Hillary Clinton Tax Proposals

hillary_clinton_tax_policyLast week I described future Republican Presidential nominee Jeb Bush’s tax proposals. This week, for balance, I will review future Democratic Presidential nominee Clinton’s tax proposals.

Now, before you #FeelTheBern folks write to tell me about your favorite candidate’s chances in the Democratic primaries, I should say the following: Every letter you write me must be followed up with a $1 bill in the mail to me when Hillary seals the nomination in Summer 2016. I’ll do the same if your candidate wins. Agreed? I’m happy to receive your letters, in that case. Thanks.

Prominent on Clinton’s website – under the topic of “Economy” – are two tax breaks.

Education tax breaks

The first tax break for students is standard stuff. Every family with a student enrolled in higher education is eligible for a $2,500 credit, via the already existing American Opportunity Tax Credit, currently set to expire in 2017. Clinton’s idea there is to make it permanent. No big change there.

Profit-sharing

More interestingly, Clinton calls for private employers to receive a tax advantage for including employees in a profit-sharing plan. Meaning, if every eligible worker receives a proportion of annual profits, then the federal government would incentivize the private employer through lower corporate taxes. Clinton cites studies that link higher worker productivity to profit-sharing plans.

In my town, a large grocery chain (with an estimated 80,000 employees!) named HEB recently announced plans that sound quite similar to Clinton’s tax proposal. HEB’s stated purpose is to foster employee loyalty and enhance employee financial stability. Employees who own HEB shares would qualify for profit-sharing dividends, similar to what Clinton would like to push companies to do through this tax plan.

HEB did not wait for Clinton’s tax incentive to announce the change. It’s unclear from Clinton’s website whether profit-sharing in the form of private stock ownership is what she has in mind, or some other unstated mechanism.

A skeptical part of me thinks employers like HEB will decide to share profits – or not – based on factors much bigger than a possible one-time federal tax incentive like Clinton proposes. But I could be wrong.

clinton_logoPaying for tax breaks

Interestingly, the Clinton campaign includes estimates of the cost of these two taxes, something not obvious on the Bush campaign site.

The college credit, she estimates, would cost $350 Billion over 10 years.

The profit-sharing tax incentive, she estimates, would cost $20 Billion over ten years.[1] So, combined, we’re talking $37 Billion per year, which sounds like a big number to me, but really comes to less than 1% of the Federal Government’s annual expenditures.

How do you pay for these things?

The only answer on her website is to “close loopholes” to make up the lost revenue. This is an interesting example of closing loopholes to pay for other loopholes. But I suppose one person’s “loophole” is another person’s thoughtfully crafted tax benefit? Also, “closing loopholes” is what one always says when one needs a cop-out answer.

Estate Tax

This is the best of all taxes, just ask me. Clinton’s campaign website does not mention her views, but I can make an educated guess.

Clinton voted as a Senator to maintain taxes on estates as small as $1 million, so we can intuit that she supports maintaining or increasing estate taxes. On the other hand, since that time she’s acquired a grandchild and we’ve learned she and her husband have earned over $100 million (!) after leaving the White House, mostly through speaking fees (!). Her personal incentives at least have evolved a bit on this issue

Burden of tax compliance

The Jeb! campaign made comprehensive tax reform its central proposal, arguing that the cost of filing taxes added up to $168 Billion per year for individuals and corporations.

The Clinton campaign also mentions this problem in the section on jumpstarting small businesses. Her focus remains small, however, stating “The smallest businesses, with one to five employees, spend 150 hours and $1,100 per employee on federal tax compliance. That’s more than 20 times higher than the average for far larger firms. We’ve got to fix that.”

I’m pretty sure adding loopholes isn’t going to help, and there is not a single specific simplification proposal on her website, but I guess it’s the thought that counts?

Carried Interest

I’m a bit obsessed with carried interest taxes – as a former hedge funder – except my views would not be popular with hedge funders.

Fortunately Clinton says she would eliminate hedge funders’ favorite tax break. This makes me happy.

Progressive taxation

Along a similar vein, Clinton proposes enacting the ‘Buffett Rule’ to ensure that wealthy folks pay a higher proportion of their income than lower earners. Only a monster – or, you know, Steve Forbes – disagrees with the idea of progressive income taxation, so that’s not a surprise.

The real reason Buffett pays a lower tax rate than his secretary is that he earns money on his money through capital gains, rather than through a salary. If you want progressive tax rates, you have to address the favorable taxation of capital gains and dividends, rather than salaried income, because that’s where wealthy people actually make their money.

What is a bit innovative is Clinton’s proposal to incentivize long-term investing through a gradual reduction in the capital gains tax. Under Clinton’s plan, the longer you hold the investment, the less you pay in taxes.

Clinton’s capital gains tax proposal is a bit of behavior-modification meddling, but I mostly forgive that because it rewards the buy-and-hold investor behavior that everyone should adopt.

 

Next week: An analysis of third-party candidate Trump’s tax policies. Kidding! A genius like Trump knows tax policies are for Losers!

