Winter 2012 – Newsletter

Nothing in life is so exhilarating as to be shot at without result – Winston ChurchillMy son just started high school and promptly received a C in Algebra I, a class he aced in the 8th grade. He was immediately reminded that continued poor performance at a top institution might land him in the rugged DC public school system, an environment for which he is ill-equipped to survive. Imagine what would have happened to this very effective message had it been diluted by 435 house members, a divided senate, filibusters the 24 hour media entertainment circus.The American voter, having suffered unspecified injuries from the blunt force of vague ideas, must have noticed that the fiscal cliff was never seriously discussed during the contentious presidential campaign. Apparently, nobody wins elections by promising to take stuff away, or so says Nate Silver.

As one compares all of the competing equities, however, there hasn’t been a better opportunity to revamp the tax code, address deficit spending and tailor the U.S. economy to be able to compete globally since the 1940’s. For whatever reason, people tend to compromise when a gun is pointed in their direction. Call me naïve, but few of us enjoy being shot at close range.

Yes, consider me the most optimistic person within walking distance of the U.S. Capitol Building. As one dissects the means by which the government generates revenue and how it spends the proceeds, we’re not so bad off. We have one political party licking its wounds in places it didn’t know it had, while the other, suffering from a chronic case of poor self-esteem, is likely skeptical of its good fortune – maybe now they can actually get something done.

Throughout this tug of incomplete policies, it’s been understood that out of control government spending led to this inevitable showdown. According to “White House Burning”, however, non-defense discretionary outlays (transportation, education, social programs etc.) have been four percent of GDP for the last 50 years, suggesting that our demand for government cuts has been largely misdirected. Truth be told, the increasing expenditures are a direct result of the rising cost of entitlement benefits, as people are living longer and health care costs have been skyrocketing for decades.

But if you believe like I do that society is judged by how it cares for the elderly, another generation will have to take it on the chin. Despite having few crumbs from the cookie jar visible on our fingertips, odds are that Generation X will bear most of the burden. It may not be fair, but compared to living through a great depression or getting drafted into military combat, I’ll take it.

Payroll taxes represent 36 percent of all federal revenue , such that a one percent increase in FICA rates from the existing levels would reduce the deficit by an estimated $60 billion a year. For what it’s worth, Ronald Reagan raised the social security and Medicare tax for self-employed workers by 4.65 percent and he still managed to have an airport named after him – this is politically possible.

It’s also worth mentioning that contrary to popular belief, our nation is not deluged by high taxes. In fact, the tax burden of the United States (federal, state and local) is the second lowest amongst the 34 industrialized countries and the United States collects less corporate tax relative to the overall economy than almost any other country in the world.

What can be said is that Americans must decide what they’re willing to pay for with borrowed money. The mortgage interest deduction is not only expensive, but Canada has a higher rate of home ownership without any help from the government. It seems that gradually capping the deduction at $400,000 would increase tax revenue by $30 billion a year without disrupting the housing market, as less than 10 percent of homes in the United States sell for more than $500,000. Even if deductions are capped at $25,000, tax revenues would increase by $1.3 trillion over the next 10 years, starting at $70 billion in 2013.

The estate tax law allows beneficiaries to inherit assets at a stepped up cost basis, effectively eliminating any tax exposure on the accrued capital gain. Per the Joint Committee on Taxation, abolishing this tax break would create an estimated $41 billion in annual revenue to the treasury. Moreover, interest on state and local bonds is deductible, which is simply a transfer from the federal government to the state coffers and costs another $50 billion.

The United States has over 2,000 federal subsidy programs to support favored industries and pet projects, increasing in number by 21 percent during the 1990s and 40 percent during the 2000s. Eliminating the agriculture subsidies that largely benefit corporate farmers would save $15 billion and subsidies to non-renewable energy amounts to another $8 billion.

In five paragraphs we just wiped out a respectable chunk of the budget deficit without touching the military ($662 billion a year), low capital gains and dividend tax rates ($130 billion a year), the annual $48 billion in Medicare and Medicaid fraud or allowing the Bush tax cuts to expire on income over $500,000 ($315 billion over a decade). We also haven’t cut any social programs that may ultimately outweigh tax increases or considered the $200 billion increase in federal tax receipts since 2009 that are expected to grow by another $600 billion next year.

Does anyone doubt that reducing our deficit, even by 50 percent, would improve economic growth that might undoubtedly find its way into the pockets of high wage earners? There, I just paid everyone’s higher taxes. My point is not to suggest that we could implement these changes and solve the problems over night, but rather demonstrate that viable solutions exist if they are constructively applied when the exit door is locked shut.

All of this comes in the face of a slow yet relentless economic recovery. The American economy created 171,000 jobs on October, but the real news was in the labor force participation rate, a key metric that measures those working or looking for jobs, which edged higher to 63.8 percent after wallowing around 31-year lows for the past several months.

Moreover, confidence among U.S. consumers climbed to a five-year high in November, improving the prospects of bigger spending gains that will help spur the expansion. The economy has also seen 13 straight quarters of GDP growth and manufacturing has added 489,000 jobs since 2010 , even as the industry struggles to fill another 250,000 positions due to a lack of skilled workers. Remember the beleaguered real estate industry? Well, housing starts jumped 15 percent to a four-year high in November and Builder Confidence is at its highest level in six years.

The ongoing debate about government spending and debt is nothing new. During President Washington’s first term, Thomas Jefferson argued for a narrow definition of government powers, while Alexander Hamilton preferred a strong central government that could quickly gather resources to pay for a national emergency. Hamilton went on to assert that the ability to tax and enable a government to repay loans kept interest rates low and maintained available credit markets.

Jefferson and his new ally James Madison were steadfastly opposed to permanent indebtedness and providing a central government with capital to fight meaningless wars. In 1801, the Republican majority overturned much of Hamilton’s policy, cut taxes and shrank the size of government, which at the time consisted of the army and navy.

Lo and behold, the War of 1812 culminated when the British army sailed up the Chesapeake Bay and burned down the White House because our underfunded navy was ill-equipped to stop them. The measure turned out to be a diversion and foreign troops ultimately withdrew, but the credit markets’ trepidation to lend us money on the grounds that we were unwilling to pay them back with tax revenue was perilous.

The necessary fiscal space that a government needs to address financial shocks is currently lacking in the United States and an unprecedented window of opportunity is staring Congress in the face. This has not been lost on the top CEO’s who are petitioning elected officials for a swift resolution because the Fiscal Cliff would have awful consequences. Big business has seemingly heeded Warren Buffett’s famous two rules: #1 is to never lose money and #2 is to never forget rule #1.

Speaking of profitable endeavors, take a look at the trendy pre-season Super Bowl picks. Given the fiscal turmoil in the European Union, Germany is now threatened by a recession of its own. China, accustomed to double digit growth, has slowed down considerably to 7.5 percent due to economic problems in the EU and United States. Aesop would be proud, the US dollar, still in possession of its reserve currency status, is within striking distance of the hare.

Excessive national debt is an impediment to growth and prosperity because it crowds out private enterprise and incurs mounting and unsustainable interest payments. Once this cloud of suspicion about America’s commitment to pay its bills and limit spending is moderated, perhaps some of that $2 trillion sitting on the sidelines will get reinvested and the economic recovery can gather speed. The can of gross fiscal incompetence has been kicked to the end of the cul-de-sac, and now lacking the requisite wiggle room, a solution might very well be forthcoming.

That’s my story and I’m sticking with it until December 31st.

Securities offered through LPL Financial, Member FINRA/SIPC ( Investment advice offered through Delancey Wealth Management, LLC, A registered investment advisor and separate entity from LPL Financial.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

1. US Treasury Department
2. Social Security Administration
3. Organization for Economic Co-Operation and Development (OECD)
4. The corporate tax myth; CNN; 2/23/12
5. Should we stop encouraging home ownership?; CBC News Canada; 9/24/12
6. Reducing the Deficit: Spending and Revenue Option; CBO; 3/10/11
7. Limiting Tax Deductions: What It Might Cost You; CNBC; 11/13/12
8. 8 tax breaks that cost Uncle Sam big money; Fox Business; 3/13/12
9. Office of Management and Budget
10. CATO Institute
11. Farm Subsidies: Sacred Cows No More; Wall Street Journal; 4/9/11
12. The Energy Subsidy Tally; Wall Street Journal; 8/17/12
13. By the numbers: Defense spending;; 5/18/12
14. 8 tax breaks that cost trillions, 4/12/12;
15. GAO: Medicare losing $48 billion;; 3/2/12
16. Fiscal cliff tax deal: Getting to $1 trillion;; 11/26/12
17. Office of Management and Budget
18. Pre-Election Jobs Report Shows Some Gain; Rate 7.9%; CNBC; 11/2/12
19. Consumer Sentiment in U.S. Increases More Than Forecast; Bloomberg; 11/9/12
20. Five Takeaways From GDP Report; Wall Street Journal; 10/26/12
21. Surprise! American manufacturing is rebounding; USA Today; 5/15/12
22. Housing Starts Jump 15% to Four-Year U.S. High; Bloomberg; 10/17/12
23. Could Housing Be the Antidote to the ‘Fiscal Cliff’?; CNBC; 11/14/12
24. CEOs warn Obama, Congress to avoid ‘fiscal cliff’; Washington Post; 10/18/12
25. Germany ‘risks entering recession’ say think tank; BBC News; 10/11/12
26. S&P: China slowdown to hit bottom in 4th quarter;; 9/28/12
27. The $2 Trillion Corporate Cash Hoard Is Only Getting Bigger; Business Insider; 3/21/12