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What You Need To Know About Obama, Buffet, And Socialism

October 21st, 2011 No comments

There is a battle in politics and the media going on about what the future tax rates should be and whose rate should change. President Obama and Warren Buffet are on the side that believes that the wealthy should pay more for numerous reasons. And there are political opponents who are arguing that no one should pay higher rates, especially wealthy business owners who are presumably the ones who will create the jobs that are the main goal of Obama’s Jobs Bill.

There are people who articulate the politics of this issue well enough that make it unnecessary for me to go into it here. In this article I will discuss how this issue has been misunderstood in the media, and what you should know about it concerning your own finances.

Socialism Vs. Capitalism

Unfortunately, the mass media makes mistakes in how this issue is portrayed. The most common one is that they make a link between income and wealth that isn’t as strong as they believe. There are reams of studies, political papers, and opinion written about how social standing, health care outcomes, etc are determined by your income. It’s deafening. I’ve read many newspaper articles and OpEds over the years that use the idea of income and wealth interchangeably.

People who make large incomes are not necessarily wealthy. What makes someone wealthy is what they own, not what they earn.

This misunderstanding is rooted in the difference between socialism and capitalism. In both economic systems, people earn incomes and how much they earn is determined by skills, experience, and training to varying degrees. However, in a capitalist system, the capital goods such as equity, equipment, financial instruments are generally owned by private entities whereas in a socialist economy they are owned and managed by the collective. In a Socialist system, the fight is on income because no one can own capital assets where the real wealth is.

Warren Buffet made $40M of income that was taxable, yet this is less than 1% of his total wealth. What makes Buffet wealthy isn’t that income it’s the huge stake he owns in his company, Berkshire Hathaway that is over 100X larger than his declared yearly income. Journalists usually make no mention of this either because they don’t understand capitalism or how it works. If one really wanted to tax the wealthy, the right place is to go after their wealth not their income.

Key Takeaways

  • Mass media influences public policy and they are generally antagonistic towards people who earn large incomes and muted on true sources of wealth. Focus your efforts on activities to accumulate assets that will make you wealthy. As the balance sheet of Warren Buffet shows his assets are the real story and not his income.
  • We live in a mostly capitalistic society so the engines of the economy (including Warren Buffet’s company) are for sale for anyone to own. This is the best way to achieve financial independence, buying assets that will growth and make you money over the long term.
  • Don’t concern yourself too much with these battles because the combatants are fighting over issues that are not front and center concerning the ones you need to focus on to achieve financial independence.

Determine Your Personal Wealth Factor

Buffet is one of the richest persons in the world. His income is very small compared to his assets. This naturally leads to determine a method to compare anyone’s wealth to Buffets. This is not a simple total of wealth, but a ratio of your income to your assets. If your assets are large relative to your income and they are growing faster than your income then you are on the right track. Here’s the calculation:

Wealth Factor = ( Assets – Liabilities / Earned Income )

In Buffet’s case, his assets are 40B. It can only be guessed what his actual earned income is, but it is most likely much less than his reported income of 40M because a lot of that is probably unearned, or investment income. According to SEC filings Buffet’s income from Berkshire is only 524K.

For Buffet, his Wealth Factor is 75,000. When calculated for the author, it’s 7. There is a long way to go!

Categories: Economy, Politics Tags:

A Tax Change Whose Time Has Come

August 20th, 2011 No comments

If you read through the proposal by the bi-partisan commission on deficit reduction there are a few important details that didn’t make the headlines. That’s unfortunate because there’s a lot to like about the entire proposal.

Most beltway politicians either have criticized it or have tried to distance themselves from it (Obama). It’s easy to see why, it addresses many sacred cows or ‘third rail’ issues such as the mortgage interest deduction, investment tax rates and Social Security benefit
and taxes.