A version of this post ran in The San Antonio Express News.

 

Please see related posts:

JEB! Tax policies

Death Taxes and Fairness

Shhhh…Please don’t talk about my tax loophole

Adult conversation about income tax

Real Estates Tax Rant

 

[1] Incidentally, for a wholly new tax proposal, I have no confidence that Clinton’s $20 billion is the right number. It totally depends on how many companies adopt the plan to share profits, and that seems quite unknowable at this time.

Post read (321) times.

Tax Liens In My Life

tax_liensSince I like to write about finance, all of real life is merely raw material for finance lessons, so I beg your pardon while I talk about tax liens in my life.

A while back  I described my astonishment at how low property taxes were for ‘agricultural exemption’ property that I happened to be eyeing for investment purposes. Long story short, I ended up buying a one-fifth interest in raw land in a rural part of the County where I live (Bexar County, TX) agricultural exemption included.

My property investment

I mention my property investment to illustrate the role of tax liens. Bear with me for a bit as I explain a sort of complicated situation.

I only bought one fifth of the property, while the other four-fifths remain owned by four siblings (not mine) who inherited the property. While the family dynamic is opaque to me (they were strangers to me before my investment), I understand that some siblings have sufficient money and some don’t, and some siblings care to pay attention to details like property taxes, and some don’t. Meanwhile, taxes on the parcel of land have gone unpaid for a few years.

This makes me extremely nervous for my investment.

Fail to pay property taxes, and you eventually run the risk of losing your property to the foreclosure power of the taxing authority, typically a city or town. Needless to say, I don’t want to lose this property, and if we leave taxes unpaid for too long, eventually Bexar County will take the land.

Tax lien lenders

Now, you may or may not have ever heard of ‘tax lien’ lenders and investors, so if not, let me be the first to illuminate for you a fascinating little section of the real estate finance world.

Ever since I registered my name on the property deed as partial owner last Spring, I have been inundated with solicitations from tax lien lenders. My name – along with the siblings – shows up publically as owners of a parcel with delinquent taxes owed. Hence, the solicitations.

The tax lien lenders offer to pay our property taxes now owed on the property. Meanwhile, if we did the deal, the lenders would use the real estate as collateral for the loan in the event I (and the sibling heirs) fail to pay back the loan in the future. Tax lien buyers (or in Texas, tax lien lenders) have the power to act like the municipality, and eventually take over the property for themselves in the event of non-payment.

In my complicated situation, with some of us owners unable to pay the taxes or possibly unwilling to put up money for the others for an indefinite amount of time, these lenders make some sense.

Partly I mention this whole anecdote because tax lien investing/lending is an obscure but important part of real estate and municipal finance.

Partly I mention this because tax lien investing may inspire a natural aversion. On the face of it, any lender who has the power to take away your property seems, I don’t know, scary? I mean, regular bankers seem unlikable enough. From a PR standpoint, however, the specific combined function of ‘tax collector’ and ‘money lender’ has an even tougher time getting a fair hearing. Those labels have served for thousands of years as biblical shorthand for enemies of the common people.

Personally, I have no problem with the solicitations to pay my taxes in exchange for an eight to twelve percent loan. We might need that solution.

The ironic thing here is that – in my old investing life – I was on the other side of this situation.

My tax-lien buying

I discovered tax lien investing in 2005 after buying a book called The 16 Percent Solution, in which the author explained a high-return and low-risk path to wealth through tax lien investing. Through my investment company I first started purchasing liens in New Jersey and New York, eventually branching out into Connecticut, Vermont, Rhode Island and even Mississippi.

Incidentally, I was a very unwelcome (meaning: Yankee) participant in my one Mississippi tax lien auction. I’m just happy to have gotten out of there in one piece. Bless your hearts, people of Wilkinson, Mississippi!

Tax lien investing and lending happens around the country, with state and local variations adding to the complexity. On the positive side, the interest rates earned seem very attractive, while the risk seems low. On the negative side – as I learned over the course of a few years of tax lien investing – it’s quite easy to lose money through tax lien investing as well.

As I purchased liens, I sometimes wondered about the complex situations that led people to become delinquent on their real estate taxes. Now I’m in one of these complex situations, and I sort of get it.

My situation

I don’t know when we will all be able to agree on paying the taxes. It may be a better idea to borrow the tax money – even if we have to pay eight to twelve percent on the loan – than to risk losing the property outright to the county via foreclosure. A loan may give us enough time to figure out an eventual solution – either by paying the taxes or selling the property.

 

A version of this ran in the San Antonio Express News.

See related post:

 

Real Estate Tax Rant – Agricultural exemptions

 

 

Post read (391) times.

Book Review: The Clash of Generations by Scott Burns and Laurence Kotlikoff

Scott Burns and Laurence J. Kotlikoff wrote The Clash of Generations: Saving Ourselves, Our Kids, and Our Economythought-provoking and highly readable financial policy book in 2012, featuring four “purple” policy proposals – “purple” meaning meant to appeal to both red and blue sides of the American political spectrum.

