Jacobs' Tax Angles

Why Does the Fed Fear Deflation More than Inflation

2011-01-19T14:53:00.000-08:00

Have you noticed that the Fed Chairman seems to be far more concerned about deflation than inflation? It's reflected in his public comments and in the policies being pursued by the Fed.

In a nutshell, when deflation is caused by corrections of bad investments made during a bubble (like the sub-prime mortgage loans and their related derivatives) it is manifested by bad loans that don't get repaid. Individuals and businesses take bankruptcy or they negotiate more favorable terms. Most of the lenders are banks and they don't get repaid. Never mind that the banks made a lot of those loans with artificial money created by the Fed or the fractional reserve banking system. The banks don't like to write off their loans.

In addition, deflation has the opposite effect of inflation. Whereas inflation is caused by an increase in the money supply, deflation reduces the money supply. The effect is to make it more expensive for banks to secure money with which to make loans.

in case you may have missed it, the Fed is owned by the banks. It's completely separate from the Federal government, despite the implication caused by the name "Federal Reserve Bank".

So it makes sense that the Fed is far more concerned about preventing deflation than about preventing the kind of inflation that is caused by an increase in the money supply and by the fractional reserve banking system.

Just my two cents.

Vern

Dealing with the Debt Ceiling

2011-01-17T14:55:00.000-08:00

The Republicans who were supported by the Tea party are talking about not agreeing to an increase in the national debt ceiling as a way of putting a lid on more federal spending. Treasury Secretary Geithner is telling lawmakers that failing to raise the debt ceiling could "Have catastrophic economic consequences".

Not mentioned in any of the articles I've seen about this matter is the impact not raising the debt ceiling would have on interest rates being paid on short term U.S. debt. Right now U.S. treasury bills are paying less than 1% interest in trillions of debt. If we don't raise the debt ceiling, it's my understanding that the bond rating services would be obliged to downgrade our credit rating as a nation -- which would result in our having to offer higher interest rates to induce people to buy our bonds and short term paper. This is in addition to numerous other dire consequences predicted by Geithner.

Mark Thiessen in the Washington Post tells us that "The Treasury Department has many tools it can use to continue paying U.S. obligations during an impasse -- such as suspending sales of non-marketable debt, trimming or delaying auctions of marketable securities and under-investing in certain government trust funds." He also argues that if the GOP stands firm, Obama will be forced to agree to serious spending concessions in order to get the debt ceiling raised.

So it looks like a game of high stakes "chicken". Who will cave first?

Vern

Have You Memorized the Entire Tax Law?

2011-01-05T08:18:00.000-08:00

Yesterday I received a book in the mail from Commerce Clearing House (CCH), one of the largest tax publishers in the U.S. The book is an analysis of recent 2010 tax laws along with a copy of the actual legislation and the tax writing committee reports. The analysis part is about 500 pages, single spaced, about 11 point type. The part that copies the law is about 9 point type. The complete book is 927 pages. Earlier in 2010, I received a copy of the Health Care Act, which was about 800 pages in size.

Have you read these books? Are you familiar with the changes in the law?

Did you say "Of course not."?

Really! Perhaps you are not aware that you are expected by the IRS and by the courts to able to understand ALL of your obligations under the tax law. It's true. You are. Of course, you can hire a tax professional to help you, but that does not relieve you of the legal duty to be familiar with the full scope of the U.S. tax laws, the related IRS Regulations and rulings, plus any relevant court decisions.

According to www.fourmulab.ch, "... the complete Internal Revenue Code is more than 24 megabytes in length, ... printed 60 lines to the page, it would fill more than 7500 letter-size pages. It contains more than 23,000 cross references to other parts of the tax code or to other parts of the U.S. Code." Based on the printed size of my copy of the tax code, the IRS regulations are about 4 times as large.

It seems to me that we have reached the point where even the brightest tax professionals are unable to understand and advise clients relative to the entire tax law. Like the medical profession, tax professionals have to decide whether to be general practitioners or specialists. Those who choose to be specialists can choose from over two or three dozen major categories of tax law. We have also reached the point where a general practitioner who prepares returns is rarely able to do so without the aid of a computer and tax preparation software.

The tax law has reached the point where it is virtually beyond comprehension. No taxpayer can reasonably be expected to understand the thousands of special rules and exceptions to exceptions. If the taxpayer is unable to understand the law, it is not possible to comply with the law in every respect.

Nonetheless, the Congress continues to add hundreds of new pages to the tax laws every year. At some point more and more taxpayers will decide that the law itself must be scrapped in its entirety and replaced with a totally different kind of tax to provide funds for national defense and other essential services.

Vern
www.offshorepress.com/liberty/

Tax Cuts and Deficits

2010-12-17T08:26:00.000-08:00

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?

2010-12-01T08:13:00.000-08:00

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

2010-11-23T12:15:00.000-08:00

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

2010-11-23T08:12:00.000-08:00

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

2010-11-19T08:41:00.000-08:00

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?

2010-11-16T08:31:00.000-08:00

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?

2010-11-09T09:05:00.000-08:00

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

2010-11-02T08:41:00.000-07:00

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

2010-10-26T14:28:00.000-07:00

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

2010-10-22T10:05:00.000-07:00

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

2010-10-20T08:06:00.000-07:00

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

2010-09-21T07:31:00.000-07:00

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

2010-09-14T08:04:00.000-07:00

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 ?

2010-08-27T09:26:00.000-07:00

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?

2010-08-27T08:36:00.000-07:00

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?

2010-08-24T14:32:00.000-07:00

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?

2010-08-23T14:18:00.000-07:00

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?

2010-07-27T08:05:00.000-07:00

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?

2010-07-23T12:50:00.000-07:00

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

2010-07-17T09:21:00.000-07:00

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?

2010-06-28T09:14:00.000-07:00

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

2010-06-22T09:03:00.000-07:00

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

2010-06-15T08:49:00.000-07:00

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?

2010-06-14T09:01:00.001-07:00

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?

2010-06-10T14:10:00.000-07:00

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

2010-05-28T08:56:00.000-07:00

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

2010-05-25T08:32:00.000-07:00

"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

2010-05-21T09:27:00.000-07:00

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

2010-05-17T13:54:00.000-07:00

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

2010-05-13T07:52:00.000-07:00

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

2010-05-05T14:28:00.000-07:00

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

Hidden Tax on Fixed Income Investors

2010-04-22T08:20:00.000-07:00

If you are an investor, you have been suffering from a lack of safe, moderate yield investments.

U.S. T-Bills have been yielding less than 1/2% since late December 2008. One year bank CDs are yielding from 1/2% to 1.5%. Money market funds are paying from 1% to 1.5%. Meanwhile, the inflation rate for the past five months has averaged close to 2.25%.

These low rates on fixed income investments are due to the Federal Reserve. The Fed has been keeping the discount rate charged to member banks below 1% since late 2008. While there is some concern that they will begin to raise this rate in 2010, there is a lot of pressure for them to keep rates low. If this base rate rises, the interest rate on government debt will rise and will add to the deficit.

The bottom line is that fixed income investors -- mostly retirees -- are subsidizing part of the federal deficit. They are paying in the form of lower yields on their savings in order to keep the deficit and the debt from increasing due to higher rates.

The effect of the Fed policy of keeping rates low is like a hidden tax on fixed income investors.

For more see "The Cruelest Tax of All".

Vern

Flat Tax vs. the Fair Tax

2010-04-14T10:12:00.000-07:00

With the approach of April 15, there are a lot of commentators who are advocating the replacement of the income tax with a flat tax while others are promoting something called a "Fair Tax". What are the differences? Do either forms of taxation have any chance of replacing the income tax?

The flat tax is the easiest to explain. Instead of multiple, progressive tax rates that look like a stairway, there is only one tax rate. Instead of hundreds of diverse deductions, exclusions, exemptions and tax credits for different taxpayers, there is only one deduction for each taxpayer or family based on family size. But that deduction is substantial enough to eliminate the tax for lower income families. Various advocates of the flat tax disagree about what the single rate should be, but most of the proposals range from about 12% to as high as 33%. Most of the flat tax advocates seem to argue in favor of a revenue neutral rate that would produce the same amount of tax revenue as the combined revenue from the personal income tax, the corporate income tax, the social security tax, the estate and gift tax and an assortment of other taxes. But it would not require any major cuts in government spending as a pre-condition for switching to a flat tax.

Critics of the flat tax point to the 28% top income tax rate introduced by the 1986 Tax Reform Act that was pushed through by President Reagan. It was only a couple of years later that the rate was raised and has gradually gone up to 35% for individuals. Many deductions and tax incentives were removed by that law, but others have been introduced to take their place. Currently, the politically popular types of tax incentives are tax credits for various kinds of energy conservation. Critics also point to the fact that the flat tax is still a tax based on income and that it would require the continued intrusion of the IRS to verify that income had been reported truthfully.

For more on the flat tax see the CF&P video at http://www.youtube.com/watch?v=nhUOpNve1bY

and the Heritage Foundation Guide to the Flat Tax.

