Millionaires and Billionaires

Wikipedia  (http://en.wikipedia.org/wiki/Millionaire ) defines a millionaire as one whose net worth is at least 1 million units of currency. A billionaire has about 1,000 times that much. Net worth is a concept that is calculated by subtracting what you owe from what you own. Furthermore, statistics tend to net out a family’s primary residence. In that sense net worth is essentially examining your ability to spend beyond your primary house. For example, if I borrowed $1 million from the Dumbhead Bank of Bloomington and I bought $1 million dollars of gold (or a second home or a Rolls Royce, etc) – that would not improve my net worth. I would have more stuff but I would also have a big liability to go with it. I would not be wealthier. If, on the other hand, I now own bonds, stocks, second homes and numerous cars and but I have no debt, then I would have substantial net worth that increases my ability to spend.  

Millionaire has a special and specific meaning. According to Wikipedia’s further analysis approximately 3 million persons or 1% of the US population is a millionaire in the sense of net worth. Wikipedia says that about 95,000 US families have more than about $30 million in net worth. Of course, there is some disagreement about the exact number of millionaires but I won't get into that here.

So what does all that mean? Let’s suppose your net worth is $1 million. At today’s interest rates you might be able to invest that money with little risk at about 3-4%. That means that your net worth could produce an annual income stream of about $30,000 to $40,000 per year. That’s a lot less than a plumber earns in most cities of the USA.

Which Americans have all that net worth? The answer is that half of them are retirees. That is, these are people who spent much of their lives squirreling away money here and there to take care of them in retirement. For those who acquired millionaire status as a result – they can live on a little more than $30,000 to $40,000 per year assuming they eat into the capital to live.

We hear some politicians saying they want millionaires and billionaires to pay more in taxes. So notice a couple of things. First, many of these folks are old people who spent their lives saving and probably live on less than $50,000 per year. It hardly seems fair to penalize these people. Second, let’s see what we can get from them. If there are 3 million people whose average net worth is $3 million, then by confiscating all of it we would net a one-time amount of $9 trillion dollars. That sounds like a lot of money. But think further. The US government will spend about $3.8 trillion in 2012. So that doesn’t make a lot of sense. We take away all their wealth and blow it in less than three years! What do you do in 2016? They have no more wealth left to take!  The estimate for the Gross Federal Debt for 2012 is a little more than $16 trillion. So a 100% net worth tax on all millionaires would still leave us with a debt of $7 trillion and no real means to keep it from rising thereafter by about $1 trillion a year.

No one has suggested taking away all the assets of millionaires but this illustration shows that if you took a more “reasonable” 20 - 30% of millionaire’s wealth -- it isn’t going to go very far to solve our problems. You cannot just increase the taxes on millionaires and billionaires and hope to avoid major changes in taxes paid by the middle class or reductions in the growth path for spending.

No one has seriously mentioned raising the necessary funds by taxing the net worth of millionaires. In fact, while the rhetoric focuses on millionaires and billionaires, tax policies are aimed at annual incomes. Much of what I read today defines policy in terms of adjusted gross incomes and mostly for families well below the million dollar income mark. I keep seeing numbers like $200,000 to $250,000. Since when is someone who earns in that range a millionaire? I agree that these people are doing pretty well. But do they really fit the vivid picture of a millionaire? Are they really people who are the envy of the rest of us? Are they people who somehow lied or cheated their way through society and now fail to pay their fair share?

I won’t sufficiently answer those questions because many people simply want to take from these folks regardless of the real situation. But maybe Joe made that much because he worked 16 hours a day for forty years at a tough job. He is now really good at his job and earns both respect and high income because few people have the skill or knowledge he brings to his job.  Maybe Tom is a retiree who saved for 50 years and now enjoys a decent retirement income. He made a decision that it was better to spend less in his younger years so he could enjoy some income security in his retirement. Maybe Ann worked her way through college, borrowed money for an advance degree, and is now a prominent scientist engaged in the development of new cancer drugs. Given our tax laws in the US – many of these people are entrepreneurs who forsake normal working and social lives and risk everything to start and run new businesses.