What hasn’t been reported widely is that the proposal suggests reducing and simplifying all the income tax rates. The top tax rate in the proposal would only by 23%. How is this possible, if the plan is trying to reduce the deficit? Well, all those sacred cows are slaughtered. By eliminating deductions, there is room to reduce the deficit as well as lower rates.

I’m going to go out on a limb here and call this a Flat Tax. You will never here any politician who is looking to get elected call it that, but that’s what it is.

You see, marginal income tax rates have varied over the years from very low (<10%) to very high (90%). Inevitably, when rates go higher, special interests seek relief which manifests itself as “special treatment”. It’s all that special treatment that’s gotten us into this mess of having such a complicated tax code.

You may have seen past articles that talk about how most taxpayers pay similar overall
tax rates (a fact that Warren Buffet has famously pointed out previously) no matter how much income they make. This is a clear indication that the higher marginal tax brackets aren’t working to get more revenue.

At some tax rate, though, most people will not seek special treatment, especially if
all the various forms of income are treated equally. For example, workers might seek
investment compensation instead of wage income because the rates on each are currently significantly different. Also, the mortgage interest rate deduction distorts the housing market by creating incentives to overbuild home size. If these distortions didn’t exist, this would create more efficiency in the economy as well as raise more revenue.

This is a change whose time has come.

More Information

http://news.yahoo.com/s/ap/20101111/ap_on_bi_ge/us_cutting_deficits

Categories: Economy, Taxes Tags:

Energy Efficiency Increases Not Decreases Energy Use

August 1st, 2011 No comments

A recent article in the Economist makes a convincing case that environmentalists have it all wrong about energy efficiency. Energy efficiency promotes higher energy use because the more light created with the same amount of electricity creates demand for more uses of light not less.

This is not the first study I’ve read on this topic. If you think about it, it makes a lot of sense.

Environmentalist think that efficiency will lead to stable or lower energy use over time. Consumers have something different in mind: they want more light and producers are going to want to deliver it. Efficiency will hasten this trend.

You may have read articles about the problems that Google is having keeping up with server demand. Growing so fast, one of the main roadblocks they encountered was server power supplies. The main driver of server costs is not the hardware but the cost of electricity. So, they designed their own equipment that is more efficient.

But in the end, does anyone think that Google is going to use less energy in the future than it does now? Nope. They are getting involved in the energy market big time all to create even more data centers and more services.

There’s only one way to reduce energy use: make energy more expensive. Nobody wants to do that, at least not directly. The cap-and-trade bills in Congress would increase the cost of energy, but only indirectly.

Categories: Business, Economy Tags:

QE II Is Here: Why Gold Will Be A Bubble

November 3rd, 2010 No comments

As expected, the Federal Reserve announced Quantitative Easing II (QE II). There were no surprises here, the reports over the past weeks were indicating easing in the amount of a few hundred billion to up to $1 Trillion. The headline number is $600B, but the total will be closer to $1 Trillion if you include additional purchases to replace expiring mortgage bonds. The additional purchases don’t expand the Feds portfolio, they will simply replace existing positions.

This sounds like a lot of money, but put $600B in perspective. It’s less than 6 months worth of the U.S Federal Government’s budget deficit. The entire U.S economy is over $14Trillion dollars.

One of the important details about QEII is that the majority of the Fed purchases will be within the bond maturity window of 5-7 years. This is important because the Fed will eventually need to reverse QEII as well as unravel all its other existing positions.

How It’s Supposed to Work

The Fed is trying to accomplish a few things here with QEII. First, the purchases will cause interest rates to decrease because buying bonds increases prices. Bond yields go in reverse to bond prices, so these purchases tend to depress bond yields. Lower interest rates in theory makes credit more easily available (this argument doesn’t reflect reality though – just ask people who are trying to get those cheap mortgages).

Second, lower bond yields make government debt less attractive. This will make other productive, private market assets more attractive because the risk adjusted return rate of those assets should go up. This phenomenon is thought to be contributing to the rise in the stock markets, particularly income investments.  Why earn 2+% on a 10 year Treasury when much higher yields are available from the highest quality, AAA rated, stocks?