The fair tax is a national sales tax that would ostensibly replace the income tax. The government would send a check to each citizen that would represent the equivalent of an exemption from the tax at lower income levels, which is referred to as a "prebate" by the designers of the fair tax.

Advocates of the fair tax argue that a tax on consumption would have a stimulative effect on investment and would even draw investment from other parts of the world. The tax would be collected by businesses and could be managed by the state governments that already have a sales tax in place. In those states, the tax rate would include the amount already being charged in each state. States that do not impose a sales tax would either adopt one or the federal government would impose and enforce a sales tax in those states. One of the arguments in favor of the sales tax is that it is far more difficult for people to evade the tax.

Critics point to the fact that while the FAIR tax proposal calls for a repeal of the 16th Amendment to eliminate the income tax, that would require approval by 3/4of the state legislatures and would take a long time. Meanwhile, there is nothing to require that the proposal to amend the Constitution be submitted to the states. And there is nothing to prevent the politicians from simply adopting a national sales tax (or value added tax) in addition to the income tax. This is precisely what has happened in many European countries. Also, the politicians would be free to tinker with the amount of the prebate, and the various goods and services that would be granted an exemption from the tax. In addition, a high sales tax rate in border states with Mexico or Canada would lead to extensive smuggling of higher priced goods.

For more on the FAIR tax see the FAIRtax.org web site. and Wikipedia.

Is there a better choice?

While I favor the Fair Tax over the Flat tax, my main concern is that I see no mechanism to tie the introduction of the fair tax to the elimination of the 16th Amendment. I would favor a plan that would propose a repeal of the 16th Amendment with the stipulation that IF the income tax is repealed, then the federal government would replace it with a national sales tax. I would even favor making the repeal of the income tax (and other taxes like the Social Security tax, corporate income taxes, estate taxes, etc.) and the adoption of a sales tax part of the same Amendment. And while I have a problem with the idea of revenue neutrality, I do believe that once people are having to pay a sales tax of 15% to 30% of everything they buy, it will put a lot of heat on the politicians to reduce the rate and to not introduce a lot of exemptions. In addition, competition with other countries would help to keep the rate at a reasonable level.

Of course, there is also the "little" problem of getting a very left wing president and congress to go along either idea.

But that's just my two cents. And a lot of my professional colleagues think I'm a crackpot.

Vern

Estimated Tax Tips

2010-04-09T09:28:00.000-07:00

Taxpayers who have income that is not subject to withholding not only have to deal with paying income taxes (and possibly self employment taxes) on their 2009 income; we also have to pay in advance for taxes on our 2010 income.

This can be a huge shock to people who first enter the murky tax world of the self-employed -- which has happened to a lot of employees who were laid off in 2009. But it also affects people who have income from foreign investments, controlled foreign corporations or foreign trusts. First there is the discovery that they won't be getting a refund anymore. Instead, they have to pay all their 2009 income and self-employment tax by April 15th of 2010. (The alternative is some substantial penalties and interest.)

But, to add insult to injury, they also have to decide whether to make advance payments of their 2010 taxes and they have to find a way to estimate what their tax will be for 2010. The tax law provides a safe harbor from penalties and interest on an underpayment of estimated taxes that is based on the previous year's total tax bill. Basically, if a taxpayer bases his 2010 tax estimate on his 2009 total taxes, s/he can avoid the penalties for an underpayment of estimated taxes. (For high income taxpayers, the estimate has to be 110% of the previous year in order to avoid penalties.)

Many newly self-employed taxpayers have not yet computed their 2009 taxes. But they are required to prepare an estimate in order to request an extension with Form 4868. That extension is only valid if the estimate is considered "reasonable" by the IRS, but they tend to allow quite a bit of latitude in that regard. So the first step is to estimate federal and state income taxes and self-employment taxes for 2009 and to pay whatever amount is due no later than 4/15/2010. (Penalties of up to 25% of the tax plus interest can be imposed for a late payment of the tax, in addition to any possible penalties for an underpayment of quarterly taxes for 2009.)

The next step is to use that same estimate for 2010. That creates a situation where it is as if the taxpayer is having to pay twice as much tax, although the 2010 tax can be paid in four installments. (4/15, 6/15, 9/15 and 1/15/11)

What if the income for 2009 was a windfall and is not likely to occur again?

The law does not require taxpayers to base their current year tax estimate on the previous year's tax. That is only a safe harbor from interest and penalties. Another way to make estimates is to keep track of any income (less expenses) each quarter and to estimate the total itemized deductions and other items that affect the tax bill. Those assorted deductions can be allocated to each quarter. Then the tax can be computed on a year-to-date method, based on what has actually been received. This may not eliminate the possibility of some penalties (in the form of interest) but it will avoid having to make an estimate based on a one-time windfall from the previous year.

By the way. The IRS doesn't tell you this very clearly, but the penalty for an underpayment of quarterly estimated taxes is in the nature of interest that is computed from the due date of each quarterly tax payment until April 15 of the following year. When money is really tight, it may be cheaper to underpay the quarterly taxes instead of borrowing on a credit card or from some other high interest lender. But if the taxes are not paid in full by next April 15th, the penalties and interest can be very painful.

These comments are a very non-technical summary and generalization of the specific rules. For more precise information about estimated taxes see IRS Publication 505. (http://www.irs.gov/pub/irs-pdf/p505.pdf)

Vern

Three Reasons Why Banks Aren't Lending

2010-04-02T08:24:00.000-07:00

The government wants the banks to loan money to help businesses expand. But the banks aren't cooperating. Why? One reason is because there is more profit and less risk in using nearly interest free money from the Fed to invest in government notes and bonds.

According to Richard Suttmeier,

Banks are making a basic mistake of borrowing short and lending long, as this strategy seems to be the only risk of profitability they are willing to make. This House of Cards was a factor in the late 1980s/early 1990s, as the curve shifted to inversion, causing mismatched losses on top of bad loans.

The Federal Reserve has been keeping the federal funds rate near zero for an extended time.

The banks can therefore borrow from the Fed at a near zero interest rate and use that money to invest in longer term U.S. treasury obligations that pay interest. Borrowing short means borrowing money that is due to be repaid in a short time -- such as overnight or in a month. Investing long means putting money into fixed interest debt obligations that have a long-term maturity -- like three years or more. Except for the risk alluded to by Suttmeier, the banks see this as a nearly interest free and risk free way to use funds from the Fed to invest in government obligations for which the Fed is the guarantor of last resort.

But there is a second reason why the banks aren't lending.

Some people call it the bureaucracy.

Unlike entrepreneurs, employees have little to no incentive to assume any risk that might result in criticism from a supervisor, or even the remotest possibility of being fired. So when there are written rules to follow, they tend to follow the rules, regardless of whether those rules make sense or whether those rules are out-of-date or are inconsistent with some high level policy decision. And when employees are criticized or threatened with the loss of their job for some previous infraction of the rules, they are motivated to avoid a repeat of those occasions.

Employees of the banks perceive that failing to comply with the rules imposed by the regulators is a threat to their job security even when it is obvious to all that the rules are contrary to a new policy or even to a new law.

A third reason why banks aren't lending could be called the pendulum syndrome. When we do something that causes pain, we tend to over-react by shifting to an opposite extreme. Before the real estate bubble broke, many banks were lending money to nearly every every warm body that asked for a loan, Now they are over-reacting in the opposite direction. Lending standards have increased to such a degree that few borrowers can meet the requirements.

Meanwhile, there is a steady flow of news stories about high levels of bankruptcies, loan foreclosures and other indicators that the economy has a long way to go before there is a recovery to a relatively normal level of activity.

Just my two cents.

Vern Jacobs

Dominoes

2010-03-25T09:13:00.000-07:00

Artificially low interest rates make Federal debt obligations unattractive to investors.

Higher interest rates increase the annual deficits and the total debt outstanding.

Uncontrolled entitlements like Social Security, Medicare, Medicaid and Federal retirement programs add to the deficit and debt.

Increased funding of Federal debt by the Federal Reserve (Fed) is more likely than higher taxes or annual surpluses.

Deficits that are not funded by investors (domestic or foreign) are funded by the Federal Reserve.

The purchase of Federal debt by the Fed increases the money supply.

Increases in the money supply filter into higher prices for assets and investments or consumer goods and services.

Increases in prices result in larger deficits and financial hardship for consumers.

The government usually tries to curtail inflation with price controls. (Like capping health insurance premiums.)

Price controls motivate residents to invest in hard assets or to move money outside the country.

An outflow of U.S. dollars into passive assets or overseas leads to currency controls.

Higher prices also lead to a decrease in the value of the U.S. dollar vis-a-vis other currencies.

An eventual inability to meet current debt obligations without increased expansion of the money supply leads to a devaluation of the dollar vis-a-vis other currencies.

An inability to stop the inflation spiral leads to hyper-inflation and further devaluation and price controls.

Meanwhile, investors and entrepreneurs begin to move abroad and many give up their citizenship to avoid being subject to laws that are created out of desperation.

It has happened in many other countries.