The point is that it is both rude and careless to stereotype. Stereotyping the poor is always frowned upon. But somehow making baseless conclusions and insinuations is perfectly okay when talking about people who hold $1 million in a saving account or who earn $200,000 per year. 

Rather than stereotyping anyone, one wonders why our politicians do not spend more time telling us why despite a long-term running war on poverty the number of poor people continually rises. When are they going to be honest and admit they lost the war and need to find out what went wrong. Why despite almost a century of social security have they failed to make it financially sound? Was the retirement of the baby boom generation starting in 2011 a big surprise? Did they not have 65 years to get ready for their retirements? It is sickening to stand by and watch politicians totally ignore their responsibilities to society while they insult us with meaningless demagoguery.  It is okay to discuss raising taxes. It is okay to ask wealthier people to pay more. But all this should be part of an earnest and respectful attempt to solve our national problems. 

Paul Ryan, Barry Manilow, and Edward R. Murrow

I don’t know about you but I am ready to turn my Walkman on full volume until election day. I’d rather hear Barry Manilow sing Mandy 10,000 times or have a double order of extra-garlic kimchi jammed into my ears than go through what is only going to get worse as we approach the Tuesday after the first Monday in November.

Mitt Romney chose a running mate and you would have thought from the bloody howls of the Democrats that he was supposed to pick Nancy Pelosi or Paul Krugman. Tone it down dudes – Paul Ryan is a Republican. As a result he has already signed a pledge in pickle juice to hate unions, emasculate females, reduce entitlements to a negative number, and find new ways to keep Romney’s average tax rate at .000001% of his income.

Sure, it is easy enough to turn off the TV, radio, iphone, ipad, ipod, car radio, and your next-door-neighbor, but geez, how did we get from there to here. And when I say there, I am remembering the time when you actually had to go downtown to buy a newspaper. Our TV had “rabbit ears” adorned with tin or aluminum foil and had a tiny screen that was best suited for a haze induced coma or some form of mediation. The closest thing you could get to news came from Edward R. Murrow and Ed Sullivan. Instead of somewhat objective news and commentary about once a week, we now get hot-off-the-press minute by minute reports and debates about Romney’s latest prostate scores. What a mess.

What can a moderate, thoughtful, rule-following, JD chugging person like you and I do for the next few months? My advice is to chew your meat at least 20 times before swallowing and to try to stay above the fray. While the former is easy to do, the latter is harder and takes practice. Just because all your relatives are extremist wackos does not mean you have to get sucked into arguments. For example, Ashley asserts that the world is clearly flat. Jason retorts that it is clearly not flat and explains passionately that it is hilly. Clearly all it takes is a quick drive though Brown County Indiana to see that the world is not flat. While Ashley says I always take Jason’s side, in this case it is best to stand back and let them argue. You and I and another 2 billion people who have passed third grade astrophysics all know that the world is a square planet that revolves around the moon but there is no real way to convince J&A of that point as they finger-point and mud wrestle.

That’s why I say that staying above the fray is important. Getting sucked into arguments between people with extreme views is basically a waste of time and good mental health. But that doesn’t mean one does nothing. It is true that it is hard to see a time when moderate views will prevail but one does not have to give up or give in. I once visited with Latvians who longed for the day when they would be free from the Soviet Union. They had to go through the motions each day as a Soviet citizen but many of them kept sane by planning for how they would again freely use their own language,re-introduce their former currency the Lat, and return to drinking copious amounts of Aldaris.

What does that mean for the people of the US? Could we please give up on identifying Romney’s tax returns and Obama’s college records? Instead we might want to think about some of the critical issues of the day. Health care problems were not solved by Obamacare. Just like Medicare D taught us, a new entitlement is going to cost us zillions more than initially anticipated. You do not have to be a Republican to wonder how we are going to pay for the healthcare services that will be required by tens of millions of newly eligible people. Then add to that the pressure of the boomers on social security, poorly funded private pensions, and the prune industry. Oh yes and we still seem to have a few problems left in housing, banks, and other financial institutions. No one has uttered a word about how to better reduce poverty and we have nothing but hot hair when it comes to facilitating job-creating long-term economic growth.

