Adult Conversation About Income Tax Policy

With the Fiscal Cliff1 looming, kids, it’s time for “The Talk.”

By ‘The Talk,’ I mean yank our minds into the grown-up world.  We have been innocent about how money really gets made, and kept, and taxed.  The ‘adults’ know, but they haven’t felt comfortable sharing the real truth.  We didn’t know, and we didn’t think we could talk about it.  It seems embarrassing for some reason.  Almost dirty.  Maybe it’s the way we were brought up.  Nevertheless, now’s the time for ‘The Talk.’

Here it is in a nutshell: The way the ‘grown-ups’ – our elected officials – set tax policy tells us how they value different ways of making money.  They see three different ways to make money, and they clearly favor the first two.

Inherited Money

According to our tax code it turns out the very best way to make money is the old-fashioned way:  Inherit it.

As of this writing, the first $5 million from a deceased individual can pass to you tax free.  Our elected leaders want you to know that the best way to get rich is to be born into a rich family and have the right people die at the right time.2

Stated that way, it seems a bit un-American, no?  A bit, well, aristocratic.  Nevertheless, that’s far and away the best way to earn your first $5 million.  Our leaders want you, Richie Rich, to have your first $5 million tax free.3  Mwah!

Make money with your money

The second best way to get wealthy, according to the tax code, is to already have a lot of money, and then earn money on your money.

If you already have a lot of money, then a significant proportion, probably a majority of your income, will come from three sources: Tax Free Bonds, long-term capital gains on your investments, or corporate stock dividends.4

The best of these investments, tax wise, is Triple Tax Free municipal bonds, which are exempt from local, state and federal income taxes.  You earn just about 0.5% interest5 these days, but if you’ve got $100 million in triple tax free muni bonds then you’ve got yourself $500,000 a year, tax free!  That pays for quite a few golf outings a year, with money left over for the lobster roll at the club and a tip for the valet.

The next best way to make a living from your investments, according to the tax code, is to buy and hold stocks for at least 18 months before selling at a profit, so that your earnings will be taxed at a rate of only 15%, the long-term capital gains rate.

Should you be so fortunate as to start out in life with a massive stock portfolio, your elected officials say to you: “Good Job!  That’s an excellent way to make a living!  Let us incentivize you to earn the majority of your living by having your pile of money do all the work, while you join that swell municipal bond fellow at the club.”

The third best way to earn money from your money is to hold stocks for at least 60 days, thereby earning qualified dividends, likewise taxed at a comfortable 15% rate.6

I interpret all of these three tax policies combined as our elected officials’ way of saying that the next best way of making a living – after being born into a rich family – is to sit around like Scrooge McDuck investing money, and only paying 0% and 15% on one’s income.7

Mitt Romney’s 14% effective tax rate in 2011 derives from this tax advantaged way to ‘earn’ a living, just as your elected officials would like you to.

Working for a living

The ‘grown-ups’ who make tax policy tell us this is the worst way to make money.  You see, if you work for a salary, that income is liable to be taxed at the maximum income tax rate.

If you can make less than $35,350 a year, fine, they’ll tax you at a 15% rate.

But over that, you’re looking at 25%, 28%, 33%, or up to 35% for those making over $388,351.  The lesson of the tax code is that people who actually work for a living, rather than inherit from Daddy or live like Scrooge McDuck, should be taxed the most.  “Working for a living?” they taunt us, “that’s for chumps!  Tax that man at the maximum possible rate!”

That’s “The Talk” about our tax policy which creates better and worse ways to make money in this country.  No, Virginia, there is no Santa Claus, but there is a Richie Rich and a Scrooge McDuck.  And our elected officials just love them!





