Rand Paul's Flat Tax

Recently, the republican presidential candidate, Rand Paul, put forward a flat-tax proposal for the American economy. Now, I have nothing against Rand Paul and infact I have liked Rand Paul and his ideas on various topics. But when it comes to his tax policies, I remain skeptical.

He recently introduced a proposal to tax everyone at 14.5%. His proposal was also to eliminate the payroll tax (that currently funds Social Security, Medicare and Medicaid). There will not be a separate capital gains tax and everything – individual income tax and business tax – will be taxed at 14.5%.

Now, this looks like a lot of savings for everyone participating in the economy. This is going to put thousands of more dollars each year in the pockets of everyone. I am a big fan of less taxes (who isn’t?), but I am also a big fan of reducing gross inequality in the economy. More importantly, I want to make sure that there is sustainable demand in the economy for decades to come – because if you lose the consumer market, then you lose the economy.

At first, this tax proposal looks very attractive – leaving a lot of money with the individuals rather than with the government. And I would be willing to spend my money myself rather than allowing the government to spend my money. And above all, this is deemed as a “fair tax” as every individual will contribute the same percentage of their taxable income rather than the government re-distributing it from the rich to the poor through various tax structures. So it does seem fair.  But if you take a step back from all these attractions and concentrate on the larger picture – where in the coming years, you will have to sustain demand from the middle-income people - this plan looks a little less attractive to me.

Today, one of the biggest economic malaise in the world is gross income inequality. And the U.S. is not exempted from that.  Setting aside for a minute the $15,000 individual exemption (or $50,000 exemption for a family of four) and mortgage-interest deduction that Rand's plan envisages, let’s concentrate on a simple case – a case of two individuals – named John and Mark - (and let’s start from year one), where John earns $100,000 the first year and Mark earns $1,000,000 the first year. To keep things simple, let’s say that both individuals increase their yearly income by 2% and let us also put aside any state and local taxes. 

So at the end of the first year, after paying 14.5% in taxes, John would have a disposable income of $85,500 whereas Mark would have a disposable income of $855,000. So that states that Mark has 10 times more cash left in hand than John at the end of the first year. If you continue this for the next ten years, where every year John and Mark get a 2% increment to their salary/income, at the end of the 10^th year, John would have had a disposable income of $100,890 for the 10^th year, whereas Mark would have had a disposable income of $2,394,000 during his 10^th year. Now that translates into Mark having 23.73 times more cash in hand than John at the end of the 10^th year.

Now, let’s not kid ourselves in saying that a person with millions of dollars in income would grow his net-worth at the same rate as that of a person who earns in the low hundreds of thousands. He, for sure, will grow at a faster rate. And let’s not kid ourselves by not taking inflation into account – which would eat up a large part of the additional disposable income obtained by the massive cut in taxes across the board. And when inflation occurs, Mark, who is guaranteed to own assets at that point, will see his assets’ worth going up in value, whereas John would increasingly find it difficult to buy those assets – thereby once again creating a gross inequality in the standard of living.

Moreover, to balance the budget (which Rand says he will), massive cuts in public services will have to take place. Though I am not much of a fan myself these days on government provided services and the debt they incur, it is no doubt that these massive cuts in the public services will cause a considerable re-structuring in the economy and I am afraid that that re-structuring will occur on the backs of the middle-income and low-income people – thereby once again, giving a smooth ride to the high-income people and a bumpy ride to the middle and low-income people. Now tell me how is that fair?

Even in today’s tax structure (setting aside all deductions, state and local taxes for simplicity), at the end of the 10^th year, Mark, who would have paid a federal tax rate of 39.6% vs John’s 28%, would have had 17.66 times more cash in hand than John. And Rand Paul’s flat tax would have increased that 17.66 number to 23.73. So the bottom line is – I am skeptical about Rand’s tax plans being able to address effectively the economic ills in the society – both now and in the decades to come.

If Rand or someone comes up with a multi-tiered flat tax system, I would be willing to consider and study its effects. But this one-tiered flat tax system proposed by Rand doesn’t impress me. Sorry Rand Paul!

