Tuesday, October 29, 2013

Gary Shilling: The Wealthiest Are in the Taxmans Crosshairs

After the recent recession, the personal-taxes-to-personal-income ratio dropped well below the 12.3 percent long-run average, a casualty of the tax cuts, depressed household incomes and the weak recovery. In combination with depressed corporate tax collections and increased federal spending -- especially in 2009, when outlays equaled 6 percent of gross domestic product -- these forces pushed the federal deficit to more than $1 trillion a year.

At the time, the widespread conviction in and out of Washington was that “fat cat” Wall Street bankers, as President Barack Obama labeled them in 2009, were responsible for the financial collapse, prolonged recession and slow recovery. Americans at the top have regained all they lost and then some; many lower on the income scale, however, remain mired in high unemployment and declining real wages.

Long-term unemployment leapt to record levels. The number of those who prefer full-time jobs but are offered only part-time work skyrocketed to an all-time high. And job openings began to grow much faster than new hires as cautious employers became choosy. As of August 2013, payroll employment was 1.9 million below its January 2008 peak, even though the working-age population grew by 13.1 million in that period. Payroll growth slowed in September, with 148,000 workers added, following a revised 193,000 gain in August, according to Labor Department data released yesterday.

Furthermore, the wealthy, with their large stock holdings, have benefited most from the bull market that began in March 2009. Americans who aren’t in the highest income brackets tend to have most of their wealth concentrated in their homes; in 2010, the value of the residences of the top 10 percent was only five times that of the bottom 20 percent. The stock holdings of the richest 10 percent were 50 times greater. And even with the recent rebound, the median prices of single-family houses are still 24 percent below the April 2006 peak.

Given all this, it seemed inevitable that taxes would go up. At the beginning of this year, the Social Security tax paid by employees returned to 6.2 percent from 4.2 percent on income less than $113,700. But other changes affected only high-income earners: The rate returned to 39.6 percent from 35 percent on couples’ incomes of more than $450,000; capital-gains and dividend rates rose to 20 percent from 15 percent. For joint filers with more than $300,000 in adjusted gross incomes, personal exemptions were phased out and as much as 80 percent of itemized deductions were eliminated.

As is often the case when the personal-taxes-to-personal-income is low, the Internal Revenue Service has accelerated audits of rich taxpayers. It has even created a separate division, the Global High Wealth Industry Group, to enforce compliance. In the 2012 fiscal year, the IRS audited 5.4 percent of tax returns of Americans who earned between $500,000 and $1 million, up from 3.4 percent in 2011. Audits of those in the $1 million to $5 million category increased to 12 percent from 6.7 percent; 21 percent of people reporting $5 million to $10 million in income were audited, compared with 12 percent for 2011.

More recently, the IRS sent 20,000 letters to small-business owners, seeking to establish whether they were underreporting their business income. The tax-collection agency is taking advantage of a 2008 law that gives it broader access to merchants’ credit- and debit-card records, which it can compare with tax returns. Unusually large credit-card transactions suggest underreporting of cash sales. Underreported income constitutes the bulk of the so-called tax gap, the difference between what taxpayers owe and what they pay, according to the IRS. In 2006, the latest data available, the total gap was $450 billion.

The IRS is also pursuing Americans with undeclared investment accounts in Switzerland and other tax havens. The Swiss government protected the country’s banks from disclosing information on tax dodgers to U.S. authorities. Threats to cut off those banks from business in the U.S. and cooperation from a former employee of UBS AG (UBSN) forced a change of policy.

In July 2008, a U.S. Senate investigation found that the Treasury loses about $100 billion a year to offshore tax evasion; UBS was found to have hidden about $20 billion belonging to 20,000 Americans. UBS subsequently agreed to hand over the names of 4,450 U.S. account-holders and pay a $780 million fine. In 2011, Credit Suisse Group AG (CSGN) also agreed to disclose the names of clients suspected of dodging U.S. taxes.

Switzerland is the biggest offshore banking haven, with $1.8 trillion in foreign assets under management. Five percent of the total is owned by Americans. Swiss banks are now rushing to cooperate with the IRS and tax authorities in other countries. The government recently agreed to share data for tax purposes with almost 60 countries by signing the Organization for Economic Cooperation and Development’s tax information agreement. Switzerland also has agreed to follow U.S. law requiring foreign banks to provide data on U.S. accounts.

