Category Archives: Economy

Bush Tax Cuts Post Mortem

The Bush Tax Cuts were originally passed in 2001 and policies took effect from 2001 to 2003. The most dramatic effects took place in 2001, notably cutting the top income tax bracket from 39.6% to 35%. Some of these provisions have expired while some have been extended.

Much controversy remains as to whether the Bush Tax Cuts improved the economy. In this case, hindsight is not 20/20. Simply put, can can’t hit reset and replay history as if the tax cuts were never put into effect. To add complexity, the real estate bubble that lasted through 2007 made the economy appear better than it really was.

The real estate bubble caused a great wealth deception in which people generally felt secure about their financial situation. This caused people to spend more money. Since GDP’s biggest component by far is consumer spending, it rose considerably after the 2001 recession. In fact, there was a period of time in which household savings rates went negative.

Since there was considerable GDP growth between 2001 and 2007, government received more revenue from taxes. Although tax rates were lower, GDP growth more than made up the difference. In fact, tax revenue as a percentage of GDP was higher in 2007 than in 2001.


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In order to give the Bush Tax Cuts a fair evaluation, one must consider what the pace of GDP growth would have been if asset prices rose at the same rate as inflation. This is impossible to do with any precision because asset bubble change consumer behavior. When people feel secure financially, they continue investing in risky assets and spend money on luxuries. When the opposite is true, no asset price seems too low when fear is prevalent.

Generally speaking, tax cuts are positive for economic growth. Since private individuals and businesses are better allocators of capital than governments, low taxes are beneficial. That being said, if a government continues to overspend when less tax revenue is coming in, problems are inevitable. This causes weakening of the dollar and the debt will need to be repaid at some point. Because of the increases in spending do to the wars in Afghanistan and Iraq, the dollar depreciated during this period while government deficits increased.

Extension of the Bush Tax Cuts and the Fiscal Cliff

If the Bush Tax Cuts were made permanent, the Congressional Budget Office (CBO) projects that an additional $3.3 trillion would be added to the national debt. Although it’s obvious, the debt would be higher, projections like this lack accuracy. This is because of the indirect effect tax policy has on human behavior. In addition, one change causes other variables to change such as future income and GDP. As a result, we can only take these projections with a grain of salt.

The effectiveness of the Bush Tax Cuts is questionable at best. This is a outcome that will be debated for many years to come.

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Fiscal Cliff Resolution’s Impact on Taxes and Investing

Given the large US budget deficits of the past several years, tax increases were inevitable. No doubt, this will be a drag on economic growth going forward. For starters, those earning wages will experience an increase in payroll taxes. The withholding for Social Security taxes will revert back to 6.2%, the amount it was before the financial crisis.

The Bush-era tax cuts will remain in effect for those earning less than $400,000 per year with the top tax bracket being 39.6%. Long-term capital gains and dividends will remain at 15% for those earning less than the $400,000 threshold. The top rate for long-term capital gains and dividends has risen to 20%.

Most importantly, however, is the permanent patch to Alternative Minimum Tax (AMT). Previously, AMT had to be patched every single year, leaving an element of uncertainty for many filers. Had this not been resolved this year, many taxpayers would have been caught by surprise with a stiff tax increase.

Although this resolution will be a fairly minor drag on the economy, it will not be sufficient for solving our budget problems. Our budget deficits are too massive and spending cuts will still be needed to bring our budget to a reasonable level. Simply put, the government will still spend far more than it receives in taxes.

One of the buggest dangers is a sharp increase in interest payments for the national debt. Interest alone on the national debt is around $29 billion per month. A spike in inflation and interest rates could make this amount multiply. Currently rates on US government bonds are near zero with the 30 year bond being around 3%. This is why any increase will be huge. These rates are historically low and cannot get much lower. That being said, the risk involved does not favor US taxpayers.

