Personal Saving Rate

After the 5 percentage drop of major stock indices on Thursday, there is once-again talk of a double-dip recession. Occasionally, I am told that the market is efficient and rational. But, every few years, the market proves that it is anything but, swinging from irrational exuberance to a crazed flight to safety. Currently, Apple's after-tax-ttm-earnings-to-enterprise-value ratio is 7.4%. Apple is a healthy, growing company by any measure. Yet, investors seem to prefer the "safety" of a 30-year bond with a yield of 3.84%. That bond will decrease in value as interest rates rise whereas Apple will continue to grow and either force its stock price to rise either because the stock market regains its sanity or through stock buybacks.

When news article talk about the idea of a double-dip recession they seem to focus on (1) GDP, and (2) jobs. GDP is reasonable, since a standard definition of recession is two consecutive quarters of negative GDP. But, the focus on jobs is silly. Jobs don't return until companies have used up the slack and are confident that they'll have work for the new employees. In other words, they're a lagging indicator. And, jobs are returning---as of July 2011, the U.S. has gained 1.3 million jobs compared to a year ago. But, it's more important to look at consumption, manufacturing and income since these most accurately reflect economic activity:

• Durable Goods Orders are up 7.9% versus a year ago (June 2011)
• Personal Income is up 5.0% versus a year ago (June 2011)
• Industrial Production is up 3.4% versus a year ago (June 2011)
• Retail Sales are up 8.1% versus a year ago (June 2011)

Frankly, I don't see a recession. These numbers have all been strong for about a year and a half and don't show signs of falling. If anything, we should be concerned about inflation as Producer Prices are up 7.0% versus a year ago (June 2011) and the Consumer Price Index is up 3.6% versus a year ago (June 2011).

One important aspect of our economy that I haven't seen discussed is savings. Hence the title of this article. Take a look at this chart showing the Personal Saving Rate in the U.S.. Notice how it fell from around 1982 to 2008. No wonder growth was so easy during that period! If people are constantly depleting their savings, economic activity increases! But, it recently bottomed out around 1-2%, and, well, you can't really go much lower. Now, the economy has reverted to a more reasonable rate of savings, around 5%. The growth we saw in recent history simply isn't going to return. It was unsustainable because it required a negative change in the personal saving rate. Many complain that the U.S. economy (GDP) only grew at a rate of 1.3% in the second quarter of 2011. But, it's unlikely that we'll see the "good 'ol days" of 3% growth that we saw 1982-2008. 2% might be the norm for the foreseeable future now that our ability to pillage the savings accounts has been lost.

How to Solve the Debt "Crisis"

I'll let you in on a little secret---there is no debt crisis.

What?!?! Then, what is all the noise about? If Congress doesn't pass a deal, the US will default on its debt and all hell will break loose.

Well, I'll admit that is one interpretation of what can happen, but most political "experts" seem to think that is the only interpretation. In fact, the "crisis" results from Congress providing contradictory instructions, on one hand requiring a certain level of spending, on the other neither providing the necessary revenues nor debt issuing authority to match those prescribed spending levels. The job of the US executive branch is to execute the instructions of Congress. But, in this case, that is impossible. The executive branch cannot follow the instructions of Congress, so it must do something reasonable. The two main choices are (1) default on bonds while cutting Social Security, Medicare and other payments, or (2) keep issuing debt. The first choice will create a shock, both to those who depend on payments from the US government, as well as to those who hold US debt. The second choice will be met with all the drama of an inchworm moving across a deck railing---snore.

Former President Clinton says that he would choose option #2. Who wouldn't? Yet, Obama and Geithner have ruled out this option. Presumably, they have made this declaration for negotiating purposes---the Republicans are less willing to negotiate if Obama is standoffish. Option #2 even has explicit legal backing. The 14th amendment clearly states that US debt shall not be questioned. This debt was created when Congress issued instructions creating a gap between spending and revenue. So, there is little reason to stop selling bonds unless one wants a true crisis.

Ethanol Sanity

Finally!  The US Senate recently voted to end ethanol subsidies and tariffs.  The Economist says that the subsidies cost the government $1.78/gallon.  This for a fuel that is less energy-dense than gasoline and barely more environmentally friendly.  The problem is that the US largely produces corn-based ethanol.  The process of converting corn to ethanol requires significant resources and releases significant amounts of carbon dioxide. The tariffs were designed to keep out Brazilian sugar-based ethanol.  But, production of sugar ethanol is much more efficient and environmentally friendly, requiring fewer resources and producing less carbon dioxide per gallon of ethanol produced.  So, for decades (since 1980), the US has been using subsides & tariffs to damage the environment.  It's like subsidizing the purchase of SUVs (!)  It sounds like the budget and debt limit crisis has finally brought at least the Senate to its senses.  I hope such sanity prevails in the House and the US can finally do away with this ridiculous waste of money and environmental harm.

As an added bonus, eliminating these subsidies/tariffs should reduce food inflation pressures in the US since farm land which was being used to produce corn ethanol will now be available to produce corn foodstuffs.

Where to Expense Professional Development

My wife is attending the TechMunch conference in Boston. I do her accounting, so my first instinct was: how do I file this expense? :-) After some Googling, I found this very useful Motley Fool blog post about filing small business expenses. I learned that such training (aka professional development) expenses don't have a pre-defined category and can be listed as miscellaneous expenses on the second page. The post explains in English what expenses belong in each of the major categories listed on 1040 Schedule C. In addition to the main post, there are many questions and answers in the comments for edge-cases like my issue. It seems like an excellent tax time resource.

How to use a Prepaid Rebate Card

My wife recently bought MetroPCS phones. Both had rebates associated with them. But, instead of sending us a check, MetroPCS sent us Prepaid Credit Cards. What's annoying about such cards is that if you try to charge more than the remaining balance, the charge is rejected. And, if you don't use up the balance within a few months, they start charging fees. For the first card, I tried to use it at brick-and-mortar retailers for relatively small purchases. Bad idea. You have to keep track of exactly how much you've used so you know how much to ask to be charged if the purchase is more than the balance. I got lucky and made two purchases that totaled just barely less than the total balance. The extra $.14 just wasn't worth the bother. But, with the second card, I realized my foolish ways---why not just buy myself a gift certificate. In fact, why not just buy myself an Amazon gift certificate. We buy stuff from Amazon almost every week and if you have applied a GC to your account, Amazon will apply any remaining GC funds first before charging your credit card. We were in the market for a Sous vide machine, so I managed to burn the entire GC about 30 seconds after I purchased it. Woo hoo!

Sudden Drop? Another Earthquake.

Around 10:45am EDT this morning, I noticed that the markets had taken a pretty sharp tumble, knocking 0.7% of the S&P 500 in a matter of minutes. Markets have certainly seen worse, but it looked sharper than I'd expect for a not-particularly-eventful day. I didn't see any relevant news stories on Google Finance and got caught-up with work shortly thereafter. So didn't find a satisfactory explanation---until a few minutes ago, that is. I learned of the 7.1 earthquake near Sendai, Japan. 14:32 UTC translates to 10:32am EDT. I imagine markets briefly feared the worst until details rolled in that it wasn't nearly as strong as the 9.0 quake and there were no serious adverse effects at the Fukushima nuclear plant. Phew.

How did that 8814 get in my return?

I normally fill-out my tax returns by hand and do the calculations using custom spreadsheets. But, this year, I decided to try e-filing options. The Massachusetts e-filing option worked well. The only hiccup was mediocre 1099-R instructions. But, the fix was easy and customer service communicated the fix to me quickly by email. There was a more serious issue with Federal e-filing. I used the free fillable forms provided by the Free File Alliance. A minor annoyance was that I had to use MS Windows to fill out the forms since the system uses Microsoft Silverlight. My return was "accepted" a few days after I submitted it. But, when checking status, I noticed that the IRS had changed my refund amount. I got my return about 3 weeks later with the modified refund amount. What was going on? I can't recall ever having my amount due/refund amount adjusted in 15+ years of filing Federal returns.

A phone call to the IRS didn't reveal much. After being transfered to a Schedule D specialist, he told me that I had to wait to receive a letter formally communicating the adjusted refund. I received the adjustment letter over the weekend and called again today. I learned that the IRS adjusted my Qualified Dividend amount because of the 8814 in my return. What? I had to have the IRS agent explain what he meant by "8814" as I had never heard of it. He said that an 8814 Form was included in my return indicating that my dividends were reported as child's dividends. Apparently, something went wrong between the Free Fillable Forms web site and the IRS processing center. The agent said that if I want the error to be fixed in less than 3 months (about how long a paper amended return would take to be fully processed), I would have to call back when I am ready to fax my correct 1040. I told him I could email it to him immediately since I have a scanner but no fax. He said the IRS doesn't accept such email due to "security concerns". Puh-lease. Why does "e-filing" have to be so frustrating?

Increase Rates to Lower Gas Prices

Oil (and gasoline) has been on the rise lately, up 29% over the past year according to the NYTimes. Why the rise? A recovering economy and unrest in northern Africa are commonly-cited reasons. Prices are ruffling enough feathers that Obama has publicly considered releasing supply from the Strategic Petroleum Reserve. Seriously? Shouldn't the SPR be reserved for true emergencies or for at least after other policy "weapons" have been exhausted? What I want to know is this: why isn't anyone looking to the Federal Reserve? The "Fed" is buying Treasuries and keeping the discount rate about as low as possible. Yet, the recession ended in June 2009, employment is recovering and signs of inflation are popping-up.

But, what does all this have to do with gas prices, you ask? Well, currency investments are often not made into raw cash, but rather bonds of the currency-issuing country. Cash doesn't pay interest; bonds do. So, if interest rates increase in a particular country, that country's currency looks more attractive to investors due to the guaranteed interest income. In other words, if the Fed can effect interest rate increases on Treasuries, then the US Dollar will become more valuable in the eyes of currency investors. This, in turn, will increase the value of the Dollar relative to other currencies and decrease the price of gas in terms of US Dollars. Of course, raising interest rates can also have the effect of slowing an economy. That was a serious concern 1-2 years ago when the prospects of a recovery were unclear. That's not the case any more. In fact, the Fed's discount rate needs to rise soon so that it can be used to soften the blow of the next crisis. Hopefully, the Fed will realize the benefits of increased rates before its too late.

Moving from Pensions to 401(k)s

The corporate world figured-out long ago that pension plans are untenable. It's simply not realistic to make promises 30-50+ years into the future. 'course, they didn't completely figure that out on their own. The Pension Benefit Guaranty Corporation was set up to guarantee pension promises made by corporations after a bit of a pension crisis in the 1970s. Companies which have pension plans must pay insurance premiums to the PBGC. The PBGC in turn pays pensions for bankrupt companies. That forced insurance premium payment was likely the tipping point. Why pay an extra tax on employee benefits when there are many ways to attract and retain talented employees? Anyone who thinks pensions are a great idea should look at the PBGC's finances. As of fiscal year 2010, they have $102.5 billion in obligations versus $79.5 billion in assets. 'course, it's possible that investment returns will make up the gap, but, if not, the US Taxpayer will likely be on the hook to make up the difference, as was the case with Freddie Mac and Fannie Mae.

The New York Times is currently running a "debate" on the Pension/401(k) issue. I'm amazed at some of the "arguments." Teresa Ghilarducci argues that 401(k) plans are bad for employees since

...401(k) management and investment fees are three times higher. And professionals who manage money in pooled pension funds usually get higher returns than workers who manage their own 401(k) accounts.

But, this is side-stepping the main issue which is defined-benefit versus defined-contribution. If governments and employees are concerned about this issue that Ghilarducci raises, then the government can simply continue it's pension management, re-branded as a 401(k) plan. This would eliminate fee/return issues while eliminating the defined-benefit aspect.

Ghilarducci also claims that pensions are better for managing talent:

Want an old cop to retire? Want to offer a career path to a young, earnest would-be teacher? Use a traditional plan. Risk seekers and high turnover workers tend to prefer 401(k) plans; but do taxpayers prefer those characteristics in a public employee?

If the old cop can't do his/her job any more, he should be demoted or fired---(s)he shouldn't be given a boat-load of taxpayer money. Use that extra money to pay top-dollar for the best new teachers so they don't all go to private schools.

Finally, Ghilarducci claims that "...401(k) plans fuel bubbles and make recessions worse." If anything, history seems to invalidate her claim. The Early 2000s recession was one of the mildest ever and the so-called Great Recession was barely worse than the Early 1980s recession and downright gentle compared to just about every recession before 1948. For easy to compare length, unemployment and GDP drop numbers, see Wikipedia's list of Free Banking to Great Depression and Great Depression onwards era recessions. Furthermore, 401(k) plans and pension plans invest in similar pools of equities and bonds and pensions tend to make (much) larger investment moves whereas many people barely touch their 401(k) plans.

A final flaw in Ghilarducci's logic is the assumption that a retirement opens the door for others:

At least now public sector workers can retire with a guaranteed pension, making way for other people to get jobs.

While this might be true in a very narrow sense, economies don't work like this. More jobs create more spending which, in turn, create more jobs. In fact, letting people retire earlier than they could on a defined-contribution plan just makes things worse for the new worker since he or the taxpayers will have to help pay for the retiring-too-early worker in the form of lower salary/benefits (for the new worker) or higher taxes (for the taxpayers).

Currently, many government pension plans are strikingly similar to ponzi schemes---retirees take out more than they effectively put in (considering government contributions plus investment returns). Now that baby-boomers are retiring and taking advantage of these generous pension terms, governments are finding it difficult to balance the books. It's only a matter of time before something has to bend.

Update (3/2/11): See David Leonhardt's Union Contracts, Not Pay, Are States’ Problem article for a good discussion of the real problems with public workers' contracts.

I Hate eFile

Massachusetts is strongly promoting their e-file income tax system. I should love it, right? I spend much of my time in front of a computer. I keep much of my tax information on my computer. What isn't there to love?

Let's start with a bug. It's trying to tax me on a qualifying indirect IRA-to-IRA rollover. The Form 1 instructions and this letter clearly state that the distribution is not taxable for Massachusetts income purposes if it is not taxable for Federal income purposes. In order for the rollover be Federally nontaxable, the money has to be deposited in a qualifying IRA within 60 days of receiving the distribution. We did this. Yet, there's nowhere in the WebFile for Income system to indicate so or to override the WebFile determination.

Is that the only complaint? No. Instead of helping me to make this determination, the WebFile for Income documentation only hindered my search. The "Help Library" included useless (to me) entries on rollovers and didn't even provide the relevant text from the Form 1 Instructions (!)

The only plus of the WebFile for Income system is that they caught a mistake I made in filling-out the dependent care expense worksheet. In incorrectly interpreted "qualifying expenses" as being the total paid for dependent care whereas part of the instructions clarify that line 1 of the worksheet should be line 31 of a pro-forma Federal 2441 with the Massachusetts limit entered into line 27.

In principle, I like the idea of electronic filing. It has the potential to be much simpler, easily eliminating 80%+ of the fields I have to fill-in with a traditional form. However, people always underestimate how difficult it is to get software right, especially for something as complex as taxes. I hope that the Massachusetts DOR keeps trying as the current version is a valiant effort.

Update (2/28/11): The Mass. DOR provided me with a speedy clarification: non-taxable rollovers should not be entered into WebFile for Income. I hope they improve their wording in future years as the system indicated that any 1099-R showing income should be entered into the system.

Rich Pay Only 14.7% Federal Income Tax

The NYTimes just posted an article entitled The Little People Pay Taxes. Also see the original article, At the Helmsley Building, the Little People Pay the Taxes. I think it's fascinating that it's so easy to identify a super-rich segment of the U.S. population since The Helmsley Building has its own zip code, 10169. Comments on the NYTimes article exhibit the usual outrage at the rich. But, it seems that many comment-ers didn't understand that the low tax rate paid by those rich residents of the Helmsley Building is probably just a simple result of the tax system we've made for ourselves. Here are some facts to consider:

• The year considered was 2007, the end of a bull market (in both stocks and real estate). The "poor" and "middle class" tend to have little money invested in stock and real estate whereas the "rich" tend to have large amounts of money invested in such capital-gains-vehicles. Long-term capital gains are taxed at 15% for high incomes.
• State and municipal bond income is exempt from federal tax. However, this income is excluded from Federal AGI and so is irrelevant for the referenced tax rate calculation. (It is entered into line 8b of the 1040).
• AGI excludes business expense deductions. Martin A. Sullivan notes that Helmsley frequently wrote off home improvements as business expenses. While there are cases where such expensing is legitimate, it sounds like Helmsley's was not, as she served 18 months for fraud and tax evasion.

Personally, I'd like to see more summarized details from these tax returns. In fact, it'd be great to see an average 1040 for the residents of the Helmsley building. It would also be quite useful to see the numbers for a year where there were few-if-any capital gains, such as 2009. I bet the federal tax rate as a function of AGI for the Helmsley residents would be quite a bit higher for 2009.

I wish more people would direct their outrage toward the convoluted tax system rather than at the people who manage to play it to their advantage. Here are some questions I think people should be asking:

• Why are long-term capital gains taxed at only 15%?
• Why is mortgage interest deductible?
• Why is state and municipality bond interest tax-free?
• Why do we allow the tax system to become more-and-more complex? The more complex it is, the more money you need to take full advantage of the system, and the less likely the IRS is able to enforce the law.

Enterprise Value

One valuable lesson I learned from The Little Book that Beats the Market is that market capitalization (of a stock) is only useful as a component in calculating enterprise value. Two companies with identical market capitalizations can have drastically different "values". Market capitalization just tells you (# of shares) x (current share price). Enterprise value tells you the (net) cost of buying the entire company at the current share price---when you buy, debt needs to be paid off and cash goes into your pocket. So, valuation metrics based on market capitalization miss an important aspect of valuation.

Are Mass Transit Systems Really More Efficient than Cars?

Some would have you believe that mass-transit systems are always more efficient than cars. But, it doesn't take much critical thinking to realize that this isn't always the case. Consider that mass-transit vehicles:

• are much heavier than cars
• must stop (and hence accelerate) frequently
• carry relatively few passengers during non-peak times and when traveling in non-peak directions

I'm not going to do a full analysis here since someone has already done that work for me. I encourage you to read Brad Templeton's mass transit analysis. His is one of the few, if not the only, analysis I've seen that is fair and reasonable. He notes that the US would be better off promoting fuel-efficient cars (increase the gas tax, anyone?) than building public transit where the benefits are murky. The Toyota Prius's 50 miles-per-gallon combined rating beats the average commuter rail efficiency and one of the more efficient subway systems (NYC). Of course, Brad fairly notes that at an individual level, mass transit is more efficient from a marginal perspective since the buses and trains are running no matter whether you use them or not.

New 1099 Requirements: A Heavy Burden?

The new health care law will require increased 1099 reporting for businesses. Currently, businesses must generally report payments of greater than $600 to non-corporations. Starting in 2012, they may also need to report payments to corporations. This could prove to be a significant burden. A small business which has no employees but purchases supplies from 10 different stores will suddenly have to acquire tax information from stores and learn how to generate and issue 1099 forms. But, the IRS has proposed a regulation to only exclude most credit and debit card payments since they are already reported by the issuing banks. The IRS is exploring other ways to eliminate duplicate reporting so as to limit the burden of the new law.

Fox News reports that the law may increase tax evasion and cash payments. Considering the credit and debit card regulation the IRS is likely to put into effect, I don't think there will be such a net effect. Credit and debit card business payments will incur few, if any, additional reporting requirements, so businesses would have little reason to change those. Cash and check business payments would incur new reporting requirements. Businesses which make cash and check payments of over $600 would be faced with a choice:

• Switch to using credit or debit cards.
• Start reporting the payments.
• Hide the payments.

Some businesses will switch to credit/debit cards while others will try to evade reporting, possibly switching check payments to cash to minimize the "paper trail". But, the costs of switching to credit/debit cards is low, whereas cash transactions incur loss, theft, and evidence-of-payment risks which simply don't exist for credit cards. So, I believe relatively few businesses will take the cash/evade approach. And, since the additional requirements will increase reporting and IRS knowledge, I think some businesses which currently hide some transactions will think twice in the future.