In the context of a 2016 Presidential contest featuring the unappealing choice between Know Nothingism (Trump), Socialism (Sanders), Nepotistic Oligarchy (Bush), and Nepotistic Pandering (Clinton),[1] I find it refreshing to read ideas designed to appeal to a broad spectrum of the right and left. Maybe you will too.

Inter-generational screwing

No, I’m not referring to an inappropriate Spring/Winter romance. Rather, Burns/Kotlikoff’s central thesis is that the older generation has – through a combination of tradition, neglect, and the compounding affects of fiscal policy – doomed the younger generations to financial deterioration and eventual financial wipeout.

Intergenerational burden

One of my favorite illustrations of the inequality between generations is the example of seniors gathering for a “Senior Coffee” breakfast at a McDonalds, featuring 55 cent coffee and $1 specials. It initially sounds innocuous.

mcdonalds_low_wage_worker
It takes 10 low-wage McDonalds workers to fund one senior’s social security

However, with an average senior’s monthly Social Security check of $1,172, the authors point out that the average McDonald’s worker has to put in 1,172 hours (at $8.00/hour, that’s a 50 cent payroll tax from worker, and a 50 cent payroll tax from employer going to the Federal Government) to generate enough tax revenue for a single senior’s monthly check. With the typical Mcdonalds worker putting in 120 hours per month, it takes almost 10 minimum wage McDonalds workers to support each senior. We don’t usually view the different generations at odds this way, but that’s the kind of intergenerational burden the authors are talking about.

When they run through the runaway increases in federal health care costs [Medicare, plus increased prescription drug reimbursements (W Bush) and the Affordable Care Act (Obamacare)] in addition to unequal tax treatment, the ‘clash of generations’ seems both unfair and unsustainable.

This crisis sets up the background to their main four policy proposals.

Purple Policies

I like this book a lot, and their purple policies deserve to be part of any serious fiscal policy conversation (although which leaders would have that conversation, I’m actually not sure, such is our political discourse these days). I suspect the authors would have their own doubts about the political viability of their somewhat radical solutions, but would argue that the risks of inaction are too great, given the impending fiscal insolvency.

I’ll briefly describe below their four big policy ideas, with links to their further thoughts online.

Finally, after reviewing their policy ideas, I have one critique of the tone of the book’s early chapters.

Purple policy #1 – Limited Purpose Banking

Kotlikoff and Burns advocate a radical simplification of banking functions. Their proposal says that any and all banks (plus insurance companies, brokerages, credit unions, private equity firms) must fund themselves and be regulated as “mutual funds,” taking in actual deposits for every dollar invested in loans. No borrowing, full stop. Any company that prefers to leverage itself (hedge funds might want to) must operate under a “full-liability” regime, meaning losses are guaranteed personally by the business owners and executives. You can see why this is kind of appealing in the wake of the 2008 crisis and bailout of Wall Street.

[Incidentally, my own radical ‘purple plan’ addresses this same post-2008 moral hazard problem, but in a different way. My rule is: Any financial firm over a certain size (I don’t know how many would qualify but let’s say the biggest 25 firms, and any that are considered ‘systemically important’) get regulated like public utilities, with massive restrictions on executive pay. Of course, all financial firms are invited to get smaller through divestiture, sales, breakups, whatever, to get under the size limit and become systemically irrelevant. At that point, executives at the newly smaller firms can go back to paying themselves whatever they want. That’s my solution to the problem of “profits get privately enjoyed via executive compensation but any liabilities get socialized” when a systemically important financial institution gets bailed out.]

Purple policy #2 – Health Care

Their plan begins with individual vouchers for everyone for purchasing a basic plan to receive care from a private provider of their choice. Vouchers are individually ‘risk-adjusted,’ meaning documented medical conditions receive larger vouchers. Anybody is allowed to supplement with additional care out of their own pocket. Insurance companies providing standard care cannot deny coverage. For fiscal sanity, however, they advocate a panel of doctors to set strict budgets on the total cost of all federal vouchers, not to exceed 10% of GDP in any year. (death panels!)

Comprehensive health care policy is well beyond my ken to deeply comment on, but I do appreciate their attempt to set limits to how much public money is spent on health-care. Unfortunately there has to be some rationing of costs when we set a limit like 10% of GDP maximum. I know this a politically radioactive (again, death panels!) but seems like an important adult conversation to engage in.

Purple Policy #3 – Tax Plan

Since tax policy is arguably the most important and least understood part of public policy, I appreciate the authors’ radical approach here.

For starters, they eliminate personal and corporate income tax (whoa!), which they argue is surprisingly regressive in its current form.

They replace it with a high 17.5% federal retail sales tax, as well as a tax on all consumption above $5,000 done abroad (to catch up you folks running over to Canada to do your shopping, to avoid the high retail tax).