Will it work? Perhaps it might have some effect marginally though its clear that in the short term the markets think it will simply cause inflation as evidenced by the increase in prices of hard assets such as gold and commodities. In the end though, the Fed can’t make a recovery happen by printing money, that needs to happen from the private sector.

How The Fed Will End It

I think the more important question to ask is how will the Fed end it. If you have been making the right moves recently, you will want to keep an eye out for new bubbles developing that could blow up on you because of the Fed’s actions. All this Fed manipulation is after all artificial market fingering. Markets are smart, and they adapt. The best example of this is that these artificially low interest rates really haven’t done that much to make credit more available because lenders have rightly raised standards.

Buying Treasury Bonds gives the Fed a clear and easy exit strategy: hold the bonds to maturity then retire the money. The Fed’s action to focus on the 5-7 year time frame leads one to conclude that this might be their exit time frame.

Inflation could occur more than otherwise if the Fed was forced to sell the assets at lower prices or worse simply write the money off. Because bond prices are so high, any sign of a growing economy will only make these bonds lose value. So, the risk of extra inflation will depend upon if the Fed takes a bath on its assets when it starts tightening. Simply letting the bonds expire to maturity enables the Fed (or anyone else invested in Treasury bonds for that matter) to get all of their principal back. This is the best that can be hoped for to keep inflation in check.

Gold Is A Bubble

The biggest risk I see going forward is a gold bubble. Not next year, maybe not even in the next few years but at some point gold won’t be a good trade anymore (at least a long trade). Here’s why:

  1. Gold doesn’t make you money. If you buy quality stocks and overpay because of bubble pricing, at least you won’t lose your shirt because stocks can outgrow overvaluation if earnings increase. Gold can’t do this.
  2. Inflation won’t be the problem it was in the 1970s when gold was a bubble last. Don’t expect 18% interest rates, the Fed will move.
  3. Gold has technicals in the market that make it a good trade. When the trade goes against it those market speculators will be weeded out.

Gold will probably never be $300 again because world demand for jewelry and industrial uses will continue to increase as markets develop around the world. But, at some point this trade won’t work anymore.

Categories: Economy, Market Analysis Tags:

What’s At Stake (Financially) In This Election

November 2nd, 2010 No comments

As I write this, polls across the country will be closing within hours. It’s been an unusual year in politics, to say the least. The Democrats run the entire Federal Government and this year has been an awful year to be an incumbent.

Politics is messy. One would think, that the Democrats would repeal much if not all of the Bush Tax Cut legislation. I’m still surprised that the Democrats didn’t do anything about the estate tax. This year and only this year, the estate tax at the Federal level is ZERO.

The problem is, of course, that the Bush Tax Cuts are popular. Bush after all did get re-elected and his mark lives on even though he left office two years ago.

What’s a Democrat to do? From a politics point of view, they need to come on the side against the tax cuts. From a re-election point of view, if they try to repeal them they potentially will offend some of their own voters as well as independents (which pols need to win). So, in the end, after all the problems of unemployment, foreclosures, housing market, etc in the minds of the voters, the Democrats “punted” and decided to do nothing.

Unfortunately, this causes a lot of uncertainty if you are an investor. Because they punted, the following policy is essentially in limbo, in order of importance to investors:

  • The dividend tax rates, specifically whether or not the special lower “qualified” rate will continue to exist.
  • Capital gains tax rates.
  • Wage income tax rates, which applies to some investment income.
  • Estate tax, which affects the taxes for your descendants from your investments.

Because of this uncertainty it is harder to compare investments because taxes are an important (though not the only) factor to consider. After almost a year of inaction, it’s a fairly good bet that this issue will be resolved in the next few months, either in the lame duck session later this year or first thing next year when the new Congress is sworn in.

Categories: Economy, Taxes Tags: