US Taxes Returning to Economy-Killing Level

I have written about him many times and posted some of his free work on this blog in the past but this week’s post by Tom McClellan is very enlightening. Tom, one of the fathers of technical analysis, takes on US taxes, US debt, US economy and the US stock market and how they are all interrelated in one fell swoop.  I have copied his insightful look below but I encourage anyone who I wants to stay tuned into the market to check in with him regularly here  

US Taxes Returning to Economy-Killing Level

The April 15 income tax filing deadline came this week, and so taxes are on the minds of a lot of Americans.  As Arthur Laffer noted 3 decades ago, it really is possible to set tax rates too high such that it actually hurts the economy.  We appear to be in such a condition now.

I wrote about this topic back in January, when lawmakers were contemplating raising the tax on gasoline.  But it is worth revisiting as we see total federal receipts creeping up toward 18% of GDP.  Whenever total federal tax receipts have exceeded 18% of GDP, the result has always been a recession for the U.S. economy.  And sometimes we can see that effect from a total federal take at less than 18%. 

The current number is 17.5%, based on total federal receipts for the 12 months from April 2014 through March 2015, and based on projected GDP for Q1 of 2015.  That is very close to the 17.7% reading we saw in 2007, just before the financial market collapse.  It is still some distance away from the all-time high reading of 19.8% seen in early 2001, and because of that some economists argue that we can safely go back to those higher levels and have the same strong economy that we saw in the late 1990s. 

There are two problems with that hypothesis.  The first is that economy of the late 1990s was not as strong as the revisionist historians would like us to believe.  The high taxation then pretty effectively killed the technology boom.  Total stock listings on the Nasdaq actually peaked in late 1996, and were in a genuine free-fall long before the bubble peak of the Nasdaq Composite Index in 2000.  That peak came about because a few large tech stocks were hogging up all of the available liquidity, and crowding out the smaller players, sort of like the biggest hippos taking up the last remaining water hole on the Serengeti during a drought.  Unemployment rates also bottomed out in early 2000 and then started upward.

The second problem with that hypothesis is that we don’t have the same demographic conditions now.  In 1999, the members of the Baby Boom generation (born 1946 to 1964) were between 35 and 53 years old, in the peak of their entrepreneurial years.  They were working hard, building companies, and pushing the economy faster than it would normally go.  Now, they are 51 to 69 years old, and are more interested in playing with their grandchildren than in starting a new company and hiring people.

The children of the Baby Boom generation make up what is known as the “Echo Boom”, which peaked in the birth year of 1990.  Those 1990 babies are now just 24 to 25 years old, and many are just now moving out from their parents’ homes.  So they are not quite at their peak of hard work and entrepreneurialism, and even when they do reach that point, their numbers are just a shadow of their parents’ generation.  So the Echo Boomers cannot absorb the same degree of a repressive tax burden that the Baby Boom generation could. 

This 18% recession phenomenon is not new.  It has worked going all the way back to World War II.  Here is the same comparison for the years 1944 to 1980:

[taxes as percentage of GDP 1944-1980]

Federal receipts got all the way up to 19.8% of GDP in late 1945, as Congress was trying to pay for WWII and pay off all of those war bonds.  And in case anyone fondly remembers the strong war-time economy then, we should remember that an economy which requires price-fixing and rationing is not a strong economy.  When people cannot find a place to live because of lumber shortages, and have to grow “Victory Gardens” to have produce, that is not a strong economy.  The effects of that taxation repression finally showed up in stock prices during the late 1940s, and only when taxes dropped back down to a less onerous level did the stock market finally start to rebound again. 

When the federal government takes a smaller portion of GDP as taxes, that leaves more money in the actual economy for real people to spend on what they want, and to spread around employing other people.  Growth is the result.  When the federal government takes too much out, it is like a farmer eating his own seed corn; he does not have as much to plant next year. 

Meanwhile, federal government spending for the latest 12 months equals 20.4% of GDP, almost 3 percentage points higher than receipts.  I keep hoping that someday we will get some leaders who realize that in order to pay off $18 trillion of debt, we have to get the spending number underneath the receipts number, and leave it there for a long time.

And we need to keep the federal receipts number well below 18% if we are to avoid the next recession, and its associated downturn in stock prices.  We may already be too late in that regard. 

The Suit Magazine - Interview

Click here to read an interview with me, featured in the March 2015 issue of The Suit Magazine

April 29, 2014 - Household debt

I was traveling and apologize for the late post but bad weather (Arkansas tornados), remote location and delayed travel hindered me from actually being even a little productive. As such this week’s blog post is not from me but rather a recent one Tom Mclellan posted which I thought was quite interesting and definitely worth watching going forward. If you have not visited his site or aware of his work, I would encourage you to dig a little deeper at www.mcoscillator.com

Debt is bad, at least for you and me.  But debt held by others can be a wonderful thing, as long as it is increasing. Debt is only a problem at the point somebody decides to do something about it.

The unfortunate fact for stock market investors is that household credit market debt as a percentage of disposable personal income has been shrinking ever since the peak back in 2007.  Normally it is bullish for stock prices to see household debt increasing, and bearish to have household debt decreasing.  But occasionally the two can go in opposing directions, which is the condition we see right now.

Historically when such a divergence has happened, the stock market eventually realized that it had wandered off track, and it worked extra hard to get back with the program.  But here we are, almost 7 years into a decline in household debt versus income, and thus far the stock market shows no sign of recognizing its off-track condition.  It is a bigger and longer divergence that we are accustomed to seeing in past episodes, such as those labeled in the chart.  The most likely explanation is that the Fed is helping to push up asset prices, in hopes that such action will eventually help push down unemployment rates and other indications of economic malady, and that this action by the Fed is continuing the divergent condition much longer than normal. 

The Fed's data on household credit market debt only extend back 62 years, which is just barely one interest rate cycle period, but is still a pretty long period of time.  And in that time, there has never been an instance of stock prices moving up while the debt to income ratio moved down that did not resolve itself by having stock prices moved hard downward to get back on track.  I do not see it as good news that the stock market is now going for its longest divergence ever in this regard.  I instead see that as a sign of trouble that will eventually have to be paid back double once the reckoning commences. 

It is understandable at this moment in history that we are seeing debt decrease, or perhaps I should specify PRIVATE debt.  U.S. government debt, on the other hand, has doubled in the past 8 years.  Through either willful action or neglect, Congress has been taking up the slack in the debt market.  But while Congress is still on a spending spree with other people's money, Baby Boomers are facing retirement from an ever closer vantage point, and realizing that piling up 2nd and 3rd mortgages on McMansions is not a great way to prepare for the day when the paychecks stop coming.  So they are doing the wholly rational action any reasonable person would do, increasing their savings and reducing their debt. 

The big problem, though, is that there are a whole lot of us Boomers trying at the same time to reduce our debt and get ready for retirement.  The "echo boomers" and millenials are not feeling any compulsion to take up the slack.  They would rather live in Mom & Dad's basement than take out their own mortgage to relieve the Boomers of those McMansions, which leaves the housing market moribund, the banking system seeking yield wherever it can find it, and the Fed trying to fill the void with free money.  So far that has not reached a trigger point that would cause the stock market and the banking system to reverse course, but I have to figure that such a reckoning day is coming.  It always has before, eventually.  And if the crude oil leading indication is right, it could take until 2018 before that reckoning point will appear and start to matter. 

Ironically, if Congress ever decides to mend its ways and step back from the ever-increasing debt levels, then history shows that the stock market could be in for real trouble.  As long as we are spending somebody else's money for whatever we want, the party goes on.  The only time that the problem manifests itself is when somebody tries to do something to solve the problem. 

Mar 3, 2014

It’s time again for the regular check-up on the state of retirement accounts in the US. Fidelity recently updated numbers for 2013, and while accounts have increased, the bottom-line still remains that the overwhelming majority of employees are still well underfunded for retirement.

The average 401(k) balance hit $89,300 at the end of the year, up 15.5% from $77,300 in 2012, according to an annual tally by Fidelity Investments. Most of the boost came from stock market gains as all three major stock indexes ended the year more than 20% higher.

People on the verge of retirement, ages 55 to 64 years old, saw their nest eggs grow to an average balance of $165,200 from $143,300 in 2012, Fidelity said. Savers with both a 401(k) plan and Individual Retirement Account managed by Fidelity had larger nest eggs, with an average balance of $261,400, up from $225,600 in 2012.

Even a balance of $261,000 is hardly enough for a comfortable retirement. And many Americans are much more woefully unprepared for retirement. A 2013 study by the Employee Benefit Research Institute found that nearly half of workers had less than $10,000 saved.

Here’s something I found interesting: part of the problem is that many workers are putting their retirement savings at risk when switching or leaving jobs by not rolling over the accounts to 401(k)s or IRAs. Of the roughly 800,000 workers with Fidelity accounts who left a job in the first nine months of 2013, 35% cashed out their 401(k) balances, as opposed to leaving the money in their former employer's plan or rolling it into a new 401(k) or IRA. While Fidelity said the statistic was "concerning," it was not a significant increase from previous years.

These cash-out balances averaged $15,500, and were especially common among young and low-income workers. More than 40% of participants between the ages of 20 and 39 and 50% of workers earning between $20,000 and $30,000 had opted for the cash. Unless workers use the funds to open an IRA account within 60 days, they get hit with significant taxes and a 10% penalty.

Ultimately this makes it harder for their savings to grow. For example, a 30-year-old who cashes out $16,000 could lose nearly $500 in monthly retirement income, assuming she retires at 67 and lives to the age of 93, Fidelity said. Plus, the 30-year-old would be hit with $3,200 in taxes and another $1,600 in penalties at the time she cashes out.

Such an impact is why it never hurts to reiterate that, especially for young savers with years of potential investment gains ahead, it is important to save, and save often. Though personal financial situations will be different for everyone, one literally can’t afford not to sock away for retirement.

Source: http://money.cnn.com/2014/02/13/retirement/401k-balances/index.html?hpt=hp_t2

Feb. 3, 2014

President Barack Obama used his State of the Union speech to roll out a plan to coax low- and middle-income Americans into saving more for retirement. New retirement accounts being set up by the Treasury Department would target workers whose employers don't offer retirement benefits or who haven't started saving yet for old age. The new "starter" savings program is called "myRA" — for "my IRA." Treasury expects to have a pilot program working by the end of the year. The White House does not need congressional approval to start the program.

The plan is a response to a looming retirement crisis. Companies have largely abandoned traditional pensions, which provided workers with guaranteed incomes in old age. Social Security is under strain as Baby Boomers retire. Many Americans lost their jobs or saw their wages stagnate in recent years, leaving them less able to save for retirement.

How would myRA work?

The plan is voluntary. The accounts — which are intended for people who do not now have employer-sponsored savings plans — will operate much like Roth IRA’s, according to Treasury officials. Married couples with modified adjusted gross incomes up to $191,000 and individuals earning up to $129,000 will be able to save up to $15,000 total in after-tax dollars for a maximum of 30 years. The accounts are governed by Roth IRA rules that limit annual contributions to $5,500 — $6,500 for those 50 and older. When the balance reaches $15,000, the savings would be transferred to a private sector Roth IRA.

Savers could have money deducted from their paychecks and put into a retirement fund that pays the same variable interest rate as a retirement fund available to federal workers. They would contribute after-tax dollars into the accounts, starting with as little as $25, or could opt for contributions as low as $5 a paycheck.

Savers can withdraw what they've contributed tax-free at any time. Although the money would be deducted from workers' paychecks, employers won't have to administer the program or contribute to it. Savers could take the accounts with them when they change jobs and could roll the savings over into another private-sector retirement account at any time.

Is this a safe investment?

There will be only one investment option: The Treasury will create a security fund modeled after the federal employees’ Thrift Savings Plan Government Securities Investment Fund, which pays a variable rate.

For the year that ended in December 2012, it had an average annual return of 1.74 percent. It posted an average annual return of 2.69 percent for the five years that ended in December 2012. There are no fees, the Treasury said.

The accounts would be backed by the U.S. government; the principal would be protected from loss. Still, unlike in 401(k) plans, workers also will not have the benefit of potentially higher returns when investing in a diversified portfolio of stocks and bond funds.

What problem is myRA designed to solve?

Americans aren't saving enough for retirement. Boston College's Center for Retirement Research estimates that 53 percent of Americans won't have enough money to maintain their lifestyle in retirement. The National Institute on Retirement Security puts the retirement savings shortfall at a staggering $6.8 trillion — or higher. More than half of workers do not have retirement plans at work, the White House says. Obama's plan is designed to get workers into the habit of saving for retirement by giving them an easy-to-use option that protects their principal.

How much will myRA help Americans prepare themselves for retirement?

It's just a start. It is by no means a solution on its own. The program is voluntary for employers too. And the Obama administration acknowledges that it doesn't yet have a commitment from any employers to offer the program.

Another problem: Most workers won't save adequately for retirement unless they are automatically enrolled in savings programs and forced to opt out if they don't want to save. MyRa is completely voluntary. Moreover, the plan allows participants to withdraw contributions without penalty; the possibility that savers will deplete the accounts before retirement makes MyRa still seem an underwhelming response to the retirement crisis.