To correct the regressive nature of consumption taxes, they would include a monthly ‘demogrant,’ effectively a transfer to all households, based on family composition, and meant to alleviate the sales tax burden (get to net zero tax) on families below the poverty line.

Estate Taxes in their plan

Interestingly (since I think estate taxes should be discussed more frequently) they would eliminate the federal estate tax, and replace it with a 15% inheritance tax above $1 million. The effect there, I think, would be to encourage estate planning that involves a greater number or recipients. If you had $10 million to pass to heirs, for example, and could pass it on tax free as long as recipients only got $999,999. I think lots of people would choose ten recipients, rather than pay 40% on amounts over 5.43 million (so, $1.828 million in taxes) when giving to a smaller number of heir under the current system. The effect is a wider distribution of inheritance, which is a reasonable goal for addressing intergenerational wealth transfers.

Purple Policy #4 – Social Security Plan

Burns and Kotlikoff address the problem of our unsustainable unfunded social security liabilities, and argue that funding retirement with real worker contributions (through a Personal Security Account PSA) is a necessary replacement system. Workers under age 60 would fund their accounts with a mandatory contribution of 8% of wages. Funds would be invested by the government, at zero cost, in global securities. The federal government would match contributions by the poor, disabled, and unemployed on a progressive basis.

My favorite part of their plan is that retirement benefits get invested in global market-weighted indexes of stocks and bonds. This may sound ‘risky’ but really isn’t, although its easy to find online critiques of their privately-funded plan to replace the defined benefit plan of Social Security.

In any case Burns and Kotlikoff argue there should be a government guarantee of at least a ‘zero real return’ for individuals, which seems like a reasonable solution to the fact that some people will find investing in global securities ‘too risky.’

I’ve skipped many of the details of each of their four policy plans, including quite a few specific provisions to address problems that would arise in the process of shifting from our current system to their radical purple solutions.

I’ve linked above to each of their plans because if you’re a policy nerd, you might enjoy reading through their radical and thoughtful solutions to pressing financial problems.

Ok, now one critique of their book.

A problematic first three chapters

I don’t particularly like their first few chapters, in which they lay out their alarming financial thesis in warnings bordering on Chicken Little-style.

The tone seems intended to strike extreme notes about our future financial doomsday.

  • The younger generation is getting financially screwed by the older generation! [2]
  • Fiscal deficits are forty times worse than anything the federal government reports!
  • Unless dramatic, politically impossible steps are taken soon (and they wont be!) the United States economy will sink into a morass worse than Greece! [3]

Specifically, they note that official estimates of government deficits systematically undercount unfunded public liabilities – for health care and social security in particular – and that the unchecked growth of these liabilities, in the long run, will completely overwhelm the United States’ economy. The losers in this scenario won’t be old folks today, but rather their grandchildren, who inherit the public liabilities. I believe this basic premise, and I believe it’s important to point out, but I guess I don’t like some of the hyperbolic ways its presented, and I don’t think the use of big future numbers tracking deficits is carefully interpreted.

One of the things I’ve noticed when describing compounding effects on money with long time periods is that you can quickly get into overwhelmingly large numbers. I have even done this trick myself in the service of making a dramatic point, but because it combines assumptions about an unknowable future with compounding effects, it’s not hard to mislead readers in the service of a particular thesis.

Between them Kotlikoff and Burns have written and published many serious books (and I have published precisely zero books, serious or otherwise, so what do I know?) but the tone of these first chapters struck me as BIG PUBLISHER driven.

“Make sure you make the case to the reader in Chapter One that everything will go to hell unless people buy this book and also legislators make the policy changes you advocate,” seems to have been the mandate handed down by BIG PUBLISHER.[4]

One problem with this tone is that, if the sky does not fall, and three years have since passed (the book came out in 2012) their dire warnings begin to look less true in retrospect. Or, even if true, (and FWIW I trust the economics behind their warnings) the consequences are less imminent or less dramatic than claimed.

Anyway, what I really mean to say is, their book is much better than the tone of their initial chapters would suggest.

clash of generations

 

[1] And those are just the leading candidates. Further down the ballot we get financial policies such as Fundamentalist Christianity (Carson, Huckabee), Fire Everyone (Fiorina), Shut Down Government (Paul), Shut Down Government And Burn All The Buildings Too (Cruz), Personal Bankruptcy At Any Moment Now (Rubio), Bully Everyone But Especially Unions (Christie), and I’m Just An Average Joe Son Of A Coalminer From Hellhole Scranton (Biden). And finally for completeness’ sake, I have no idea what they think about financial policy (Chafee, O’Malley, Pataki, Graham, Kasich, Jindal, Santorum).

[2] Somewhat charmingly, both authors are of an age eligible for social security, so they are really writing and advocating against their own self-interest, narrowly understood. If this book was written by a twenty-something, complaining about how the US financial system unfairly favors older people at the expense of younger people, it would read more as a call to intergenerational conflict by the aggrieved youth.

