Wednesday, December 13, 2017

Stock Market Gains 2017

Kelly Evans on CNBC

Twice a week I go to a gym in a nearby Senior residential facility for a light workout. Most of the residents take exercise classes in the morning so when I go in the afternoon, I am virtually alone. I like to turn on the TV and watch the business news on CNBC for an hour. I like CNBC because it is much less political than Fox News, CNN, or MSNBC. Also, during the commercials the stock ticker keeps streaming at the bottom of the screen.
I usually watch “The Closing Bell” jointly anchored by Kelly Evans and Bill Griffith. It is a real plus that Evans and the other women on the show, while as attractive as those on the other cable news networks, do not have to expose their legs or show excessive d├ęcolletage. They are free to report the news and interview their guests without appearing as bimbos.
Usually the pace is rapid fire with guest panelists going back and forth in the limited time available. Evans and Griffith are intelligent and curious questioners who do a good job of keeping their guests to the point. Often, the panelists will disagree and it is apparent that no one has the proverbial crystal ball. Even when they marshal impressive statistics, it is obvious that these can be interpreted in different ways. One guest recently argued that the improved earnings of a company would likely cause its stock to drop in price.
Once in a while, a breath of truth will come through the torrent of words. Just the other day a panel was discussing how the proposed cut in the corporate tax rate would affect the airlines. One commentator suggested that the airline companies might use the tax savings to buy back their own stock to the benefit of stockholders. But the other panelist pointed out that the cut in the corporate tax rate will have little effect on the airlines because they don’t pay tax anyway. What! Even the anchors gasped. He went on to explain that the airlines had such large loss carryovers that they would not have any tax liability for years no matter what the rate.
I thought this observation was right on the money. It should be obvious that rather than give up 35% of their profits corporations have found ways to shelter those profits from high tax rates. One of those ways was to shift operations overseas to lower tax countries, a tactic that the lower rate is designed to make less attractive.
I think most of the opposition to tax reform comes from people who just hate President Trump and do not want anything he supports to be successful. The well to do progressives who hate Trump should ask themselves how Trump has actually hurt them. Has the country really gone to Hell since his election over a year ago?
So far this year the major stock indexes have gone up dramatically. The Dow Jones Industrial Average (DJIA) closed yesterday at 24504 up 24% so far this year. The tech heavy NASDAQ average has lagged the DJIA but still is up 17.64% this year, and the broad Standard and Poor’s stock average is up 19%.
I do not want to give President Trump credit for these gains although his critics will be quick to blame him if the market goes down next year. I suspect that the increase in stock prices has little to do with politics. The dramatic rise in the stock market began during the Obama administration and nothing that Trump or the Federal Reserve have done has impeded it.
In the first place, with returns on other investment being so low, where else have people been able to go to gain a decent return? Secondly, it would appear that the number of public companies is shrinking. We have high demand for stocks but the supply of eligible companies is getting lower. Whatever the cause, those who invest in the stock market do not seem to believe that the country is in bad shape after a year of Trump.
These stock gains have benefitted not just the rich but everyone. This year has seen record inflows of money into stock index and hedge funds. A large share of this money comes from pension funds. In effect, a pension fund that needs to average 8% a year has made two or three times that amount this year. Theoretically, it could just cash in and not make anything for another year or two.
People whose retirement savings are in 401k plans or IRAs have seen similar results. Anyone looking at their quarterly statement will see significant gains this year. The only problem is that their new contributions will buy fewer shares in their funds.
It could be argued that the poor do not share in these stock market gains but the poor paid very little tax under the present tax code, and will pay even less under the new. But business profits and stock market gains will allow well to do individuals to pay the taxes that shore up this country’s social service safety net.


Wednesday, December 6, 2017

Tax the Rich?


Now that the U.S. Senate and House of Representatives have passed tax reform bills, the bills will go to a joint committee of both houses to reconcile the differences before sending the final bill to President Trump for his signature. In the meantime, political commentators and cartoonists are only intensifying their efforts to brand the Republican bills as favoring the rich to the harm of everyone else.
In particular, they point to the potential reduction or removal of the estate tax as a huge benefit to the rich. Anyone who looks at the pie chart to the left will see that the estate tax makes up less than 1% of total annual revenues. Why is this so?
In the first place, I would guess that more than 95% of estates are exempt from the tax because estates under $5 Million are not subject to the tax. Indeed, in the new proposals the exemption will be raised to $11 Million. Only the very, very wealthy are subject to the tax but in most cases, they will pay very little.
When I worked as a financial advisor, it was common to refer to the estate tax as a “voluntary” tax, a tax only paid by those too lazy or stupid to take measures to avoid or minimize it. In fact, there was a host of lawyers and other so-called estate planners who specialized in advising wealthy clients in how to avoid dreaded death taxes. When Congress raised the exemption amount a few years ago, most of these parasites had to find other areas of work.
The very wealthy, both liberal and conservative, often turn to tax-exempt family “foundations” not only to promote their own pet causes but also to avoid estate taxation. We are all familiar with the Clinton, Gates, and Buffett foundations. Just this year wealthy progressive financier George Soros added $18 Billion dollars to his foundation.
Critics of tax reform also argue that lowering the corporate tax rate from 35% to 20% is also a boon for the rich. But if you look at the pie chart again, you will see that corporate taxes make up only about 10% of federal revenues. It should be obvious to all but the most die-hard progressives that any large corporation will use its high powered attorneys and accountants to use every means to reduce its tax burden.
Lowering the tax rate will make many of these tax-avoidance strategies less attractive. As President Trump has pointed out, these companies will have less incentive to relocate their operations overseas to lower tax countries, or to keep their profits overseas.
Moreover, what do companies do if they can keep more of their profits. If they are taxed at a lower rate, they might pay higher salaries or even keep prices down to the benefit of consumers, rich and poor. If they just pay out the profits to shareholders in the form of dividends, those dividends become taxable income to the recipients.
People think that only the rich benefit from corporate profits but stock ownership in this country has spread to millions. Practically everyone receiving a pension check has benefitted from the recent increase in stock prices because most pensions invest heavily in the stock market. Most holders of IRA or 401k accounts need only to check their most recent statements to see how much the upsurge in stock prices has helped them.
One element in the tax code that really helps the rich has so far received little attention from the media. Hedge fund managers have made enormous profits during the Obama administration. These funds are investment companies that in addition to earning high annual management fees also claim 20% of the profits they make for their investors. They can charge such exorbitant fees because they are largely unregulated due to the fact that they are not open to the general public. Only large investors can participate but many small fry do get involved because many state and local pension funds invest in them. A few years ago the pension fund of my own town of Fairfield lost millions because it had entrusted funds to a money manager who, for an annual fee of more than 2% (2% of millions of dollars is a lot of money), merely turned over the money to the infamous Bernie Madoff.
In any event for some reason Congress, whether run by Democrats or Republicans, has allowed these huge hedge fund fees to be taxed at a substantially lower rate than the rate on ordinary income. In 2016 both Donald Trump and Hillary Clinton campaigned against this policy, but so far I have not seen that either party is willing to change it.


Monday, November 27, 2017

Tax Reform and Advertising


For most of my 36 years in the investment and insurance business it was my practice to send out little desk top calendars to my clients during the holiday season. As my financial planning practice grew the number of calendars increased to the point where I was sending out more than 500. The calendars were practically my only form of advertising.
Before the advent of the internet and cell phones, the calendars were a way to keep my name and contact information before my clients throughout the upcoming year. I suppose some clients just tossed them but many seemed to love them and even claimed they anxiously awaited the arrival of their calendars each year. Some even wanted more than one.
I was a self-employed financial advisor who had to pay for the calendars and the ever increasing postage out of my own pocket. However, the cost of the calendars and the postage was considered a legitimate business expense that could be deducted from my business income before taxes. Actually, the cost was lumped together with other business expenses like office rent, staffing costs, travel costs, and utility bills and then subtracted from my total income for income tax purposes.
So, if the calendars cost $1000 and I was in a 35% tax bracket, they would reduce my income tax bill by $350. If I was only in a 15% bracket, the calendars would only have reduced my tax bill by $150. From another perspective we could say that the calendars cost me $650 and that the rest was paid by the Federal government. Of course, the government never actually pays anything. Taxpayers actually subsidized my advertising.
This little example should give some insight into the potential impact that tax reform might have on the incredible amount of advertising that we are subjected to in the world of the media. It is impossible to open your computer or look at your phone without being subject to a barrage of ads. Every so-called “news” headline is just a come-on to view an ad and increase ad revenues. Even though we pay a subscription fee to watch TV on cable, a large percentage of what we see will be commercials.  
The ultimate is reached every year during professional football’s annual Super Bowl when advertisers will spend millions for a half-minute commercial. In last year’s game a 30 second commercial cost $5 Million dollars just for ad time. That expense does not include what must have been the incredible cost of making the commercial.
However, just like my calendars, the cost of these ads is a legitimate business expense. If a car or beer company wants to pay $5 Million for a Super Bowl ad, it can deduct that cost from its corporate income before paying corporate income taxes. If a corporation is in a 35% tax bracket, it will save $1.75 Million in taxes, a huge subsidy from taxpayers. Not only do we have to watch these ads as they pop up on our screens, we have to pay part of the cost.
Tax reform that reduces the corporate tax rate to 20% will actually reduce the subsidy paid by taxpayers for advertising and other business expenses. Former GE CEO Jeff Immelt always took an extra corporate jet with him on his travels just in case. I suspect that the expenses of both jets were considered legitimate business expenses by GE accountants.
Most large corporations have huge accounting and tax planning staffs that work hard to find expenses to offset income. Reducing the corporate income tax will not only make American businesses more competitive with the rest of the world, but it will also make them warier of foolish spending practices that are designed to just provide tax write-offs.
I don’t like to make predictions, but I will predict that if the corporate tax rate is reduced to 20%, there will be a major shake-up in the world of advertising, especially in the case of ad giants like Goggle and Facebook.