Banks in other tax havens such as Andorra, Liechtenstein, Singapore, the island of Jersey, the British Virgin Islands, the Cayman Islands and Monaco are also opening to U.S. tax authorities. And the IRS is pursuing money hidden in Caribbean, Israeli and Indian banks. Other countries such as Austria and Luxembourg have relaxed bank secrecy laws.

In 2008, the IRS established an amnesty program that allowed Americans with undeclared offshore accounts to avoid criminal prosecution by paying all taxes owed, plus interest for the past six years and a penalty of 20 percent of the accounts’ highest values. About 15,000 tax dodgers entered the program and 23,000 more signed up for a more punitive effort in 2011. The U.S. has collected $2.2 billion from the 2009 amnesty cases that were closed as of September 2011, with average revenue per case of $80,000. For 2009-2012, the IRS collected $5.5 billion in unpaid taxes and penalties, and it expects to collect $5 billion more.

Yes, the recent tax increases have been aimed at the “fat cats.” It is also true the IRS has stepped up audits of the wealthy and small-business owners and hotly pursued tax dodgers with foreign investment accounts.

Yet the invisible hand that underpins shifts in taxation has also probably been at work in pushing up the personal-taxes-to-personal-income ratio because the increase in Social Security taxes on employees hit lower-income people hardest in relation to their pay. Of course, the $1 trillion federal deficits were also an inducement for higher government revenue.

The invisible hand overcame the declines in real weekly wages and real median incomes. It also prevailed over the still-depressed prices of houses, the biggest asset for all but the richest. About two-thirds of homeowners have mortgages, and those with middle and low incomes account for the greatest share. The home equity of mortgage holders has risen along with house prices recently. Still, on average, it’s only 23 percent, less than half what it was in 1983.

Households are still overburdened with debt. The total has fallen to 104.7 percent of after-tax personal income in the second quarter, from 130 percent, but it still is well above the 65 percent norm in the early 1980s. Furthermore, the decline so far is almost entirely due to falling home-mortgage debt, largely a result of write-offs of bad mortgage loans. Much smaller credit-card and home-equity revolving debts have declined, though student loans have ballooned.

Household net worth has risen in relation to after-tax income, but remains below the peaks of the late 1990s and the mid-2000s. Moreover, 43 percent of the increase in the ratio since the recessionary low in the first quarter of 2009 is due to higher equity prices and, as discussed earlier, individual stockholders are predominantly high-income people. Only 8 percent of the increase is the result of the appreciation of wider ownership of real estate.


Monday, October 28, 2013

Businesses May Be Next Target of Higher Taxes - Bloomberg

The personal-taxes-to-personal-income ratio was 11.7 percent in August, almost back to the 12.3 percent long-term average. That eases the pressure on the invisible hand to push for higher tax rates or more aggressive collections.

The federal budget deficit remains huge. But it is declining: The Congressional Budget Office says the shortfall narrowed to $642 billion in the fiscal year that ended Sept. 30, from $1.1 trillion in the 2012 fiscal year. Furthermore, persistent political gridlock in Washington makes big tax law changes unlikely.

Chronic slow growth and limited upside potential for stock and housing prices probably mean that personal taxes won’t grow faster than personal income in coming quarters, restraining growth in the taxes-to-income ratio. However, other forces could influence taxes. Congress and the Obama administration were unable to avoid a partial government shutdown this month and a fight over lifting the $16.7 trillion debt ceiling.

Beyond those twin crises, Washington needs to deal with the long-postponed costs of Social Security and Medicare benefits for the increasingly large number of postwar-generation workers who are retiring. This is the reason that the narrowing of the federal deficit projected by the CBO will end in the 2016 fiscal year. In later years, substantial increases in Social Security and Medicare payroll taxes could cause the ratio of taxes to income, including social insurance taxes, to rise above its long-run flat average of 19.7 percent.

The changes in personal taxes of recent decades have been accompanied by some major changes in corporate taxation. U.S. businesses are clamoring for tax reform, especially changes aimed at lowering the 35 percent top rate, which is about the highest in the world, though it’s down from 52 percent in 1964.

The real rate is 40 percent when state and local government corporate income taxes are included. In late July, President Barack Obama offered to work with Congress to overhaul corporate taxes on the condition that any one-time revenue gains are used to fund spending on programs he favors. In mentioning one-time gains, he indicated that he is, in effect, thinking about eliminating many tax code provisions that reduce the effective corporate profit tax rate well below 35 percent.