[3] This is the jacket cover language: “The United States is bankrupt, flat broke. Thanks to accounting that would make Enron blush, America’s insolvency goes far beyond what our leaders are disclosing. The United States is a fiscal basket case, in worse shape than the notoriously bailed-out countries of Greece, Ireland, and others.” None of these sentences are objectively true, at all.

[4] The publisher is academic, MIT Press, so its not really BIG PUBLISHER in any obvious sense. But still, the early tone feels marketing driven.

 

 

Post read (266) times.

Audio Interview Wendy Kowalik Part II – On Insurance And Getting Rich Slowly

Please see related discussion with Wendy Kowalik in Part One on investment advisory fees.

Michael:          Hi, my name is Michael and I used to be a banker.

Wendy:            Hi, Michael. Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm. I started my career with an insurance company and sold insurance for the same 17 years that  we managed money.

Try to save your money from all these nice folks
Try to save your money from all these nice folks

On Insurance

Michael:          That is my pet peeve, insurance. I think too many people who are engaging with insurance as if insurance was a form of investing make a deep error. I find when people buy insurance they’re being told that it’s some kind of good investment. You and I previously spoke about this guy Dave Ramsey, who for all his flaws, has told me the number one thing I need to know about insurance, which is: figure out what the risk transfer is. And that’s what insurance is for. It’s not for mixing with investments. I deeply believe that.

You came from a firm that did quite a bit of insurance. As we’ve spoken in the past, that’s not always how insurance is sold. Probably the majority of the time it is some kind of weird blend between a supposed investment in addition to a risk transfer. You’ve done it. I haven’t sold insurance or been involved in that, but what do you think about my ideas?

Wendy:            “It depends,” is the worst answer, but globally you’re on the right track. You’re exactly right. And what I’ll tell you is if someone is walking through the door saying you should use it as an investment vehicle, you’re probably on the wrong track.

predico_partners
Interview with Wendy Kowalik of Predico Partners

Very seldom will you find that working well. The insurance industry’s argument on that side of it is it’s disciplined savings. It grows tax deferred. Well, so does your 401(k). Make sure you’re making that out first. That’s the first place you need to be saving, on that side.

The other argument is you can go in and take a loan out tax-free. Very true statement except for the fact that if the policy doesn’t last for the long term, then you pay taxes on every dollar you took out. That’s where it’s all the details within the insurance that many times make them not work as they were originally sold.

Yes, for globally, I would tell everybody that there’s only two reasons to purchase insurance.

  1. To protect an income source if you’ve got a spouse that’s working and you need their income to make your monthly budget. You need to protect that.

 

  1. The second side of the table is if you have estate taxes. You can use insurance to basically pay a lower dollar amount for you estate taxes. Outside of those two pieces of the puzzle, I don’t really see a huge need for life insurance.

Michael:          The second part, the estate taxes, is going to be much more of a high net-worth problem than an ordinary investor problem. We’re talking up at the top 5%, 1% or .01%. It gets more plausible that they’re going to be able to have a tax savings and estate planning through insurance, right?

Wendy:            Right, sitting here today, an estate over 10-million dollars for a married couple and an estate over 5-million dollars for a single individual.

 

Michael:          What I tell people, and most of my ordinary acquaintances are not in that category, I just say “You need to focus on self-insuring” through trying to invest your money so that when it comes time where you can no longer work, or you choose to not work, you’re not worried about an income stream, and you’ve self-insured though actual investments, rather than this expensive version, which is paying an insurance company to be this mix of asset protection, asset building, and income replacement.

Wendy:            That’s exactly right. You should have two different pieces of the puzzle. You should have term insurance if you’re protecting an income stream for a period of time. And use your savings separate from that.

Michael:          Right. I just don’t trust that most insurance sales people in the industry is parsing that out for people to say “If you’re got a risk of loss of income, you need term for the period of time in which you’re worried about that, and then use the savings to put that in the market.”

This is what I always tell people — without knowing — having not worked in the insurance industry that just seems to be the right thing.

Wendy:            Right.

Michael:          For most people, with obvious exceptions. If you’ve got a ten-million-dollar estate it’s a whole different situation and you probably need different set of advice, which I’m not qualified to give. We’ve got term insurance in my family related to how old my kids are, when they are going to be no longer under my protection, and can fend for themselves in a sense. But it’s super-duper cheap to get that, for a certain number of years, and a certain amount of money, not a huge amount, but sufficient to not leave them in a lurch.

Wendy:            That’s the biggest struggle on the insurance side, is figuring out what that number is.

Michael:          Tight.Certainly back to your two reasons to have insurance. One is replacing income stream, and the second is estate planning and possible tax reduction. The folks for whom that second part is relevant, estate planning — the first part seems to me to be totally irrelevant. You’re either in one or the other. You’re probably not in both because if you have ten million somewhere in assets, you don’t really need to ensure further a loss of income stream. You’re probably going to be able to feed and clothe yourself now. Or am I not thinking about that right?