It can happen here unless those currently in control of the Federal Government and the Federal Reserve are replaced by leaders who understand that unrestrained spending does not create prosperity and abundance.

Vern

Medicare Tax on Investment Income

2010-03-22T08:38:00.000-07:00

In case you missed it, the new health care bill has fundamentally changed the nature of the Medicare tax and might lead to similar changes in the Social Security tax.

Presently, employers and employees pay a Medicare tax of 1.45% each on wages of up to $106,800. Self employed taxpayers pay both the employee and employer portion which represents a 2.9% tax on earnings up to $106,800. This amount is indexed for inflation and tends to increase each year.

The new health care bill will impose a Medicare tax on investment income above a certain level, as well as on earned income. Single individuals who earn more than $200,000 and couples over $250,000 would be subject to the higher rate. In addition, the employee tax rate for the Medicare tax would increase from 1.45% to 2.35%. The employer rate would remain at 1.45% of any covered wages. An employee would pay 2.35% of covered wages and would separately pay 2.35% of unearned income.

If the $200k/$250k thresh-hold is reached, the tax would apply to unearned income in excess of the thresh-hold amount.

The Medicare tax would apply to unearned income from interest, dividends, annuities, royalties, rents and capital gains. Apparently, income from retirement plans and Roth IRAs would not be treated as investment income. Most likely, investment income would include the portion of an annuity payment that is not a return of the initial investment in the contract.

The change in the Medicare tax would not take effect until Jan. 1, 2013.

We can only wonder if or when the Social Security tax will also be imposed on investment income and if it will only be imposed on taxpayers with an income of more than $200k/$250k. We also wonder how long it will take for the thresh-hold limit to be reduced to something like $100,000 a year or even $50,000 per year. It's extremely hard to believe the claims that the health care bill will somehow reduce the cost of health care even while it is costing at least $900 billion over the next ten years. If this bill results in more deficits than projected, there will be pressure to find more sources of tax revenue.

If inflation returns and pushes average incomes up, more and more people will be subjected to the assorted new taxes on those who make more than $200,000 (single) or $250,000 (joint) each year.

For more see http://money.cnn.com/2010/03/10/news/economy/medicare_tax.fortune/

and http://www.msnbc.msn.com/id/35844649/ns/health-health_care/

Vern

Fallacy of the Progressive Ideal

2010-03-19T12:08:00.000-07:00

Those who adhere to a Progressive/Liberal/Socialist philosophy appear to believe that government is both benevolent and omnipotent. (Even the leaders of the movement who don't really believe it, promote that message to the masses.)

But this belief in the benevolent power of government to regulate every human activity for the benefit of all is predicated on a serious logical fallacy.

The Liberal or Progressive presumes that whatever the government commands will and can be done. The problem is that there are two sides to the equation. For every right or benefit, there is an obligation or burden on someone. For every form of property that is confiscated to be re-distributed, there is someone who has lost that property by force or the threat of force. Thus, the premise of a benevolent government is destroyed.

The majority of people living in a totalitarian system will comply with the demands of the government but only to the minimum extent required to avoid punitive treatment. A few members of the society will strive and aspire to become one of the leaders who always manage to enjoy a much better life style than everyone else. But the nature of their effort is to be a loyal member of the system rather than to be a productive member of society. Those who are the most productive are expected to be even more productive but are rarely rewarded for their effort. So in time, those are able to be productive give up and produce the minimum that is required to survive.

What if there was only one person on a remote island who knew how to obtain food? If the other residents on that island confiscate what has been obtained, the one who knew how would have little incentive to secure more food than he could eat while out hunting. And he might have a lot of incentive to move to some part of the island away from the others.

Little by little, the level of productivity throughout the entire economy begins to diminish and everyone must cope with fewer of the essentials and comforts of life.

To forestall this decline in productivity, the government begins to impose more and more harsh regulations and punishments for non-compliance. In time, workers are hard to distinguish from slaves who toil for a bare minimum of what is needed for them to continue working.

Those who believe that government can solve problems that have not been solved by free citizens will soon learn that government can only issue laws and regulations that can be enforced at the point of a gun. Force is not an incentive to do well. It is an incentive to become obscure.

Vern

How Much Do You Hate Paying Taxes?

2010-03-17T07:55:00.000-07:00

Many decades ago when I was the accounting manager for an insurance company, another manager was constantly complaining about the company and its administrative policies. After a couple of years of being a sympathetic ear, I asked, "If you really dislike working here, why aren't you looking for a job somewhere else?" A few months later, he had moved on to apparently greener pastures.

For those who are seriously unhappy about the taxes they must pay to any high tax state, they are free to move to a number of states that have much lower taxes. Florida, Texas and Alaska are fairly high on that list. Moving from one state to another is rarely perceived as being unpatriotic or otherwise immoral.

When people move to the U.S. from countries that have even higher taxes than we do, no one here calls them disparaging names because they left their country of birth. We actually applaud them for coming to our land of liberty. (That's assuming they came through legal channels, of course.)

But somehow the idea of leaving the USA because of high taxes is perceived by many of us as a dastardly act of betrayal that is close to treason. But why?

I suspect that part of the reason is that we have been conditioned to think of our country a lot like the way we think of our religion. Or, as a minister once told me, "If you don't believe as I do, then you haven't prayed enough." Clearly, he was convinced his religion was the only right religion. And many Americans feel the same way about our country.

This feeling is reinforced by our empathy for the men and women in the military who are risking and often losing their life or limbs in defense of our country.

But the children of the Third Reich were conditioned to feel the same way about their country. The youngsters of Communist Russia believed their country was best. The Japanese during the Second World War believed their country was superior to all others. And so it goes from country to country, religion to religion and even from school to school.

Different people have different priorities and values. Some value personal freedom. Some value economic freedom and freedom from what is perceived to be excessive taxes. If we are to encourage immigrants who wish to live here, we should also encourage emigrants to find what they value the most, wherever they can.

Charles Adams, author of "For Good and Evil: The Impact of Taxes on the Course of Civilization" contends that "The list of notables who have fled their homeland to avoid heavy taxation would read like an international Who's Who. Flight is the number one device used by wealthy people to avoid heavy taxation."

If we value freedom, then we must accept the right of anyone to be free to search elsewhere for lower taxes, fewer regulations or more opportunity.

For those who are truly unhappy with the current burden of U.S. taxes, expatriation may be the best way for them to find happiness. From a tax perspective, expatriating eliminates most of the need for "tax engineering", also known as tax planning. It can also eliminate nearly all of the time consuming and frustrating tax forms and other disclosures that are required by the U.S. government. Of course, there are other countries in the world that impose higher taxes and that are more intrusive than the U.S., but there are also many countries that are like some of our states. They do not impose an income tax and they do not intrude into the financial affairs of their residents.

Vern

Time for Truth About the Social Security Trust Fund

2010-03-15T07:52:00.000-07:00

For about 30 years, the Social Security taxes collected from employees, employers and the self-employed have exceeded the benefits that were paid to retirees and the disabled. What did the government do with the excess taxes it collected?

The excess taxes were invested. But where? Surely they had to be invested in the safest possible investment. And what would that investment be? Oh Yes; Of Course. What could be safer than U.S. Treasury Bonds?

But now, USA Today tells us that in 2010 " the (Social Security) retirement program is projected to pay out more in benefits than it collects in taxes — nearly $29 billion more." But why worry about that? After all, there are trillions of dollars sitting safely in the Social Security Trust Fund. (http://news.yahoo.com/s/ap/us_social_security_ious)

But how does the S.S. Administration get that money out of the trust fund? Well, U.S. Treasury bills and bonds are debts of the U.S. Government. In the vernacular, they are I.O.U.s. In order to pay off any of those I.O.U.s, the Treasury Department has three choices.

1. It can borrow the money from someone else -- like the Japanese or Chinese.

2. It can raise taxes.

3. It can borrow the money from the Federal Reserve.

The Chinese have already begun to diversify where they invest their foreign exchange reserves -- away from the dollar. Other countries like Japan are as broke as the U.S. And some of the recent policies of the U.S. Treasury and the IRS are likely to drive a LOT of foreign investment away. So borrowing from foreign investors isn't as easy as it used to be.

President Obama has already told us he wants to raise taxes on the folks who make more than $250,000 a year and he wants to eliminate some alleged loopholes in the tax rules for U.S. based multi-national corporations. But he has promised not to raise taxes on the "middle class" -- which presumably means everyone making less than 250k per year. As I've indicated in other articles, the folks and companies that are targets of these tax policies won't be cooperative lame ducks. They will be doing everything the law allows to avoid or to postpone having to pay more taxes.

So that leaves the third choice. The Fed is always the lender of last resort for the U.S. government. But when the Fed buys debt obligations from the Treasury, it pays for the debt with newly created money. It isn't really necessary to physically print the money. The Fed just makes a bookkeeping entry and more money is magically created.

