Tax Cuts and Deficits

After nearly ten years and at the last minute, the Congress finally passed an extension of the 2001 tax cuts. But only for two more years. With a Republican House and a Democratic Senate and White House, there seems to be little chance for agreement on a permanent solution to the problem that was caused by a budgetary gimmick used in 2001.

For those who don't recall, the Congress generally has to make revenue neutral laws over a period of ten years. So if they cut taxes somewhere, they have to increase taxes somewhere else or they have to cut expenses somewhere. And, the Congress always likes to push problems into the future when other legislators will have to deal with the problems. So the tax cuts in 2001 were set to expire in 2011 with a reversion of the tax deductions, credits and other variables to the 2001 levels. Meanwhile, in the intervening nine years, they introduced voluminous changes in a law that was at risk of being repealed by a sunset provision. Trying to deal with all of the changes from 2002 through 2010 would be a legislative and regulatory nightmare.

After nine years of lower tax rates, increased deductions and exemption, plus hundreds of subsequent revisions, the argument about extending the 2001 cuts turned into an argument about whether extending them would be the same as a tax cut or whether letting them expire would be the same as a tax increase.

Take your pick. Is the glass half full or half empty?

For me, letting the cuts expire would be a tax increase on everyone, rich and poor alike. (Even the poor were getting "refundable" tax credits.) Simple logic suggests that you can't have a tax cut by letting the rates and exemptions remain the same. The alleged "cut" is simply a cut from a fictitious amount that might have been if the "cuts" were extended. The cuts have been embedded in the law for nine years and the potential repeal was a mere budget gimmick.

But the Liberals want to argue that extending the tax cuts is like a new tax cut and will cause an increase in the annual deficit and in the national debt. First, it's not a cut from the existing law. It's a continuation of what is. Second, the Liberal/Keynesian argument that taxpayers won't react to tax increases and that the higher rates will result in added revenue has been proven false time and again. The rich are sensitive to higher taxes and they are able to hire experts to help them find ways to modify their business or investments to postpone or avoid the higher taxes. As a last resort, if taxes are increased beyond their toleration level, they will vote with their feet and will leave the U.S. permanently.

For some details about the 2010 tax relief act, see http://finance.groups.yahoo.com/group/JacobsReport/message/881

Vern

Why Do Super Wealthy Support Higher Taxes?

Warren Buffet, Bill Gates father and about 43 other millionaires have sent a letter to President Obama in support of his attempt to repeal the Bush tax cuts for the wealthy. Some of them have also previously spoken out in support of reinstating the estate tax.

Why do some of the most wealthy people in the country want to pay more taxes?

Is it because they are genuinely patriotic or are they financial masochists? They argue that it's because the country needs the taxes on the super wealthy to help pay down the deficit.

But these are the same people whose wealth is mostly generated from owning stock in some of our largest corporations. And I suspect that all but a few of them have established a family foundation to own a large part of their stock. So if you have a billion dollars worth of stock do you sell it and pay taxes on the gain, or do you hold it and let the estate tax consume a large part of it -- or do you donate a few million each year to your foundation and claim an income tax deduction for that contribution? And by giving the stock to a charitable foundation, it isn't subject to the estate tax.

Another way that the super wealthy are able to generate tax free cash to pay for their multiple homes and planes is with borrowed money, that is secured by the appreciated stock in their corporation and/or by the assets they acquire.

From my perspective, there is nothing wrong with doing what the law permits. But let's not be deceived into thinking that the super millionaires who advocate higher taxes on the wealthy are going to incur any financial pain from their patriotic gesture.

Vern

The Best is Yet to Come

Have you seen the t.v. commercial that expounds on the merits of gold as an investment?

Near the end of the message, the announcer is talking about how much gold prices have increased in the past ten years or so. And then he says,

"And the best is yet to come."

Really?

Do you really want the price of gold to increase? If so, do you really understand that the price of gold is a measure of fear, inflation and political instability?

I first bought some gold back in 1979 when the price was closing in on $700 an ounce. By early 1983, the price was down to near $300 an ounce and it stayed there for nearly twenty years.

Why? The monetary policy of Paul Volcker drove interest rates way up and set off a serious recession. But it took the steam out of the double digit inflation we were experiencing. And it took away a large part of the reason that gold prices were so high. In spite of moderate inflation from 1980 through 2003, gold prices didn't increase -- which demonstrates that gold is not a pure inflation hedge. The price of gold does not correlate closely with inflation because it is also a measure of the degree of political instability. And, of course, the price is affected by large purchases and sales by governments.

Speaking for myself, I'd be happy if the price of gold were to drop from it's current level because that would be an indication that things were back to normal. Over time I do believe that gold will increase to reflect the loss of value in the dollar due to creeping inflation.

As far as the price of gold is concerned, I surely hope the best is not yet to come and that gold won't go up to $5,000 an ounce as some promoters are claiming.

Nonetheless, I will continue to maintain a portion of our net worth in what Lord Keynes called "the barbaric relic" -- just in case things get worse instead of better.

Vern

Dangers of Online Tax Preparation and Banking

I've been what's called an "early adopter" with respect to personal computers since the seventies. I was one of the first people to develop a tax forecasting and planning software program for the very early personal computers. And I've been using the WWW and Internet since about 1994. The reason for making these statements is only to clarify that my refusal to use online tax software and online banking is not based on a lack of familiarity with computers.

Banks today go to great lengths to persuade us that their computer systems are ultra-secure and safe. And they may well be right.

But it doesn't make a dime's worth of difference if your own connection to the Internet is not equally secure. When you consider the cost of developing and maintaining a secure computer system by a bank, having an equally secure system on your home computer is not an option.

I've been hyper-sensitive to computer security for many years and probably have a fairly effective system for a home based business. But that gives me virtually no comfort with respect to whether my system is 100% secure.

Have you heard about "key stroke loggers"?

According to Wikipedia, "Keystroke logging (often called keylogging) is the action of tracking (or logging) the keys struck on a keyboard, typically in a covert manner so that the person using the keyboard is unaware that their actions are being monitored." These key logging programs can be inserted in a computer with a variety of worms or computer viruses.

Once a key stroke logger is on your computer, the people who put it there can then retrieve the data -- consisting of the history of your key strokes. Your key strokes clearly include any passwords that you enter to use your online banking and/or online tax preparation software. Other software used by the thief analyzes the data to reconstruct what is being done. Connections to various web sites are easy to identify. With the password and other data obtained from your computer, the thief has complete access to all of your online banking, investment and tax returns.

What can you do to protect yourself?

The safest solution is to not use online financial services, but that's becoming impractical in today's world.

The second safest solution is to have a separate computer that is used exclusively for online banking, investment management services and tax planning or preparation. That computer should be 100% off limits for any kind of email or web surfing that is not essential for the online financial services. If you have an IRA or 401k, you should be able to afford the cost of a separate computer to be used only to manage your investments, taxes and banking.

Even if you have a stand-alone computer for this purpose, you also need to avoid using public wireless connections such as those at airports, hotels or coffee shops.

One of the greatest dangers of getting some kind of malware onto your computer is the use of your computer by your children or by anyone else. If you can afford it, it's best to provide the kids with their own computers. If that's a bit too expensive for you, let them use the older computers that you have replaced with newer models. Failing that, you may want to simply prohibit the kids from using your computer at all.

And, as a last resort, you can simply not use any kind of online financial service.

Vern

Why the stock market has been doing well

The politicians and their followers are using gains in the stock market as evidence that the economy is recovering. While I'd like to believe it, I can't help being a bit nervous about putting more money into equity investments at this time.

The reason for the increase in the market value of stocks is because of the absurdly low interest rates on fixed income obligations like C.D.s, money market funds and short term treasury bills.

