compliance agony we go through here in the U.S. My wife and I use an accountant, of course, but I'd estimate that we spend 20 or 30 hours just to prepare all the necessary documentation for the accountant. Then we have to answer his questions, of course. More time, more expense, more stress.

There has got to be an easier way to give money to the government. Tax simplification should be a huge political winner for either party. The problem is, they are too fond of using the tax code to implement their social engineering fantasies, or as a way to dispense favors to politically connected donors and friends. A flat tax is not a convenient play toy for politicians, but its implementation, besides promoting economic growth, would have the salutary effect of reducing political corruption.

Tuesday, July 13, 2010

Death and Taxes

George Steinbrenner passed away today. As a lifelong Yankee fan, I always had mixed feelings about the Boss. Way too mercurial, but it's hard to argue with his results.

The Boss, a businessman first and foremost, would surely appreciate the business sense in the timing of his death. Because of the Bush tax cuts, death taxes for 2010 are zero. They were meant to stay that way, but in order to get the tax bill passed at all, Bush had to compromise by including sunset provisions. So, get this, next year when they expire the rate goes back to 55%. Steinbrenner is worth $1.3 billion. Thus the timing of his death is worth $700 million to his heirs. Had he passed away next year, the tax bill would have been enough to force his kids to sell the Yankees.

Here's a prediction: towards the end of the year, I believe there will be a lot of "soft" suicides by people with substantial assets. If they are sick anyway they may simply allow the process to accelerate. There may even be a spike in more deliberate suicides. Suicide cancels the obligations for a life insurer, but it will certainly beat the tax man.

This may seem like a very cold-hearted prediction, but what's really cold-hearted, and perverse, is the existence of a tax system so penal and complex that people may literally make life and death decisions based on its rules. It is a system beyond simple repair. The entire edifice must be razed and something simple and fair must take its place.

Monday, July 12, 2010

Prediction Markets Update

Here are the current odds of various events happening according to Intrade prediction markets (before year end):

Republicans take over House        56%
Republicans take over Senate        14
Sarah Palin runs for President        61
Sarah Palin gets nominated            18
Harry Reid wins reelection             53
Cap & Trade becomes law             17
Obama reelected                          60
Bin Laden Captured                       5
Someone drops the euro               10

And you can put a stake in real money movie futures becoming a reality. Cantor Fitzgerald has laid off the staff members who were going to be involved after lawmakers, led by Blanch Lincoln, bowed to film industry pressure.

Thursday, July 8, 2010

Where LeBron Won't Get Crushed

The New York Post (my favorite paper) pointed out that LeBron might pass on the Knicks for no other reason than New York tax rates are much higher than the other cities/states he's considering. They estimate he will pay over $12 million in New York City and state taxes over the life of his contract.

Let's look at how the various suitor cities stack up in the analysis I did a few months ago. (Where Should I Live Where I Won't Get Crushed?)

                           State Tax       City Tax       Total      Debt Rank

New York               8.9                3.7            12.6             46

New Jersey            10.8                 0             10.8             50 

Cleveland                5.9                2.0             7.9              44

Chicago                  3.0                   0              3.0              42

Miami                       0                    0                0              12

(Note: see the linked piece above to read about Total Real Debt per Capita.)

Hmm. Looks like no contest. Since they will all pay him roughly the same amount (due to salary caps), these tax differentials will be highly meaningful.

Let's see what the market at Intrade is saying about where LeBron is heading...


New York                    7%
New Jersey                  7
Cleveland                    24
Chicago                        3
Miami                        63

Looks like the market agrees.

Introducing the Candwich!

Sandwiches in a can. Talk about can't miss!

This culinary item-to-be has come to light because someone named Travis Wright raised $145 million to invest in commercial real estate but then decided - without telling his investors - that he was plowing his money into the Candwich instead. While it remains to be seen which is the better investment, the SEC has taken issue with his approach.

Read all about the Candwich at their website:

Wednesday, July 7, 2010

Does the U.S. Have the Highest Taxes in the World?