But -- for those like myself who agree with the Austrian school of economics, when the Fed creates new money it filters through the economy and increases prices. Sometimes the new money increases the price of consumer goods. Sometimes it gets invested in stocks or real estate or things like gold and silver bullion. And in today's economic environment, a lot of the new money is likely to be used to pay off some consumer debts or business debts. But over time, it will add to the total amount of money in the economy which will result in inflation. (See http://en.wikipedia.org/wiki/Austrian_School)

Those are the choices available to the Treasury Dept. to deal with existing obligations.

The Congress and the President have a fourth choice. They can renege on some of the promises of previous politicians who transformed Social Security from a reasonably sensible program for those who lived far beyond their productive years into a program that provides benefits for the low income beneficiaries far in excess of what a real insurance program would provide in exchange for the same contributions or premiums. Those who earned the maximum income during the past 40 years and therefore paid the maximum amount of taxes won't get as generous a return. They could have done better if they were allowed to invest the taxes they paid in a conservative mix of investments. But Social Security benefits are highly regressive -- meaning they provide proportionately more benefits to the lower income participants.

So, we can reasonably expect the Government to borrow as much as they can, to raise taxes as much as they can and to reduce benefits as much as they can (without extreme push-back from the retired and near retired). Once those sources have been tapped out, they will borrow the money from the Fed and we will pay for the benefits with funny money that will reduce the real value of our investments and will increase prices on the goods and services we need.

Vern

For more see http://money.cnn.com/2009/07/29/news/economy/fixing_social_security.fortune/

The Inflation Tax

2010-03-11T09:39:00.000-08:00

When I started my first newsletter on legal methods of tax avoidance, my focus was on income taxes. But a few years later, the U.S. economy was experiencing double digit inflation. Somewhere during that period I discovered what I chose to call the "inflation tax".

While I agree with those who argue that inflation is a tax, I don't agree that it is a hidden tax. When inflation rates get into the double digits, everyone is acutely aware of how inflation is hurting their purchasing power.

But there is an aspect of inflation that is hidden and few people are aware of it.

First, let me make it clear that I agree with the economists who argue that inflation is a function of an expansion of the money supply when the Federal Reserve buys government debt by issuing new money. There are other elements in the equation -- such as the so-called multiplier effect and the velocity of money -- but the driving force is new money created by the Fed.

The new money drives up the price of both assets and the price of nearly all products and services.

The assets and products and services aren't worth more. it just requires more dollars to buy something.

With respect to assets like stocks, real estate, natural resources, foreign currencies, collectibles, precious metals and most tangible assets, the increase in the dollar price of those assets is deemed to be a gain by the tax law. If the asset is sold, the increase in the price from when it was acquired and when it was sold is taxable. Under current law the tax might be 15% of the gain, plus state income taxes of up to 10%. Some types of assets like collectibles are taxed at a 28% federal rate and a state tax rate of up to 10%.

Suppose you bought some stocks in a company that produces oil. The stock cost $100 per share. With 6% inflation, it would double in about 12 years assuming that there is no change in the profitability of the company. Although the price has doubled, the original $100 will only buy half as many goods or services. This is like a 50% tax on the stock shares. Then, when the stock is sold, the tax law treats the increase in the dollar price as a gain and subjects that $100 to an income tax of up to 15% federal and up to 10% for some states.

So that's a tax on a tax. And it's what I call the "inflation tax".

Vern

The "Secret" U.S. National Sales Tax

2010-03-09T08:48:00.000-08:00

A lot of people who don't like the income tax believe the U.S. should adopt a national sales tax or value added tax. But those on the left of the political spectrum denounce a sales tax as being regressive -- meaning that it hurts the poor more than the well-to-do.

What seems to be lost in this argument is that we already have a tax that works just like a national sales tax.

For 2008, income taxes, employment taxes and excise taxes paid by corporations equaled about 30% of total tax revenues. And this did not count the same kind of taxes paid by the owners of pass-through businesses like S corporations, partnerships and limited liability companies. These pass-through entities tend to be smaller but there are a lot more of them. Conservatively, I estimate that at least 40% of the government's total revenue comes from taxes imposed on businesses.

But here's the catch. A business doesn't really pay any taxes. They merely collect the taxes.

When all businesses are faced with the same cost, that cost will be included in the price of their products and the consumers will bear the real burden of the tax. One could argue that the taxes on employers for social security, Medicare and unemployment benefits have the effect of reducing the wages that could be paid to the employees. But the result is the same as imposing the tax on the consumers.

The far left will argue that it is the evil owners (capitalists) of businesses who bear the burden of the taxes imposed on businesses. That argument falls apart when you consider that owners will shut down a business (or sell their stock) if they are unable to earn a competitive return on their investment. Without an adequate return in relation to risk, investors will put their savings under the mattress or in a low yield but safer savings deposit.

However, when the government imposes more taxes on businesses than other countries do, a lot of the U.S. business owners will move to more hospitable countries. Or they may begin to hire more self-employed independent contractors instead of hiring more employees. Or they may even outsource work to cheaper labor in other countries.

Vern

www.vernonjacobs.com

Life without Big Brother

2010-03-05T09:32:00.001-08:00

A growing number of Americans are becoming vocal about reducing the size of government, cutting federal spending and cutting taxes. As April 15 approaches, the number of taxpayers who want to change the system will increase dramatically.

But have you contemplated what life would be like without "big brother"?

First of all, if the federal government were to comply with the limitations embodied in the Constitution, it would be limited to providing for the national defense, maintaining a judicial system, setting rules for immigration and eliminating restrictions on interstate commerce by the states. Everything else would be within the authority of the states.

There would be no federal income tax and the IRS would be limited to collecting excise taxes. The Federal Reserve would not have the ability to inflate the currency if the federal government was not issuing more debt. The federal government would not be involved in education, space exploration, Social Security, Medicare, Medicaid, farm subsidies, corporate subsidies, highway construction, environmental protection and many, many other activities. Our interference in the affairs of other countries would be minimal. There would be no federal food and drug administration and the legality of using drugs would vary from state to state.

Some states would have an income tax and would provide a high level of government services in addition to a social safety net. Other states would rely on a sales tax or property taxes and would not provide many benefits.

A lot of the social safety net that is provided by the federal government would either be provided by some of the states or by private charity. The cost of government would be dramatically lower -- by a lot more than 50%. With less regulation, businesses would not have to spend a lot of time and money on regulatory compliance and paperwork. The federal government would not be able to confer special privileges on unions. There would be fewer lawsuits because there would be fewer laws and regulations that govern behavior unless the behavior is harmful to others.

The U.S. would become even more of a magnet for entrepreneurs and capital from around the world. Consumer prices would decrease due to productivity gains without the offsetting cost of inflation. The IRS would not be terrorizing the citizens.

But many people who are now dependent on the federal government for most of their income would become dependent on the states, on relatives or on private charity. Businesses that derive most of their revenue from selling goods and services to the federal government would need to adjust to a marketplace without the government.

For some this would be good news. But for others it would be financially painful.

Vern

Are You a Conservative or a Liberal?

2010-03-01T11:59:00.000-08:00

I received the following comparison of a conservative and a liberal via mail from an unknown source. However, the lack of a specific source doesn't detract from the message. (Vern)

Listed below are very obvious issues that have sprung up in the past two decades. It is an attack on life in America .

If you ever wondered what side of the fence you sit on, this is a great test!

If a conservative doesn't like guns, he doesn`t buy one. If a liberal doesn't like guns, he wants all guns outlawed.

If a conservative is a vegetarian , he doesn't eat meat. If a liberal is a vegetarian, he wants all meat products banned for everyone.

If a conservative is homosexual, he quietly leads his life. If a liberal is homosexual, he demands legislated respect.

If a conservative is down-and-out, he thinks about how to better his situation. A liberal wonders who is going to take care of him.

If a conservative doesn't like a talk show host , he switches channels. Liberals demand that those they don't like be shut down.

If a conservative is a non-believer, he doesn't go to church. A liberal non-believer wants any mention of God and religion silenced. (Unless it's a foreign religion, of course!)

If a conservative decides he needs health care, he goes about shopping for it, or may choose a job that provides it. A liberal demands that the rest of us pay for his.

If a conservative reads this, he'll forward it so his friends can have a good laugh. A liberal will delete it because he's "offended".

Health Insurance Hypocrisy

2010-02-26T07:40:00.000-08:00

Either Obama doesn't know much about the economics of health insurance or he is intentionally being deceptive.

In his summary of the seven hours of discussion at the health care "Summit" on Feb. 25th, he stated that the people want a system that (1) covers pre-existing conditions, (2) and doesn't increase premiums. The second point was implied by his endorsement of a "cap" (price control) on "excessive" premiums. He also continued to argue that an insurance "exchange" would provide more competition in the market place. And he wants this "exchange" to provide a means whereby individuals can get coverage at group rates.