The point is that we have some difficult political decisions to make and while the zealots running our country now seem hopeless at even discussing whether to order white or wheat bread, it won’t hurt us to get educated about ways we can actually solve some of these problems.  If you want to learn how to build a house there are good sources of information to accomplish this. This approach is better than letting your neighbors drink your expensive wheat beer while they hotly debate the pros and cons of wood versus aluminum siding. The same is true for economic issues. There are many good things to read and programs to watch that avoid ideological purity.

Perhaps those of you who are still either awake and/or sober might help me with this discussion. Do you have recommendations for highly readable and minimally biased sources of economic information about our current economic problems? What do you recommend? Can you recommend a good source for housing problems? Healthcare policy? Maybe if we use this blog to share good sources of information that will help divert our attention away from all the stupid stuff we read and see. I promise (ha ha) to reward each recommender with a free bottle of virtual JD. 

I can kick this off a little bit. Most US regional Federal Reserve banks have publications, for example the Federal Reserve Bank of St. Louis publishes National Economic Trends and Monetary Trends. The US government has many good sources of information from the Bureau of Labor Statistics (employment and inflation), the Bureau of Economic Analysis (GDP and international trade), and the Congressional Budget Office. The World Trade Organization, The International Monetary Fund and the Organization for Economic Cooperation and Development are international organizations that among other things publish macroeconomic forecasts for the world. Your local college or town probably has non-political forums or guest speakers that are not always highly ideological.

I know what you are saying – Larry, this is like work. But let’s face it – you have a choice. You can listen to idiots shout at each other in bright, vivid colors with lots of useless and annoying commercials – or you can use that time to do something positive. Better yet, you can keep reading this blog and send money so that I can take care of my wacky relatives. 

Falling Off a Cliff? By Guest blogger Buck Klemkosky

Note from Larry -- I originally posted this article with an early draft. Please note below that I have inserted the proper and updated third paragraph. Apologies for excessive JD while on duty.

Falling off a cliff may be harmful to one’s health or even life if the cliff is high enough. In the U.S. a fiscal cliff looms in 2013 if Congress and President Obama do nothing between now and January 2, 1013. The fiscal cliff refers to the automatic tax increases and spending cuts that take effect in January 2013. Many believe that the combination of the tax increases and spending cuts will push an already slow-growth U.S. economy into a recession in 2013. The problem is that the U.S. has presidential and congressional elections in November 2012, and most of those up for re-election, including Obama, seem unwilling to address the fiscal cliff issue before the elections. After the elections, there will be a lame-duck Congress and perhaps a lame-duck president with little incentive to address fiscal issues. Many remember the U.S. debt ceiling debacle in August 2011 and anticipate the same political paralysis in addressing U.S. fiscal policy and the looming fiscal cliff.

The amounts involved in the fiscal cliff run into billions of dollars. The tax increases mostly center on the Bush tax cuts in 2001 and 2003, but also involve some of Obama’s tax cuts that will also expire at the end of the year. The Bush tax cuts were set to expire at the end of 2010, but were extended for two more years as a compromise in the last debt ceiling increase.

If the Bush tax cuts expire, the maximum individual income tax rate will increase from 35.0 percent to 39.6 percent, plus a recently enacted Medicare tax of 3.8 percent, for a new maximum tax rate of 43.4 percent. And this will affect not only high-income earners. The 10 percent income tax bracket will be eliminated and the upper levels of tax brackets will be 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent, up from 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. So everyone will pay more income taxes if the Bush tax cuts expire at the end of 2012.

Almost half of those who file U.S. income tax returns do not pay federal income taxes. However, even these will pay more taxes. Obama had cut the employee share of the Social Security payroll taxes from 6.4 percent to 4.4 percent and this provision also expires at the end of 2012. Since everyone who works pays this tax, all income levels will be affected. For example, someone with an income of $50,000 will see his or her Social Security tax increased from $2,200 to $3,200. Additionally, the so-called marriage penalty, which had been eliminated by doubling the standard deduction for couples and adjusting tax brackets, will return. Limits on itemized deductions and personal exemptions will be reinstated, meaning more taxes for higher-income taxpayers. Change in the alternative minimum tax provisions may also result in more people paying higher taxes in 2013.