When interest rates on short term debt obligations are near zero, what choice does an investor have other than to invest in the stock market? Despite a weak economy and relatively high unemployment, the majority of people are still working and are trying to save more money. Ongoing contributions to various kinds of tax deferred retirement plans have to be invested somewhere. The real estate market is still dicey and fixed income investments offer near zero returns. So the money is going into the market.

I can't think of any way to accurately predict when or if the Fed will stop their "quantitative easing" (money creation) and let interest rates return to whatever the market dictates for various kinds of debt obligations. But until that happens, it's a little bit like living under the "Teeterin rock" in the Li'l Abner cartoons. Once interest rates return to normal, a lot of money will move out of the market.

At least that's the way it seems to me.

Vern
www.vernonjacobs.com

A Cure for Inflation?

Have you noticed that we talk about an increase in the price of gold, silver and various foreign currencies, instead of talking about a decrease in the value of the U.S. dollar?

As of about 10:30 am (central time) in the U.S., on November 15th, the spot price of gold was $1,338. If you bought some gold at $1,000 an ounce, have you made a profit of $338 (33.8%) or has the value of the dollar decreased by about 25%? If you invested in Euro's at 1.20 per dollar and sold out when the Euro was at 1.40 per dollar, have you made a profit of 16.7% or did the dollar fall by about 14%?

If the increase in the relative value of gold or other currencies versus the dollar is actually a decline in the purchasing value of the dollar, why do we have to pay taxes on the alleged gains in the value of gold, silver or other currencies?

One of the diverse suggestions for a way to curb inflation is to permit people to use gold or silver as a substitute for the dollar, but without eliminating the dollar. This would require that we do not impose a tax on any increase in the value of the competing currency in relation to the dollar. Many people would continue to use dollars to conduct business, but an increasing number would choose either gold or silver to establish the price of various products or services. This would be particularly attractive for transactions (such as loans) that expose one of the parties to a potential loss because of a decline in the value of the currency. But this would also put a lot of pressure on the Federal Reserve to stop inflating the currency.

Of course, that's simply a lot of wishful thinking on my part because there is no way the political and banking establishment would allow us to use any competing substitute for the declining dollar.

Vern

See The Tax Reform Alternative
http://www.offshorepress.com/taxreform2010.html

Cut Spending or increase Taxes?

Yesterday, Rand Paul was interviewed by a t.v. commentator and Paul stated that one of his goals as a Senator would be to persuade his colleagues to cut federal spending by $100 billion a year.

The interviewer asked if Paul didn't think that increasing taxes was also essential to help reduce the deficit. The way the question was posed clearly implied that the answer to the question was that taxes had to be increased -- particularly on the upper income taxpayers.

But Rep. Paul stated emphatically that the problem is not inadequate or insufficient tax revenues. The problem is entirely about excessive spending. He then trotted out some compelling data about the rate of increase in federal spending since 2008 and suggested that just getting back to the 2008 level would reduce spending by far more than $100 billion.

According to the Washington Post, federal spending went up by 16% in 2009 to $3.2 trillion. That represents an increase of some $475 billion, which is far more than Paul's modest proposal to cut spending.

Nonetheless, the mantra from the left is that we can't cut spending without cutting essential programs. When given some examples of popular things that would have to be cut if Paul's proposal became law, Paul replied that the left always trots out the most popular programs and insists that these are the only programs that can be cut. This is the same tactic as threatening to cut police or fire services or funds for education when there are demands to cut spending at the local level.

As for the argument by the left that continuing the Bush tax cuts will cause a loss of federal revenue, Paul rightly points out that the 2001 tax cuts are the law today and that letting them expire would be the largest tax increase in recent memory.

Vern

http://www.offshorepress.com/taxreform2010.html

The Conservatives Don't Have a Plan

Lately, the Democrats have been making the argument that the Conservatives are just being negative and they don't have a plan to solve the numerous problems we face.

That' a little bit like asking, "When was the last time you beat your wife?".

The question presumes it is necessary to have "a plan". The Progressives and most Democrats apparently believe that smart people in government can solve every kind of problem with central planning.

Conservatives believe that central planning is the problem rather than the solution. The Conservative "plan" is to quit trying to micro-manage the unmanageable. The plan is to get rid of most of the regulatory agencies and their stifling regulations. The plan is to stop trying to manage the environment, the economy and every aspect of business. The plan is to let the citizens work out these problems with a minimum of government interference. The plan is to downsize as much as possible. The plan is to have an honest currency rather than one that depreciates as much as 75% in 50 years (with 3 percent inflation). The plan is to let the magic of competition drive down the cost and improve the quality of health care for everyone. The plan is to shift most Federal activities to the states, as required by the Constitution.

Vern

Roth Conversion for Retirees

Making a decision about whether to convert a regular IRA to a Roth IRA can be extremely confusing. An often overlooked issue that adds to the confusion is the potential impact on whether future Social Security benefits might be subject to income tax.

One of the somewhat obscure tax traps that can hit Social Security (SS) recipients who have other income is the income tax on SS benefits. Depending on your income level and whether you are single (or are married and filing a joint return), you may have to include as much as 85% of your SS benefits in your taxable income.

So what does this have to do with a conversion of a regular IRA to a Roth IRA?

After making a conversion the income earned by the IRA and any distributions from the IRA would not be taxable. This could reduce the amount of SS benefits that is otherwise subject to income tax.

But bear in mind that the conversion results in adding the full amount of the IRA to your income over a two year period in 2010 and 2011. That is likely to push you into a top tax rate. For those already in or near the top rate, that might not make a difference. In any event, the government is eager to get more taxes now, rather than waiting until you retire and that's the main reason why this tax break was offered.

The conversion option is not available after this year.

For information on the income tax on SS benefits see http://www.ssa.gov/pubs/10035.html

For some information about Roth conversions see
http://www.money-zine.com/Financial-Planning/Retirement/Disadvantages-of-Roth-Conversions/

Your IRA trustee may also be able to help you with this decision.

Vern

Prospects for Real Tax Reform

The income tax and the inflation tax have provided the liberal politicians with the ability to extract an unlimited amount of money from the public. Most previous administrations and Congress's have exercised at least some restraint in using that ability. The current Congress and White House seem to have no regard for the consequences of their insane spending programs.

Many of my clients and some of my professional colleagues have concluded that the only way out for them is to give up their citizenship and to seek opportunity or retirement somewhere else. Although there are only a relative handful of people who are included on the government list of tax expatriates, my private sources tell me that there are long waiting lists at the embassies in major cities -- of Americans who want to renounce their citizenship now.

The U.S. has become a magnet for immigrants not because of freedom of opportunity, but because of our extremely generous social safety net. As we attract more poor people with limited education and skills, we are also beginning to lose our entrepreneurs and people with capital. Carry that forward five or ten years and then think about the impact on our economy. Then recall the incredible trillions of unfunded entitlements that will be demanded by millions of retiring baby boomers.

Can this madness be stopped? Perhaps, but I fear we have reached the "tipping point" or the point of no return where the number of people who are dependent on the federal government exceed the number who are not. Who will vote for radical change to restore the U.S. to the kind of representative democracy that is described by our Constitution rather than by the judges who have redefined it to permit the creation of a welfare state? We need to get rid of the income tax by repealing the 16th Amendment and generating federal revenues with some kind of consumption tax, and by either repealing the Federal Reserve Act or somehow restricting the ability of the Fed to create new money without limit.

I hate to be a pessimist but I believe we will need a LOT more pain before there are enough voters who are willing to return us to a land of opportunity and to give up the illusion of a land of free goodies.

Consequently, I anticipate that we will see a substantial increase in the number of U.S. citizens and green card holders who choose to move somewhere that is believed to be less hostile to those with capital or business talent.

Vern

See The Tax Reform Alternative
http://www.offshorepress.com/taxreform2010.html

Taxation, Inflation or Expatriation

Many people have been trying to reform the U.S. tax laws for many decades, but without much success. With each attempt, the politicians add more complex provisions to the tax code and in a few years, they introduce new tax breaks for various supporters and interest groups.

Meanwhile, even if the income tax were eliminated, the government could generate unlimited money through the inflation tax. This is done by issuing Treasury notes to the Federal Reserve in exchange for new money. Combined with the fractional reserve banking rules whereby banks are allowed to loan out as much as 90% of their net deposits, the new money causes an increase in the money supply and in inflation.

For those who despair of being able to repeal the income tax and the ability of the Fed to create new money, there is the alternative of expatriation -- of giving up citizenship after acquiring dual citizenship in another country. New laws passed in June of 2008 impose a complex "exit tax" on the unrealized gains and deferred income of expatriates. But for those who have modest assets and are seriously concerned about the increasing degree of government control over the economy, there are other countries that offer lower taxes and less government intrusion.

I've just completed a new book called "The Tax Reform Alternative" that ties together these three issues. How can we reform the income tax? How can we limit the ability of the Fed to create new money? And if we can't do that, how can we escape from an America that is turning into a socialist state? It's available as an e-book (in a PDF Format) and is designed to be easy to read on a digital device like a computer, ipad or smart phone. The price is a a modest $15 and can be ordered at http://www.offshorepress.us/rismanforami.html

Copies are available at no extra cost to paid subscribers of my online library of e-books and my bi-monthly newsletter. Further details about The Tax Reform Alternative are available at http://www.offshorepress.com/vernonjacobs/taxreform2010.html

Vern

An inflated Recovery

The big news today and yesterday is that the "great recession" is over. Five economic indicators are given as proof that the economy has turned around and the President is quick to take credit for the recovery.

However, what did we expect to happen when over a trillion dollars is pumped into the economy as part of a variety of stimulus and bail out programs? And it appears that all of that money has not yet reached the general public.

The infusion of new money into the economy is like giving a drunk another drink or giving a junkie a fix.

But what happens as the dust settles in the aftermath of the infusion of new money?

After a while, prices go up. Sometimes it's the price for various investments. Other times it's the price of consumer goods. And most times it's a combination. Those who weren't on the receiving end of the stimulus will have to pay higher prices for various goods and services. Or they may have to pay more for some investments. Those who held any investments that enjoyed a price rise because of the new money will feel like they have made some money, but when they have to sell the investment, they will have to pay taxes on the inflated value. And the money they get from selling won't buy as much stuff as before.

The government is telling us that the rate of inflation is low and under control. But they aren't talking about the concurrent deflation that is still ongoing. Businesses are going bankrupt. Homeowners are still defaulting on their loans. Consumers are taking bankruptcy. Debts are being written off. Without the infusion of new money into the economy, the elimination of debt would be causing deflation. And without the bankruptcies and debt defaults, we would be experiencing higher prices on assets, on consumer prices or both.

So it seems we are experiencing both deflation and inflation at the same time.

Whether this is really the beginning of a recovery or a temporary correction from a recession remains to be seen. Caution seems to be the better choice for now.

Vern

The Road Less Traveled

In economic circles, the views of Lord Keynes reign supreme and are the conventional wisdom of the day. A very simplified part of his economic theory is that increases in the money supply do not cause inflation. Instead, he argued that the government can use borrowed money to stimulate the economy and to generate income for the citizenry. He also claimed that government debt doesn't matter. His theories are the basis for the government stimulus program and for the ongoing effort to continue providing unemployment benefits to the unemployed and to continue bailing out failing industries. Keynesian economic theory gives the government the theoretical justification to expand the money supply, expand federal spending and to entice more and more people to feed at the public trough.

At the polar opposite of the economic spectrum, an Austrian economist by the name of Ludwig von Mises argued that debt does matter and that prosperity can't be created with borrowed money. Mises also argued that increased taxes result in a decrease in economic activity. But his views are ignored by most of the economic community, the political establishment and the mainstream media.

Like the little girl who saw that the emperor was naked, a relatively few people agree (with Mises) that endless borrowing and spending by the government will result in either a hyper-inflation or a massive deflationary depression. But it's not comfortable to be in the minority and to be on the opposite side of the popular perception of the times. How can so many really smart people not see what seems so obvious? The best reason I can think of is that it's easy to believe whatever everyone else believes. And it's difficult to believe anything that is ridiculed by the intelligencia of the day. But what we believe will dictate what we do or fail to do. And it will dictate whether we take steps now to avoid or at least to minimize severe losses as a result of a potential economic Armageddon.

Check out the great insights available at the http://mises.org

Vern
www.vernonjacobs.com
www.offshorepress.com

When Will The Economy Turn Around ?

During long periods of financial prosperity, people feel optimistic and are confident their income will continue to increase. So they are eager to borrow money to buy stuff now rather than having to wait. Even with moderate inflation, there is a feeling that prices will be higher in the future, so it is better to buy now.

But when the economy turns around and people start to lose their jobs or have to take big pay cuts, they quickly adopt an opposite attitude toward the future. They are not confident they can repay more debt in the future or that prices will increase. So they start to reduce their debts and to accumulate assets by cutting way back on every kind of discretionary expense.

At the same time, the banks, credit card companies and other lenders that have been overly eager to extend credit begin to adopt a far more conservative practice about making further loans. So even if people want to borrow, there is less money available.

The government sees this as a bad thing because this kind of behavior will put more downward pressure on prices and will lead to less buying and therefore to more business failures and to more unemployment. Voters get angry. Politicians worry about being voted out of office. So they jump on the stimulus bandwagon and agree to use borrowed money to prime the economic pump and to bail out businesses that are deemed "too big to fail".

The stimulus and bailouts provide a lot of people with money but it does not cause people to feel optimistic about the future. Businesses with non-essential goods and services continue to suffer and go broke, adding to the unemployment statistics.

To a large extent, the bailouts, stimulus and extended unemployment benefits simply delay the point when the excesses of the earlier financial bubble are gone, when businesses that have survived are lean and mean and when the unemployed are willing to accept jobs that are far less lucrative than the ones they enjoyed during the boom times. And everyone except the government has been reducing their debt or accumulating savings.

Gradually, businesses begin to rebuild their inventories and some entrepreneurs embark on new ventures that require them to hire some of the unemployed. Little by little, pessimism and fear give way to cautious optimism and the economy begins to recover. But the more the government continues to intervene, the longer it will take.

Just my two cents.

Vern
www.vernonjaccobs.com

End the Health Care Mandate?

Ron Paul, (R-Tx) has introduced a very short bill to "End the Mandate" in the health care bill that requires everyone to obtain a minimum amount of health care insurance or to pay a fine. This extremely short proposed bill (HR 4995) would simply end the mandate and would make no other changes in the health care legislation. One problem that has been mentioned by opponents of Paul's bill is that is does not also eliminate the mandate for insurance companies to provide coverage for people with a pre-existing condition. If Paul's bill were to become law, it would encourage people to wait until they have a medical problem before they buy health insurance. The insurance industry is therefore very likely to oppose this bill to end the mandate. And while I strongly support the sentiment about getting the government out of the health care business, I believe this is an overly simplistic solution that would create more problems in the unlikely event that it were to become law.

However, Paul has also introduced a more extensive bill (HR 5444) to repeal the entire Patient Protection and Affordable Health Care Act and to replace it with a number of changes in the law to encourage more competition in the health care industry and a more equal tax treatment of health care costs. The bill also offers a novel way to deal with the problem of malpractice during surgery. So while I can't support the bill to end the mandate, I can certainly support his bill to simply repeal the entire health care act and to eliminate some obstacles to competition in the health care marketplace.

Ending the mandate is a catchy sound-bite that grabs our attention, but like many sound-bites, it papers over some serious complications. I wish Paul's supporters would spend more time and effort in promoting his bill to simply repeal the health care act in its entirely. For more on this topic, see

End the Mandate
http://www.house.gov/apps/list/speech/tx14_paul/EndMandate.shtml

http://www.ronpaul.com/legislation/end-the-mandate/

http://www.chooseliberty.org/hr4995.aspx?pid=cz01

Private Option Health Care Act (Repeal the Health Care Act)
http://www.house.gov/apps/list/speech/tx14_paul/PrivateOptHealthcare.shtml

http://www.ronpaul.com/legislation/private-option-health-care-act/End the Health Care Mandate?

Vern
www.vernonjacobs.com

If I pay Less Will You Pay More?

A scholarly analysis of the IRS penalties versus the excessive fines clause of the Constitution concluded with the statement (in part) that

"When one taxpayer pays less, we all pay more."

This is also an often used comment by various IRS officials. But is it true?

If it is true, it means that the government somehow arrives at some budgeted amount that is somehow divided among all taxpayers. Furthermore, if the full amount that is budgeted isn't collected in the current year, it must somehow be picked up in a later budget year.

And what happens when a lot of taxpayers lose their jobs and end up paying less taxes? Do the rest of us have to somehow make up for that lost tax revenue?

If that's true then every time the government introduces some kind of new targeted tax incentive (aka special interest tax expenditure), all of the taxpayers who are not part of the favored group must have to somehow make up for the shortfall. And what about the fact that roughly 50% of the households in the U.S. don't pay any income taxes at all? Clearly, the other half must make up for the shortfall.

However, it doesn't really work that way.

First of all, this cliche' presumes that the expense side of the budget can't be changed. Is that the way things are in your household or business? If there is a shortage of revenue, don't you make up for the difference by either borrowing (if you can) or by cutting back on expenses if borrowing is not an option? And if the loss in revenue persists (or is expected to persist), you start cutting some expenses, like the cruise you wanted to take or the new car you were going to buy. In extreme cases, you might even downsize by moving to a smaller home and selling some stuff.

With the federal government, there is a lot more opportunity to borrow the funds, which are rarely repaid. The annual deficit is just added to the accumulated national debt which results in having to pay more interest. But the debt isn't repaid -- it is just rolled over from year to year. And if the debt gets to be too much, we pay off some of it with new money courtesy of the Federal Reserve. Of course we try to do that gradually because if we print too much too fast, it would upset all of our trading partners around the world. (Because our money would lose value.)

Back to the question. If I somehow pay less taxes by not working or by getting a cut in pay or by using some sort of obscure tax break, do you have to pay more? The answer is no! There is no connection because the government has an almost unlimited ability to borrow money.

But I can hear a few readers asking, "O.K., if that's true why do they need to collect taxes at all?" And my humble two cents on the question is that they don't have to collect taxes as long as they have the Federal Reserve available to create new money in exchange for new treasury obligations. But doing that would make it obvious that inflation is actually a substitute for taxes.

Vern

Fight or Flight?

The political left try to divert the real objectives of the Tea Party movement by arguing that taxes are low for the middle class and that Obama intends to continue the Bush tax cuts for those making less than $200,000 per year. (Those on the bottom half of the economic spectrum don't pay any income taxes.)

But the Tea Party people aren't complaining about current tax levels. They see the huge amounts of deficit spending and the costly laws that the liberals are passing or trying to pass and they understand that huge deficits and enormous levels of debt will translate into either higher taxes or inflation or a combination of the two.

So the members of the Tea Party are organizing and exchanging information in order to replace the liberal members of the Congress with candidates who seem to reflect the goals of the Tea Party for a smaller government, less spending and less taxes. Of course, voting for newcomers is a lot like buying the proverbial "pig in a poke". We won't know if the new comers are just jumping on a bandwagon or are sincere in their intentions and have the fortitude to resist the siren call of power and influence.

Meanwhile, there are some of us who remember the very limited success of the "Contract with America" where a lot of newcomers went to Washington and quickly got indoctrinated with the way things are done in the "Land of Oz." (The crystal city was not in Kansas; it was in Washington.)

I currently have four clients who have retained me to help them with the paperwork to expatriate. That means they are going to give up their U.S. citizenship. For those who don't have any confidence that the Tea Party or anyone else can really change things in Washington, flight is their choice. And there are many indications that flight is becoming the choice for a lot more people.

For myself and my wife, we are at an age and have a family situation such that we are going to stay. Since we have ruled out the choice of flight, we intend to do what we can to join the fight -- even if past efforts to turn things around were not successful. At a minimum, I will continue to share what I'm learning about the issues with those who may have an interest in one more voice for freedom.

As Glenn Beck and some other have concluded, the first step is for all of us to learn about the history of the Progressive Liberal movement so that we can better understand what is happening now. The second step is for each of us to share our discoveries with others and to encourage them to become politically aware.

Just my two cents.

I invite you to visit my Liberty portal at http://www.offshorepress.com/liberty/

Vern

Do Tax Cuts Cause Deficit?

If you have watched Fox News you are probably familiar with their "fair and balanced" panel discussions. They usually have two conservative commentators and two liberal commentators to discuss issues of the day.

One of their more interesting discussions was about cutting taxes versus cutting the deficit.

The commentators who favored tax cuts argued that tax increases would hurt small business owners who are the source of about 85% of the new jobs that are created. Therefore, tax increases would extend the current recession.

The commentators who favored deficit reduction argued that it was inconsistent for fiscal conservatives to support both deficit reduction and tax cuts at the same time. Their obvious assumption was that tax cuts reduce the amount of taxes the government collects and must therefore result in higher deficits.

Neither group discussed the issue of spending in relation to deficits.

But the tax cut advocates did argue that tax cuts increase total economic output and therefore result in higher tax collections. They also pointed out that past tax cuts have reduced the annual deficit and in some cases have helped to generate surpluses.

The liberals who argued in favor of tax increases to reduce the deficit apparently operate on the assumption that the economy is static and that tax policy does not alter economic activity. They seem to be unable to accept the idea that lower taxes results in more jobs and prosperity which in turn result in more tax revenue that can be used to reduce the deficits. Nor did they seem to be concerned about the impact of government spending on the deficits.

Vern

Who Suffers from Deflation?

It often seems that the financial media treats deflation as if it were some sort of financial plague.

It's somewhat obvious that everyone is hurt by inflation, right? Oh yeah, I almost forgot. People who owe money to banks or other lenders like inflation because they get to pay off their debts with cheaper money. That must mean that the lenders don't like inflation and logically should like deflation. And debtors should be the ones who get hurt financially during periods of deflation.

But it seems that it's the bankers who scream the loudest about the evils of deflation. Why is that?

Put simply, it's because they have less money to loan at interest rates above what they have to pay for the money.

The banks get money to lend from three main sources. One is from the money that is deposited with them. They can loan up to about 90% of those deposits to borrowers at interest rates above what they have to pay the depositors. The second source of money is from the deposits by the borrowers or from people who have borrowed funds from other banks. But that is probably their most expensive source of funds.

The third source of funds is from the Federal Reserve and it is often the cheapest source of funds. Right now, the Fed is keeping the interest rates they charge member banks as low as possible. In fact, the rate is so cheap that the banks are finding it safer and more profitable to just park that borrowed money in U.S. treasury bonds.

With deflation, it works pretty much in the opposite way.

Fewer people are borrowing money so the banks have less money to lend. The Fed is likely to try to push money into the market with lower interest rates but if people aren't borrowing, it's like pushing on a string.

With deflation, prices are generally declining. Each dollar in circulation has more purchasing power. Although borrowers pay off their debts with more valuable dollars, that's not a profitable thing for them to do. So they try to pay off debts as soon as possible instead of delaying the payments as long as possible. And there is then less money in circulation which reduces the profits for the banks.

The bottom line is that it is the bankers who are hurt the most because of deflation. And the Fed is owned by the bankers. So if I have to place a bet on whether we are more likely to have inflation or deflation, I'll bet on inflation.

But there are some times (like now) when some deflation or at least a lack of inflation is unavoidable. That's because bankruptcies and loan defaults are inherently deflationary. They offset the money that was created when the loans were made and reduce the money in circulation.

But in the long run, those who avoid debt would be better off with deflation.

At least that's the way it seems to me.

Vern

Logic vs. Faith

For a long time I have found it difficult to understand how otherwise intelligent people can honestly believe that any government is able to create prosperity or even security. To a large degree it seems that those who are the most educated (and therefore presumed to be highly intelligent) are the most likely to argue that government is the solution to every problem and the great provider of greater prosperity and justice for all.

I have developed a litmus test with respect to the honesty of politicians based on their promises about what the government can do for their constituents. When a candidate for President claims that he will be able to "fix the economy", I regard him as either a fool or a lier. The government can impose laws and regulations and they can impose taxes or create new money through cooperation with the Federal Reserve. They can create an environment that encourages entrepreneurs but they can't create prosperity. That can only be done by private industry.

More laws and regulations rarely solve more problems than they create. The regulations consume resources to fund the bureaucracy and they restrict or inhibit industry in a variety of ways. They create distortions in the economy and cause industry to divert resources to deal with whatever mandates are imposed. For every useful law or regulation, there are a dozen others that are politically motivated and pander to the goals of various special interest groups. Government benefits for various constituents inevitably lead to an expansion of the intended scope of the program.

The laws and regulations inevitably require more taxes or more "funny money". The progressive income tax provides an incentive for those who are excluded from the tax (the bottom 50% of households) to demand more government benefits at the expense of those who do pay income taxes. It is a simple truth that whatever we tax, we get less of. When we tax income we end up with less income. When we tax assets, the assets always evaporate. When higher taxes become unproductive, the government resorts to the debasement of the currency. In a country with a central bank that simply involves the issuance of government bonds in exchange for newly created money. And that leads to inflation, which diminishes the purchasing power of the currency.

But the advocates of more government and central planning are immune to this kind of logic or common sense. They seem to base their decisions on blind faith that a few people with concentrated power can somehow produce a better result than millions of individuals who are motivated to find solutions for whatever problems they may face. The advocates of bigger government believe that centralized power and planning can force people to do what they would otherwise not do. But force is never a motivator. It does not lead to maximum effort. It only leads to the minimum effort required to avoid punishment.

In a controlled economy, the government pretends to pay the workers and the workers pretend to work. Eventually the entire system begins to fade the way a battery operated appliance does as the battery loses its power. History is full of failed attempts at managing an economy. But the proponents seem to believe that they have the magic missing ingredient to force people to be more productive.

Faith in the flawed concept of economic equality is the cause of untold misery. The advocates of more government operate on faith and blindly ignore the many clear lessons of history and logic.

Just my two cents.

Vern

Chemo Now or Surgery Later?

The news today (6/28/10) says that the G-20 rejected the proposal by Obama and some of the G-20 member countries to expand the stimulus program with more borrowed or printed money. Spokespersons in favor of the stimulus plan are arguing that this will result in an extended recession (or worse) and more unemployment.

O.K. Of course it will cause financial pain to stop throwing new money at the problem.

But what's the alternative? More false prosperity for another year or two or even three years? And with each trillion of new money creation or expanded borrowing, the problem gets worse.

Seems to me it's lot like having to decide whether to submit yourself to chemo therapy treatment for cancer now, rather than having to endure severe surgery later on. In a financial context, it's a lot like individuals who have to choose between cutting up their credit cards now or be faced with bankruptcy a few years later.

Most of us prefer to avoid pain as long as possible, but sometimes, the longer we wait, the worse the pain will be. And in some cases, the result is devastating rather than being merely painful.

Just my two cents.

Vern

www.vernonjacobs.com

Average Tax Rates and Marginal Rates

When people complain about high tax rates they are usually objecting to marginal tax rates.

When politicians argue that taxes are low they are usually talking about average income tax rates.

A marginal rate is the rate that determines the amount of tax on some increment of taxable income. Most people refer to this as the top tax bracket, but that generally only refers to federal income taxes. The marginal tax rate includes Social Security taxes and state income taxes. People make financial decisions based on the marginal tax rate that will affect the outcome of a particular decision.

A single self employed taxpayer in 2010 with a total income of $75,000 and who uses the standard deduction will be subject to a marginal federal tax rate of 25%. If s/he lives in a high tax state like California, the marginal state income tax rate might be as much as 10%. The tax rate on self employment income is 15.3%, but there is a deduction that is allowed for 50% of that tax, which reduces the federal income tax. That represents a savings of 25% times 15.3% or 3.825%. So the combined marginal tax rate on an additional $100 of self employment income would be about 46.5%.

However, if you compute the actual tax based on the multiple tax brackets for the federal and state taxes, and then add the net self employment tax, the total Federal income tax might be about $11,200. The Self Employment tax would be $11,475 and the state income tax might be $6,000. The total actual tax would be about $28,675. When you divide that by the total income of $75,000, the average tax rate is 38.23%.

For a single taxpayer who makes $50,000 of interest income and has no other income or deductions, his marginal federal income tax rate would be 25% and his state income tax rate in a high tax state might be 7% -- for a total of 32%. (The self employment tax would not apply.) But if you compute the actual tax for this person, the average tax rate would be about 18% instead of 32%.

In addition to distorting the argument with average tax rates, the politicians include the non-paying taxpayers in their calculations. Roughly half of the families in the U.S. do not pay any federal or state income taxes. If the average rate for those who do pay taxes in 20% and only half the families pay income taxes, the politician will tell us that the average income tax per family is only 10%. But the marginal rate for many of the families that do pay taxes and that are also paying the self employment tax may be closer to 50%.

Vern

www.veronjacobs.com

The Real Price of Freedom

For the past six months, I've been reading a lot more books about the issues of the day. A few of the more recent books include

The Road to Serfdom by F.A. Hayek

To Save America by New Gingrich

What's So Great About America? by Dinesh D'Souza

Glenn Beck's Common Sense by Glenn Beck

Drill Here; Drill Now; Pay Less by Newt Gingrich

Myths, Lies and Downright Stupidity by John Stossel

Partly, I've been reading these books for insight into the motivations of the far left, or the "Secular-Socialist Machine" as Gingrich calls it. In spite of abundant evidence that more government simply creates more problems and that Socialism is a flawed approach to governing, the far left has been bull-dozing the legislative landscape with highly Socialist laws that a substantial majority of Americans have clearly said they don't want. In spite of numerous books and articles that demonstrate serious flaws in these proposed laws, the far left is aggressively moving to impose a much bigger government on us.

They claim to be non-partisan, but can't get the support of a single Republican for many of their bills and ram those bills through Congress with deceit and bribery. They blatantly lie to us about cutting taxes, reducing government, dealing with illegal immigration, protecting the environment and much more. They use offshore tax havens and our multi-national corporations as scapegoats for not being able to collect more taxes when the taxes that are collected are being grossly wasted. They talk about energy independence but refuse to utilize any of the effective sources of energy that we already have.

I have finally come to understand that the far left is not motivated by seeking to solve problems.

Their motivation is simply to secure raw and unlimited power.

While it defies common sense, they are intentionally destroying the economy of the U.S. so that all but a tiny fraction of the populace will come meekly like cows and pigs to the government feeding trough. Why? Because that's the only way they can sustain their positions of power. They prefer to be masters of a devastated economy than to be free members of a society of merit and ability. Many of them can't or won't compete in a free market and seek to establish an alternative universe of idealistic equality for all -- except for the leaders of course.

They are supported by a diverse collection of special interest groups, each of which participates in the plunder of the income and property of the people in order to secure political support for narrow and self-serving purposes. The unions seek government help to pass laws that give the unions more power over the workers and employers. The environmentalists want the government to pass laws that devastate the principle of private property and deceive us with false science about global warming. Some farmers support the far left in order to continue their generous farm subsidies. Nonprofit organizations support the far left because of generous grants and tax laws that virtually mandate that wealthy persons leave a large part of their estates to charity. They are supported by academia in exchange for subsidies, influence and even power. And the national media supports them because they seem to believe the Utopian fairy tales about the great benefits of economic equality. Also, the media owners generate a huge amount of ad revenue every two years and many of the largest media are owned by persons of far left persuasion. Even large businesses support the agenda of the far left in exchange for laws that make it extremely difficult for smaller businesses to compete.

And a lot of the people who advocate policies of the far left are highly idealistic and have little interest in such mundane subjects as economics or taxes. In fact, many of them openly disdain the merits of discussing such topics. They simply refuse to discuss why Keynes' theories are false, why lower tax rates produce more tax revenue, how the government causes inflation with the help of the Federal Reserve or why a free market provides the greatest benefit to the poor.

Then there are the younger voters who have limited experience with life and have been supported for 25 or more years by their parents. Despite protests of wanting to be independent, they have a basic belief in the nanny state. Finally, there are the people who truly believe that they know what is best for everyone else and are entirely willing to support laws that impose their views on everyone else.

That's just a sampling of the varied special interest groups that provide financial and political support for the far left.

The prospect of resisting the supporters of the far left seems nearly impossible.

Advocates of freedom are vilified by the far left and get little sympathy from family or even from some friends.

Those who like the status quo are generally those who are getting a substantial benefit of some kind from government. And there are a lot of us who would encounter financial difficulty if there was a dramatic change toward less government. Employees of the federal and state government and their families worry about how they will be able to live if their government agency is closed or drastically reduced in size. Retirees worry about how they will be able to afford health care and whether they can get by without Social Security, Medicare or Medicaid. Union members worry about losing the power of the government to give them leverage over large employers. Contractors who do work for the government worry about their livelihood. Farmers worry about their subsidies. Academia worries about their government research grants. And the large number of people who get some kind of subsidy like low income housing, food stamps, school lunches and a host of other benefits worry about whether they can really afford a smaller government.

So it seems that the real price of freedom is the willingness to give up our respective government subsidies based on a faith that freedom is worth it and that greater prosperity will come from a much smaller government.

Either we have faith in the false promise of equality for all or we have faith in the benefits of a free market, private property, honest money and limited government.

What sort of government funded financial aid do you receive or expect to receive?

Can you live without that support? Is freedom worth it for you?

Before you say "No", read Newt Gingrich's book, "To Save America" and get a copy of The Road to Serfdom by F.S. Hayek.

If we are not willing to be independent of the government, we will soon be little more than the tame pigs and the cows that are used as meat for the owners.

Vern

http://www.offshorepress.com/liberty/

Do T.I.P.S. Really Make Sense?

One of the solutions that is often offered for those who are concerned about inflation is to invest in Treasury Inflation Protected Securities or TIPS.

But for those who accept the logic of the Austrian School of economics, inflation is caused by an expansion of the money supply by the Fed's purchase of otherwise unmarketable U.S. debt securities.

So if we are concerned about inflation arising from recent legislation that will require a huge amount of deficit spending, does it really make sense to invest in government debt that promises to keep up with the inflation that is caused by that same government?

Also, there is a lot of plausible information to support the view that the inflation index that is managed by the government is about 50% of the real rate of inflation. For more about that subject see Shadow Stats.

What kind of investments do keep up with inflation? Think about a combination of precious metals, commodities, short term debt, a paid off residence, tangible things like guns, ammunition and generators.

Can you make a profit by building up a lot of debt during the current recession and then paying off that debt with cheaper (inflated) dollars? Perhaps, but the lenders are also aware of possible future inflation and will be raising rates in anticipation of future inflation. So the question is, can you outsmart the bankers on the timing of future inflation? And can you invest that borrowed money to make an after tax return in excess of the inflation rate?

Vern

www.vernonjacobs.com

Are Taxes a Moral Obligation?

Morality has been defined as "a system of conduct and ethics that is virtuous." It has also been described as being good or doing right. Because rights can not exist without a commensurate duty, morality could also be described as accepting a duty to satisfy the rights of others to "life, liberty and the pursuit of happiness". From a Judea/Christian perspective, it could be described as striving to satisfy the laws of the "Ten Commandments".

So in this context, is it immoral to avoid taxes by using loopholes within the law?

There is clearly an obligation of a voluntary citizen or resident of a country to either accept the duties imposed by that country or to find another country with duties that are more tolerable.

So one way to address the question of whether paying taxes is a moral obligation is to decide if there is a contract of sorts. Some people might call it a "social contract:". But a social contract implies that there is freedom to choose. However, the U.S. tax system does not offer a choice; which is in contrast to the tax systems of most other major countries.

Unlike most countries of the world, the U.S. imposes an income tax on its citizens or permanent residents regardless of where they reside or for how long. A person can become a U.S. citizen by the accident of birth and can be subject to the U.S. tax laws even if they reside outside the U.S. for most of their adult lifetimes.

If citizens or long term residents could simply move and thereby avoid the burden of U.S. taxes, there could be an implied social contract. So long as someone chooses to reside in the U.S. and so long as they are free to leave without penalty, there is an implied contract.

But since June, 2009 it is not possible for everyone to leave without having to pay some kind of "exit tax". This is a tax on what the tax law determines to be unrealized gains and deferred income. It's as if a citizen were required to sell every asset, compute any gain (or loss) and to compute the income tax on that gain. In addition to paying a tax on any assets as if they were sold at a gain, the person who wants to leave is required to pay taxes on any deferred income -- such as retirement savings accounts or section 529 education savings plans. (This commentary intentionally avoids delving into the arcane details of the exit tax.)

Admittedly, the exit tax does permit citizens or residents with a net worth of less than $2 million, who comply with some time consuming reporting requirements, to give up their citizenship or resident status without owing any exit tax. But the $2 million is not indexed for inflation and as time goes on, this limit will apply to more and more people who might prefer to leave.

And the often stated argument that the U.S. income tax system is voluntary is clearly "b.s." as every citizen and resident is aware. We are required by the law to file income tax returns and if we do not, there are increasingly harsh penalties for different degrees of non-compliance. In a few extreme cases where someone simply refuses to pay income taxes they can be incarcerated. If they resist with force, they could be severely injured or even killed by the authorities.

So there is little justification to argue that the income tax is a moral obligation arising from a social contract.

Instead, it is an extraction of the earnings of the citizens and residents that is enforced by any necessary means.

Also, a moral obligation implies that there is a clear and simple way to satisfy the duty -- usually by simply refraining from some conduct that is injurious to others. There is nothing simple or clear about the U.S. income tax. And it's not about refraining from causing harm to others. It's about causing harm to ourselves and our dependents without any real limit except for the terms of the law at any given point in time.

Thus, it comes down to the law.

We obey the law because there are always significant consequences for failing to do so. The income tax laws include a mind-boggling assortment of penalties for non-compliance and some of the penalties are out of all proportion to the failure to comply. So we pay the amount of taxes that the law requires in order to avoid painful sanctions.

And to the extent that the law permits or even encourages us to engage in politically favored behavior, we can often reduce our tax burden. We can get an $8,000 tax credit for buying a new home. We can get up to $250,000 of tax free gain from the sale of a home. The interest on state and municipal bonds is exempt from the federal income tax. Retirement savings are tax deferred. There are a huge assortment of tax incentives to produce or to purchase various energy saving products. Some expenditures are deductible. Others are not. The tax law is reputed to include nearly 3.5 million words, which would equal 10,000 pages of a normal sized letter. The IRS regulations are estimated to be about 3 to 4 times as long.

Complete compliance is virtually impossible even for the most co-operative taxpayers.

Those who argue that paying taxes is a moral duty never explain how much taxes are moral. Should we pay 10% of our income or 25% or 50% or more? How do we measure income? Should we ignore the legal tax incentives, deductions and credits in the law? Is is it immoral to deduct interest on a home mortgage or the fees paid for child support by a working parent?

There is no way to answer the question of how much is a "fair tax" or a moral tax. The only way to determine how much taxes we should pay is to look to the tax law. Our tax liability is determined based on our income and individual circumstances. Hardly any two citizens will ever pay exactly the same amount of income tax. If the law permits the use of a deduction, exclusion, credit or deferral, using it must be regarded as "moral" or at least legal. There is simply no way to determine how much we should each pay as part of the social contract without reference to the monstrous U.S. income tax law.

Vern Jacobs

Expanded 1099 Rule Invites Identity Theft

An obscure tax rule in the health care bill is a huge invitation to identity theft.

In case you missed it, the massive health care bill includes a tiny provision that will require all businesses to issue 1099 information forms to every company with whom they do business in excess of $600 per year, starting in 2012.

The form 1099 is presently required when a business pays more than $600 in a year for services provided by an independent contractor. The form is not required for the purchase of goods or for purchases from corporations. The health care bill would require every company to issue a 1099 for the purchase of goods or services from any business including corporations.

Apart from the huge increase in record keeping and reporting for both buyers and sellers, there is an aspect of this that has not been mentioned previously.

The company or person who issues a Form 1099 has to secure the Social Security or Tax identification number of the vendor and their address in order to complete the form.

That means every business will need to write or call every supplier to ask for the supplier's tax ID number. This is going to put a huge time burden on a business unless they choose to disclose their tax ID number in every document that represents an invoice or receipt for a sale of goods or services. And every business that buys goods or service will have to be sure that they have the tax ID number of the vendor in case they need it.

And, the 1099 form also requires the issuer of the form to include their name and tax I.D. number and address. So every business will have the tax ID number of every customer that buys more than $600 of goods or services. And every business will have the tax ID number of every supplier from whom they bought more than $600 in goods or services.

Rep. Dan Lungren (R-CA) has submitted a bill that would repeal this rule. Let's hope he gets a lot of support.

Vern

Past the Tipping Point and the Watershed

"The word "Tipping Point" ... comes from the world of epidemiology. It's the name given to that moment in an epidemic when a virus reaches critical mass. It's the boiling point. It's the moment on the graph when the line starts to shoot straight upwards." (The Tipping Point by Malcolm Gladwell)

The May 25, 2010 issue of USA Today included an article about "Private Wages Fall in Historic Pay Shift". The main point of the article is that the amount of compensation and employee benefits provided to government employees and the benefits provided by Social Security, unemployment insurance, food stamps and other social benefits was substantially greater than the wages and benefits paid to employees of private companies. According to USA Today, "Paychecks from private business shrank to their smallest share of (total) personal income in U.S. history during the first quarter of this year. ... A record low 41.9% of the nation's personal income came from private wages and salaries in the first quarter, down from 44.6% when the recession began in December, 2007".

So we have long passed the watershed event where total government benefits and employment compensation exceeds the income of the private sector. That is, more than half the economic income of the populace is derived from government. According to the Tax Foundation, the top 50% of the taxpayers (as measured by adjusted gross income) paid 97.11% of the Federal income tax. Thus, the lower income half of the U.S. population has no reason to support any effort to restrict, modify or eliminate the income tax. And it appears that a significant part of the top half (by income) also receives a substantial amount of government benefits, employment compensation or payments to government contractors whose employees indirectly depend on government spending.

In the 3rd quarter of the 20th Century, it was a common belief that government employees received less compensation and benefits for the same kind of work done in the private sector -- but that the government employees preferred the job security over the compensation and benefits. In the last quarter of the 20th Century, the common belief was that government employees enjoyed greater job security and employee benefits but lower wages than non government employees.

But it seems times have changed. USA Today reported in their March 4, 2010 issue that government employees received 20% more in compensation and benefits than similar employees in the private sector. So we have reached the point where a job in government offers higher pay, better benefits and far greater job security than a similar job in the private sector. So who chooses to work in the private sector? A relatively few who are able to secure wages and benefits at the top of the scale (some MBA's, doctors, lawyers, CPAs, engineers) and a lot of other people who aren't able to get a job with the government.

And, more than half the population derives more benefits from the income tax than they pay in income taxes.

Meanwhile, in little more than than a year, we have effectively nationalized health care, we are trying to legalize more than 12 million illegal aliens who are mostly non-taxpayers and are likely to get government subsidies and we are also trying to impose a costly "cap and trade" tax on the entire energy sector. That's in addition to spending more than a staggering $8.5 billion on nearly two dozen different bailout and stimulus programs. (Based on an analysis attributed to Bloomberg)

Is this what they mean by the tipping point when the line on the graph shoots straight upward?

Vern

The Greatest Threat to Your Wealth

Asset protection planning appeals to those of us who are constantly subject to lawsuits and predatory litigation. But the greatest danger to accumulated wealth is our government.

They can take an unlimited share of our income with the income tax. They can take a large bite out of the money we spend with an assortment of excise taxes, a national sales tax or value added tax. Although the estate tax is presently repealed for 2010, it isn't going to stay that way and they can set the estate tax at any level to consume any portion of an estate. They impose an exit tax on any unrealized gains and deferred income if we give up our citizenship or resident status. If they want, they could even impose an exit tax on assets and confiscate any percentage of our assets if we wish to leave. Obscenely excessive fines and penalties can be imposed for alleged money laundering or for failing to comply with a mind boggling assortment of very confusing laws. And, if we are merely accused of any one of a variety of crimes, they can confiscate our property under the forfeiture laws.

What can you do to protect your wealth from these threats?

As long as we are still a country of laws, we can look to the various laws to identify legal (allowed) ways to hold assets or to dispose of assets to children or grandchildren. For now, it is still legal to move money offshore, even though offshore assets may need to be disclosed each year. And, for now, each person can take their assets with them if they expatriate and settle up with the IRS on any untaxed gains or deferred income.

But it seems to me that the doors are closing on both domestic and offshore methods of asset protection if the government is the party that wants our assets. Hopefully, it is mostly because the far left lunatic fringe of the Democratic party is in control and they are pushing through every change they can that will move us closer to a Socialist society. Perhaps the Tea Party and the Conservatives can get rid of enough Democrats and Liberals this fall to put a stop to this crazy frenzy of "progressive" legislation. But it seems highly unlikely that anything that has already been turned into a law will be repealed. Our move toward the European style of Socialism is like taking three steps forward and two steps back -- but the momentum is clearly for more government rather than for less.