Wendy:            Yes, no you’re right. Could they self-insure? Absolutely. What you’ll find a lot of times, though, is you’ve got people in that situation that have purchased property or they’ve got a family-owned business that makes that up. Then it becomes a liquidity event. Do I really want to unload Pepsi to pay the estate taxes? Or do I want to have to sell at that point or do I want to buy some time? It still may not be this massive convoluted structure, but I may be that I want to purchase an amount to give me time to figure out what I want to do with the asset.

 

On Budgeting, and Getting Rich Slow

Michael:          So, any other topics you think we should get onto the podcast?

Wendy:            The other thing you put on there was budgeting. How do people come up with a budget.

Michael:          Oh yeah, let’s talk about that.

Wendy:            I do think that is a big piece of the puzzle. The number-one side we run through is no matter how much money you have, you’ve got to understand how much you spend that’s fixed expenses and will not change, no matter what you do right now, unless you actually make radical lifestyle changes, such as selling your home, changing your cars, that type of thing.  Or is it just discretionary, and to me that is such a big piece of the puzzle, is understanding exactly what you’ve got that’s fixed, what you’ve got that’s discretionary, because that’s the only way you can determine can I really cut back and make some changes, and start saving more, because we don’t need to eat out as much or go do this as much. Or is it that we’ve extended beyond what we can truly afford either in a home, or cars, or things such as that, and we need to change lifestyles more dramatically than just not going out to eat on Friday nights.

money_problems

Michael:          I’ve taken to saying to people, my friends, or peers, or people that ask my advice that nobody has any extra money at the end of the month. Whether you make 350,000 bucks a year or you make  35,000 bucks a year. There’s no extra money. Your lifestyle builds to whatever you’ve gotten comfortable with, and I tell people you basically have to trick yourself into creating little streams of savings and investments. This isn’t true for everybody and to bring up my nine-year-old daughter, she’s basically a hoarder. Her babysitter basically said early on she’s going to be on the hoarder TV show. She never throws anything away, so if you give her some money — there’s a few people like that, who save all their pennies, nuts, and squirrel them away.

But for most people there is no money. There’s no salary that’s enough to make sure you have extra money. If you move up from the Honda to the Audi, then you have to get the Jaguar. You’re still just buying a car, but somehow if you make 350,000 dollars. It’s not hard to go bankrupt on 400,000 dollars a year. Mike Tyson went bankrupt after earning 300-million dollars in his life. There isn’t any real money…[that’s sufficient.] You have to figure out tricks and ways to get the excesses.

Then you have these weird stories of the person who never made more than 40,000 dollars in their life, and they have huge investment accounts, relatively speaking, at the end of their life. They were able to do it.

Wendy:            My favorite was we had a client referred to us in my former firm. That was exactly it. He had been a civil service employee, never made over 40,000 dollars for many years, and finally topped out at 65,000 dollars. She was in her early 80s, late 70s, and her investment account was worth 15 million dollars. She purchased with every extra few dollars, at the end of the month, she’d say this is what we’re going to set aside for savings. He would purchase bank stocks because he decided that it paid a little bit in dividends, and that was what he followed. He did financial stocks and he purchased six stocks, followed them. He never once sold a dollar of them. He never cashed them in for anything, and just added to those same six. That’s what it grew to. It was absolutely incredible.

stocks_v_bond
Stocks for the long run

Michael:          That is incredible. If you have 60 years of doing that, there’s the compound returns of equity exposure to a couple of good stocks or six different bank stocks over a certain period of time. That’s incredible, yet mathematically very plausible when you look at it, how much you could put away, and if you let it ride for 40 to 60 years. It’s totally doable. It doesn’t feel like that until holy cow, 30 years later suddenly it’s grown.

Wendy:            Right.

Michael:          I feel like that message doesn’t get out to enough people or it gets out when you turn 62 and you’re like huh, so I should have been starting 40 years ago? Now you tell me?

Wendy:            That’s right. And I think it’s hard to withstand, and I think what many people strive for is they keep trying to find a better way to get to the investment returns. They’re looking for that — there’s some trick to get there. A lot of it is just hard work and discipline.

Michael:          I think automatic deductions from paychecks or your checking account, so you never see it — just like investment advisors are going to secretly, stealthily take out 1% or 1.5% per year. If you can get your 401(k) and then your brokerage account to sneakily take out a few hundred and then a few thousand dollars per pay period, it works out in the long run.

Wendy:            Exactly. You’re right.

Michael:          It’s hard to make the affirmative choice to do it, but if just sneakily happens by default you can build up wealth, I think.

Wendy:            I completely agree. We tell everybody if you take it and send it to a brokerage account that’s not in your bank, leave it in cash for 90 days, that way you know can you really make it without that money, without having to go back and take it back. You normally won’t call the brokerage account and ask them to send you a check. You really do need it if you’re doing that. So then at the end of 90 days put it to work. See if you can increase it and put away more in the next pay period.

Michael:          I think that method works. GET RICH SLOW. It’s hard to get rich quick.

Wendy:            Very true.