The Fiscal Cliff consisted of mostly media hype. The real problem involves the mushrooming amount of debt. If this is not dealt with, then we will experience a real crisis. According to Reinhart and Rogoff’s This Time is Different, once debt-to-GDP rises to over 90%, it becomes a significant drag on the economy (We have already passed this level). In most cases cited by the authors, governments eventually default. Currency devaluations, resulting in inflation from printing money, are considered to be an indirect form of default. And is the most common method used by governments with fiat currencies.

Slower Growth Impacts Equities

Currently, the stock market is priced with the assumption of GDP growing at the rate of its historical trend. This is roughly 3% per year. Since the Great Recession, we have not been anywhere near that. Corporate earnings for the majority of S&P 500 companies have been disappointing for the last 2 quarters. This suggests that earnings are near their peak for this business cycle.

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Fiscal Cliff is Mostly Media Hype

Each time I turn on CNBC, there’s a clock showing the countdown of the fiscal cliff (regardless of which show is on). This is merely a recurring theme: make you think the world is ending in dramatic fashion to keep you watching the news. CEO’s like to come on the shows to tells us it’s armageddon if we raise taxes. Isn’t this just an attempt by them to avoid paying more taxes themselves?

The real truth is that the economy is already weak. Corporate profits have been below analysts’ forecasts in the second half of 2012. In addition, we are interwoven in a global economy which includes a European recession and a slowing Chinese economy. Because the global economy is so interconnected, recessions elsewhere will have an impact.

Politicians also add drama. That is, they have an interest in “standing tough”. If an agreement were reached right off the bat, it would appear as one side lost the battle or was not doing it’s job. In other words, the longer they drag this out, the more it appears they are not letting the other party win.

In the end, the US government will be forced to deal with its budget problems. Because of the massive gap between tax revenue and its expenditures, there will be no options left except higher taxes and reduced benefits. Whether a consensus is reached in the short term or not, the huge deficit will be a drag on the economy for years to come.

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Like Europe We Have Our Own Problems

Lately, the media has been extensively covering the bad financial news coming out of Europe. Meanwhile, the financial problems here in the U.S. have persisted. This is not intended to downplay the importance of Europe to our economy and the global financial system. On the other hand, we have our own critical economic headwinds to be concerned with.

For starters, we have many states and localities that are nearly bankrupt. This is somewhat comparable to the members of the European Union. States, like European Union countries, cannot control their own money supply. Therefore, they have to raise taxes and cut benefits. One key difference, however, is that states don’t have the option to leave the union unlike the members of the EU.

The federal deficit is one of the biggest problems we currently face. The aging demographics only compounds the problem. Medicare especially will add strain to our government’s financial problems. The mushrooming costs of Medicare are simply not sustainable. In the future, our health care system will have to adapt and become more cost efficient. Health care costs have been rising much faster than incomes and inflation.

Our national debt has reached a level in which it will be a drag on the economy. According to Carmen Reinhart and Kenneth Rogoff’s This Time is Different, large federal deficits are a drag on economic growth. In this type of situation, government spending crowds out private investment. In addition, government spending has a slightly negative multiplier on the economy. This is the opposite of private investment.

The odds of government debt default are very high once a nation’s debt to GDP (Gross Domestic Product) ratio gets to be over 90%. That said, the term ‘default’ is much broader than simply failing to make the payments. The most common form of default is through inflation. In this situation, the decrease in value of a country’s currency reduces its debt burden. This is a form of cheating creditors because they are being repaid with money that’s less valuable compared to the principal that was originally lent.

In the end, large and growing federal deficits lead to subpar economic growth. Recovery from large deficits can be long and painful. At best, we will go through a muddle through period. This is a period similar to the environment we are currently in. Yes, GDP is growing. On the other hand, the growth rate is slow with unemployment persistently high. To many, this feels as if the last recession never ended. This has all happened despite the fact that the government has been on a spending binge.

The largest spending binges occur after financial crises according to the research done by Reinhart and Rogoff. The financial crisis of 2008 was no exception. In the long run, however, the extra spending will only add to the problem.

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Three Headwinds that Today’s College Students Face

You should always treat your education like it’s an investment. That said, when the cost of any investment rises beyond that point at which a reasonable return can be made, it’s time to look at different options. This may include not making a decision at all. It is also important to note that by doing nothing, you are still taking a position. In fact, we see this in investing all the time. For instance, by deciding not to be in the stock market, you are taking a position in either cash or an alternative investment.

In recent years, tuition prices have risen to unbelievable levels. Despite this, young students are advised they should go to college regardless of the cost. This can be bad advice. There are three major problems that students are dealing with today. Obviously, the high tuition fees result in high student loan balances. The average borrower in his or her 30’s today has a student loan debt balance of $28,500.

The second major headwind is the fact that the job market has been weak since the 2008-09 recession. This economic recovery has been unusually weak. Indeed, the unemployment rate for those who have degrees is generally lower. However, companies are reluctant to hire inexperienced workers and invest a large amount of capital to train them. This only makes the debt woes worse. Coupled with a high balance, new graduates are unable to make their loan payments. If they get behind on these payments, penalties and interest raise the loan balance. Student loan debt is also difficult to get rid of through bankruptcy. This is because most debt is issued or guaranteed by the federal government. Similar to that of income taxes, it’s much more difficult to default on government debt than private debt.

The third headwind college students face today is globalization and technology. Many mid-level professional jobs have been eliminated through automation and outsourcing. Being able to obtain a steady career with long-term employment is becoming rare. Since the economic recovery, retail and food service have been the fastest growing job sectors. This shows that there is a mismatch between what the market demands and what colleges are preparing students for.

The media, especially the financial news, likes to talk about the value of human capital. With the price of robotics falling and the productivity improvements of software, companies can get more done with less people. Where the jobs will come from in the future is unclear. This does not ensure that the future will be grim. Productivity gains lead to lower prices which is a great benefit for consumers. Lower prices can, in the end, lead to new industries and new innovation. If consumers can get more for less, history shows they willingly spend more. 

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Income Tax Increases Will be a Drag on the Economy

Our budget deficit woes will end up making tax increases inevitable. We are far too deep in debt to grow our way out of the problem. In addition, our deficit has become too large for spending cuts alone to fix the problem. The day of reckoning is approaching faster than anyone had imagined before the financial crisis hit.

Simply put, higher income taxes are a drag on economic growth. They take money away from private investors and put it in the hands of government. We know from history that governments are poor allocators of capital. Government operates at a much lower level of productivity than the private sector.

Government expenditures, unlike private businesses, have a flat to negative multiplier effect on the economy. The historical data was outlined in This Time It’s Different by Reinhart and Rogoff. In comparison, the private sector generally has a positive multiplier effet on the economy. That is, each new dollar invested by businesses and investors will boost economic growth. Government expenditures, on the other hand, drain money out of the economy.

Tax increases often follow financial crises. This is because a financial crisis leads to bailouts of multiple companies, usually banks. Governments tend to borrow a big portion of this money, thus raising the budget deficit. In addition to bailouts, government expenditures also rise from economic stimulus programs. This is because a bad recession almost always follows a financial crisis. At the same time, tax revenues drop after a financial crisis because individuals and businesses are making less money; thus, having less taxable income. This is why banking and financial crises result in a downward spiral.

In the end, deficits have to be dealt with. Governments try to fix budget problems through inflation, reduced spending, and tax increases. Tax increases often fail because they lead to slower economic growth or could possibly trigger another recession. The result of the tax hike is even lower profits for businesses and less income for individuals. Therefore, the intended tax increases can generate less tax revenue for the government. In some situations, this only makes the problem worse.

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Middle Class Finding Fewer Opportunities

Unemployment and underemployment will continue for the foreseeable future according to Michael Spense. We have gone through a period of underinvestment and took on too much debt in terms of both individuals and government. The fact that we’ve been complacent will lead to lackluster job growth with no quick fix being possible.

