An April 15th Look at Taxes and the Stock Market

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Tax policy can impact not just how much money you pay in taxes, but how much money you are likely to make in the first place if you are an investor. U.S. capital gains taxes have risen and fallen over the last one hundred years and the stock market usually follows the direction of rates. A significant rate increase will be taking place on January 1, 2011.

The reason capital gains are taxed at different rates than ordinary income is that investing involves risk and capital will not flow unless risk is adequately rewarded. Lower capital gains tax rates encourage more business formation and expansion and bring more capital into the stock market. This is the source of real economic growth. Taking on risk to obtain gain of course means the possibility of loss as well. Uncle Sam is more than willing to demand his share of your profits if you make money, but is no longer your full partner when you experience losses. If you make a million dollars investing, you pay taxes on that million dollars. If you don't have trader status with the IRS and lose a million dollars, you get a $3000 deduction per year and will certainly be dead long before you use it up.

Originally, capital gains were taxed at the rate of ordinary income between 1913 and 1922. Top marginal rates were only 7% at first, but rose to as high as 77% in 1918 to pay for World War I.  An alternative capital gains rate of 12.5% for assets held at least two years was introduced in 1922. The top marginal tax rate on earned income was lowered to 25% in 1925. It was an era of low inflation and even deflation starting in the late 1920s. The stock market and economy did quite well; at least for seven years after the lower capital gains rate was introduced.

In 1932, when Herbert Hoover was still president, the top marginal tax rate on earned income was raised to 63%. In 1934, capital gains tax rates were changed and based on how long an investment was kept. For assets held 1,2, 5 and 10 years, the exclusions were 20, 40, 60, and 70 percent respectively. In 1942, top marginal tax rates were increased to 88%, but maximum capital gains rates were capped at 25% for assets held for six months or longer. Top marginal rates went as high as 94% in 1944 and 1945. They remained at 91% or 92% until 1963. The huge differential between marginal rates on earned income and capital gains rates along with low inflation created an economic and stock market boom that lasted from 1942 until the late 1960s.

The top marginal rate was lowered to 77% in 1964 and then 70% in 1965. Capital gain rates were raised in 1969. Inflation began picking up at around the same time and the combination was a negative for the economy and stock market for over a decade. The government made the problem worse by raising capital gains rates significantly in 1976 and added insult to injury by taxing gains that only existed because of inflation. Maximum capital gains rates peaked at just under 40% in 1977 and 1978.

In 1978, congress voted to reduce maximum capital gains to 28%. In 1981, capital gains were lowered to 20% and the top marginal tax rate to 50% starting in the 1982 tax year. The high rates of inflation from the 1970s were beginning to decline significantly. An almost 20-year boom period followed. There were bumps along the way however. The 1986 Tax Reform Act increased capital gains rates to 28% and lowered the top marginal rate on earned income to 38.5% starting in 1987. The marginal rate was lowered further to 28% in 1988. Ironically, equalization of earned income tax rates and capital gains, a long sought goal of certain liberal economists, took place during the Reagan administration.  The U.S. stock market zoomed for the first eight months. Unfortunately, it then fell almost 40% in a few days in October.

Marginal rates started rising in 1991 and reached 39.6% by 1993. The Taxpayer Relief Act of 1997 reduced maximum capital gains rates to 20%, once again creating a significant differential between earned income rates and capital gains. Inflation was falling and low during this time and this kept the real capital gains rate close to the official one. The stock market and economy did extremely well for the next three years until the tech bubble burst. To pick up the flagging economy and stock market, the Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced maximum capitals gains rates to 15% and made this the rate for qualified dividends as well. Inflation was very low during this period. The market and economy did well for the next four years.

Now the maximum capitals gain rate is scheduled to increase from 15% to 20% after the end of the year. Additional taxes will be imposed later on because of the recently passed health care legislation. It looks like we are entering a period of rising inflation and this will make the actual capital gains rate continually go up. I will leave it to the reader to decide what impact this will have on the U.S. economy and the stock market going forward.

Disclosure: Long oil.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Impossible Contradictions of U.S. Consumer Spending

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Consumers are the key to any U.S. economic recovery since they account for around 70% of GDP. Revised 2009 fourth quarter GDP figures just released indicate that consumer spending rose 1.7% on an annualized basis. This was after a reported 3.8% rise in the third quarter. These numbers are certainly good and indicate an economy on the mend if they are accurate. Unfortunately, there is little likelihood that they are.

To spend more money, consumers have to have more money. They can get the extra money through higher compensation (such as wages), larger interest and dividends payments, by drawing down savings or by being given additional credit. All of these numbers for 2009 indicate that consumers had less money to spend. According to BEA (Bureau of Economic Analysis) figures updated as of February 26, 2010 and the latest Federal Reserve credit statistics, the following changes took place during 2009:

Employee Compensation     Down    3.2%
Interest Income                   Down    4.9%
Dividend Income                 Down  16.4%
Revolving Credit                 Down     9.5%
(mostly Credit Cards)

Consumers not only had less income and credit available, they also saved more. The U.S. savings rate went up from 3.8% at the end of 2008 to 4.1% at the end of 2009. So consumers earned less money and then on top of that they saved more of that smaller amount of money. Their borrowing power dropped as well. Yet, while this is happening the government keeps reporting consumer spending is going up. There seems to be some sort of contradiction here.

The recent GDP figures indicate that this mystery can be explained by a huge drop in personal tax payments in 2009. The government claims that individual taxes dropped 25.8% during the year, an amount that is much, much bigger than the decline in income and which occurred during a period when there was no major federal tax cut (there were numerous small ones for certain groups in the stimulus package). The supposed large drop in taxes paid gave U.S.consumers an increase in disposable income. They apparently went out and spent it all immediately.

Based on the above information, there are those who might not believe that U.S. consumer spending is actually increasing. For instance, people who took first grade arithmetic and have at least some minimal attachment to reality are likely to be skeptical. If on the other hand, the average U.S. taxpayer cut their tax bill by 26% last year (presumably a number of people got 30% and even 40% reductions) while experiencing only a small drop of income, I am obviously out of the loop. In that case, please send me the name of your accountant ... unless of course he or she has been indicted or is already in prison.

Disclosure: None

NEXT: Greek Crisis Impacts World Currencies and Gold

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

An Alternative View on Art Investing

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Today's guest Blogger Dennis Mack gives an alternative view on Investing in Art:

I was glad to see a presentation on art collecting as a form of investing. I would supplement the presentation by reminding people of the many costs of owning art.

First, the markups of the dealers are significantly greater than the markups by a market-maker of a security or someone selling land out of inventory.

Second, as mentioned by one person at the Meetup, art dealers are salespeople, as we must recognize, but they are only the most visible part of a web of people who influence the price of art and create trends in favor of some types of art over others. Almost 40 years ago, I took an art appreciation course with an artist, who was the widow of a well known artist. She regaled us with stories of the relationships among, dealers, galleries, auction houses, museums, critics, the press, appraisers, collectors and artists, themselves to shape the shifting interest of the art world in certain types of work or certain artists. The tools went beyond press releases, gifts to museums, sponsorships of museum shows, holding back on the sale of available works, underwriting puff pieces and the like. She would always ask – and then answer – who stood to gain by a particular museum show or article in an art magazine.

Her advice, like that we hear at the Meetup, was not to buy art for investment but to buy for enjoyment. “Investment” in art takes lots of work to become successful or luck to ride on the efforts of others to pump up a price. “Investment” often risks buying into a bubble, only to watch it collapse as interest moves to another kind of art where prices had been low and someone had built up a significant inventory.

Beyond the markups and risks, there are some real costs that beginning buyers often overlook. These costs include insurance, conservation, restoration, and periodic appraisal. Many owners overlook these costs to the detriment of their collection.

Ordinary people who start to buy when they are young can build up collections worth more than their securities portfolio. But just at the time that the art portfolio should be supporting them, they may find that they have to support the art portfolio. I know an academic who on his sabbaticals bought art, rugs, and jewelry over the years, stopping much of his buying nearly 30 years ago. As a teacher, he was not making major purchases. Many cost less than $200. He and his wife have fewer than 400 pieces. Now in their 80’s, they need to know the value of their collections for estate planning purposes and for considering making gifts to museums. They knew that they needed an appraiser, but because their collections are so unfocused it had to be either many appraisers or a very rare generalist. After 10 years of putting off the appraisal, they finally found an appraiser recommended by their property insurer.

After consulting with other collectors and dealers about appraiser fees, they decided the appraiser’s fees reasonable. The appraiser explained to them how much work it takes to appraise for tax purposes each piece, particularly those of any value (i.e., worth over $5,000). The appraiser reviewed a CD of pictures of their collection and visited them to look things over generally and give his estimate of the amount of work. Taking lots of shortcuts, it looks like the appraisal process alone will cost well over $35,000. This appraiser’s fees are low compared to those of the big auction houses, which might charge $5000 per day. A friend who was giving away a more focused collection of photographs paid $1,500 to have his $40,000 collection appraised before he gave it to a university. Note, that is almost 4% of the value of the collection which if you wish to insure your collection must be done periodically – although updates are cheaper than the first appraisal and authentication.

There will be additional expenses of restoration and conservation of pieces and insurance on the collection. According to something I found on the web, theft/damage insurance for art, added onto home insurance, generally costs $1-$2 annually per $1000 of coverage. A collection that has appreciated to $2 million would cost $4,000 annually, although I have heard much higher rates from reputable companies. Most of the people I know who have collections have not insured them. They, then, are not looking at their collections as a holder of wealth that they can live off. If they were, they have a risk of loss from many causes.

And the insurance may not work for you if you live with your art and it is destroyed by a flood or other uncovered risk. Even storing your collection in a bank vault, a frequent practice, may not be adequate risk protection. A teacher with a passion for middle eastern rugs went on frequent buying trips in Asia, making a market in his rugs but considering the rugs largely as his retirement fund – a comfortable retirement fund. He felt that he could not afford the premiums to insure them but kept them in a large bank vault. Unfortunately the vault was in the World Trade Center.

If a picture is matted and framed, it may have to be rematted and reframed periodically. Works are damaged by sun and humidity or simply having the wrong glass over them. Contemporary art work is notoriously expensive to conserve – more so than paintings that are 100’s of years old. They are often made of materials that were not intended to survive or involve glues that dry up. An art restorer told me of horrendous charges to repair the effects of age of “ordinary” contemporary pieces that were only 35-50 years old. Sadly, much work that was purchased in the 60’s and 70’s is not matted with acid free paper. The result is damaged prints.

For the ordinary “collector” the level of forgeries can be surprisingly high. I have at least one in my collection. It hangs in my home, because I really like the image. I did not pay much for it. Therefore I do not bemoan the fact that it Is not a real Dali.

Collections can lead to wealth if you understand the system and know how to work it, particularly if you are a dealer who knows how to put the shine on base metal and get someone to need it. Unfortunately, if you are the collector, you might end up being the person who “just has to have it.”

NEXT: Dow Testing Low, Gold Testing High

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

A Nasty ETF Surprise

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

While studies generally indicate that ETFs are more tax efficient than mutual funds, there can be isolated exceptions and the ProShare family of short and ultrashort ETFs produced a truly shocking example on December 23rd. While ETF capital gains are usually minimal, in this case some of the funds distributions were closer to astronomical. Traders had no chance to adjust their portfolios to avoid the distributions either (and this was no accident), since the capital gains distribution was announced after the close and trading began ex-distribution the next morning. All holders of these ETFs, but especially short-term traders, will be getting a nasty tax bill because of ProShare's actions.

Ironically, the reason for the huge distributions are the success of the short and ultrashort ETFs. With the big drops in stocks this year, the ultrashort ETFs, which use margin to create a 200% short position, have been the biggest money makers by far. ETFs usually only incur capital gains when the indices or baskets of stocks they represent have bankruptcies, takeovers, or need to be rebalanced for other reasons. Apparently there was a lot more activity in these types or transactions in the short and ultrashort ETFs (all transactions get magnified in the ultrashort portfolios) in 2008 than in previous years.

The ProShae ETFs with the biggest distributions were:

1. $50.35 per share - SJL: Ultrashort Russell Midcap Value
2. $47.85 per share - SIJ: Ultrashort Industrials
3. $47.78 per share - SDK: Ultrashort Russell Midcap Growth
4 $42.35 per share - SSG: Ultrashort Semiconductors
5. $39.74 per share - SKK: Ultrashort Russell 2000 Growth

A full list can be found at: http://www.proshares.com/resources/news/36601289.html

If you were holding these ETFs in a non-taxable retirement account, capital gains distributions mean very little. Traders in taxable accounts however need to be careful in December. Anything ultrashort is not something that is meant to be a buy and hold position. By definition these are short term plays. You may want to take a holiday break from this type of ETF between Thanksgiving and New Years. New positions particularly should be avoided. The same advice will be good for the ultralong ETFs during a bull period.

NEXT: Pay attention to the First Four Trading Days of 2009

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Employment Losses Revealed After the Election

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

When post-election government economic reports are released in the next several months, don't be surprised if conditions are much worse than those reported before the election. This shouldn't be interpreted as conditions having actually significantly deteriorated (although this is probably happening as well), but that there is now less motivation for the Bureau of Labor Statistics (BLS) to fudge the figures to make them look better. The Employment Report released this morning is a case in point. While this report generally contains more fantasy than a Harry Potter novel, apparently there is some limit to the BLS's job conjuring . Now that the election is over, we find that unemployment shot up significantly in October and job losses for August and September were much higher than originally reported. Must be 'coincidence' that they missed reporting on those bigger job losses before people voted.

While the unemployment figures are still grossly understated, they are bad enough as is. A loss of 240,000 jobs took place in October and the official unemployment rate rose to 6.5% from 6.1%. September's job losses were revised upward to 248,000 from the previously reported 159,000 and August now has a loss of 127,000 jobs instead of 73,000. So far the number of jobs have shrunk every month this year and according to the BLS, the total loss is now 1.2 million. The official unemployment rate is now as bad as it got in the 2001 recession and is heading toward the higher levels of the 1991 recession (as you go back in time, each recession was worse in the U.S. until 1974).

Evidence that the BLS is underreporting unemployment can be found in the statistics for the number of people collecting unemployment insurance. It has already hit a 25 year high of 3.84 million, a level last reached in the devastating 1982 recession. Unemployment is paid by the states and there are already five states with insolvent unemployment trust funds and another eight states teetering on insolvency. To handle this situation, the federal government has been 'lending' the states money at very low interest rates. For their part, the states are trying to raise unemployment insurance rates paid by companies, many of which are having serious financial problems of their own (many states lowered unemployment insurance taxes when the economy was good and companies could afford to pay more). Few things are more certain than a number of state unemployment trust funds will need a major bailout by the federal government in the not too distant future.

While it should be axiomatic that a growing economy creates jobs and a deteriorating economy losses jobs, the U.S. government still has not acknowledged a recession exists even after 10 months of steep job losses. More proof of recession can be found in weekly unemployment claims. These were 481,000 last week and have been over the 400,000 level, usually considered the cutoff for an economic decline, for a long time. Perhaps now that the election is over one of the government's other great works of fantasy, the GDP report, will start to veer closer to reality.

NEXT: China Bails Out Asia - at Least for Today

Daryl Montgomery

Organizer, New York Investing meetup

http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.