Michael:          Thank you for discussing all these things. I think there’s lots of interesting ideas here that people should be paying attention to.

wendy kowalik pic 2
Wendy Kowalik, President of Predico Partners

 

Please see related posts:

Interview with Mint.com – I give ALL the answers

On Insurance – Use for Risk Transfer Only

On Insurance as an Investment

401Ks are awesome but should be simpler

Guest Post from Lars Kroijer: Don’t buy too much insurance

On Longevity Insurance: Do You Feel Lucky?

Audio Interview Part I with Wendy Kowalik – On Fees

 

 

 

Post read (963) times.

Real Estate Tax Rant

Not a lot of real agriculture  going on in this county.
Not a lot of real agriculture going on in this county.

Real-estate tax policy – incredibly important yet relatively unseen – shapes how and where we live.

I’ve ranted about estate tax policy as well as carried-interest tax policy here before, and now I’d like to rant about real-estate tax policy in my city.

As before, I don’t think it’s enough to say ‘I hate taxes,’ because taxes are a necessary evil. I don’t know about you, but I want to have adequately funded schools, parks, and public safety services.

If I have to pay taxes, however, I want to feel that everybody pays their fair share. The key to making peace with the evil of taxes is fairness. As before, I want to discuss real estate taxes in terms of what is ‘fair to me,’ and what is ‘fair to society.’

Fair to me

I recently toured (for the purposes of buying) a small fraction of a piece of undeveloped land in Southeastern Bexar County. The entire parcel of approximately 95 acres is located (for locals who care) inside the 1604 Loop, between Highways 281 and 37.

(I only looked to buy a fraction of the entire parcel, not the whole thing.)

The entire 95 acres might be worth, I don’t know, $500,000? Maybe more?

Would anyone like to guess what the 2014 taxes were for the 95 acres? Take a moment to guess.

Would you believe $170?

When I picked my jaw up off the floor I phoned the Bexar County Assessor’s office.

That’s when I learned about “Title 1-D-1” of the Texas Property Tax Code.

The 95 acres I toured are designated as a 1-D-1 ‘Agricultural Use’ – either cattle or timber. As a result Bexar County only taxes theoretical ‘agricultural income’ from that property, rather than the full ‘market value’ of the parcel.

The ‘market value’ of these 95 acres might be $500,000, but the actual ‘assessed value’ of the 95 acres is $6,780 – the estimated annual ‘agricultural value’ of the parcel.

As a prospective purchaser of a small fraction of this land, this tax code seemed very ‘fair to me.’

Fair to Society

But fair to society?

Holy cow, this is one of the least fair property tax rules I’ve ever come across.

If you own a house or any other non-agricultural property in San Antonio, you pay taxes as a percent of estimated value, typically around 2.7% of market value.

If I owned a big house in Bexar County worth say, $500,000, I should expect to pay 2.7% in taxes to the county, or $13,500 per year. Which, I don’t know about you, but seems like a lot me.

If I owned a big “1-D-1” parcel for 95 acres in Bexar County worth that same $500,000, however, I should expect to pay 2.7% of $6,780, or less than $200 in taxes per year. Which seems like very little to me.

Here’s where the unfairness hits: The “1-D-1” designations in Bexar County shift the burden of property taxes away from large landowners (like developers) and onto individual home owners.

I learned that a residential ‘market value’ property owner should expect to pay something like one hundred times more taxes than an ‘agricultural value’ property owner per year, according to Bexar County Deputy Chief Appraiser Mary Kieke.

Not about agriculture

I’m not saying I want poor farmers and poor ranchers to pay a lot more in taxes.

cowboy child
Mamas, don’t let your babies grow up to claim 1-D-1 Ag exemptions on their taxes

I can see why the State of Texas, as a whole, has decided to reward legitimate agricultural activity with favorable taxation, as a nod to its rural roots and a preservation of a certain way of life.

I don’t want to mess with that heritage. It’s not my personal gig, but I can understand the point of view.

What I am saying is that this 95-acre parcel I looked at isn’t agricultural in any real conceivable sense of the word. I mean, maybe they’ve run a couple of cows over it whenever a tax assessor is coming by? Maybe some people have cut down a few trees on the property there and reported a ‘timber use?’ I guess?

It’s land banking

Bexar County is mostly comprised of the City of San Antonio, and for the most part San Antonio has ceased to be an agricultural producer. That’s not preventing people from taking advantage of the tax code to land bank cheaply, however.

For the present owners, this parcel – as the small lots around it show – acts as a very low cost land-bank for future housing developments, either in 1-acre lots, or larger tracts.

When I expressed amazement to Appraiser Kieke, she agreed with me that “there are legitimate agricultural uses, of course, but, by and large, this [1-D-1 designation] has become a way for developers to hold land with very low taxes.”

In Bexar County

So how big is the effect in Bexar County? About $63 million per year in lost taxes.

The total difference in value between ‘agricultural’ and ‘market value’ property in Bexar County is $2,348,327,452, according to Kieke, and 2.7% of that amounts to approximately $63 million per year.