My advice to a presidential candidate: Social Security

When I followed the U.S presidential elections in 2012, I had a bad feeling when some candidates spoke about reforming Social Security. I understand that the Social Security fund is in dire danger of becoming insolvent within the next 20 years if the program itself is not reformed. But you don’t speak about reforming – and in this case, “reforming” meant cutting Social Security payments in the future in one form or another – when the country is still reeling from the effects of the Great Recession. In fact, you don’t speak about cutting any major social program that the middle class depends on when the economy is fully not out of a recession – not the least a recession that obliterated the savings of millions of people, depleted a large portion of any equity that they had in real estate or other financial assets, caused massive disruptions in the jobs, pension and health care sectors.

When millions of people have lost their jobs and are scared and unsure about their future, the talk of reforming such a major social program adds to that uncertainty of their future. You don’t want to make people psychologically suffer and get alienated by talking about things that add to the fear that they already have about their future and their children’s future.

And in my opinion, 2016 is no different. The effects of the Great Recession of 2008 are still felt well across millions of households in the country. So a talk about reforming Social Security is a strict NO, NO, NO! – if you want to win the presidency.

If the media asks you about what you would do to make the Social Security program solvent in the longer term – say what would lessen the fear of the future for the people – which is that you would grow the economy at a faster rate, creating more high-paying jobs, eliminating waste in government, sounder immigration policies and in the process through a better and stronger economy keep the Social Security program solvent. I know that this sounds just like a rhetoric, but this is better than any “reform” talk because of one reason – The country is simply not ready for a Social Security reform…yet!

I for one believe that a leader is supposed to change people’s minds for the better, help them understand the need and effects, and lead the nation towards long term glory and prosperity, but these days I don’t see leaders but rather I only see politicians who want to win elections. And my advice is to these politicians and not necessarily leaders. I would dare not blame these politicians as the system itself has become more election-oriented rather than a long-term vision. And that system includes the very people who vote these politicians into office.

Maybe in future elections, when there isn’t this severe a slack in the labor market, and the income-inequality is reduced to a certain extent, a Social Security reform talk might be apt to win the election. But now is not the time!

Minimum Wage

These days there is a lot of discussion in the United States as to whether there should be a nation-wide increase on the federally mandated minimum wage. Currently, the federal minimum wage stands at $7.25. There are proposals currently from various quarters to increase that amount to $10.10. There are also proposals from some to take that amount up to $15.50 within the next five to ten years.

The minimum wage concept is something that I am still trying to get my head around and understand its effects better. I might be willing to change my opinion as I learn more but for now, I don’t believe there should be a minimum wage concept at all. Yes, companies like Walmart who earn billions in dollars annually should increase the pay to their employees well above the minimum wage. But what about a working family who hires a nanny at the minimum wage to care for their babies when the family is out working to earn bread and butter? An increase in the minimum wage of Walmart employees may at best reduce their corporate profits. But an increase in the minimum wage of the nanny in my example would probably result in reduced working hours for the nanny or an outright prevention of using any nannies to care for their babies or at the least, an increased financial stress for the working family. So the situation of individual businesses and families differ greatly and in my view, the wages of the employees is best handled through the markets (supply and demand).

I understand the side of the argument where some experts say that putting more cash at the hands of the people who are at the lower end of the economic spectrum will generate more economic activity in the region. And I also understand and strongly believe in the argument that anyone who works 40 hours a week should not live in poverty. But increasing the minimum wage, in my view, is a flawed way to eliminate poverty. If you look closely, most of the businesses that depend largely on minimum wage employees are businesses that cater to the middle class. An outright increase in the minimum wage to all employees will undoubtedly tempt the businesses to transfer some of that cost to the consumers – who, as I said, are mostly middle income earners. The business itself would only transfer a partial amount of that cost from its profits. In essence, those calling for an increase in the minimum wage fail to see that this increase would result in a transfer of a large part of the financial wealth from the middle income earners to low income earners and not necessarily from the high-income earners to the low-income earners.

A large part of today’s economic perils could easily be ascribed to the lack of sufficient demand.  And demand itself is best created when both the middle-income earners and low-income earners have more disposable income. An increase in the minimum wage, in my view, greatly reduces the disposable income of the middle-income earners.

The best way to increase the wages of low-income earners (or minimum wage earners) is to move people out of those minimum wage jobs and into semi-skilled and higher-skilled jobs. When the supply dwindles, businesses will raise the wages to match with their demand much more efficiently than the government passing an arbitrary number by decree.

How to move people from minimum wage jobs to semi-skilled and higher-skilled jobs? – this is altogether a different analysis which I will try to cover in my later posts (or let the experts work it out).

Is the bull market over?

Is the bull market over? The simple answer is no. There are many analysts out there who warn that the market is about to enter a bear phase. But I disagree. In my view, the bull market will continue to run for the remainder of 2015 and well into 2016. Yes, from a sector wise, there are some stocks or sectors that appear to be overpriced. But there are still many individual stocks that are fairly priced or even under-priced.

The US economy – though remains sluggish – is about to enter a period where we will witness a private spending splurge and a modest wage growth. The European economy will continue to grow, albeit the growth rate might not be as fast as some might predict. China will surprise us with better economic results in various fronts, though Chinese public investments will be far less than what we have seen in recent years. Japanese investors will look outside of Japan for better yield, while Japanese companies grow modestly in the near future. India and other south/east Asian economies will continue to create demand, although the pace might be slower than the hype. Demand from African markets is a question mark. And the same could be said of the Latin American markets (though I could be wrong here).

In essence, private demand across the world is set to increase in the remainder of 2015 and 2016, while public investments take a significant dip. That combined with a relatively stronger dollar will put a lid over many commodity prices. Australia is a market that I would advise to stay away from until we see clearer directions for the future of the commodity prices.

All the above said views of mine do not mean that there is no structural risk involved in many of the economies that I mentioned. But those risks are far from derailing the bull market for now. Barring any unforeseen geopolitical events (like ‘Grexit’ for example), I don’t see a bear market in formation. Yes, there could be tantrums in the market in the second half of 2015 – but those tantrums will be short lived and the bull market would continue to run as we enter into 2016.

Thus in my view, the bull might run a little slower from this point with occasional stops and retreats, but the bear is still well into his sleep.

U.K vs U.S election questions

In following the United Kingdom’s general election this year, I noticed some interesting differences in the policies and priorities of the people of the U.K vs. the policies and priorities that are very commonly discussed during an election cycle in the United States.

Since the demographic and political culture might be a little different between the U.S and the U.K, this might not be an apple-to-apple comparison, but still an interesting one. Here are a few I observed –

1.      Health Care:

·        U.K: Every major party in the U.K wanted more funding for their universal healthcare system - the National Health Service (NHS). The question was always about which party’s ideas had a better prospect to acquire more funding for their NHS and never about reducing the funding.

·        U.S: In contrast, in the U.S, many republican politicians have been talking about defunding the Affordable Care Act (Obamacare) for the last two years without actually providing a solid alternative for the current beneficiaries of the Affordable Care Act.

2.      Marriage Equality:

·        U.K: Marriage Equality was never a topic of discussion in the U.K elections. This is no surprise given the fact that sometime in 2014, legislation was passed in England, Scotland and Wales allowing gays to legally marry. The only place gay marriage is still not recognized is in Northern Ireland and I am not sure if candidates from those constituencies had to face this question.  

·        U.S: Politicians contesting for office in the U.S are repeatedly hammered on this topic. In fact, if one wants to run for office in the U.S, he better be ready to answer questions on this topic on day one (and make sure the answer satisfies his constituents).

3.      Immigration:

·        U.K: The two major parties in U.K – Conservatives and Labour – wanted to reduce net immigration from both the European Union and non-European countries.  Many smaller parties like the U.K. Independence party were also for reducing net immigration. And all these parties also wanted to cut back the benefits given to immigrants. They were in consensus that the “free movement of people” should not be misused to turn it into “free to claim” benefits. The question among these parties was only about how far one would go to reduce net immigration (and claiming of benefits).

·        U.S: In the U.S, the question on what to do with the illegal (or undocumented) immigrants has been going on for quite a while without solid answers. And same with the benefits – some wanted to give benefits to immigrants who are already in the U.S illegally for many years, and some do not.

To put it in other words, major U.K. parties seem to be in consensus that the incentives given to unskilled or low-skilled or illegal immigrants need to be cut back so as to reduce the attraction of immigrating to the U.K just to claim welfare benefits. In the U.S though, whether those incentives even need to be cut back is still a question that is debated across party lines and among the people themselves.

4.      Neck Ties:

·        U.K: During election debates, the politicians in the U.K seem to be wearing more colorful ties than the ones in the U.S J

·        U.S: Most politicians in the U.S more or less stick to blue or red…more fanciful colors are hard to see in a U.S politician’s tie than in a U.K politician’s tie J

Where are we heading?

There were two financial reports coming out of the United Kingdom today – housing prices and general inflation. These reports petrified me – just as similar data from the US these days is causing a concern to me.

The housing prices in the U.K. have been going up at a pretty pace recently. The annual housing prices went up by 9.6% in the year to the end of March. The annual house price inflation in Scotland during the same period was 14.6% – the fastest since 2007.

Now, the general inflation in U.K. (as measured by the Consumer Price Index) turned negative (-0.1%) in April (year-over-year).

The two contradicting data above points to eerily similar situation during the housing boom before 2008. For the last decade, we have been facing this constant problem of asset price inflation not in line with the inflation of the prices of general goods and services. Now, remember, the central banks base their interest rate decisions on the consumer price index and not on the housing price index. In fact, before the 2008 recession, many central bankers thought that housing price inflation was not something to worry about. They did not believe that there could be a nation-wide housing market collapse – as they thought that housing price depends of various factors, many of which are regional. But what they failed to see was how the housing market was directly linked to the very heart of the global finance and how the collapse of the housing market could cause a chain reaction across many large financial institutions.

It would be hard to believe for anyone to think that the central banks did not foresee the link between the housing market and the banking system – as even in a traditional banking model, it is the banks which lend to the home owners and so anyone would have known that there would be an impact if the housing bubble bursts. But the irrational calculation that the central banks did at that time was that a bank, run by extremely savvy individuals, would not hurt itself by sub-par lending standards (we would call this “no-regulation”, but the central banks called it “self-regulation”). But what the central banks missed to see at that time was – it was no longer necessary for the banks to worry about the creditworthiness of the borrower – as long as the banks could securitize those loans and sell it to market participants, they thought that the risks were minimized. In fact, they thought that by selling these newly innovated financial products, the risks were shifted from just the lenders to the many number of financial market participants – participants who were more in number than one lender and who were thought to have the capacity to absorb the hit if in case the borrower defaults. These securitized loans were complex financial instruments that went under the radar of the supervising agencies of the government. So when the housing market collapsed, it set up a chain reaction with these financial instruments acting as a trigger that led to an incredible worldwide turbulence in the global financial markets - a turbulence whose effects are still being felt today, and a turbulence that brought us close to the complete shutdown of the global financial system as we know it.

Today, after ‘n’ number of new regulations introduced, various bank stress tests conducted, billions in fines paid and bills like the Dodd-Frank passed, we are again looking at data that points to assets like houses and equities going up when wages and inflation of general goods remain stagnant. Where did we go wrong? More importantly, where are we heading?

A complete mug or a dodgy prime minister

Just a light-hearted post:

Today, May 7th, is the general election in U.K. I am not a British citizen and I have no facts in hand to comment (and probably no right too :)), but I am going to say this - I am rooting for David Cameron of the Conservative Party to win the election. How can one not vote for this guy? - especially after watching him obliterate the Labour Party leader Ed Miliband during many "Prime Minister's Questions" sessions in the House of Commons!

Tomorrow will be interesting to see if David Cameron who called Ed Miliband "a complete mug" or Ed Miliband who called David Cameron "a dodgy prime minister surrounded by dodgy donors" will become the next prime minister of U.K. :) 

Gotta love those British accented face-to-face funny yet intense Q&A sessions in the House of Commons!