In my previous post, you can see that if one adds up the major categories of taxation, the U.S. is among the highest taxed countries in the world, although it is not the worst. BUT, I did not include inheritance taxes or property taxes. I believe once these are added, not to mention all the nuisance taxes we pay every day, we likely have the distinction of being the highest taxed nation in the world.

Who is John Galt, indeed.

Thursday, July 1, 2010

The Wide World of Taxes

I was travelling with my family by ship in the Baltics this month, a trip I can highly recommend. All the cities are quite beautiful, with St. Petersberg being a real stand-out (as long as you stuck to the pre-Soviet neighborhoods).
At almost every stop some fellow tourist would ask the local tour guide about tax rates. In Finland, our tour guide announced that the top marginal rate was 70%. She said this – devoid of irony - right after telling us about how the Finns kept the Soviets at bay for several generations. Top marginal rate in Russia these days? 13%. Not sure who won and who lost.
(Note: I have since learned that Finnish taxes aren’t quite that high, but they’re still high.)
This got me wondering about tax rates around the world. In March, I wrote a piece on net debt levels around the world, which gives us an idea for which direction taxes could head in different countries (see: But what about right now? How bad is it out there?
I decided to look at tax rates in countries big and small. Some of the results you may find surprising. My methodology is simple: I take the highest marginal rate for personal income taxes, corporate taxes, value-added taxes (or sales taxes), and capital gains taxes, and I add them all together to get a tax “score.” Obviously, this is simplifying something that can be highly complex. The U.S. tax code, for instance, weighs in around 20,000 pages. Further, different taxes affect people differently. But I think as a rough pass, it is instructive.
The envelope please…

Obviously, the lower the score, the better. A few observations:
·         The EU countries, which have desperate amounts of debt, are already highly taxed. Raising taxes further is unlikely to raise more revenue. It will only succeed in raising non-compliance, which is already very high and not a social taboo.
·         Switzerland, though landlocked, is quite literally an island, economically speaking. How glad are they they’re not in the EU?
·         Asia and Eastern Europe, generally, score quite well.
·         Hong Kong does not surprise me. I used to live there, and I did my taxes once a year on a postcard. Despite the low rates, the government would run surpluses most years (and was somewhat embarrassed about it).
·         Singapore is sure doing something right. They have net assets of 188% of GDP (you read that right – net assets – their sovereign wealth exceeds their debt), so they will actually have room to reduce the world’s second lowest tax burden even further.
·         The U.S. is right up there among the more highly taxed nations of the world. (Note: I added an “average” state income tax to the federal, something I also did for Canada where they have high provincial taxes. I also added an average sales tax.) In fact, the U.S.’s score probably understates things, because there are more miscellaneous taxes here than can be counted, something not captured by these numbers. Ever look at your cable or hotel bills? Taxes and more taxes. I also didn't include inheritance taxes or property taxes, both killers in the U.S.
I wrote another piece a while back called Are We Socialist Yet?
( Certainly, high marginal tax rates are a key tenet of socialism. I concluded that America had already been for some time. Obama is not leading us on a path to socialism, we got there a while ago. Republicans, save Reagan, played an active role in this. Obama is merely hastening the slide.

Movie Futures Update

I got very excited a couple of weeks ago when I heard that Cantor Fitzgerald had received regulatory approval from the CFTC to go ahead with their plans to create movie futures (which would trade on expected box office receipts). Now, it appears they are dropping their plans because the new financial overhaul bill will apparently scotch the idea for good. The film lobby – which hated the idea - got to Washington lawmakers. By “got to,” I mean bribed with campaign donations.

As you know, I am an avowed prediction markets enthusiast, so I find this highly disappointing. One also wonders what this is doing in a bill that is supposed to correct what’s wrong in the financial industry. After all, movie futures don’t exist, so why is there a need to “fix” them. Welcome to Washington, where every leviathan-like bill is an opportunity to take care of one’s friends.