Investors and wealthy individuals will also pay more as the tax on dividends increases from a maximum today of 15 percent to 43.4 percent in 2013 – the same as the tax on income. The long-term capital gains tax goes up from 15 percent to 20 percent, plus the 3.8 percent Medicare tax for a 23.8 percent rate. The estate and gift tax goes up from 35 percent to 55 percent, and the estate and gift tax exemption amounts drop from $5.1 million to $1 million.

So tax increases will increase government revenues. On the expenditure side, mandated spending cuts will be triggered by the failure of the congressional “Super Committee” to reach a long-term deficit reduction plan in 2011. The committee could not agree on $1.2 trillion in deficit reduction over the next decade, so the automatic cuts to all non-entitlement programs will kick in next year. Most of the cuts will come out of the defense budget.

Adding up the tax increases and spending cuts amounts to approximately $435 billion or 2.75 percent of 2012 GDP of $15.8 trillion. As mentioned previously, many are of the opinion that this will create such a fiscal drag that it will certainly push the U.S. economy into a recession in 2013 if not before. Economic growth has already slowed to annual rates of 1.9 percent and 1.5 percent in the first and second quarters of 2012, precariously close to zero or negative growth.

Can there be a silver lining if the U.S. falls off the fiscal cliff? Certainly in the longer term. Including fiscal year 2012, the last four federal budget deficits have each been more than $1 trillion and averaged 8 percent of GDP. The $5 trillion in accumulated deficits don’t appear to have helped the economy that much. The accumulated growth since the recession ended in June 2009 has been 7.1 percent, the weakest of all the post-World War II recoveries. The last three economic recoveries have been below par, but this one is the worst three-year performance to date.

So where is the silver lining? Since deficit spending has not stimulated a strong economic recovery, the $435 billion of tax increases and spending cuts may not be the Armageddon many fear. And they may rectify federal budget deficits that are not sustainable in the long run. This fiscal year, ending September 30, U.S. tax revenues are estimated to be $2.46 trillion or 15.7 percent of GDP, while expenditures are estimated to be $3.6 trillion or 23.4 percent of GDP. The projected deficit of $1.1 trillion means that only 68 percent of expenditures are funded by tax revenue. The rest, 32 percent, will be covered by the issuance of debt. Eventually bond investors are going to say, “Enough is enough,” and demand higher interest rates to buy U.S. Treasury securities. Historically low interest rates have helped the U.S. finance its deficits; much higher rates could be a catastrophe. So going over the fiscal cliff could help the U.S. get its fiscal budget under control on a sustainable long-term basis.

Resolving the fiscal cliff question as soon as possible may be more beneficial to the U.S. economy than whether we go over or not. The  uncertainty of the outcome has already affected corporate investment decisions and consumer spending. Less uncertainty will go a long way in helping the economic recovery. Too bad politicians don’t think that way.

How can you believe in markets when they seem so wrong?

To be more specific, world stock markets sprinted like scantily clad beach volleyball players on July 26^th and 27^th purportedly because both the Fed and the ECB gave signals that they are ready to save the planet from space invaders. Well not exactly space invaders but that is not out of the question. I can just see Mario Draghi dueling with ET! Because of actions and statements from these two mighty central banks, the world seems to be reassured the worst will not happen to our shared global marketplace. Evidence of this reassurance was the Dow’s climb to back over 13,000. Why would investors buy stocks at higher prices unless they were optimistic that things will get better and that stock values will increase even more? This is the market working – central banks act brave – people get more optimistic -- people buy stocks – and stock prices rise.

Just because markets are working it does not mean that markets are always correct. When I was a toddler in graduate school I learned about something called rational expectations (RE). My colleague at Indiana, Jack Muth, invented this idea and several macroeconomists (notably Thomas Sargent, Robert Lucas, Robert Barro, and others) were adding the RE hypothesis into otherwise dumber macroeconomic models (that assumed adaptive expectations). The cool thing about RE is that it assumed that people learn. That is – we are not consistently fooled. If Chuck Jolly sneaks up behind you in fifth grade and pulls your pants down enough times – you eventually learn to avoid Chuck Jolly or find a stronger pair us suspenders. In macroeconomics RE states that on average over time the public is able to forecast prices correctly. The words ”On average” mean that you learn. Sometimes you forecast too high. Other times you guess too low. But as an average over time you learn from your mistakes and get is about right. That doesn’t sound too crazy unless you think people are simply irrational and don’t much care. In that case I do not know what assumption to put into a macroeconomic model.

