Economic Growth and Tax Law Correlations

Author's Note: This is the third in a four-part series on wealth and income inequality.

"Tax the rich...feed the poor...
‘Til there are no rich no more?"
— "I'd Love to Change the World"
as performed by Ten Years After

Should we soak the rich to solve wealth and income inequality? 

European nations attempted to and found their tax policies ineffective. Seeking more friendly tax havens, many of their wealthier citizens simply moved their businesses and residences abroad. Levying a wealth tax on Americans would likely produce similar results. In an era when the U.S. is struggling to keep businesses operating here at home, tax law changes which drive them elsewhere will likely prove counterproductive to our national economic goals.

Still, soak the rich proposals abound. Last week we reviewed Senator Huey Long's “Share The Wealth” program, proposed in 1934. We are currently seeing more wealth tax proposals than at any time since the Great Depression.

Currently, income tax rates top out at 37%. Capital gains taxes are imposed on profits generated through investments and max out at 23.8% for higher-income folks. 

Historical evidence is scarce as we only have about a 100-year contiguous window to study how various income tax rates impact economic growth. So it’s difficult to look back in time and definitively prove that higher or lower tax rates helped or hurt broad economic growth. Although periods like the 1960’s featured high tax rates on the wealthy and strong economic growth, the two don’t necessarily go hand in hand. And there are some significant cautionary signals for raising taxes on the wealthy. 

Back then our rich citizens were more often becoming wealthy through earned income rather than through financial investments. Today, many of the wealthiest Americans earn their money through investments or leveraged financial transactions which are often only subject to the lower capital gains rates. Additionally, capital is much more mobile than it was back then, which makes tax avoidance easier.

Still, many of the 1% are becoming wealthy through small business enterprises, and indeed pay taxes on earned income. Should we really institute a progressive tax of 70% on income over a certain threshold? Should we charge a 2% tax on wealth over $10 million?

These questions are at the heart of the current wealth inequality debate. We must address this issue, but it should be tackled from the bottom up, not from the top down. Soaking the rich with oppressive tax rates will drive business away and cause entrepreneurs to seek foreign tax havens. 

Next week we’ll wrap up our four part series with tax proposals that would address wealth inequality in a way that would create opportunity for more Americans while avoiding the pitfalls of past taxation policies.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a fiduciary investment advisory firm located near Sandestin.This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.

The Arbor Outlook: Shutdown - Markets Crave Stability and Certainty

"Houston, we have a problem."
—from Astronaut Jim Lovell (Tom Hanks) speaking to Flight Director Gene Kranz (Ed Harris) in the movie “Apollo 13”

While rewatching this Ron Howard classic recently, I was reminded of the bold initiatives that characterized our space program and inspired Americans everywhere. As most know who followed the flight of the Odyssey in 1970 or watched the movie, our engineers, scientists and astronauts brought the damaged spacecraft home utilizing less amperage than is used by a small kitchen coffee maker. That Lovell, Haise and Swigert returned to splashdown safely is a miracle, a true milestone in the annals of American ingenuity.

China has now successfully landed a "rover" on the far side of the moon. So while we are still ahead of China in space exploration, it's obvious that they're making headway.

Knowing these historic American capabilities, then, we are befuddled and confused when we can't even reach a compromise that allows our federal government to operate. At this writing, the shutdown is in a record 34th day. One government economic advisor warns that first quarter growth could stall at zero as a direct result of this logjam. By the time you read this, hopefully the shutdown will be in our rear view. But perhaps not.

Either way, we have seen the short term effects of political turbulence, including massive swings in stock prices. Not all market volatility can be attributed to politics, of course. Global growth rates, interest rates, jobs reports, and so many other factors influence market movements. But all economic experts agree that markets crave certainty, and our current political climate is anything but certain.

Long term, our investments will suffer from constant political unrest. Imagine how wildly markets would be gyrating if unemployment was still at 9% and large financial institutions were crumbling, as occurred in 2008. With low unemployment and relatively sanguine economic conditions, we need to address and correct our known problems before the unknown ones arise.

When elected officials fail to compromise for the common good, they create an environment which magnifies market risk. Enough problems will impact markets negatively without us creating these issues of our own volition. Stock prices spiraling downward and fluctuating wildly due to political turmoil is certainly not good for investors. Markets function most effectively when elected officials compromise and reach accords. At one time, that's how our government operated.

Traditionally, we define market risk as the chance that one's investments will be impacted by the like of recessions, natural disasters and political upheaval. And some market risk is unavoidable. Like 9/11 for example. Or the Great Recession. Truthfully, global and domestic politics are often intertwined with these occurrences as well.

But meanwhile, I'm with Apollo Flight Director Gene Kranz. Let's get this thing fixed.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a fiduciary investment advisory firm located near Sandestin.This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.

The Arbor Outlook: Seinfeld, The Diner Bill and Gregg Allman

"These days I seem to think a lot... about the things that I forgot to do... for you... And all the times I had the chance to."
—from "These Days" as performed by Gregg Allman

George Costanza is in a diner and he thinks he's having a heart attack and tells Jerry and Elaine. Right about then the bill comes and George looks at it. There's a mistake and he's been overcharged. The trio delay rushing George to the hospital so he can complain to the waitress about the erroneous amount.

This genius episode of "Seinfeld," written by Larry David, tells us a lot about our relationship with money. It's something we care deeply about, even when we think we're dying.

I recently read several articles about what people regret most at the end of life. All the expected responses were listed, including spending too much time at the office; not trying hard enough to save a struggling marriage; failing to spend more time with family and children; regrets about being a better parent; not paying proper attention to our health; not reconnecting with old friends who were once important to us; and not following our "true north" in a choice of vocation. Surprisingly, one item listed that many people regret is not taking better care of their finances.

Isn't that interesting? You'd think that that would be the last thing on peoples' minds during life's final stage, but instead, it's often a major consideration. And it makes sense when you think about it. How we handle our financial affairs is related to our quality of life and the lifestyle that we're able to enjoy and provide for our family and our heirs. And it's often commensurate with exercising willpower in various other areas: if we don't have the self-discipline to exercise or balance our home and office hours, we probably won't have the willpower to organize and care for our financial health. People very much regret not saving and investing money during their peak earning years or having squandered their resources.

Of course, it goes without saying that many folks delay addressing estate planning issues. One of the great entertainers of our generation, Aretha Franklin, died last year without proper estate planning. We're all guilty of postponing these duties. Nobody wants to spend an afternoon poring over the details of their own demise. That said, estate planning is something we address as an important kindness to those around us.

The fact is, organizing our personal finances, saving for retirement, and living on a reasonable budget are all significant factors in creating a healthy life for ourselves, and in minimizing regret. We ignore our financial health at our own peril, just as we fail to take care of ourselves physically at our own risk.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a fiduciary investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.

The Arbor Outlook: Winter, SAD and the January Effect

"Ain't it foggy outside... all the planes have been grounded; Ain't the fire inside... let's all go and stand around it."
—from "Sandman" as performed by America

All four of our seasons enthrall me. Sometimes, though, I love winter just a little less than the others.

Days are shorter. Outdoor activities take a backseat to indoor gatherings. Last year's national winter flu epidemic was historic. More folks pass away in winter than in other seasons, especially older citizens. There's even an illness associated with winter and decreased sunlight and lowered serotonin levels: Seasonal Affective Disorder (SAD).

So why do stock prices traditionally increase in January, right in the heart of cold, depressing weather? Or does the January Effect actually exist?

One reason stocks have risen in January is because there's often been a drop in December prices, as investors and advisors frequently perform tax-loss harvesting to offset realized capital gains. This selling can cause a drop in prices, and January's buying returns them to normal. Some also believe that investors often employ year-end cash bonuses into the market in January, and this can cause prices to rise.

Some even believe that January is a "new beginning" for many investors, and the month benefits from financial resolutions associated with the New Year. A study which analyzed stock prices from 1904 to 1974 noted that the average return for stocks in January was five times that of any other month, and that this was especially true for small cap stocks.

That said, the impact has lessened over the last several decades; so much so, that some economists believe that the cost of transactions negates the possible small gain associated with purchasing stocks in January. Another concern is that stocks that rise in January may not hold their value in other months.

There's an urban legend that if you buy in January and sell in May (sell in May and go away), you'll profit every year. Here we arrive at the heart of investing strategy, which begs the answer to two questions. One, what do you want this money (your investing dollars) to do for you, and two, when will you need it? If you want your investment dollars to make a small, extremely short-term profit, one that you'll capture in four months, the January Effect might interest you. But a seasoned investor with a longer time horizon won't be lassoed into this type of thinking.

Say you're 65, and plan to retire at age 70. You want your assets to grow, and possibly produce income along the way if you need it. And you want to begin using the money at retirement. This is a plausible, common scenario. You've got a five-year time horizon. So what stocks do month to month is not your major concern.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.

The Arbor Outlook: The Challenge of Income Inequality

“Some folks are born into a good life; And other folks get it anyway, anyhow…”
—from “Darkness on the Edge of Town” as performed by Bruce Springsteen

If Warren Buffett and Jeff Bezos and Mark Zuckerberg knew their personal annual income was limited to $2 or $3 million, would they have studied and innovated and worked

Here in America, we are limited in how wealthy we can become only by our imagination, creativity, drive, persistence and ambition. Putting limits on CEO compensation or individual wealth isn’t the way to deal with income inequality. If we limit CEO pay to 50 times what the average employee in the company makes, say $50,000 a year, CEO compensation in that company would top out at $2.5 million annually. Now that's a very nice salary, but this type of "cap" violates what we know about incentives and motivation. Huey Long and others advanced this “limit the top earners” concept during the Great Depression. It failed then, and it should fail now.

After all, in today’s globally connected community, an extremely effective CEO can add billions of dollars in shareholder value. If “hiring” LeBron James, who is compensated lavishly, even by NBA standards, brings your team a championship, everyone benefits.

Consider a successful small business owner who invested their entire life savings to start a small business. After 15 years of 100-hour weeks and personal sacrifices, they finally turn a nice profit. Shouldn't he or she, as the business owner who took all the risk and invested their own money, be allowed to profit by as much as they reasonably can?

Instead, what we ought to do, through private and public initiatives, is lift the earning power of all people, not limit income for one segment to benefit another. Businesses should be encouraged to provide training and part-time employment opportunities for high school and college students, who receive academic credit and a salary for their labor. When they graduate, they’d have real life job experience and often would go to work full time at the company where they’d been interning. This serves the corporation and the work force.

Ultimately, we've got to remake our work force into a viable one that can compete successfully in global markets and deal effectively with challenges like automation and cheaper labor abroad. This requires training and investment. Income inequality is a complicated issue, but our country is capable of creating this kind of sea change in the labor force.

Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin.