Thursday, August 18, 2011

Dreaming of Plurality

We’ve just returned from the future – December 18th, 2012 to be exact – and the lead story in the newspaper we picked up for "investment advice" said the following:

WASHINGTON - The Electoral College has voted and, as predicted by the general election results, no candidate received the 270 votes required to be elected as President of the United States. President Barack Obama received 213 votes, Governor Mitt Romney received 165 votes and Mayor Michael Bloomberg received 160 votes as every state adhered to their usual practice of voting in line with their state’s election results.

Per the rules of the Twelfth Amendment of the Constitution, the election is now in the hands of the House of Representatives who, for the first time since 1825, will be required to choose the President. Each state’s delegation is permitted only one vote (no vote for the District of Columbia) and the candidate who receives 26 or more votes will become the President-elect. The House will continue voting until a candidate receives 26 votes.

Despite receiving a plurality of the popular vote, it will be virtually impossible for President Obama to receive the 26 votes necessary to get re-elected given the large Republican majority in the House (33 state delegations have Republican majorities).

While President Obama’s outlook is bleak, the outlook for the other two candidates is less clear. The ultimate result will depend on whether House Republicans decide to remain loyal to the Republican Party nominee or whether they will remain loyal to their constituents’ votes. If they remain loyal to the Republican Party, Governor Romney has a clear path to the White House; however, if the delegates remain loyal to their constituents’ votes, it will be a battle between Governor Romney supporters, Mayor Bloomberg supporters, and potentially even Democratic state delegates. The wild card in this voting process is the Democratic states, who, knowing that a vote for President Obama is a wasted vote, could vote for Mayor Bloomberg in an attempt to prevent the more conservative Governor Romney from reaching the Presidency.

There will be urgency to this battle as the Twelfth Amendment requires that a President be selected before March 4th, the failure of which will result in the Vice President being named as President.

The Vice President will be selected by the Senate following a similar procedure, except that all Senators are permitted to vote and only the candidates with the top two Electoral College votes are eligible. Therefore, only Vice President Joe Biden and Governor Nikki Haley are permitted on the ballot, and with a clear Democratic majority in the Senate, it’s almost certain that Vice President Biden will have 4 more years in One Observatory Circle.

Both the House and the Senate have called sessions to hold the special elections tomorrow at 10am.
Imagine the chaos this election result would produce? Cable TV could spontaneously combust at the mere possibility of this scenario. Democrats would be up in arms about losing another election after receiving the most votes and Republicans would be fuming about the entrance of a right-leaning independent into the race, poaching votes from their nominee, a la Ross Perot (even though they would likely win any House vote).

We’d love it.

This would solidify the viability of an independent or third party candidate in our way- too-polarized world of politics. The 2012 election is shaping up as the perfect venue for this to occur. Numerous Democrats are unhappy with President Obama, Governor Romney (or whoever wins the Republican primary) will be too far to the right for many moderate Republicans, and independents are itching for the chance to vote for a reasonable candidate who’s not beholden to the pure and strict Democratic or Republican views on life. Even if Mayor Bloomberg, Governor Huntsman, the Americans Elect nominee (by the way, we love this idea, but not sure it's ready for 2012) or any other viable moderate fails to win the general election outright, they will have set the stage for independents to confidently run as such in their local elections – whether it is for city councils, state legislatures, seats in Congress or future Presidential elections.

The 2012 election could go down in the history books as the year independent candidates became relevant and took their rightful spot alongside the out-dated duopoly of the Democratic and Republican parties.

We hope our trip in the flux-capacitor-powered Delorean is prescient and not just a naively optimistic dream…

Tuesday, August 16, 2011

Warren Buffett's Missing Facts and $3,000 Gallon of Milk

The has great admiration for Warren Buffett, but we take issue with the completeness of his high profile op-ed in Sunday’s New York Times. After reading the headline, we immediately knew that it would be latched onto by President Obama and the media, and posted as a link 4,354 times on our Facebook and Twitter accounts as a “we told you so” for increased taxes on “millionaires and billionaires.”

We’re not even close to being affected by Mr. Buffett’s proposal, and are not opposed to increased tax revenue if done in a responsible and balanced manner, but it’s important to keep this issue in perspective.

Higher taxes on 0.2% of the population is a lazy and populist political solution to a major and complex fiscal problem.  As we’ve mentioned before, these taxes would have a limited impact on the deficit and only serve to distract from the real cuts and reforms required to reduce long-term deficits.

To help complete the analysis, here are some key points, derived from IRS data (i.e. cold hard facts), that everyone needs to keep in mind when referencing Mr. Buffett’s piece - points that you are unlikely to see in other media stories or populist rhetoric on TV:

  • The 245,107 households that earned more than $1 million make up roughly 0.2% of total tax returns filed, yet provide roughly 28% of total income taxes paid into the US Treasury. These taxes were paid on earnings that amount to 15% of total adjusted gross income (AGI). 0.2% of the population making 15% of total AGI is stunning, but having that same 0.2% pay 28% of the total tax bill is even more stunning, especially when the current political argument for higher taxes for “millionaires and billionaires” is made under the guise of “fairness.”
  • The top income tax bracket has a rate of 35%. We’d like to understand how his employees have effective tax rates of 33% to 41% with an average of 36%. I’m sure there is a very good reason for this, likely resulting from Mr. Buffett’s convenient and incredibly misleading inclusion of payroll taxes paid by the employees and on behalf of the employees. Most of these taxes are only paid on the first $100,000 or so of income and are paid (in theory) to fund the future benefits of Social Security, Medicare, Unemployment Insurance, etc. No different than the insurance premiums that Mr. Buffett has built his fortune on. This cost results in an insignificant rounding error in Mr. Buffett’s effective tax rate, but has a larger impact on his staff’s (who presumably make significantly less than Mr. Buffett) effective tax rate. The comparison is very misleading because Mr. Buffett will receive the exact same Social Security, Medicare, Unemployment (HA!) benefits as his employees. Why should he pay more for the same benefit? Because he can? It’s the logical equivalent of charging Mr. Buffett $3,000 for a gallon of milk because he earned 1,000 times more than the average household. 
  • Mr. Buffett’s personal effective tax rate is not representative of the 0.2% of the population that made more than $1 million in 2008, nor is it representative of his 399 peers in the “super-rich” club.  Based on this data, we estimate that those who made over $1 million paid an effective tax rate, as a group, of approximately 23%, and according to Mr. Buffett, his peers had an effective rate of roughly 22% (as compared to an effective rate of roughly 10% for the remaining 99.8% of taxpayers). Other than citing the capital gains and carried interest tax rate of 15%, Mr. Buffett does not explain why his effective tax rate is 25% less than his peers. It’s bad science and bad policy to rely on one man’s tax return to justify a change in the tax code that affects 245,107 or more people. 
  • Regarding the 15% capital gains tax, Mr. Buffett has repeatedly failed to address the interaction between capital gains taxes and corporate taxes. In theory, capital gains taxes are lower than the marginal rates because the investors economic gain has already been taxed (at least) once at the corporate level. Any distributions of those net gains (i.e. total gains less corporate tax paid) are taxed again in individual tax returns as capital gains. Using a very simplistic example, if the capital gains tax rate was 35% (same as corporate tax rate, and the highest individual rate), a $100 economic gain would result in an after tax benefit of $42.25 for the investor. $35 ($100 *35%) would be paid in corporate taxes, and $22.75 ($65*35%) would be paid in income tax. Therefore, the government will receive $57.75 for every $100 of economic gain generated by business activity. For the mathematically challenged, that’s a 57.75% tax rate on economic activity. This becomes infinitely more complicated due to the unwieldy US tax code, but the concept remains valid. Look to Europe to see the results of that level of taxation. Carried interest is a complex issue that we’re not qualified to comment on, but it’s an immaterial issue as it relates to the US debt problem. 
  • The is full of CPA’s and we still can’t figure out all these various taxes, deductions, exclusions and special rates. This has nothing to do with Mr. Buffett’s op-ed, but it speaks volumes to the unnecessarily complex, voluminous, out-dated and special interest laden US tax code.
  • Mr. Buffett identifies who should pay more, but does not suggest how much more they should pay. 10% more, 25% more, 50% more, 100% more? This seems like a very important aspect of the debate. For the record, the government could take every last cent from those making over $1 million dollars (i.e. a 100% effective tax rate), and ignoring the devastating impacts of that property grab on incomes and the economy, that tax revenue would still not cover the single year deficit projected for 2011. 
  • If he feels his tax contribution is too small, Mr. Buffett is free to write a check to the IRS. 
  • Mr. Buffett fails to mention the impact a higher tax rate would have on his charitable giving programs. He’s pledged to give huge amounts of his fortune to charity – wouldn’t a higher effective tax rate take money away from that fortune, and therefore away from his charities? I’d like to hear Mr. Buffett’s views on who will make more effective use of his fortune, the US government or his preferred charities. If Mr. Buffett wanted to provide $100 million to improve education, who would he want spending that money – Congress and the Department of Education or the Bill and Melinda Gates Foundation? 
  • Here is a summary of the IRS income tax data referenced above, we think it’s quite interesting:

