Taxes And Incentives

Bill

Your ongoing tutorial on the relation between taxation and incentives is deeply appreciated. There's no question that we all respond to the incentives created by tax policy. A good part of the time, (whether one agrees with the incentive created or not), that seems to be the point of tax policy. I certainly wouldn't buy mini bonds, or fund my kids Roth IRAs if it weren't. Now I imagine you see that as part of the problem. The government's efforts to guide the economy, to reward some behaviors and punish others creates inefficiencies that the marketplace, left to its own devices would resolve.

Whatever my sympathies (and here my fiscal conservatism is ascendant), I think the Democrats are overreaching in their current brinkmanship over the taxation and spending cuts. Victors, it seems, always do. I like the idea of a cap on deductions as a way of limiting those incentives without wading into the minefield of deciding which specific deductions to cut. I am equally sympathetic to having a minimum tax for upper upper income earners. You might call that envy. Others, including myself, would call it justice. The Dems however seem determined to once again avoid the hard choices on entitlements, especially Medicare, that got us into this mess in the 1st place.

Eli

The Other Reason We Spent Too Much on Healtcare

Bill

The Republicans aren't the only ones having trouble accepting science. Lots of us are equally guilty. The accumulated evidence in multiple venues examining various populations over long periods of time suggests that  screening mammography for all comers increases cancer incidence rates (because lots of small tumors are detected earlier) but does not reduce overall breast cancer mortality. Ditto for chemical screening for prostate cancer. Yet routine mammography is still hailed as some sort of magical bullet, and any evidence to the contrary is regarded as the work of evildoers.

Despite the revolution in evidence based medicine that has predominated for much of my career, magical thinking still persists. Just because something makes sense doesn't mean that it will turn out to be so. More is not always better. I still remember the dean's opening remarks my first day of  medical school. About 90% of patients, he reminded us, will get better on their own. An unfortunate 5% will worsen despite all efforts to help them. The real business of learning to be a doctor revolves around the 5% or so for whom one's skill will make the difference. After 25 years in the business I'd say that figure comes pretty close to the mark.

The country does 80 million CT scans a year. We only have 300 million people. One in four Americans doesn't need a CT scan

Eli

Costco and Incentives

Eli,

Imagine that. Costco anticipates potential change in tax rates.

Bill

Costco special dividend to beat fiscal cliff

Costco special dividend to beat fiscal cliff
Costco will pay $3 billion in a special dividend next month.

NEW YORK (CNNMoney) -- Costco Wholesale, the warehouse merchant, announced Wednesday that it will pay a special $3 billion dividend before year's end, saving shareholders from a big bite should taxes rise due to the fiscal cliff.

The company said the $7-a-share payment is possible due to its strong balance sheet and its good access to capital. The payment will be in addition to the regular 27.5 cent a share dividend that will be paid on Nov. 30.

The special dividend will be paid Dec. 18 to shareholders of record on Dec. 10. That will allow investors to pay the lower 15% tax rate currently in effect on dividends. With taxes set to rise on Jan. 1 as part of the fiscal cliff, the rate paid on the dividend could more than double for many high income taxpayers.

Related: Companies speeding up dividend payments

Numerous companies, including Costco rival Wal-Mart Stores (WMT, Fortune 500), have moved dividend payments normally made in January into December. But in Wal-Mart's case, it was the regular dividend being moved, not a special dividend being added.
Shares of Costco (COST, Fortune 500) rose 4.7% in premarket trading on the news.

Related: Record Black Friday shopping

The company also announced strong sales for November and the just completed quarter, periods that included the Black Friday weekend that kicks off the holiday shopping period.

Sales at stores open at least a year, a closely watched retail measure known as same-store sales, rose 6% at its U.S. stores for both the four-week and the 12-week periods ended Nov. 25, when the effect of higher gas prices were excluded. Total sales rose 9% to $8.15 billion in the four weeks ending Nov 25.

The National Retail Federation estimates that total U.S. shopping during the four-day holiday weekend rose 13% from a year ago, to a record $59.1 billion.

First Published: November 28, 2012: 7:50 AM ET

Lunch with the Liberals

Eli,

I had lunch with a bunch of liberals over the weekend. Mrs. Knabe had strict instructions: Be nice, or else.

What did I think would be the impact of the fiscal cliff I was asked? Nothing. Defense companies are already adjusting their headcount for a lower level of business, with our without sequestration. Workers and consumers know the President wants to raises taxes on the rich, but also know the rich is a fluid concept that almost always means everyone. Besides, even with confiscatory tax rates there isn't enough gold in that pot. The current deficit is unsustainable, so it must end; either in higher taxes, lower spending, higher inflation or all of the above. What changes if we go over the cliff? Nothing. The higher taxes and lower spending we all know have to occur, occur. If we go over the cliff, taxes will go up and spending cut or if we don't go over the cliff and taxes will go up and spending will be cut. The cliff is not a surprise and spending and saving habits already reflect this.

Will the Fed's quantitative easing program work?

I have no idea. But I don't think there is a magic wand that can be waved by either the Fed or Congress. We seem to want to believe if Congress avoids The Cliff all will be right with the world. Or if the Fed would only engage in more QE growth will accelerate.  But what if the problem is micro, not macro? What if growth is being impeded by the mountain of regulations we have imposed over the decades? Minimum wage laws raises labor costs, which reduces labor demand. That is obvious to everyone. If it weren't obvious we would simply mandate everyone be paid one million dollars per year. Increasing generosity for food stamps and unemployment benefits may be humane but increases unemployment. Period. Full Stop. Forcing Intrade to cease and desist may serve some social purpose but it dampens economic activity or dampens the desire of others to engage in risk-taking. Farm supports mis-allocates resources. Ethanol subsidies raises prices. Forcing GM to build electric vehicles may serve a social purpose but it lowers profits and mis-allocates resources. Renewable energy standards raises prices to consumers and mis-allocates resources. I could have gone on, and on, and on. Maybe the issue isn't the Fed or taxes or spending. Maybe it's the million little cuts we have inflicted on ourselves. 

Why shouldn't we tax the rich like we did in the '50's. There was pretty good growth then, so 90% marginal tax rates can't have an impact on growth. Right?  I asked what is the purpose of taxing the rich. If it is based on the belief taxing the rich causes growth, there is no evidence of that. If the purpose is to make the incomes of others higher, there's no evidence of that either, unless you are one of the lucky recipients, but society as a whole getting wealthier by taxing the rich isn't a calculus that works. If the purpose is to reduce the deficit solely or mostly on the rich, those numbers are challenging as well. It seems the purpose is to satisfy envy. Slippery slope. I think it's a smokescreen anyway for higher taxes on everyone.

Sure, the 1950's had high marginal tax rates for the wealthy and the economy grew. But federal spending to GDP was about 15%, not 23% as it is now. Plus there was little  industrial competition, plus the massive regulatory state had yet to be built. There was no EPA, OSHA, Medicare, Medicaid, ethanol, FDA and on and on an on.

What I found most odd about this desire to tax more was this was a group of people who recognize the monetary value of an education. Yet they couldn't see the disincentive higher tax rates, particularly on the wealthy, has on education.

Bill

Buffett vs Buffett

Eli,

Buffett in the NY Times says taxes don't matter.

Suppose that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.” 

Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 percent.” Only in Grover Norquist’s imagination does such a response exist.

Buffett in his 2011 letter to shareholders (emphasis in the original):

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

You don't have to be an investing genius to recognize purchasing power is reduced if taxes increase. And just one step further, if your expected after tax purchasing power is reduced because of higher taxes there are investments he won't make, that he would make in a lower tax environment.

Further in the letter he writes of returns on US Treasury bills since 1965 when he took over at Berkshire:

During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points.

Again, when it's his money, taxes matter.

Buffett is smart enough to know investment leads to growth. Encourage investment, encourage growth. Discourage investment, discourage growth. And he obviously knows taxes matter.

I'm pretty sure I could go through every one of  his annual letter to shareholders and find clear statements by him that taxes matter greatly in his investment decision.

Bill

PS. Look at Greg Mankiw's post, A Master of Tax Avoidance, on the Buffett letter.

Buffett's 21%

Eli,

I doctored a graph from John Taylor that shows federal spending as a percent of GDP. Your icon's 21% suggestion is far below anything proposed on paper and since the (extremist) Democrats are dead set against changing one comma of Obamacare, Social Security, Medicare, Medicaid, SNAP, I don't see how you get to 21%. Heck, they won't even admit that in a world of 500 channels we shouldn't be subsidizing Big Bird. Of course the Republicans are only slightly better given their predilections to subsidizing Boeing via the Ex-Im bank and agribusiness with farm price supports.

Most of Buffett's op-ed focused on asserting without evidence marginal tax rates don't matter. But he never addresses the issue. Instead he makes the obvious point that investors invest. Thanks Warren, whoda thunk it? But marginal rates matter. Hell, ask a former heroin addict. 

I love this idea of going back to the 1950's tax rates, or Bill Clinton's tax rates and assuming if we do that ONE thing then everything else will magically follow. In case your memory needs refreshing Medicare and Medicaid started in 1965. The combined (worker and employer) tax rate on social security was 2.25% from 1951-1953 and ended at 3.75% in 1959. Today it's 12.4%. 

So sure, let's go back to the 1950's. If you eliminated Medicare and Medicaid and cut back Social Security by 80% you can achieve far less than 21% federal spending as a percent of GDP.

Here's one more thing to consider. I know in the fantasy liberal world tax rates and incentives don't matter. In the grittier world of drug users it somehow seems to apply. So let's assume the incentives drug users respond to is indicative of how people respond to marginal tax rates. And lets raise tax rates. On the rich, super-rich, middle class, you choose. What happens to young people's investment decisions? 

Investment decisions you ask? Yes, their investment in human capital, their investment in education. What happens? In the incentive-driven world they invest less. Simply because the after-tax returns have declined. Why would you as a policy maker on the one hand propose a policy that lowers the after-tax returns to education and on the other hand encourage investment in education via subsidies like Pell Grants and direct student loans?

Bill

Warren Buffet Numbers

Bill,

I'm not ashamed to admit I've been a big Buffet fan since way back when. I read his biography while moonlighting as a resident. I had, for the 1st time, a little money to save and wanted to learn something about investing. I always thought his value approach made a great deal of sense. Needless to say I don't have his touch, or I wouldn't be headed off to the hospital to work tomorrow.

In today's op-ed piece in the Times, Buffet proposes targets for Federal revenue and spending at 18.5 and 21 per cent respectively. As he notes, that doesn't entirely close the deficit, but it's a significant improvement  from the current gap between 15.5 and 22.4%.  I doubt those are numbers that will set your heart aflutter, but they'd certainly be a move in the right direction.

 Eli