I hope it's obvious to everyone that when pre-existing conditions are covered by an insurance policy, the premiums have to increase. Even group policies are more expensive when pre-existing conditions are covered, but there are offsetting cost elements that makes group insurance cheaper than individual policies even when pre-existing conditions are covered. If pre-existing conditions are covered in individual health insurance policies, buyers are motivated to wait to buy insurance until they have an injury or illness that is very expensive. Without coverage for pre-existing conditions in individual policies, more people are motivated to buy insurance before they have a serious illness or injury. With group health insurance, a lot of the administrative work is done by the employer, which saves the insurance company enough money to offset the cost of covering pre-eisting conditions and to even reduce the premiums compared to individual policies. The bottom line is that any law that requires health insurance companies to provide coverage for pre-existing conditions will increase the cost of insurance for everyone.

As for putting some sort of a "cap" on health insurance premiums to prevent price gouging, that's a blatant form of price controls. If insurance companies can't cover their costs, they will either find ways to reduce benefit payments or they will exit the market.

As for the idea of an "insurance exchange" that will help individuals to get insurance at group rates, that will only happen if some intermediary between the customer and the insurance company provides the administrative functions that are typically provided by an employer with a group policy. It is a contradiction (or oxymoron) to argue that group rates can be provided to customers who buy one policy at a time. If pre-existing conditions have to be covered, there would be some savings in the cost of issuing a new policy (such as no health examination.) But that's not likely to be enough to fully offset the added cost for pre-existing conditions and for having to issue individual policies.

Finally, a government managed insurance "exchange" is certain to be regulated -- which will increase costs for everyone.

Just my two cents based on having worked as the CFO for an insurance company.

Vern

A Simple Solution to the Health Care Problem

2010-02-12T12:14:00.000-08:00

First, let me define the "problem".

Health care is too expensive and the cost keeps going up.

Obama and his progressive friends want to solve the problem by providing some kind of "insurance" for about 15 million currently uninsured people and by cutting back on what the government will pay to medical providers. It's beyond my comprehension how anyone can seriously regard that as a solution. This so-called solution will increase demand on the medical care industry while creating pressure to reduce the supply of service providers. Let's see now. More demand. Less supply. Isn't that the definition of what causes higher prices?

Meanwhile, the ultimate consumer of medical services is kept out of the loop.

Need another test? Sure. Why not? I'm not paying for it. Need an operation -- just in case? Same answer. I'm not paying for it. Is another doctor less expensive than the one I'm using? Maybe so, but I don't like to expose myself to another doctor. I'll stick with the more expensive one that I know because I'm not paying for it.

Who is paying for it?

Well for most of us, it's the insurance company selected by our employer.

Wait a minute. I choose my own auto insurance company, my life insurance company and my home owner's insurance company. Why is someone else choosing a medical insurance company for me? Oh, yeah! That's right. It's because my employer is paying for the insurance.

But why? Why don't I pay for my own medical insurance the same as my auto, home and life insurance?

Well, it's because when my employer pays for it, it's tax free. The company deducts the premiums the same as they deduct what they pay me and what they pay for other expenses. But I don't have to pay taxes on the cost of my insurance. And the benefits I get when I use the insurance is also tax free.

What about people who don't have employer paid health insurance? If they buy their own insurance or just pay for their medical expenses as and when they need to do so, they may be able to deduct those medical costs as an itemized deduction. Or they can set up a deductible health savings account and use tax free income from the earnings to pay their medical expenses and insurance.

Either way, most medical care in the U.S. is income tax free and isn't subject to the Social Security tax either.

Why? Part of the reason is because it is popular and because it didn't seem right that taxpayers had to pay income taxes on money used for medical care when the expenses were often such a large and uncommon burden. Also, it goes back to the second world war when there was a freeze on wages. So some employers came up with the idea of giving their employees some benefits because they couldn't give them a raise.

But in time, the system grew more and more popular. Unions jumped on the bandwagon and negotiated more and more generous medical benefits for their members. Eventually, only a very few employers didn't offer company paid medical insurance with generous benefits.

So now, we have a system where the consumer is divorced from direct involvement in the cost of his medical care and where comprehensive medical benefits are the norm. Thus, health insurance pays for small and recurring charges like an annual exam or prescription drugs that we need every month. And few people have any incentive to care about the actual cost of the medical care that is paid by the insurance company. Is it really a surprise that the costs keep going up?

So here is the simple solution to the health care cost crisis.

Eliminate the tax incentive for medical care entirely. No more employer paid free health insurance or medical reimbursement plans or tax free health savings accounts. And no more itemized deductions for medical expenses. Health care insurance won't be deductible, but the benefits received from the insurance company won't be taxed as income. That's the same approach that applies to auto, home and many other kinds of insurance.

But there should be a quid-pro-quo from the government to make up for the loss of tax benefits for health care. The government should be required to provide everyone a tax refund or tax credit to offset the extra taxes they would collect. That would help to buy some genuine insurance for major medical costs. And it would give the insurance industry an incentive to dust off some rarely used major medical policies they haven't been able to sell.

Also, the government should eliminate the state monopoly on not being able to buy health insurance from out-of-state insurance companies. I understand that insurance is regulated by the states instead of by the federal government, and I'm in favor of that. But I suspect the commerce clause in the Constitution could be used to end the state monopoly on health insurance.

Of course, I'm indulging in a fantasy of common sense rather than the reality of a socialist government. Don't lose any sleep over the prospect of losing the tax give-away for health care insurance and benefits because it "ain't goin' to happen" any time soon. And don't seriously believe that any other solution will really reduce the cost of health care.

Just my two cents.

Vern Jacobs

IRS Propaganda and Disinformation

2010-01-26T10:14:00.001-08:00

The IRS fishing expedition for offshore accounts with the Swiss bank UBS is an example of a long standing IRS method of discouraging taxpayers from doing something without getting any kind of court decision or getting new legislation to support their efforts. I first noticed this disinformation procedure back in the late seventies when I was Editor of the popular Tax Angles newsletter. It hasn’t changed much in the last 30 years.

First, they identify some area of assumed non-compliance with their interpretation of the tax rules. Then they issue a press release announcing that they are going to study the problem. This will cause at least half the taxpayers who are considering this type of transaction to back off.

The next step is a press release announcing that they are going to investigate and audit taxpayers who are may be “guilty” of whatever the IRS is trying to discourage. This will often scare off about half the remaining taxpayers who have been considering use of the disputed tax avoidance device.

Then they look for a few egregious cases where taxpayers have blatantly ignored the law. This step can be described as shooting at crippled ducks. They then announce the results of successful tax collections, penalties and occasional criminal charges from these early cases. By this time less than 10% of those taxpayers who were considering use of the disputed tax device are willing to take their chances. As the IRS continues to prosecute those with the temerity to base their decisions on the law, they frequently encounter resistance from some judges who do read the law. But the cases they lose are never described in a press release. (Note: The percentages used here are not based on any measured research and are only a reflection of my observations over many years.)

Vern

Defining a Fair Share of Income Taxes

2010-01-22T08:38:00.000-08:00

With few exceptions, my clients tell me they don't want to pay more than their "fair share" of income taxes. The implication is that they are willing to pay a "fair share".

But what is a fair share? And are we talking about a share of government spending or a share of the personal income tax? And how do we define a "share"? Is it an equal part of the total tax or the total spending? Or is it an equal percentage of the total? Those on the left of the political spectrum argue that income tax rates should be progressive -- meaning that tax rates should increase as income increases. Those on the right of the spectrum are more likely to argue on behalf of a flat rate tax or even for a national consumption tax.

The proposed federal budget for 2010 is $3.6 Trillion. There are about 310 million people in the U.S. So the budget works out to an average of about $12,000 per person. We have about 100 million households in the U.S., so the budget works out to about $36,000 per household. Is that how we should define a "fair share"? Obviously, a lot of households don't make that much or only make a little bit more than $36,000. But almost half of the households in the U.S. made less than $50,000 in 2009. The poverty level for a family of three is about $18,000 and about 15% of the households make less than that amount. We can't tax 100% of anyone's income and if a family with $50,000 of gross income had to pay $36,000 in taxes, the amount that is left would put them below the poverty level. But if you exempt those lower income people from paying any tax, then the total has to be divided among a much smaller number of households. (Actually, almost all of the personal income tax is paid by the taxpayers whose income is above the median.)

However, the government gets a lot of its money from sources other than the personal income tax. There is a corporate income tax and the Social Security tax and the Medicare tax and a few hundred diverse excise taxes. And the government does not base its spending on the amount of taxes it expects to collect. If the spending exceeds the tax revenue, the government borrows the difference -- which they call a deficit. (Instances when tax collections exceed spending are very rare.)

The taxes we pay are not based on what the government spends. It is based on the existing system of collecting taxes. Then the amount that can be spent is based on a combination of the estimated amount of tax revenue plus the amount that can be raised by issuing additional federal debt.

Therefore, government spending is a function of the taxes it can collect.

From time to time, the government will attempt to raise more taxes if they can find some sort of crisis (like a war) or urgent need (like health care or the climate) that will motivate the voters to agree to higher taxes. But when that amount gets to be excessive in the perspective of the taxpayers, they look for ways to reduce their tax burden. Some of them engage in political action like the current tea party movement. Others engage in tax evasion. Those who can afford professional help look for legal ways to restructure their assets to defer or avoid taxes. And a few choose to vote with their feet and expatriate.

Because the income tax is a body of law, I have concluded that a "fair share" is no more than what is required to avoid excessive fines or other sanctions like incarceration. What is excessive varies from person to person. Some taxpayer will tolerate a much heavier burden than others. So it comes down to what the law permits. As mentioned in an earlier memo, when tax rates are high, there are inevitably more "loopholes" or tax incentives available for those who wish to use them. The cash for clunkers and the first time homebuyer credit are only two recent examples. Not all available tax "loopholes" are worth the cost or the risk or even the time that is required to utilize them.

So it comes down to a process of identifying the varied tax breaks that are available and then exercising judgement and analysis to determine which of those tax breaks are suitable for a particular person or family.

A fair share is then based on finding the minimum amount of personal income taxes that are tolerable for a particular taxpayer.

And because there is no other logical way to determine what constitutes a fair share, there is no moral duty to pay any more than the law requires.

Vern Jacobs

www.vernonjacobs.com

How Much is Trillion?

2010-01-18T14:36:00.000-08:00

With all the news and talk about taxes and deficits and such, I’d thought I’d share a few statistical perspectives with you – just for fun and cocktail conversations.

It’s hard enough to comprehend a million let alone a billion, but a trillion is almost beyond comprehension. To put the number in some perspective, there are approximately 300 million people in the U.S. as of July, 2007, according to the World Fact Book. A billion is 1,000 million, which means that a billion dollars is equal to about $3 per person in the U.S. and $1 trillion is equal to about $3,300 for every person in the U.S. Since there are about 100 million households, $1 trillion represents about $10,000 per household and $2.7 trillion is about $27,000 per household. That’s clearly more than the total income for a lot of households.

Based on an analysis of the 2007 federal budget, it appears that this budget total does include Social Security and Medicare tax collections, which represents about 1/3 of the total. Another 1/3 is from corporate income taxes and various excise taxes, with a little over 1/3 from personal income taxes. So that means that the average household would be paying about $9,000 of income taxes.

According to the National Taxpayer’s Union, the taxpayers in the top 50% (as measured by adjusted gross income) paid 97% of the individual personal income taxes in 2005. This means that about 50 million households paid nearly all of the personal income taxes. That works out to an average of about $18,000 of income taxes per household in the top half of the income category – which is in addition to their share of the payroll taxes and other taxes.

If we were to assume that the payroll taxes for Social Security and Medicare and the other taxes were shared equally, that would amount to about $18,000 per household. ($1.8 trillion / 100 million households) And the top half of the income earners would also pay an extra $18,000 per household for income taxes. But 60% of the income taxes are paid by the top 5% of income earners, which means that $600 billion of income taxes is being paid by about 5 million households. That works out to about $120,000 per household for those in the top 5% of income earners.

And some politicians are still saying that the “rich” aren’t paying enough taxes!

As John Stossel likes to say, "gimmie a break".

Vern Jacobs

A Lower Tax Profile for the Affluent

2010-01-15T08:23:00.000-08:00

The IRS is developing a program to target what they call high net worth (HNW) taxpayers who have any form of foreign financial involvement for more intensive scrutiny. Since they don't currently have much information about net worth, what they are really targeting are taxpayers with a high income level. There isn't any information available about where the dividing line is, but it would be safe to assume that it will be somewhere above $250,000 a year of total income on page one of the Form 1040.

These audits will inevitably begin with a review of two or three years tax returns and the foreign bank account reporting (FBAR) forms. Laws that are currently being proposed may eventually require an annual disclosure of foreign based assets in addition to bank and financial accounts. If those laws are passed, the reports that are likely to be required will certainly be reviewed along with data in the IRS computer databases.

Once upon a time, moving assets offshore was a way to secure greater privacy from prying eyes. To a limited extent that may still be true with respect to non-government snoops -- such as lawyers who are contemplating whether to pursue some litigation on a contingent fee basis. But for the prying eyes of the U.S. government, greater privacy is now available within the U.S. Moving assets offshore is no longer an effective way to secure greater privacy and tax savings.

To minimize the potential for time consuming and potentially costly audits that are looking for unreported income from foreign investments, one solution is to reduce the level of foreign based assets to fall under the reporting thresh-hold. There is presently an exemption from reporting foreign bank and financial accounts that total $10,000 or less at any time during the calendar year. A husband and wife could each have somewhat less than that amount in an offshore account without having to file the FBAR form. The proposed law calls for a reporting thresh-hold of $50,000 of non-financial assets. And, it does not seem that direct ownership of foreign real estate must be reported. Storing collectibles in an offshore vault may also be exempt from reporting if access to the vault requires the presence of the depositor or an agent other than an official of the storage facility.

Another way to maintain a lower profile is to find ways to accumulate income in tax deferred arrangements and to consume after tax assets for necessary living expenses. For a very simple example, otherwise taxable interest income could be replaced with a tax deferred annuity. Then assets otherwise used to generate investment income could provide the cash needed for living expenses. Another tactic is to invest otherwise income generating assets in a variable life insurance policy and to use policy loans for some living expenses. For some taxpayers, these tactics will also reduce the potential for having to pay income taxes on some Social Security benefits. Other ways to minimize the income that is reported on a tax return depends on the specific facts and circumstances of each taxpayer. And in some cases, it is not feasible to avoid reporting a large amount of taxable income. But anything that can be done legally to defer income will usually decrease the potential for an intrusive audit or review of the income and assets of a high net worth (aka income) taxpayer.

Some additional tax saving ideas are available at http://www.vernonjacobs.com/ and my book on Legal Ways to Save Taxes Offshore and Onshore has about 100 different ideas for ways to reduce the tax bite and potential exposure to intrusive audits.

My book on the FBAR report is presently the most comprehensive source of information available about what must be reported and what the exceptions are.

Vern

http://www.offshorepress.com/legalways2save.htm

http://www.offshorepress.com/fbar.htm

Socialism Explained

2010-01-11T08:35:00.000-08:00

Got this from an email that is being circulated. The alleged professor who conducted this alleged experiment is not identified, but the story is an excellent parable about the logical consequence of enforced equality. However, it seems unlikely that this occurred as recently as the last semester in 2008 or the first semester in 2009 when Obama's economic views were widely known and he was a clear contender or had won the election. That's why I describe it as a parable rather than as an actual classroom experiment. Vern

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An economics professor at a local college made a statement that he had never failed a single student before, but had once failed an entire class.

That class had insisted that Obama's socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor then said, "OK, we will have an experiment in this class on Obama's plan".

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A.

After the first test, the grades were averaged and everyone got a B.
The students who studied hard were upset and the students who studied little were happy.

As the second test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too so they studied little. The second test average was a D! No one was happy.

When the 3rd test rolled around, the average was an F.

The scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.

All failed, to their great surprise, and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great but when government takes all the reward away, no one will try or want to succeed.

Tax Rates and Tax Loopholes

2010-01-04T14:32:00.000-08:00

In 1975, when I started writing about tax loopholes, the top federal income tax rate was 70%.

And the tax law was full of diverse ways for different taxpayers to reduce their taxes.

Most people who didn't take the time or effort to look for ways to save income taxes referred to these diverse tax saving opportunities as "loopholes". The government called them tax incentives. Economists often referred to them as "tax expenditures" because they had the same effect as giving money to a select group of taxpayers. Quite often the select group consisted of members of an occupational group such as real estate developers and brokers or homeowners.

Taxpayers who had enough income to be faced with a 70% marginal tax rate were highly motivated to take advantage of as many of these "loopholes" as possible. In many cases, the loopholes required the taxpayer to invest in something (like a real estate venture) that would generate a deductible loss. By using borrowed money that didn't have to be paid back for many years, the taxpayer could secure the equivalent of a low interest loan in the form of a tax reduction.

In some cases, taxpayers could rearrange their business so as to qualify for some tax break they were not currently eligible to use. For example, a self-employed person was (back then) not able to get a tax break for his medical expenses comparable to an employee. But an owner and employee of a corporation could establish a corporate benefit plan that would pay the medical expenses of the employees and the owners. Businesses could qualify for substantial tax credits for an investment in business equipment. So some investors would put up the money to buy the equipment and would share in the use of the investment tax credits. Parents would loan money to their children (or to a trust for the benefit of their children) at a zero interest rate. The children (or the trust) would invest the money to earn interest, dividends or capital gains. The children were in a low tax bracket and the parents were in a high tax bracket.

At one point I had accumulated and documented more than 200 of these pre-meditated tax breaks. By "pre-meditated" I mean that the taxpayer generally needed to engage in some planning to identify which of the tax breaks were suitable for that taxpayer and then had to write a check or take some action to qualify for the tax break.

But in 1981, President Reagan pushed through a tax law that reduced the top tax rate to 50%. And that tax law eliminated or curtailed many of the loopholes that were being used to shelter income from high tax rates. Then in the Tax Reform Act of 1986, Reagan pushed through a reduction in the top rate to 28% -- along with a huge reduction in the many different tax shelters, loopholes and tax breaks that were still being used.

As tax rates have crept back up to a top rate of 35%, each new tax law includes new tax incentives -- often for various energy conservation or production investments. For many years the government has been trying to motivate small business owners to provide retirement benefits for their lower income employees. But the Congress also tries to restrict the ability of the business owner to benefit from the plan. The result is that the owners don't jump on the tax breaks and the Congress keeps raising the incentive. After the investment tax credit proved to be popular and was used by a lot of people, the Congress imposed severe limits on who could use it and it fell out of favor. But now, the Congress has increased the one year deduction of business equipment to $250,000.

But there is a pattern to the ups and downs of tax rates and tax loopholes. The higher the tax rates, the more loopholes the politicians will create to encourage investment in selected parts of the economy. And when tax rates are reduced, there is usually a compensating reduction in the variety and the appeal of various legislated tax incentives, aka "loopholes".

Vern Jacobs

Half Empty or Half Full?

2009-12-31T09:07:00.000-08:00

Optimist or Pessimist ?

“For myself I am an optimist - it does not seem to be much use being anything else. The pessimist sees difficulty in every opportunity. The optimist sees the opportunity in every difficulty."

Winston Churchill.

Most of the time, I share Churchill's sentiments, but tempered with a lot of apprehension about the huge amounts of money the government and the Federal Reserve have created out of thin air.

Do you recall a book called "Bankruptcy 1995" written by Harry Figgie and Gerald Swanson in 1992? I found it to be highly persuasive and wrote an article about different ways to cope with hyper-inflation. After it was published, Mark Skousen (an economics PhD, a friend and former co-worker) wrote to me and made the point that the 1995 hyper-inflation pinnacle predicted by Figgie and Swanson was pre-mature. He pointed out that the government has enormous powers and tools to "stretch the rubber band." Of course that was about 16 years ago and we have experienced a huge increase in money creation (inflation) since then with a lot more that will be coming in the foreseeable future. I read Mark's newsletter (Forecasts and Strategies) regularly and he is not predicting imminent doom and gloom but he is cautioning about monetary expansion which leads to inflation.

Instead of having to choose between being a pure optimist or a pure pessimist, a better choice is to plan for the best possible future but hedge your bets with some asset protection and risk management strategies. Having some assets offshore in a foreign LLC or a foreign trust would be worth considering along with some diversification out of the U.S. dollar plus investments in hard assets that are likely to keep pace with inflation. And having a portable business that can function from anywhere in the world would be another valuable hedge against severe inflation in the U.S.

Vern

Trickle Down or Trickle Up?

2009-12-28T08:37:00.000-08:00

Keynes and his followers -- which includes nearly everyone on the left of the political spectrum -- claim that supply-side economics is a fallacy. They derisively refer to supply-side economics as "trickle down".

The logical implication is that there must be some sort of "trickle up"system of generating economic activity and prosperity.

But that raises the proverbial "chicken or egg" paradox. What causes income to trickle up? The Liberal's answer is that the government stimulates a depressed economy by borrowing or creating money and spending it. The money then filters through the economy creating jobs and prosperity. Pardon me, but isn't that the same process as providing private investment that then filters through the economy creating jobs and prosperity? Except for the source of the money, both methods involve putting money into the top of the spigot and then it uses economic gravity to give people money to spend and to thereby create jobs.

But when the government borrows money, it is paid back by taxpayers in the form of taxes. The actual repayment can be delayed almost forever, but in the meantime, taxes are being used to pay interest to the lenders. If the government creates new money by selling its debt to the Federal Reserve, that results in new money in the system and eventually causes inflation. Inflation causes a loss of purchasing power which has the eventual result of confiscating part of the value of any assets. Either way, if the government stimulates economic activity by spending more money, it will have a bad outcome in the future.

So what happens in the supply-side process?

In this theory, there are people who don't spend all of their available income. Like the Chinese, they save as much as possible. Then, in order to secure some income from their savings, they invest their savings in stocks, mutual funds or other investments. Most of that money is used by businesses to buy equipment, land and buildings that are necessary to produce some kind of product or service. That investment results in income for those who help to build the productive assets. Part of the money is also used to hire and train employees to produce the goods or services in the factories.

The money that investors provide to build factories and equipment results in relatively permanent jobs, which leads to an expansion of other businesses that serve the needs of the employees of the factories. And the money that is provided by investors is used by businesses to earn a profit. Businesses that are unable to use the money they get from investors to provide an attractive return to the investors will soon be unable to secure more funds. The businesses that do the best job of earning a profit for the investors will find it easier to secure more funds to expand their business and create more jobs.

Of course, the Liberals argue that the money spent by government also creates jobs. And some of them even claim that the government is "investing" borrowed money (or future inflation) to create jobs. But the government's concept of investing is far removed from the practical approach of the market place. An investment is something that has value as long as it is producing some income or growth in value. Few government projects provide an economic return or can be recovered by selling the alleged investment to someone else. Most government projects are politically motivated to divert money to the supporters of the politicians and to voter blocks that help the politicians stay in office. And when those projects fail to produce the results that were promised by the politicians, they inevitably are expanded and given more money. In a business, a project that doesn't work is closed up.

The free market is a hard task master, but it produces long term results.

Government stimulus is like another drink to an alcoholic or a fix for a junkie. It fees good for a short time but has no enduring benefit.

Vern Jacobs

http://www.vernonjacobs.com

http://www.offshorepress.com

Regulatory Chaos

2009-12-26T11:59:00.000-08:00

Many, many years ago, it was standard practice for the legislature to hold hearings and invite comments on proposed legislation for many months or even years before putting a bill into the legislative hopper. The IRS used to draft proposed regulations and they would hold hearings for years before adopting the regulations. Major changes in the law often took up to ten years of hearings.

Today, the government rushes to pass complex new laws written by their staff and rarely read by any of the legislators. The president is pushing hard to pass his massive 1,000+ page health care proposal that no one has had time to read. Behind the scenes he is also pushing a massive new tax scheme called "Cap and Trade" to allegedly curtail pollution. To add to the nearly comic confusion, the President and some legislative supporters are trying to make fundamental changes in our very complex international tax system without serious consideration of the economic consequences.

Meanwhile, the IRS issues regulations dealing with complex financial matters and then responds to complaints after the fact. Early this year, the IRS issued what they apparently thought was a clear and simple expansion of the instructions to the Foreign Bank Account Reporting Form along with an expansion of the size of the form itself. Questions began to arise within a few months and increased up to the filing date of June 30th. Due to many complaints, the IRS extended the penalty free filing date to September 23rd for those who have reported all foreign source income, but the questions continued to roll in. The IRS was rushing to issue further clarification up to the filing date for the form.

And as of Dec. 26, 2009 the Congress has postponed extension of a variety of expiring tax provisions -- as well as failing to act before the estate tax rate changes to zero in 2010. While I'm personally in favor of total repeal of the federal estate tax, it would be generous to call that wishful thinking in the present political and economic environment. It can't be repealed, but it will cause a great deal of needless problems because of allowing the rate to fall to zero for even a few days in 2010.

And it seems that the IRS is only one of dozens of agencies that are subject to the ineptitude of the Congress.

Vern

The High Cost of Free Health Care

2009-12-22T08:17:00.000-08:00

December 22, 2009

With a mere 5 votes out of 435, the House managed to pass their version of a health care bill. The bill (HR 3962) includes the infamous public option which will inevitably drive competing private insurers out of the market if it is included in a final compromise bill. The provision to prohibit the denial of coverage for pre-existing conditions will add to the cost of health care insurance which will lead to higher premiums or will put push many (if not most) health care companies out of the market. In addition, employers with more than a $500,000 annual payroll will have to pay an 8% tax on gross payroll if they do not provide health care to their employees. (At an assumed average payroll of $25,000 per employee, that represents a company with only 20 employees.)

On December 21st, the Senate voted 60 to 39 for cloture to stop further Republican efforts at a filibuster. Getting a few hold-out Democrats to vote for cloture was an example of old fashioned back-room Chicago politics at its worst. CNN said,

"Democrats call it compromise. Republicans call it bribery. But both sides agree that special deals are why the Senate is on track to pass a health care bill by Christmas. It wasn't clear whether Senate Majority Leader Harry Reid had the support needed to move ahead with his chamber's health care bill until Sen. Ben Nelson, the last Democratic holdout, had a change of heart this weekend. He agreed to support the bill in return for compromise language on federal funding for abortion and more money for his home state of Nebraska. As a part of the deal, the federal government will pay 100 percent of Nebraska's tab indefinitely for expanding Medicaid for low-income Americans."

Senate Majority Leader Reid even went so far as to say

".. those who missed out on the perks can blame themselves. I don't know if there is a senator that doesn't have something in this bill that was important to them. And if they don't have something in it important to them, then -- [it] doesn't speak well of them,"

With 60 solid votes in the Senate, final passage in that body is assured. The next step is for a joint committee to convene to work out a compromise between the very different elements of the House bill and the Senate bill. With Democratic control of the committee, it's likely the final bill be closer to the House version and will include the most costly elements of both.