Again, could Mr. Buffett afford to pay more in taxes? Absolutely. Would a sensible and reasonable increase in tax rates on those making over $1 million have devastating impacts on the economy? Probably not. Would that same increase make a noticeable dent in the budget crisis? No. Is it a political winner to scapegoat “millionaires and billionaires” while at the same time asking them to pay even more in taxes? Might be, but that’s why we’re here.

Tuesday, August 9, 2011

Desperate Times, Desperate Measures

Wow, the S&P downgrade has sent the panic in liberal Washington to incredible heights.

In what must be a coordinated effort, numerous Obama administration officials, leading Democrats, and liberal media outlets, including David Axelrod, John Kerry, Howard Dean, and the usual suspects at the New York Times, took to the airwaves and print over the weekend in an aggressive attempt to brand the S&P downgrade as the “Tea Party Downgrade.”

They’ve resorted to the theory of throwing everyone up against the blame wall in the hopes that someone sticks. The Tea Party has now joined a wall that already includes George W. Bush (ad nauseum), S&P, fat cat Wall Street bankers, China, Big Corporations, private jet owners, “millionaires and billionaires”, Boeing and pretty much everyone except themselves and their campaign contributors.

Desperate times call for desperate measures.

We do not identify ourselves as Tea Partiers. We’ve previously cautioned them to not overplay their hand during the debt ceiling debacle, for which they obliged, yet they are unjustifiably the scapegoat du jour for President Obama's administration. This is the ultimate cop-out in populist politics, shows an incredible lack of leadership and is revolting.

Let's look at the plain facts of the debt ceiling debate, the result of which led to the S&P downgrade:
  • The President wanted a clean debt ceiling increase, and has proposed a budget that increases spending to historic levels. 
  • The Tea Party opposed a debt ceiling increase, arguing that it’s too high already, and provided input into a Republican budget that significantly cuts spending in an effort to balance the budget. 
  • Congress and the President reached a compromise where the President received 100% of his debt ceiling increase, upfront, in exchange for some immaterial spending cuts over the next 10 years and the hopes of additional, yet still immaterial, cuts-to-be-named-later by another special committee that is doomed to fail.
Despite the liberal outrage, it seems that President Obama worked out a pretty good deal. He got all of his requested debt limit increase, avoiding an election season showdown, only had to agree to immaterial cuts to discretionary spending, and washed his hands of any future cuts by deferring the tough decisions to a Congressional committee. This "compromise” avoided a “default” but, in the minds of S&P, was too weak to keep us in the AAA club.

There is not a single rational reason why the Tea Party (which only recently has all of 15% of the total seats in Congress!) should get blamed for the downgrade, when they are the only party in town attempting to seriously fix the fiscal problems cited by S&P.

Additionally, what exactly did the Tea Party gain from the debt ceiling debacle? A moral victory from achieving spending cuts that are completely immaterial to the overall budget? Another opportunity to suggest sensible cuts that will ultimately get ignored by Democrats and most Republicans because supporting those cuts might hurt their ever-important re-election campaign? Their biggest win was avoiding President Obama’s last-minute, Populist Politics 101, demand for tax increases on “millionaires and billionaires” (interestingly defined as those who make more than $250,000 a year, including small businesses) that wouldn’t have made a dent in our budget problems anyway, and in fact, could actually compound the problem.

The President and Democrats were so intent on avoiding a “default” that they were happy to just kick the can down the road...again. Apparently S&P’s had enough with the can kicking and took the bold action of downgrading the US from a 0.0001% chance of default (AAA rating) to 0.001% chance of default (AA+ rating), turning a virtually meaningless downgrade into a political football.

The President and Democrats quickly punted and immediately went on defense by aggressively pointing their fingers at the Tea Party and holding yet another press conference spouting out the same meaningless clichés and talking points.

The American people want leadership in the face of our economic crisis, not blame games, condesending clichés about “shared sacrifice” and “compromise” or deferrals of important decisions to others.

Desperate times indeed.

Sunday, August 7, 2011

The "Progressive Crack Up"

Here's a brilliant op-ed in Saturday's WSJ by Peter Berkowitz.  No party has a stranglehold on hypocrisy, but this piece does an excellent job at highlighting the hypocrisy in today's progressive politics.  A couple of our favorite lines -
"Progressive partisans also displayed economic illiteracy, refusing to recognize the respectability or even the existence of alternative economic views."
"How often they have haughtily lectured the nation on the vital importance of civility in public discourse, the urgency of constraining executive power under law, and the need for impartial expertise in public affairs to pragmatically weigh competing public-policy options. But in the debt-limit debate the virtues they profess could hardly have been more spectacularly absent."
"Add to this the progressive belief that human beings can be perfected through the rule of experts, and you have a recipe—when the people make choices contrary to progressive dictates—for generating contempt among the experts for the people whose interests they claim to alone represent. And not just contempt, but even disgust at diversity of opinion, which from the progressive's perspective distracts the people from the policies demanded by impartial reason."

Monday, August 1, 2011

But Americans Want It!

“Poll after poll suggests that Americans prefer the president’s call for a mix of spending cuts and tax increases to the Republican Party’s anti-tax approach.” – Ross Douthat in his Op-Ed in today’s New York Times

This is an argument that we hear over and over again from the “tax the rich” crowd (President Obama, New York Times, Bill Maher, etc.), but it’s an incredibly weak argument and fails the test of logic.

For starters, it’s a stretch to say that the results “suggest” that Americans prefer a mix of spending and tax increases.

50% responded that the deficit is best reduced with only/mostly spending cuts, while only 11% respond that the deficit is best reduced with only/mostly tax increases. To me, this “suggests” that tax increases aren’t very popular. Additionally, given the fact that the President continues his sharp rhetoric for “millionaires and billionaires” and “huge corporations” paying higher taxes, it would be reasonable to assume that 98% of those who replied “mostly with spending cuts” (30%) and many who replied ”equally with spending cuts and tax increases” (32%) support raising someone else’s taxes, not their own. Which leads to my next point…

It’s a flawed analysis of responses to an incomplete survey question. 

Does it surprise anyone that Americans prefer that someone else pay more taxes to reduce the deficit? It shouldn’t. I wonder what the results would be if we changed “Equally with spending cuts and tax increases” to “Equally with spending cuts and an increase in my taxes”? How many people would change their mind if it was their own money being used to reduce the deficit created in Washington, and not just "milionaire and billionaire" money?

Simple analogies illustrate the flawed analysis. What if we polled everyone in line at the post office (where we know there will be a statistically significant sample) and asked them "who should pay for your postage?" The multiple choice question has two answers – “I should pay for my postage” and “Millionaires and billionaires should pay for my postage”. I guarantee the poll would “suggest” that Americans prefer that "millionaires and billionaires" pay for their postage.

Would it then be logically sound to use those poll results as an argument for forcing "millionaires and billionaires" to pay for the postage charges of the rest of the populiation? How about a poll asking “Would you prefer to pay for pizza on Friday’s or have free pizza on Friday's?” Again, I guarantee that poll would “suggest” that we pass legislation requiring Free Pizza Friday’s across the country, because, hey, poll data suggests that Americans prefer free pizza.

As we've mentioned before, we're not necessarily opposed to tax increases, but we'd prefer tax policy to be based on sound economic theory and evidence, not poorly constructed public opinion polls, which as we've shown above, will always "suggest" that someone else pick up the tab.