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  1.  Is it weird that I love the sound that the phrase ‘Fiscal Cliff’ makes in the mouth?  Its poetry, really.  To mangle a bit of Nabokov:  “Fis.Cal.Cliff.  Taking a trip of three steps through the split fricative to tap front teeth, at three, on the lower lip.”
  2.  Yankees owner and billionaire George Steinbrenner famously died in 2010, the one year in recent memory during which the Estate Tax was wholly repealed.  George was worth an estimate $1.1 Billion, so the fact of the Estate Tax repeal in 2010 made the Steinbrenner heirs $500 million richer than they would have been had he died in 2009, as the estate tax rate was 45% of inherited wealth that year.  As a Red Sox fan, I’m just so happy for those boys, Hal and Hank.  It couldn’t have happened to a nicer family.
  3. We will hear, or we should hear, quite a bit about the estate tax in the coming weeks, as the limit exemption on tax-free inheritance reverts back to $1 million and a 55% rate in 2013, if Congress does not take action. “Death Taxes on Small Businesses” is how one political side always describes the Estate Tax, but that’s mostly a load of bull.  The real implication of the estate tax is to what extent our leaders signal that the best way to get $5 million is to be born into the right family.
  4. If you’re not making any money through tax free munis, long term stock holdings and dividends, well then you can just skip to the third section, you working stiff.  Our elected officials can’t be bothered with you, if you can’t take a hint about how to make money.  Jeez.
  5. On 5 year municipal bonds, for example.
  6. The low 15% ‘qualified dividends’ tax incentive ends in 2012, unless Congress acts to extend or modify it, as Congress did, with Obama’s approval, in 2010.
  7. The other great advantage to being Scrooge McDuck from a tax perspective, is that – unlike a working-stiff salaryman – you can choose what year to harvest stock market gains.  Scrooge McDuck can end up with virtually no taxable income in any given year should he choose to sell no appreciated stock.  Or Mr. Duck can match up investment losses with investment gains to have no net taxable income, or even to trigger a tax refund.  In a related story, did you know Mitt Romney got a $1.6 million tax refund last year?

Book Review: Nickel and Dimed – On (Not) Getting By in America

Most of the books I review on Bankers Anonymous purport to give insight, for the non-financier, into how Wall Street works, a main theme for this site.  This book review, however, aims to give Wall Streeters insight into the life of the woman who cleans your house.

Barbara Ehrenreich engaged in stunt journalism in order to write Nickel and Dimed: On (Not) Getting By in America.  She temporarily shed her middle class, educated life in order to understand the working poor.  Over the course of six months, she worked minimum wage jobs and tried to pay for shelter, groceries and other expenses on only her monthly take home pay – an impossible task for her.

She apologizes upfront for the stunt by acknowledging the artificial short-term nature of the experiment as well as her advantages over the typical working poor in the United States.  She is white, native English-speaking, highly educated, in excellent health, and very motivated.  And yet the challenges she faces in paying for basic food and shelter would – if we are honest with ourselves – break most of us down.

Ehrenreich works for $2.43 an hour – plus tips – at her first job in Key West, FL at a hotel restaurant.   Next she moves to Portland, ME to juggle a maid job at $6.65 per hour with a similar low-paying job in a nursing home.  Later she works in the ladies clothing department at a Minneapolis Wal-Mart.  Typically, a single job leaves her short on rent and food money at the end of the month, although she lives in low-rent places such as a cramped, out-of-the-way cabin, a weekly-rate hotel, and a dingy, off-season trailer park.  Juggling two jobs, a theoretical solution, leaves her exhausted and physically unable to perform the first job.  It never quite works, and there’s seemingly no way to get ahead for the working poor.

Ehrenreich’s prose is funny[1] enough to lighten the burden she feels at the indignities of pee-testing, preposterous middle management patronizing, personality testing, and polyester uniforms.  She illustrates in specific ways[2] how the poor live in a parallel universe from you and me, even though they are stocking shelves or pouring coffee right next to us.

Ehrenreich’s writes about her experience during a boom time in America – 1998 – when unemployment reached a record low and corporate America complained about a dearth of workers.  This makes her narrative all the more compelling today, as in even the best of times the working poor have little chance to afford basic material necessities.

Although I read the book years ago when I worked on Wall Street, during the past few years of the Great Recession I’ve thought frequently about Nickel and Dimed.  We often hear a television commentator or political leader speak ruefully about the “middle class jobs lost,” as if that’s the national tragedy.[3]

It really gets up my nose, however, that we find tragedy in “educated, middle class people being out of work,” but we don’t focus on the persistent national tragedy of people who have been in recession all along.  Yes, the Great Recession threw a high number of white collar folks out of a job.  But the GR narrative stresses ‘white color’ jobs, by which I mean the image of ordinarily highly employable people suddenly struggling, rather than the large number of long-term working poor or under-employed people.

