We Need a Transaction Tax: Gambling is not Investing!

In order to frame the argument, consider the following statistics.

1.)  Traditionally, 30% of oil futures trading was made up of speculators, or people who never had any intention of taking possession of the oil involved in the contracts they were trading.  Oil producers and others involved in the oil industry made up the other 70%.  Today, as gas pump prices once again go above $4 per gallon, that 30/70 ratio has been reversed.

2.)  By some measures, 70% of all stock market transactions are now made by high frequency traders.

Common sense would seem to dictate that “investing” and “gambling” are actually two different endeavors.  Traditionally, investing meant providing capital to a purpose that would, OVER TIME, produce a profit, or a return on the investment.  Usually, the additional value was created by producing some type of good or service.  In other words, wealth was created by creating something new that did not exist before, and that provided a benefit to someone.

Oil speculators, and high frequency traders “create” wealth in quite a different manner.  By trading on both the ups and downs of the “investor” driven markets, they create wealth from nothing at all.  They do not produce a good or service.  And the “value” that is created provides no benefit other than to increase the wealth of the person doing the trading.

Now, one must recognize that the creation of “new” capital can, in itself, be considered beneficial to society as a whole.  However, unless that new capital is invested in the tradition manner that creates new goods and services, then again, it only benefits the wealthy that can afford to invest or gamble is such a manner.  To be blunt, it represents yet another method by which the proverbial rich get richer.

Please note that I strongly believe in the free market system.  I do NOT advocate abolishing the existing system and I do NOT begrudge the wealthy capitalists from exercising their right to engage in speculative “investing”.  Their actions are legal, as they should be in a free market system.

However, the two statistics above strongly indicate that perhaps the “system” has become out of balance.  The shift from traditional wealth creation to speculative wealth creation has been a major contributor to the last two oil bubbles, and in fact the Great Recession in general.  In addition, rather than benefiting society as a whole, it has also contributed to the ever increasing concentration of wealth in the US (see other posts in this blog).

There is a simple, elegant, and fair solution to this problem.  It’s called a transaction tax, which involves placing a small levy on each transaction made.  The effect of such a tax is to place a natural governor on high frequency trading and speculation.  The more you trade, the more transaction taxes you pay.  You can still trade as much as you wish, but the more you do, the more you pay back to the society which supports the systems that allow you to conduct such trades.  Society as a whole is better off no matter the effect on speculative trading.  If folks trade less, the markets will better reflect actual wealth creating economic activity.  If speculative trading volume increases, society reaps the windfall benefits produced by the transaction based tax.

Opponents will immediately counter that such a tax will hinder the markets, deter trading, and thus dampen economic activity overall.  I disagree.  If a transaction tax reduces the disastrous effects of too much speculation in the markets, I say great.  That will benefit the economy as a whole.   And if the super rich want to continue their speculative activities, they are free to do so, but must be willing to pay a fair price for the privilege.  Why wouldn’t a wealthy investor want to pay back, and pay into, a society and a system that is directly responsible for their ability to acquire such wealth?

But what about the small investor?  Do we really want to create ANY additional barriers for the common man to invest?  Certainly not.  So based on the premise that the wealthy got that way because of a system that we all support and contribute to, I believe a transaction tax could be fairly implemented in a relatively simple manner.  Below I present a proposal to get started along with some of the reasoning for the rates and ranges proposed.

Transaction Tax (on all SEC Registered securities AND unregistered securities transactions in the hedge fund, futures, OTC, and other various markets both regulated and unregulated.)

$0 – $10,000 = No Tax
These folks are not wealthy enough to pay to support the system.

$10,000 – $100,000 = 0.1%
Ten to one hundred dollars are a tiny amounts in this range.  They would hardly be noticed and are virtually insignificant compared to management fees and investment returns.

$100,000 – $1 million = 0.5%
The same arguments above apply to this range (where the tax would range from $500 to $5000).  Acknowledged, at five grand we are starting to talk about real money.  So we will include the “Frequency” exclusion described below.

$1 – 10 million  = 1%
Let’s face it, if you are moving one to ten million dollars around on a frequent basis, then 1.) you are very wealthy and can afford 1% as many times as you want to, and 2.) you are moving amounts that are significant to the point that they could in themselves affect the market.  (High Frequency Traders operate on such tiny fractions that any $1 million dollar bet on a single position could affect that position.)  Thus, you should pay this highest amount to help protect the system you are gaming.

$10 million on up = 0.1%
Now economies of scale kick in.  A tenth of one percent on $10 Million dollars is $10,000 which is a significant transaction fee no matter how you look at it.  It’s also a significant tax payment, especially if paid frequently.  But it is also small enough (ten cents per $100 dollars) that it still represents a fairly insignificant, and fair, overall effect on your transaction.

The “Frequency” exclusion would provide that that the tax does not apply to the first four transactions made by any individual or entity in a single year.  So a traditional investor (think “buy and hold”) would never pay the tax at all.  Re-positioning assets from time to time is a critical requirement for any well managed diversified portfolio.  But 99% of the population can not “re-position” amounts of $100,000 very often.  For those that need to do so more than four times in a year, a 0.1% fee is reasonable and fairly insignificant.  And, because 0.1% is reasonable and fairly insignificant, the Frequency exclusion for the first four annual transactions would not apply to the $10 million-and-up traders.

Once last example to make a point.  The $10,000 investor who watches the market and moves his money quite a bit would pay $10 the fifth time he traded in one year.  I guarantee you that his broker dealer or investment adviser has already charged him far more!

So think about the intuitive and innate fairness of a transaction based tax.  And think about the positive benefits to the financial system and society as a whole, not to mention a more logical approach to raising revenue for the government.  After all, it is our government (of and by the people) that backs the almighty greenback (dollar) and the entire financial and banking systems.  Shouldn’t those that own and control the largest amounts pay the most to protect this system, and their own assets?

A transaction tax has been proposed but has yet to make much noise in the news.  As it does, consider providing strong support for such a measure.

Millionaire Goggles: Why Romney has no clue about the American Dream

Recent polls show that income disparity is increasingly a  concern across all sectors of the population (including Republicans).  However, 43 percent of respondents said that the rich became wealthy ”mainly because of their own hard work, ambition or education.”  The belief that being rich is transitory by nature is part of the fabric that makes up the American dream.  People think if the rich became rich by their own efforts, perhaps they can get rich too.

Unfortunately, although we cling to this romantic belief, it is becoming less true every day.  The reason this part of the American dream is becoming a thing of the past is directly linked to the income disparity caused by the concentration of wealth discussed in previous articles.  As we become more aristocratic, more or our wealthy are born into wealth, rather then becoming wealthy based on their own efforts.  Inheritance tax not withstanding, the trend of more and more of the rich inheriting their wealth as opposed to earning in on their own is an undisputable  consequence of the concentration of wealth.

It is perhaps even more unfortunate that many of our political elite come from such a background because in a sense it separates them from the rest of us.  They simply have never faced the everyday challenges that the majority of the population experiences.  Do you think George H.W. Bush ever had to bus tables at a local diner to pay for his college education?  Did he ever need a paper route in order to buy baseball cards for trading?  I doubt it.  I would suspect that he never would have owned a major league baseball team if not for the high level oil executive job he was able to get right out of college.  Were you offered such a position just after graduating from college?  These are just some of the privileges enjoyed by the wealthy upper class.

Perhaps today’s most concerning example is presumed Republican presidential nominee Mitt Romney.  Recently he tried to connect with voters by saying that there were times he worried about getting a pink slip.  He was trying to say that he know what it felt like to be worried about getting fired.  I seriously doubt it!