The Government Accountability Office estimates that the effective rate on worldwide income for large, profitable U.S. companies averaged 12.6 percent in 2010. When taxes paid to foreign as well as U.S. state and local governments are included, the effective rate rose to 16.9 percent, still only about half the 35 percent top federal marginal rate. Federal corporate tax collections dropped to $181 billion for 2011 from a peak of $370 billion for 2007, at the height of the housing-led boom. They are expected to rise to $288 billion for the 2013 fiscal year, which ended Sept. 30.

An especially contentious issue is foreign earnings of U.S. companies that aren’t subject to taxes until they are repatriated. By contrast, most other developed countries tax only domestic profits. Many U.S. corporations have no incentive to return foreign earnings and pay the U.S. taxes. But there is intense political pressure for them to do so.

In May, Apple Inc. Chief Executive Officer Tim Cook testified before the Senate Permanent Subcommittee on Investigations. The panel headed by Senator Carl Levin, a Michigan Democrat, found that Apple avoided paying $9 billion in U.S. taxes in 2012, and $74 billion over the past four years, largely by basing profitable operations in Ireland, which has consistently used low tax rates to attract foreign business.

Levin called this “the Holy Grail of tax avoidance.” Cook said Apple favored corporate tax reform, including a lower tax rate, but with a reasonable levy on foreign earnings. The adverse publicity led the Irish government to announce plans to change the tax rules affecting Apple and other companies beginning in 2015.

Audit Analytics estimated that total U.S. corporate profit parked abroad rose 15 percent last year, to $1.9 trillion. This partially reflects the 70 percent increase in offshore earnings in the last five years. Offshore profits are normally taxed where they are earned, so companies often use a technique known as transfer pricing to shift earnings to low-tax countries. The tactic sometimes involves moving valuable intellectual property so the high profits from royalty payments will be realized in lower-tax jurisdictions.

A reform of U.S. corporate taxes could reduce the top marginal rate, but at the expense of higher taxes elsewhere. Congressional proposals include a special low tax rate on profit held offshore, which would encourage companies to bring the money home. Eventually, it could mean an end to taxes on overseas earnings, bringing the U.S. in line with other countries. Other ideas being proposed to raise revenue include stretching out depreciation timetables and changes in inventory accounting.

From the standpoint of economic efficiency, trading corporate tax loopholes for lower tax rates makes sense. As companies adapt to special tax provisions, normal market-driven responses are distorted. In any event, major tax reform and simplification for corporate or personal taxes is very unlikely as long as gridlock and partisan animosity persist in Washington.

In addition, the persistence of large federal deficits means the long-run decline in corporate tax rates is unlikely to continue unless lower rates are traded for higher business taxes elsewhere.

Meanwhile, corporate profit and the tax revenue they generate appear vulnerable, even if positive economic growth persists.

Even as corporate taxes as a percentage of profits are going down, taxes as a share of gross value-added of corporate business -- essentially corporate sales -- have been flat since the early 1980s because profit margins have been rising. In recent years, U.S. businesses have slashed labor and other costs in response to the lack of pricing power and declining inflation as well as the meager sales volume growth in the sluggish global recovery.

But productivity growth from cost-cutting and other means is no longer easy to come by. Also, the growth in value from productivity-enhancing technology equipment and software in the decade ending 2011 has been the weakest since World War II. Furthermore, neither capital nor labor has the upper hand indefinitely in a democracy, and compensation’s share of national income has been compressed as profit’s share leaped.

Corporate earnings are also vulnerable to the strengthening dollar, which reduces the value of revenue from exports and foreign earnings by U.S. multinationals. And exports and foreign earnings of U.S. companies are under pressure, especially in developing countries where growth has slowed.

China’s growth is slowing as it shifts to an economy led by consumer demand and away from exports, which are depressed by weak demand from the U.S. and Europe. China has also vastly overbuilt its infrastructure. Vacant cities and other excess capacity could become considerable problems, particularly for the lenders who financed them. Deceleration in China implies slow growth for the other developing countries that have thrived by exporting commodities and components to the Chinese manufacturing juggernaut.

Meanwhile, the prospective tapering of Federal Reserve asset purchases and the related interest rate increases that have already occurred are causing financial harm to those nations.

