Category Archives: Finance

Arthur Laffer vs. The Beatles

The Laffer Curve has been a favorite bit of Republican pixie dust since the Reagan years, the core idea of “voodoo economics.” So simple that the idea fits, famously, on a cocktail napkin. If the tax rate is zero, the government receives no income. If the tax rate is 100%, the government also receives no income because no one is willing to work for nothing. Therefore, the idea goes, there must be a curve in-between zero and 100 that contains a point where government revenue is maximized.

The pixie dust part comes from claiming that current tax policy puts us on the side of the curve where reducing rates will actually increase revenue. That’s where The Beatles come in.

Taxman” is a tune that shares the feelings of the high earning musicians when they learn that they are paying a marginal tax rate of 95% on their income. “There’s one for you, nineteen for me,” says the taxman.

And what happened then? Was that the point when The Beatles downed tools and went on strike for a lower tax rate? No. They just grumbled and kept on making hit music.

Nobody stops working because they pay a lot of taxes. That is the craziness of the Laffer Curve. 95% rates aren’t enough to stop people from working. During wartime, top tax rates in Britain went to 98% and people still worked hard.

So by the argument of the Laffer Curve itself, we now know which side of the curve we are on. If we want to maximize revenue, raise taxes.

Of course, the government is not in the tax-farming business. We don’t want a revenue-maximizing rate. We want a rate that allows us to pay for the government services we want and to pay off previous debts. That rate is still higher than what we have today. And it is a progressive rate, where very rich people pay a lot in taxes.

(Yes, there is a difference between the marginal rate and the actual, blended rate. But for those making millions of dollars a year, the difference is small and not one that invalidates the argument against the Laffer Curve.)


Follow the Money

Where does a corporate tax cut go? Let’s follow one billion dollars as it gets diverted from the IRS into the financial system.

Megacorp gets a billion dollar tax cut. However, on the same day as the money arrives there are no billion-dollar opportunities waiting for investment. Company management invests in new product lines and billion dollar capital investments such as factories with an outlook and schedule of years of planning. A tax cut could be taken away by the next administration – it isn’t a reliable source of funding.

It isn’t reliable, but it is a windfall. Found money goes into quick return financial shenanigans such as stock buybacks and retiring corporate debt. This what happened to the Bush tax cuts in 2004.

OK, Megacorp spends 800 million on stock repurchase and 200 million on retiring corporate debt. Where does the money go?

Most common stock is held by funds – retirement funds, pension funds, and insurance funds. Most corporate debt is held by similar funds. So almost the entire billion dollars is injected as cash into the funds. Funds have rules for what to do with the cash from non-recurring sources – reinvest it. (The same for recurring sources such as dividends and interest payments. The point is that it won’t be a direct or immediate distribution.) So one billion dollars is almost immediately invested into the financial markets.

The money will eventually find its way out of the funds in the form of distributions to individuals at retirement. At this point, many years after it was given to Megacorp, it starts to turn into consumer spending that benefits the pensioners and retirees and the larger economy. During that time inflation and management fees have cut into the amount, though general market growth may have offset that.

And, of course, it will be taxed. But the tax will be paid by a retiree, not by Megacorp.

Bottom line: Corporate investment uses reliable funding sources and has a long timeline. Tax cuts don’t fit that description. The money does eventually trickle into the consumer economy years afterward. Infrastructure investment would create more jobs, immediately, than any tax cut.

Brexit and the dream of Apartheid

“I don’t want to sound racist, but I think there are just too many people coming into the country. I moved out here from Dagenham four years ago, because Dagenham was looking like a foreign country.”

Nobody wants to sound racist, but sometimes racism happens.

The referendum vote in Britain has been an object lesson in the dangers of direct democracy. This is what we hire politicians for.

It is also an object lesson in the dangers of loose confederacy over a tight Federal union. The greatest triumph of American statesmanship was to replace the Articles of Confederation with the Constitution. The states were bound together much more tightly by the Constitution, and it was a one-way street.

David Cameron has given Vladimir Putin the best bit of news the Russian dictator has had since the Ukrainian Revolution. Why join? Why stay? These questions are so much easier to ask, today.

The effects within the UK are still to be assessed, but already we see that English relations with Scotland and Northern Ireland have been vastly complicated, perhaps fatally for the Union. At the same time, London will face the largest threat ever to remaining a more important financial center than Frankfurt.

North Korea and Myanmar have been stark lessons in the success of going your own way. All Britain is, I’m sure, breathless to hear what Nigel Farage’s juche advice will be. The rest of us are simply shaking our heads.


Half the story and no punchline

Marketwatch recently published a piece on the sad history of the Central States Pension Fund of the Teamsters union. As a quick update for those that do not know why there are jokes about Jimmy Hoffa being buried at the fifty-yard line of Giants Stadium in New Jersey, the Teamsters were a very powerful union in 20th century America, covering the trucking industry and related trades. It fell under mob influence and union leader Hoffa is widely believed to have been murdered by the Mob to keep him from cooperating with the FBI investigation.

The Central States fund is a classic underfunded pension. Many truckers today are not union members, so the ratio of working to retired is 1 to 5.2, according to the article. Investment management of the fund was taken away from corrupt union officials in 1982 and put in the hands of Wall Street firms such as Morgan Stanley, Goldman Sachs (a former employer of the author), and Northern Trust.

The Marketwatch article opines that Wall Street did worse for Central States than the mob did. But is that true? It appears that part of the strategy to deal with the underfunded pension was to invest in higher risk/reward assets than the typical pension. When the financial crisis hit in 2008, this strategy means that the fund’s losses were also magnified.

That’s all the story tells us, but that is only half the story. Yes, the downside in stocks was worse than bonds in 2008, but the rebound was also better. The long-term outperformance of equities over all other asset classes has persisted after the crisis of 2008. And if the mob was still in charge and heavily invested in Vegas casinos – that would have been better for Central States? Of course not.

The real problems here are two, in my opinion. Did the investment managers abandon their equity-heavy allocation at the bottom of the market? That would be a tragic misstep. Did the investment managers consider the average retirement age of the members in their asset allocation decisions? This should have driven concerns for generating cash vs growth. There is a tension between these two, but that is why GS and NT were getting paid the big bucks.

As a piece of financial journalism, this article doesn’t close out the issue it raises in the headline. A stock-heavy allocation does make sense (in my opinion). That in itself is not the problem. Changing strategy at the bottom – now that is a problem. But the article doesn’t document that that actually happened. We have only half the story and no punchline.

H.R. 1105 – What’s In A Name? Nothing.

Legislation is often named in an utterly pretentious style, as if every subparagraph is the second coming of the Constitution. Other bills are named like advertising slogans, The Whiter Teeth and Job Creation Act. Still others are named like the Holy Roman Empire, which we all know was not Holy, nor Roman, nor an empire. H.R. 1105, the Small Business Capital Access and Jobs Preservation Act probably hits the trifecta. Continue reading H.R. 1105 – What’s In A Name? Nothing.

Grant Thornton’s Big Tick Nostalgia

English: Crowd gathering on Wall Street after ...

Previously, I said that no one had offered me a coherent explanation of how larger tick sizes would create jobs (outside of Wall Street). I’ve just finished reading the latest in a series of Grant Thornton whitepapers on this subject. Let’s talk about it, because while it is an explanation, it is less than coherent. Continue reading Grant Thornton’s Big Tick Nostalgia