Let’s run some numbers.  Romney’s net worth is reported to be $250 million.  Let’s assume a safe conservative investment return of 5%.  (Note:  In 2012 5% is a pretty optimistic expected rate of return for the average non-wealthy individual.  However, historically it would be considered a conservative assumption.  Also, if you are worth $250 million, you can afford some pretty high end money managers using “absolute return” strategies and almost guarantee a rate of return at least that high.)  So on $250 million, Mitt Romney can safely expect to earn $12.5 million dollars per year on his investments alone.  That is equal to $34,246 per day.  That is over $34,000 per day, every day, without working a day.  Now, if you had that kind income derived solely from existing  wealth do you think you would worry much about losing your job?

The average American worries about losing a job because that means he might not be able to pay his rent or mortgage!  There certainly must be a substantially higher level of fear for that person.  I seriously doubt that Mitt Romney has EVER experience this type of fear and uncertainty.

It’s true that Mitt Romney was not always worth $250 million dollars.  The manner he earned much of it was by what Newt Gingrich recently called “vulture” rather than “venture” capitalism (most likely the subject of a future article).  But he certainly was born into money.  My favorite quote about Bush (43) was when Ann Richards said “he was born with a silver foot in his mouth”.  Today columnist Reuben Navarrette said of Romney, “it’s one thing to be born with a silver spoon in your mouth, and it’s another to have been saddled with a 20-piece set of sterling flatware.”

So Mitt Romney got rich by being born into the wealthiest segment of our society.  If a big part of the American Dream is that anyone can get rich by their own hard work, then Mitt Romney certainly doesn’t have a clue about that.

What makes a Millionaire, Wealth or Income?

This week Senator Jim DeMint (R, SC) was on Jon Stewart’s “The Daily Show”.  He was defending the Right Wing’s economic policies that overwhelmingly favor rich people.  He said that there are many many misconceptions about the rich in our country, and then made an assertion that demands examination.  He stated that most “millionaires” are only millionaires for one year, and one year only (see quote below).

My first reaction was that this statement is flat out patently false.  But then I realized the rationalization he was using to make such an assertion.  In defining a millionaire, he was making the common mistake of confusing income and wealth.  The distinction between the two is incredibly important.  This distinction is often blurred, which is incredibly unfortunate, because it is at the center of the debates on wealth disparity and tax policy in this country.

If one defines a millionaire as anyone who received a million dollars in annual income, then his assertion may indeed be correct.  It is fairly easy to think of examples of individuals that make a million dollars in one year, but do so for only one year.  Think about the guy that invented the Pet Rock which was a short lived fad back in the 1970′s.  He most likely made a million dollars that year, and I doubt that he ever did again.  Or consider employee numbers 20-50 of a high tech start-up that just launched their I.P.O.  Many of these folk might make a million dollars in the year of the I.P.O. but their annual salaries on a continuing basis are nowhere near seven figures.  Even a small business owner with a healthy on-going annual income might a have single banner year where they make a million dollars.

I believe that a millionaire is more traditionally defined as someone who has a net worth over a million dollars.  In the investment industry, this definition also excludes the value of one’s home.  So a millionaire is someone that has over one million dollars of invest-able assets.  If you make one million dollars in a single year, you are going to pay at least 30% in taxes, and you’ll most likely spend another 10% on living expenses for the year.  So even the frugal one million dollar income earner would have a net worth of about $600,000 at the end of a single year with that income.  Such a person would not be considered a “millionaire” under the traditional definition.

So our friend Senator DeMint is defining a millionaire by income rather than wealth an that does not make any sense.  Any true millionaire with a bit of intelligence and a modestly conservative investment philosophy will remain a millionaire not only for one year, but indefinitely!  Many people who enjoy a one year of million dollar income will enjoy a comfortable life, but they are not millionaires.

There are a good number of reasons that this distinction is so important.  For starters, once you are a millionaire, your wealth can provide enough income for you to live on via investments.  You no longer have to work for income.  You live on “investment income” rather than “earned income”.  Everyone else that is not a millionaire must trade their time for money doing something for someone other than themselves.  In short, they have to have a job.  They must work.  They don’t have any other choice.

I call this precept the “endowment concept”.  Generally an endowment is used to fund a cause using only income earned on the endowment itself.  The principle of the endowment is never spent, and thus the cause can be supported at a certain level forever.  Any individual that has over a million dollars in investable assets is self-endowed.  That person can choose to never work again, and live at a modestly comfortable level in secure manner forever.  In fact, the endowment can be passed on to another generation.  One million dollars can support a single person forever.  Perhaps in some parts of the county such as New York or San Francisco this number is more like 1.5 or even 2 million (based on a 5% return providing $50,000 dollars of annual income).  Granted, this level of income is modest, but it will support an individual, or even a small family in most parts of the country today.  Many folks live on a lot less!

But people should be entitled to live beyond this modest level.  Living larger is part of the American dream.  True indeed, but the the point is that everything beyond this level is by choice.  Most millionaire choose to continuing working in some capacity to become even richer.  But that is their choice.  For those without a million dollars, there is no choice other than to work.

Another reason the distinction between income and wealth is so important is the role it plays in our system of taxation.  A tremendous amount of our tax system is based on income rather than wealth.  That is why it is called an “income tax”.  Government revenue is based on how much people (and corporations) earn in a year, rather than how much wealth they own or control.  Senator DeMint’s assertion is based on this concept.  Much our our tax policy debate centers around setting tax rates and defining the wealthy by income.  In some ways this makes sense.  It would be difficult for example to force a company to sell some factory equipment to settle a tax debt based on the value of that equipment, or to force a rich guy to sell part of a car or business to settle a tax debt based on his total net wealth which includes that car or business.  Taxing wealth is difficult because it is seldom liquid whereas taxing income is easier because annual income is generally liquid.

However, remember our friend the millionaire who lives on investment income rather than earned income.  Thanks in part to the Bush Tax cuts, he mostly pays a tax rate of 15% (the current capital gains tax rate for investment income in place since the Bush Tax cuts) rather that 35% (the top tax rate for people who work for a living).  Why we tax income that people must work for at a higher rate than we tax income that people earn simply for being rich already is beyond me!

The important thing is to understand that the lower tax rate on investment income is the reason the Bush Tax cuts mainly benefit the wealthy.  Tax policy is at the center of this country’s economic problems and is likely to be a major topic in this year’s elections.  During the debate, you will hear many politicians and pundits use the concepts of wealth and income interchangeably as if they were the same thing.  It is critically important that the distinction between income and wealth is recognized and dealt with fairly in public policy.  Let’s hope our leaders truly understand the difference, and consider it when they talk about millionaires and then institute a fair policy of taxation!

Quote of Jim DeMint of “The Daily Show” 1/11/2012
“ There is lot of mis-information about the rich in our country. Fifty percent of the people in our country who are millionaires, are millionaire for one year. So we have this kind of revolving door.  We don’t have this kind of permanant class of millionaires like a lot of other countries.”

Class Warfare? Of course it’s Class Warfare

Last August President Obama became less conciliatory and started directly attacking the Republicans for protecting the Bush Tax cuts which overwhelmingly benefit the wealthiest members of our society.  Immediately, the right-wing politicians and pundits began to accuse the President of using “class warfare” to divide rather than to unite the nation.  The expression became a fixture of Republican “talking points” and remains that way today.

Instead of deflecting criticism from those using this seemingly divisive term, I wish the President had embraced it and adopted it as a tool in the coming election battle. The following speech is one that I wish Obama had delivered back in September, and that I still hope he will give sometime during this election year.  He is welcome to use this essay as a basis for such a speech.

President Barack Obama’s Speech to the Nation (undetermined date):

My fellow Americans, I have been accused of inciting “class warfare” for my criticism of Republicans for their uncompromising support of the Bush Tax cuts. Is this class warfare?  OF COURSE THIS IS CLASS WARFARE!  I suggest that, in fact, almost all of politics is class warfare.  Certainly in a representative democracy with a free market economic system, politics is about class warfare.  That is the whole point.  That is how it is supposed to be.  Instead of fighting real wars and killing each other in a state of anarchy, we elect representatives to argue out our disagreements and formulate laws to keep the system running in a peaceful manner.  Politics is our peaceful means of conducting class warfare so that we don’t actually have to fight real violent wars over economic disparity.

Economic disparity, by the way, has and always will exist.  This too, is as it should be.  It is a natural element of a free market economy.  It is endemic to the system of capitalism which has made this country great.  I am a free market capitalist and I fully believe in this system, even with the economic disparities it inevitably produces.  And, I am profoundly proud that we use our democratic political system to manage affairs in our market economy and continue to keep our country strong and functioning well.

So with regards to the Bush Tax cuts, let’s call them what they are.  They are single battle in the perpetual class war that is part of the social fabric of this nation and of our economic and political systems.  This particular battle has been won by the rich.  In fact, the rich have been winning almost ALL of the battles for the last three to four decades!  Since the 1970′s, the wealthiest in our society have continued to control a larger and larger proportion of the total wealth of this county, while the middle class and the poor control much less.

When Ronald Reagan endorsed Supply Side or Trickle Down economics he believed that a rising tide would lift all boats.  This phrase has been used repeatedly since that time.  It sounds nice.  It even sounds logical.  But to date, it simply has not happened.  The policies put in place to support this philosophy have so far increased only the size of the yachts for the very richest among us.  The middle class has been left to get by in ever smaller and fragile dinghys.  Recently, the unequal size of these metaphorical boats created a tsunami that literally swamped the tiny boats of the middle and lower classes.  Many people are drowning or barely staying afloat.  It would seem a rising tide does not in fact, lift all boats, at least not equally!

This same economic philosophy tells us that the wealthy are the job creators.  The Bush Tax cuts were supposed to create more economic activity that would result in the creation of thousands and thousands of new jobs.  This too simply did not happen.  During the years after the Bush Tax cuts and before the beginning of the Great Recession, our economy effectively added no new jobs.  The number of jobs did in fact increase during this period, but that was primarily due to increased government hiring as the nation added to the ranks of security, intelligence, and defense employees from the federal level down to the local level.  If you remove government hiring from the numbers, the economy did not produce a significant amount of new jobs as a result of the Bush Tax cuts.

So how long are you willing to wait?  It has been thirty years since we began this “supply side” experiment.  It has been more than a decade since we tried the Bush era tax cuts for the wealthy.  The promised results have simply not come to pass, at least not yet.  Once again, how long are you willing to wait?

In fact, the opposite has happened.  The wealthiest among us have continued to get richer and richer.  So of course it is class warfare, and guess what?  If you are not part of the tiny wealthy class, then you are losing the war, and you have been for decades.

I believe that our economy is more healthy, and the country is stronger when more of us posses and control a greater proportion of the huge wealth that the country is capable of producing.  The rich will always be there, and the rich will always be rich.  That’s OK.  But I believe it is time to turn the tide of the “war” and win a battle for the rest of us.  The first step is to repeal the Bush Tax cuts!

Public Employee Pensions: Evil luxury or the last hope for a progressive society?

I just read a letter to the editor in which the writer declares he will not vote for any tax increases until pensions are completely eliminated for all public employees.  He also states emphatically that “defined benefit pension plans are a thing of the past”, and that “companies have decided they were just too expensive”.  This opinion seems to be fairly common these days as public employees are vilified for their seemingly generous retirement benefits.  While I agree that these benefits do appear generous today, the issue presents a far more important matter that we, as a society, should be debating.

In my opinion, public employee retirement benefits have not become egregiously generous so much as private employee benefits have become excessively lean!  It’s true (at least locally and in the state of California) that public pension costs have risen disproportionately during the last decade.  Returning benefits to the levels that they were at in the 1990′s is most likely a good idea that I would not oppose.  However, when it comes to completely eliminating these plans for public employees, I am not so sure that is a route we should be taking.

First of all, let us look at a little history.  Section 401(k)* was written into the tax code in 1978 and became effective on January 1, 1980**.  It created the “defined contribution” retirement plan which is more commonly known as a 401(k) plan.  Before that, most middle and large sized companies provided employees with a “defined benefit” retirement plan which is more commonly known as a traditional pension.  The 401(k) plan is nothing more that a tax-differed savings account with no guarantees of income levels during retirement.  The pension provides a guaranteed level of income for life during retirement based on the number of years of service.

More important than the difference in retirement income, is the difference in how each type of plan is funded.  The traditional pension must be fully funded by the employer.  The employer must set aside sufficient amounts of money each year and manage the investments so that it is able to meet the lifetime guarantee obligations of the plan.  This responsibility is rather onerous, and generally companies used professional money managers to handle the investments and administer the plans.  In the case of the 401(k) plan, the responsibility for funding the plan is completely shifted to the employee.  The employer might make matching contribution up to a certain capped level, but they are not required to do so, and in most plans the employer can stop making matching contributions at will, such as during down times.

So while our friend the letter writer says “companies have decided they were just too expensive”, it might be more accurate to say that companies realized they had to ability to shift the burden of retirement planning onto employees.  This shift allows companies to have much leaner operating costs and presumably contributes to greater profitability and efficiency.

However, that improved business performance has come at quite a great cost for the employee!  Since 401(k) plans are voluntary, not everyone participates (i.e. saves for retirement).  Even with automatic enrollment, most worker do not contribute enough to properly fund their retirement.  The national average for the amounts saved in 401(k) accounts across all age ranges is dismally and potentially disastrously low.  In addition, most employees lack investment management skills.  Most, simply choose a few mutual funds and let the money just sit there.  While some plans contain automatic asset re-allocation, in general the investments in 401(k) plans are not actively managed.

So while 401(k) plans may have been really good for businesses, they are actually not very good at all for the average employee.  In the three decades they have been around they have almost completely replaced the traditional pension plan in the private sector.  The question is rather workers are better off now then they were when a traditional pension was the norm.  I would argue that they are far worse off under the 401(k) system and that the average employee would be far more secure in retirement under the old system.

So, our letter writer is probably correct when he states, “defined benefit pension plans are a thing of the past.”  But, is that a good thing?  We have lost a great deal of security for the sake of greater company profits.  Combined with the insecure future of the Social Security program, the retirement landscape for my generation is looking far more precarious than that of the Baby Boomers or even the Greatest Generation before them.

So the next time you feel like a public employee is getting a free ride, remind yourself of what you have given up, or what has perhaps been taken from you.  I don’t know how we can steer our society back to a more conservative and secure approach to retirement planning.  However I do know that public employee pensions may not be such an evil luxury, as they are currently portrayed.  In fact, if embraced as a model for future retirement plans, they might be our last hope.

*Section 401(k):  As I understand it, the 401(k) plan was never intended to replace the traditional pension.  In fact, Section 401(k) was written to allow companies to provide a supplemental system for employees to be able to save in a tax-differed account on top of their traditional pension.  In fact, it was written specifically for one company, Xerox, to provide such a plan.  I have not been able to confirm the company specific reference in my research on the matter, nor have I reviewed the congressional debate over this provision of the tax code.  However, the obscure nature of the provision as simply Section 401(k) of the tax code leads one to understand that it was not intended to replace the traditional pension system prevalent in this country at the time.

** January 1980:  It is remarkable (however unrelated) that the effective date of Section 401(k) coincides with the same month that Ronald Reagan became President of the U.S. ushering in the era of Supply Side Economics (see Republican Myth #1).  It’s a incontrovertible  fact that this country has had a steady contribution of wealth since that time.  I can’t help but believe that the shifting of retirement savings burden from employer to employee may be yet another contributing factor in the nation’s long slide towards becoming a two tiered society.  Watch for the topic of income disparity and wealth distribution in future posts.