The point of the last paragraph is that there are no assumptions in useful economic models that assume that the public guesses right all the time. Thus, one can believe in the power of markets and still believe that the strong response in the stock markets was simply off base. RE says that when markets learn that they were wrong, then the market will adjust. In the case of the July performance cited above, it seems to me that the stock markets will soon reverse.  As a retiree who will live off the value of whatever stocks are left in my portfolio, I take no joy in making this point.

So why am I so pessimistic about the results of the Fed actions?

It is true that central banks have a lot of ammo. Central banks can inject trillions of dollars or euros at will and it’s as easy as slipping on a banana peel. So it is true that central banks can easily slip a bunch of money into banks. It is also true that in doing so, they can influence some interest rates. So if they buy a bunch of slip-shod mortgages, it is likely they can force the interest rate on slid-shop mortgages down a notch or two. If they buy Spanish bonds they can do the same. They can also promise to keep interest rates low until hell freezes over. In doing this they can try to convince people that the central banks will make it as easy to borrow tomorrow as it today. So why am I not skipping down Kirkwood whistling a happy tune?

First, look around you. There is no lack of money in banks and interest rates are not high enough to stop anyone from borrowing money. In the USA you can borrow gobs of money to buy that 19 bedroom house you always wanted as an assistant professor with a wife, 1.2 children, and a pet boa. This week you could borrow that money for 30 years at about 3.5%.

Second, pushing that rate to 3.2% by adding another trillion or so in dollars/euros will do nothing to get the economy moving. You can put more gas in the car but if it is on the side of the road with a dead battery, going from quarter of a tank to half a tank just isn’t going to do anything.

Why aren’t banks lending more money? One reason is that people are deeply in debt and they don’t want more.  Even devoted greens won’t buy another Chevy Volt if they are worried about the weak economy. Another reason is that the banks know the economy is weak and they do not want to be back where they were in 2008 when a weak economy wiped out their assets and made them look dumber than a bunch of rocks.  Notice the predicament here. If bankers and their customers were optimistic then there would be more lending and spending and the economy would grow. So if the Fed/ECB can make them more optimistic the whole problem is solved. But it doesn’t work that way now because there really is a dead battery and we all know it. If banks watch the Fed pour more gasoline into a car with a dead battery – it will make them MORE pessimistic not less! RE says that we learn. RE says that the central banks are making us worse off with their Dirty Harry approach to defending our jobs.

So what about this dead battery? What is really wrong? I don’t think any of this is a secret. Numerous governments in Europe are simply in trouble and this is leading to very slow growth if not a recession in Europe.  We use the term “fiscal cliff” to describe a pending fiscal disaster in the USA but the same problem is plaguing Europe. A fiscal cliff implies an unusually large reduction in government stimulus that would greatly reduce spending in an already weakened economy. China has its own problems as do many once hearty economies like Brazil, South Korea, and the Virgin Islands. Even Alfred E. Neumann knows that monetary policy is not the solution to a fiscal cliff.

There is no sense beating a dead horse. Monetary policy is being used to provide hope instead of a solution. Monetary policy is being used because we do not know what else to do. It is like the battery is on back-order and we don’t know when it will be delivered. So putting more gas in the car won’t hurt and it might make the driver feel a little better. But it is kicking the can down the road. Neither the EU nor the US is going to improve without serious attention to real problems. Private debt has to move towards normalcy. Banks need clearer guidance about what they can or cannot do in this uncertain environment. Governments have to bravely address their own debt problems without encountering a severe fiscal cliff. Business firms need more clarity about financial, health, environmental and other regulations. Central banks could hand out $1,000 gold bars to middle class people all over the world but that would do little to improve the economy or confidence about it. Since there is no thundering herd of politicians trying to solve any of these problems it is hard to see the stock market being happy much longer.