I really do not mean to sound indifferent about the tens of thousands of wonderful finance jobs lost in the Great Recession, or the millions of middle class folks who have struggled in recent years, but I do find the obsession with the middle class, rather than the working poor – the true underclasses in the United States – a curious omission in our American economic narrative.

The national unemployment rate rose from a low of 4.5% in 2007 just prior to the Great Recession to a current rate (in mid-2012) of 8.2%.  The African-American unemployment rate meanwhile has remained high at 8.3% and 14.4% respectively, nearly twice the national rate in 2007 and in 2012.

Are the 30% of Americans in a persistent state of underemployment, unemployment, and poverty invisible?  Yes, they are.  In this Great Recession, we just ignore them, because their situation is assumed to be unchangeable.

Both political parties shy away from acknowledging the working poor or people in chronic poverty. It seems only the “middle class jobs lost” are worth lamenting.

From the Obama “Jobs and Economy” page: “For years before the economic crisis, middle-class security had been slipping away. Wages stagnated while health care costs soared.”

From the Romney “Jobs and Economic Growth” page, we get a helpful “Middle-Class Promise Gap: Unemployment“ [LINK has been taken down with the end of the campaign.]

You will not find either candidate for President discussing the working poor or the persistent underclass in the United States.  I guess the working poor and unemployed don’t vote in sufficient numbers?  They certainly don’t donate enough to campaigns to matter.

The cone of silence increasingly ignores the American reality of wealth stratification.[4]

I currently live in the one of the poorest large cities in the United States, an urban environment with persistent poverty rates around 25% of the population.  For children under age 10, closer to 30% are growing up in households below the poverty line with a similar rate of undernourishment.  Their poverty was real before the Great Recession, it is real now, and because few leaders seem concerned about the issue, it will be true for the whole next generation to come.

In my hedge fund business, I invested extensively in municipal tax liens[5] in upstate New York.  Many upstate New York cities barely noticed the Great Recession.  Instead, decades prior to the recession, the regional Rustbelt deindustrialization kept them in a depression characterized by high rates of poverty, declining population, and falling real estate values.[6]

A permanent recession in some regions and in some population groups is the real story.  Nickel & Dimed is the real story.

My guess is anybody who reads this book review lives well ensconced in the middle class or above, and spends little time thinking on a daily basis about the working poor or the nation’s chronic underclass.  I’ll be the first to admit I certainly don’t.  Instead, my day – like yours – is full of what may be called ex-banker problems, and of course, cat videos.

Ehrenreich’s Nickel & Dimed gave me insight into the way millions of my fellow citizens live.   If more people should understand how high finance works, it’s even more essential that high finance folks understand how millions of their fellow citizens are getting by, or not, in America.

Please see related post: All Bankers Anonymous Book Reviews in one place.




[1] In writing this review I found myself struggling unsuccessfully to find something funny to say on the topic of the working poor and underclass in America.  Her specific experiment had light moments, but humor kind of eludes me on this one.

[2] Multiple restaurant co-workers live out of their cars because they can’t afford the rent anyplace near their place of employment.  Grocery shopping for healthy perishables proves impossible without a real refrigerator or kitchen.  Working slowly can be rational when you’re paid by the hour.  Neglecting antibiotics or doctor’s visits because of the cost can be devastating to your health and ability to work.

[3] It is certainly terrible to lose one’s job, and I do not mean to be callous about middle class folks who got laid off in the last few years.  The great risk for a middle class person who joins the unemployment ranks is really falling into the huge underclass, at which point he will be effectively forgotten in the national narrative.

[4] Which is why I was happy to interview a member of the 1% to speak candidly about his life here.

[5] As an investor, I purchased from municipalities a lien representing a senior claim on real estate for which the property owner had not paid City or County or School or Water taxes.  After the expiration of a statutory period of time, my firm had the right to foreclose on the real estate.  Many municipalities in upstate New York have a constant need to sell tax liens because of persistent tax delinquencies.  That of course reflects the relative poverty and declining real estate values in the cities and towns of the region.

[6] For investors who would like to know just how depressed the situation is in some upstate New York cities, perhaps my real world example will provide a point of comparison.  I sold a seven-unit residential building (acquired via tax lien foreclosure) in January 2011 for $75,000.  While two of the units needed a little improvement, three of the units had renters, providing cash flow on the building.  And I was happy to sell the building just to be rid of the risk.  That upstate New York city is not coming back any time soon.

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