It's a certainty there will be an overwhelming variety of provisions that will raise taxes or an assortment of fees, force insurance companies to raise premiums and cut back on coverage provided by Medicare. As I heard the President confidently state that this bill would reduce the deficit, I thought that this President is either woefully ignorant of basic economics or he is the best liar in recent history.

There is no way in the world that this bill can reduce health care costs, insurance premiums and the Federal deficit. And I'm appalled at the blatant self-serving position of many Senators who voted to move the Senate bill onward toward certain passage. I hate to be a pessimist, but this looks like the beginning of the end of the best health care system in the world. Even worse, it will greatly limit the funds that drug companies are willing to invest in new research because of political restrictions on what the insurance companies will be able to charge for new drugs that cost billions to discover and develop. But the worst outcome of this legislation is not the cost; it's the unavoidable consequence of having to ration health care and of making critical health care decisions by bureaucrats rather than by health care professionals.

Of course, this is just my not so humble opinion.

Vern Jacobs

www.vernonjacobs.com

Is Saving Taxes Worth the Trouble and Cost?

2009-09-25T08:10:00.000-07:00

There are a lot of people who are eager to help you to pay less taxes.

There are the stock brokers who are selling tax exempt bonds or the insurance agents who are pushing tax deferred annuities. Real estate sales people are quick to remind you that you get lots of deductions when you own a home and that you can make up to $250,000 of gain on a personal residence that is tax free. Sales people who are involved in one of the dozens of multi-level marketing programs will point out the variety of tax breaks that you get from owning a business. Financial planners will often offer to show you enough tax saving opportunities to more than cover the cost of their fees. Tax preparers often offer to help you save taxes by finding over-looked deductions. Lawyers often encourage you to prepare an estate plan in order to avoid federal estate taxes.

But many of these promoters are slow or reluctant to explain the downside to their tax saving tactics. With very few exceptions, there is another side to every coin that represents some kind of tax saving opportunity. And it's not just the potential risk of a dispute with the IRS. The hidden downside is the time and the opportunity cost; it is the alternatives that are not utilized.

First of all, there is the cost of hiring the professional or the hidden risks involved with whatever investment they are promoting. For example, tax exempt bonds rarely pay as high a yield as U.S. government or corporate bonds. Thus, the difference in the yield is like a hidden tax. When a U.S. bond is paying 4% and a tax exempt bond is paying 3%, that's equivalent to a 25% tax rate. And exempt bonds are subject to unique market risks that require expertise to evaluate. An annuity might be a simple way to reduce your taxable income in some circumstances, but the return on your investment will be fully taxable, even if the annuity was receiving income from long term capital gains or tax qualified dividends. In effect you would be trading a potential tax rate of 15% (or even zero %) for 25% or more.

Financial planning and estate planning might result in a net tax savings over time that is in excess of the fees you will be paying to the professional. But don't overlook the time you will have to invest to engage in the process -- which will require you to gather and organize a LOT of your personal financial records and information.

I have seen very few tax saving opportunities that were not without some cost in time or money that reduces the payoff. Clearly, the goal is to find those particular opportunities that are suitable for you and that provide a payoff that is greater than the costs -- including the hidden costs.

Vern Jacobs
http://taxangles.blogspot.com/

IRS Propaganda and Disinformation

2009-09-24T07:40:00.000-07:00

Have you read "1984" by George Orwell?

If not, it's worth getting a copy from Amazon.

For those who haven't read the book it describes a world where there are three main political units which are in a perpetual state of war. The European and U.K. government engages in extreme disinformation by twisting words and phrases to mean the opposite of their original meaning.

What's the got to do with the IRS?

Back in the late seventies I wrote about their propaganda and disinformation tactics and since then they have only gotten more skilled in the practice.

Everyone is familiar with the "voluntary" description of the income tax. IRS officials and politicians repeatedly refer to our tax system as being voluntary. But when pressed, the IRS explains that our tax system gives taxpayers the right to self-declare their income rather than having the IRS compute their tax. What they don't tell us is that if we don't "volunteer" we are not only subject to whatever taxes the IRS might impose (based on information returns of various kinds), but we will also be subject to some nasty penalties and interest.

If you read their instructions, you will encounter an extreme use of such words as "must", "required", "does not", "may not" and "shall not". Instructions and information that will increase your tax liability are stated in the most forceful and authoritative terms and in a negative context. References to penalties for non-compliance are used frequently.

Even when the IRS regulations and instructions are discussing some provision of law that explicitly permits taxpayers to do something to reduce their taxes (like investing in an IRA, claiming a deduction for business equipment or investing in tax-exempt bonds), the emphasis is about what must be done to qualify for the tax break. In many cases, their explanation of tax saving provisions of the tax law are so negative that they create the impression that using the break would be risky.

Each year, in the early Spring, the IRS begins a media publicity blitz with news about the successful conclusion of various court cases against tax evaders. As much as possible, they publicize criminal charges and jail time for highly prominent persons. The author of "The April Game" (an un-named former IRS agent) says that the conclusion of fraud cases are times to gain maximum publicity value.

Another tactic is to convince us that they can catch every tax cheat and tax return error. The truth is that only about 1% of all the returns are audited, and that only about 1 out of 200 returns of middle income taxpayers are audited.

Few taxpayers are familiar with the arcane language of the tax code and the IRS regulations. Since the income tax is based on income, it is necessary to have some understanding of what that means. However, the term is not defined in the tax code because it is such a broad and elusive concept. Without some education as to the meaning, most taxpayer will assume that every form of cash receipt is income. That's not true, but you will have a hard time finding any admission of that fact in the tax law or the IRS regulations or voluminous instructions.

To counter the IRS propaganda, taxpayers who do not have any training in the subject of accounting or tax law may need to secure help from someone who does.

To be Continued

Vern Jacobs

www.vernonjacobs.com

The Tax Angles Story

2009-03-11T14:59:00.000-07:00

Tax Angles was the name of a very popular consumer tax guide that was published between late 1977 and about 1985. At its peak it had about 60,000 paid subscribers and it was one of the first publications that focused on showing taxpayers how to reduce their taxes. The unique element of our newsletter is that we didn't really deliver a lot of NEWS. Instead, we focused on giving our readers practical and legal tips on how to save taxes.

The marketing focus was on the idea that taxpayers could not afford to wait for their tax preparer to bring tax avoidance ideas to them; they needed to be more pro-active and look for ideas in our newsletter which they could show their tax preparer and ask for help to determine if that tip was suitable for the taxpayer. Needless to say, more than a few tax accountants and preparers took exception to our advertising and we got more than a small amount of hate mail.

But we found that a substantial portion of our subscriber base consisted of tax professionals who wanted to read about the tax tips in our newsletter and then pass them on to their clients.

I was the founding editor and principal author. The publisher was Kephart Communications, Inc. (KCI) -- a very successful publisher of multiple newsletters, based in Alexandria, Virginia. Prior to creating Tax Angles, I had been writing and self publishing a very tiny newsletter with the rather provactive title of "Tax Tricks and Techniques for the Self Employed". The owner of KCI was apparently one of my first subscribers and it turned out that he liked my approach to explaining tax saving opportunities to my readers. So he made me an offer that was too good to refuse. He bought my newsletter at an attractive price and then offered me a very generous royalty on the gross sales of the new newsletter.

From late 1977 through about 1984, I scoured various sources of tax news and information that was mostly aimed at tax professionals and explained what I found in plain English -- as much as possible without distorting the meaning of the law. KCI not only promoted the newsletter, they actively promoted me as an "authority" on the subject of taxes and made arrangements for me to be invited to be a seminar speaker at a variety of financial conferences like the New Orleans annual hard money conferences.

It's about 25 years later and I still encounter former subscribers of Tax Angles who still recall some of my more titallating tips on how to save taxes without going to jail. And although KCI is no longer in business I'm still pursuing my favorite avocation; explaining our insanely confusing tax system to the general public in plain English -- or as close to it as I can get.

Vern Jacobs

An Introduction

2009-03-06T12:21:00.000-08:00

Welcome to Jacobs' Tax Angles

I've created this blog to serve as a platform for some of my personal views about taxes, politics, economics and an assortment of related topics.

By way of introduction, I'm a tax author, teacher and accountant with a primary focus on international tax law.

As an author I write and self publish books, reports and a web site dealing with asset protection and taxes. I have a second web site that provides information for those who have an interest in my professional services.

Unlike a great many tax professionals, I do not look forward to more tax laws and regulations which represent opportunities for more work. I would much prefer to eliminate the Federal income tax by repealing the 16th amendment to the Constitution and to repeal the Federal Reserve Act of 1913. Despite my seemingly bizarre political views, I'm a long time student of the U.S. tax system and am aware of the heavy handed penalties that can be imposed on those who deviate from compliance with the law.

I am not an advocate of an assortment of "tax protester" theories that have been summarily and repeatedly rejected by the U.S. courts. Instead, I assist taxpayers who wish to avoid problems with the IRS by complying with the tax law and I limit my somewhat controversial opinions to the written word where I have at least a modicum of protection via the First Amendment.

Vern Jacobs