Meanwhile, there are relatively few legal structures that can survive a challenge by a rogue government -- which is what we will most surely have if the November elections do not result in a sea change in the Congress. So maybe it's time to invest some time and money in helping to "kick the rascals out" this fall. Otherwise, the only way I can think of to preserve your wealth will be to leave the U.S. after becoming a citizen of some other country. And if we don't kick enough rascals out this fall, even that option may be extremely limited.

That's my two cents.

Vern

The REAL Rate of Return

A few days ago, I came across an article about "The Law of Zero Return", which is a concept that was partly attributed to me. (See http://members.cox.net/mathmistakes/zeroreturn.htm)

The concept is that the combined impact of inflation and income taxes consumes all of the return from an investment.

But that's not exactly what I said or intended to say.

For any kind of investment there is a rate of return, which can be positive, negative or even zero. For example, a bond issuer may offer to pay interest at the rate of 5% on the face value of the bond. This is sometimes referred to as the investment rate or gross rate of return.

Most investors are also well aware of the concept of the "real rate of return", which is defined by investment professionals as the investment rate of return minus the inflation rate. Generally, the inflation rate is assumed to be the same as the rate of change in the Consumer Price Index. If the investment rate of return is 6% and the inflation rate is 2%, the real rate of return in 4%.

Most investors are also aware of the after tax rate of return. This is defined as the investment rate of return minus the rate of tax as a percentage of the investment. And it varies from one investor to another depending on their own marginal tax bracket. For a taxpayer who is paying the maximum 35% federal income tax plus a 5% state income tax on his/her investment income, the combined income tax is equal to 40% of the investment rate of return. So if the investment rate of return is 6%, the income tax rate on the investment income is 40% times 6%, or 2.4%. Thus, the after tax rate of return is 3.6%.

But few investment advisers like to talk about the after tax real rate of return. Perhaps that's because it is a very depressing concept for any fixed income investor.

If the rate of inflation is 2%, and the after tax rate of return is 3.6%, then the real rate of return after taxes is 1.6% on an investment that is paying a gross return of 6%.

Now here's the "fun" part.

If the rate of inflation increases, what usually happens to the gross rate of return?

It goes up, because the people who have money to lend don't want to get repaid in cheaper dollars.

So, let's assume that the expected rate of inflation increases from 2% to 4% and the gross rate of return increases from 6% to 8%. How will that affect the after tax real rate of return?

The taxpayer is still in the 40% federal and state marginal tax bracket, so his 8% is cut down to 4.8% after taxes. But now the rate of inflation is 4%, so the after tax real rate of return is 0.8% instead of 1.6%.

And if the rate of inflation rises to 8%, the investment rate of return would increase to about 12%. The tax rate would be 4.8%, leaving an after tax rate of return of 7.2%. But now the inflation rate is 8%, so the after tax real rate of return is - 0.8%.

The result is that as the rate of inflation increases, the investment rate of return generally increases by an equal percentage and the after tax real real rate of return will decrease.

Like many other elements in investments and economics, there isn't a perfect correlation between inflation rates and rates of return on fixed income investments. However, I did a study in 1986 of various fixed income rates and the CPI inflation rate from 1940 to 1986 and the correlation was very high. The difference is due to the fact that investment rates are set by investors who add the expected rate of inflation to the interest rate that they require. Thus, the inflation adjustment is based on projections of the rate of inflation by investors. The actual rate of inflation will turn out to be more or less, depending on how the Federal Reserve attempts to deal with the problem.

But whatever the Fed might choose to do, it's not a good idea to wish for higher interest rates because higher rates are usually an indication of increasing rates of inflation in the economy. During periods of low inflation rates, investment rates of return are generally very low. And when investment rates of return are very high (as in the late seventies), the rate of inflation is also high.

Vern

www.offshorepress.com

Rethinking the Tax Refund Argument

For many decades, tax accountants and financial planners have argued that overpaying your withholding during the year in order to get a big refund doesn't make financial sense.

if you underpay your estimated taxes, you may have to pay interest to the IRS. But if you overpay, you don't get any interest on your refund. Overpaying your withholding is like making an interest free loan to the IRS.

But a great many taxpaayers prefer to get a big refund because it's a pile of money that is often large enough to do something significant. They may use it to pay for a cruise or other kind of vacation. They might use it to buy some appliances or to make renovations in their home. Some of them will put it in the bank or a Section 529 plan to save for their children's future college expenses.

By contrast, it's difficult to do anything significant or satisfying with a few extra dollars each day or each week. A $3,000 refund will amount to $8.21 per day, $57.53 a week or $250 a month. In today's investment market, money market funds are paying about 1% interest. If the excess tax withholding was received each week and put in a savings account. it would generate about $15 of additional funds at the end of the year. However, that interest would be subject to income taxes. For a middle income taxpayer in a state that imposes income taxes, the tax would be close to 30% or $4.50 -- leaving a meager $11.50 of extra after tax money.

I've argued for over 40 years that getting a tax refund is wasteful. But when short term interest rates are below 1%, I can certainly understand why a lot of taxpayers prefer to overpay some taxes in order to get a bigger refund each year.

Making good financial decisions is important, but sometimes there are other important considerations.

Vern

The Income Tax Multiplier

If you haven't heard of the "money multiplier" or "fractional reserve banking" I encourage you to spend a few moments looking at the definition of each at Wikipedia. (See http://en.wikipedia.org/wiki/Money_creation#Money_multiplier and http://en.wikipedia.org/wiki/Fractional-reserve_banking)

Very briefly, it's the process by which banks can expand the money supply because -- as a group -- they are permitted to loan a percentage of the money they have on deposit. The Federal Reserve establishes a reserve ratio, which is about 10%. When a bank gets a deposit of say $1,000, it is allowed to loan as much as $900 to various borrowers. What do the borrowers do with the money? Well, they deposit it in another bank. The second bank is allowed to loan as much as 90% of $900. The third bank in the chain can then loan as much as 90% of $810. And so it goes until the original $1,000 has been expanded by a factor of 10. So the banking system now has $10,000 of deposits from various customers. If the reserve ratio were set at 20%, the multiplier would be 5 to 1 instead of 10 to 1.

But what about the income taxes that are collected by the government on those multiple deposits? Well, it depends on whether the money that is received and deposited is defined as "income" by the tax law.

For example, assume we have an average income tax rate or a flat tax rate of 20%.

Taxpayer # 1 gets $1,0000 of income and he deposits $1,000 in the bank. Then he writes a check for $200 to the IRS. The first bank is now able to make loans of 90% of $800. But wait, The second bank that gets the tax dollars is also able to make loans of 90% of the $200 in taxes. So the banking system still gets to expand the money in circulation by the same amount.

Two taxpayers now borrow the $900 from the two banks that received the money from the first taxpayer and from the IRS. They spend the money on non-deductible personal expenses -- but the people who receive that $900 have to treat it as income. They therefor deposit the $900 in their local banks and then send a combined total of $180 to the IRS.

So the original $1,000 circulates through the economy and expands the money supply by 10 to 1. But the IRS also benefits from the money multiplier because they end up collecting $2,000 -- which is 10 times the original $200 of tax on the initial $1,000 of income.

So the next time you have to pay the IRS $200, you should know that you have actually contributed about $2,000 to the government coffers through the income tax multiplier. ANd if you don't spend the money you borrow on things that generate income tax from the people you pay the money to, then the tax multiplier doesn't work. So if you don't want the IRS to get more money, invest your borrowed money instead of spending it.

Vern