If you’re a homeowner in Bexar County you are subsidizing landowners with 1-D-1 exemptions to the tune of $63 million per year, money the county needs that has to come from your much higher homeowner appraisals.

The point here isn’t to increase tax collection by an additional $63 million. But homeowners have a very unfair deal compared to many land-banking owners with 1-D-1 exemptions in Bexar County.

 

Please see related posts

Adult conversation about tax policy

You prepare your own taxes???!!?

The good old days of taxes, 1948 edition

 

Post read (1342) times.

Taxes Rant: Carried Interest Edition

Note: A version of this post appeared in the San Antonio Express News.

Dear Money: I miss you so, so much.

I recently mailed off – with deep feelings of loss – two of my biggest checks of the year: one for real estate taxes to the county where I live and the other to the IRS for estimated federal income taxes.

Money: I miss you so, so much
Money: I miss you so, so much

After we said our long sorrowful goodbyes at the US Post Office, money and me, I wiped those tears away, threw my shoulders back, and bravely walked back to my car. No looking back. Please, county and federal government, take good care of my money. I raised it with my own two hands, and I dearly loved it.

Don’t worry, though, this is not going to be an anti-tax rant. I’m not a TEA Party member. [1]

On the contrary, over the years I learned to embrace what my accountant taught me: If you think you pay a lot in taxes, try to remember to be happy, because it means you made what to you is a lot of money that year. Or, in the case of real estate taxes, paying a lot means you own valuable real estate.

Seen that way, complaining about paying high taxes is unattractive in the same way that a guy bemoaning the cost of expensive repairs on his Porsche is unattractive. I mean, seriously, don’t be that guy.

The key is fairness

While I believe everyone should pay a fair share of taxes, the key word here is fair.[2]

Since I just coughed up too much money in federal income taxes and local real estate taxes, I’d like to complain now about an unfair aspect of federal income taxes. Later, in an upcoming post, I’ll rant about unfairness in local real estate taxes.

Federal Income Tax unfairness

I started and ran a hedge fund for a short while. (This was years before I landed this lucrative gig writing financial rants online, for free. But anyway.)

The awesome thing about running a hedge fund or private equity fund is just how unfairly advantaged these business structures are, from a federal income tax perspective.

Fund managers earn fees in two ways, a ‘management’ fee and a ‘performance’ fee, sometimes also known as ‘carried interest.’

The more important of these – the ‘carried interest’ or ‘performance’ fee – in most cases gets taxed at a lower rate than other types of income because of the illusion that the performance fee is somehow like ‘long-term capital gains,’ rather than like regular income. It’s not.
But the tax law says it is, so, big tax advantages if you’re a hedge fund manager!

Carried interest tax loophole
Carried interest tax loophole

If we were talking about the regular scale of incomes for a blue-collar or white-collar job of people you meet in your ordinary life, the difference in these tax rates might not matter much, something on the order of $500, up to maybe $5,000, tops.

But since we’re talking about hedge fund manager-level earnings – which sometimes hit a billion dollars a year, the difference in the tax code for certain individuals can reach the hundreds of millions of dollars per year level. Which, I don’t know, starts to chafe me in my sensitive areas a bit.

Don’t get me wrong, we can all agree that nobody deserves an unfair tax break more than private equity and hedge fund owners, but at a certain point we begin to wonder about the extent of the unfairness of it all, no?

 

Please see related posts on taxes:

Shhh…Please don’t talk about my tax loophole

Adult conversation about tax policy

529 Accounts and tax fairness

 

[1] A quick aside to my liberal friends who think the TEA Party is something new. Unhappiness about paying taxes (TEA, as we know, stands for Taxed Enough Already) is as American as Apple Pie, the Star Spangled Banner, and eating greasy food until you nearly burst, on Super Bowl Sunday.

The drunken faux-Indians of the Boston Tea Party Patriots hated paying taxes to the English King. The death-seeking gun-nuts of the Alamo hated paying taxes to Mexico City, and the tyrant Santa Anna. A complete history of the United States could be written using tax-opposition as the prime motive for all major events. I’m not saying TEA party folks aren’t wacky (because many are!) but I am saying at least they have a long list of historical precedents from which to draw political sustenance.

[2] A quick aside on fairness: Fairness, of course, is in the eyes of the beholder.
In my family we retell the story of my super-cute niece, then aged four, who announced one evening: “It would be fair, to me, if I got to take a bubble bath after dinner.” She had learned enough by age four that “being fair” was important to adults, but like many of us, decided to interpret fair according to her own worldview. Since then, I frequently tell my family over dinner that it would be fair, to me, if someone drove out to Dairy Queen and bought me a treat, like, right now. This never works. Anyway, fairness. It’s important in the tax code.

[3] In the tax world, there are always exceptions to everything so I am simplifying greatly and using these hedging words like ‘usually’ and ‘sometimes’ and ‘often.’

 

Post read (1082) times.