Jobs in the U.S. into two very large sectors: tradable and non-tradable. Tradable jobs are ones that can be done by anyone around the world: manufacturing, back-office operations, pharmaceuticals, engineering, finance, consulting. Non-tradable jobs are those that really can only be done by people in the U.S., such as retail, health care, food service, government, and construction.

Because most of the jobs that have been created since 1990 have been of the non-tradable variety, these jobs should remain as they can’t be offshored easily.

Spence believes that the only long term solution is to invest in education, research, and infrastructure. Currently, there are too many people who don’t have the required skills in which employers are looking for.

Click the link below to watch video

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Barry Ritholtz on the Continuing Weakness in Housing

The economic conditions are perfectly normal when comparing this recovery to all other post credit crisis recoveries.  These types of recoveries tend to be very anemic and take a long time to wear off the excesses created from the previous boom.  Corporate balance sheets are in very good shape while consumers continue to improve theirs by paying down debt.  Government, on the other hand, continues to be leveraging up.

With regards to people who bought homes during the boom years who shouldn’t have qualified, only about half of them have been returned to being renters according to Ritholtz.  Therefore, we are only about half way through the correction in housing. 

No doc loans are called “rent with an option to default.”

Housing prices remain (as measured by affordability) about 8 to 10% above the mean for home affordability.  This metric measures median income to median household prices.

Housing will not be a significant part of economic growth for another 5-10 years.  You can watch the full video from Yahoo! Daily Ticker below:

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Inflation and the End of QE2

QE2 will end June 30.  The economy is barely growing despite low interest rates, stimulus spending, and quantitative easing.  The side effect of the Fed’s policies has been the excess money going into commodities.  The price of silver has skyrocketed.  Other commodities have also rallied because of the speculation in which investors expect continued weakness in the dollar and future inflation.  The end of QE2 may result in a pull back in commodity prices.

Real estate is still slumping and will continue.  Automobiles cost about the same as they did some years ago, we’re paying about the very same for airline travel that we did 10 years ago, and computers are becoming more affordable.  (Keith Springer) For many items not tied directly to commodities, the list goes on.  Nonetheless, it does not really feel like that because food and energy are much higher. The Fed eliminates food and energy from the inflation index, but the problem is, we all eat and drive. 

There seems to be no problems associated with the supply of oil and the Saudis have claimed to reduce production.  This implies that much of the rising prices has been due to speculation.  According to Yahoo! Daily Ticker, only about 1% of oil futures trades involve actual delivery.  The rest is form speculators attempting to profit from price volatility.  Prices may continue to rise in the very short term, however, there will be downward pressure in the intermediate term.

There may eventually be a QE3.  However, it will likely come later because of rising inflation.  If we were to go into a new recession or renewed slump in the economy, QE3 may be the only tool the Fed has because interest rates are already at zero.  A worsening economy always results in a government feeling the need to do something.  With our budget problems and the limitations of the Fed, there are fewer options.

QE2 did not lower interest rates which was the Fed’s intent.  Instead, it pushed up asset prices in equities, commodities, and emerging markets.

Bill Gross, the world’s most prolific bond investor, believes that government spending is out of control.  He has sold his positions in treasuries and is now short treasuries.  That being said, the smart money betting against treasuries should be a warning.

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John Mauldin: We will get through the Next Financial Crisis One Way or Another

“We generally only accept change in the face of necessity and we only see necessity in the face of a crisis,” says Mauldin. “The odds are we’ll have to have a crisis” that might lead to a long-lasting recession.” ( We do have choices to fix our debt problems. However, the longer we wait, the fewer (and more painful) choices we will have. Structural problems with income taxes and Medicare will need to be dealt with. In the long run, trends that can’t continue won’t. The videos below show Mauldin’s view that taking action now will eliminate or reduce the severity of the next crisis.

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