Earlier, the likes of Brazil, India, Indonesia and Turkey were almost overwhelmed by inflows of hot money that drove up the value of their currencies and financed their large current-account deficits. Now that hot money is rushing out, leaving them with three unsavory choices. They can allow their currencies to slide, which aids exports but also promotes inflation as import prices jump. They can raise interest rates to help retain foreign money, but that threatens growth. Or they can impose capital controls to keep money from leaving, but that discourages future inflows and triggers huge outflows when controls are lifted.

The invisible hand will probably continue to favor taxpayers when the tax-to-income ratio rises considerably above the 12.3 percent long-run average, and it will increase their tax payments when the ratio drops substantially below. The long-term downtrend in corporate tax rates, however, is unlikely to persist unless lower rates are traded for higher business taxes elsewhere.

(A. Gary Shilling is a Bloomberg View columnist and president of A. Gary Shilling & Co. He is the author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” This is the first in a three-part series. Read Part 1 and Part 2.)

To contact the writer of this column: A. Gary Shilling at insight@agaryshilling.com.

To contact the editor responsible for this column: Max Berley at mberley@bloomberg.net.

A Gary Shilling

A. Gary Shilling, a Bloomberg View columnist, is president of A. Gary Shilling & Co., a consultancy in Springfield, ... MORE

View the original article here

Monday, October 21, 2013

Tapering is just a start

"When the economy resumes normal growth after the Age of Deleveraging is over, these excess reserves will spawn huge loans and money expansion, propelling the economy past full employment and into serious inflation. So the Fed's major job is to get rid of these excess reserves by selling securities. Tapering — i.e., adding more to this hoard — is just the start.”

source: businessinsider

Monday, October 14, 2013

Shilling concerned about interest rates and fed bond buying

Gary Shilling talks about the Fed bond buying program and its concern. 

"For now, because economic growth is tepid, this isn’t producing any overheating in the world of bank lending. But when the economy resumes faster growth, excess reserves could propel the economy through full employment and into serious inflation,” That may not happen for a few years, he adds. But the risk is still one for the Fed to ponder, because that giant balance sheet of bonds can’t be adjusted in a hurry. “If assets are sold off rapidly, interest rates could well leap, precipitating a recession.”


Sunday, October 13, 2013

SHILLING: Im Balanced Between Risk-On And Risk-Off

Gary Shilling has gone from tilting toward seven-risk off trades, to being "balanced between 'risk-on' and 'risk-off' as we prepare to move either way as the fog clears." This comes as the global economic outlook remains mixed and as the Fed takes its time clarifying its plans to taper its $85 billion in monthly asset purchases.

These trades include: 1. Modestly long treasury bonds. "They've been beaten up, maybe too much so. Also, they serve as an anchor against a sudden Grand Disconnect-closing shock that something like the government shutdown and the looming debt ceiling crisis may precipitate." 2. Long the dollar. 3. Short emerging market stocks and bonds. 4. Long U.S. dividend-rich stocks.

Shilling continues to be cautious and "advocates heavy cash positions."

"The percentage of S&P 500 stocks with P/E ratios within 20% of the index level is near its highest level in nearly 20 years (the height of the financial crisis notwithstanding)," writes Brian Belski of BMO Capital Markets. This suggests that investors are valuing stocks that have different earnings growth profiles in a similar manner. "From our perspective, the main culprit has been the strong outperformance of value strategies this year."

"We believe that as QE has driven stock prices higher, investors have sought out more attractively priced areas of the market. The result has been a surge in price multiples for areas at the lower end of the valuation spectrum making market valuation more homogeneous.

"Going forward we would urge investors to avoid such singular investment approaches and instead incorporate other variables (such as earnings growth) when making decisions. This is particularly relevant in the current environment since earnings growth among US stocks has become increasingly more disperse (Exhibit 2, right) – a trend we expect to continue given the stage of the current cycle."

While we've been bombarded with headlines about the S&P 500 hitting new all-time highs, the inflation adjusted index tells a different story. JC Parets at All Star Charts writes that the inflation adjusted chart shows "is the consistency of the lower lows and lower highs since the year 2000. Hardly the uptrend and bull market that we hear about so often." 

"I think it’s important that when I speak with investors, they understand how in Real terms, not only is the S&P500 not at all-time highs, but actually down 20% over the last 13.5 years."

UBS Financial Services largest wealth management team in San Diego that managed $540 million in client assets has gone independent, according to Investment News. The team includes Ajay K. Gupta, and two other partners that have registered with the SEC. Gupta and his partners moved because they wanted "access to new technology, a broader choice in clients and independence as a fiduciary adviser to its 119 family clients," reports Trevor Hunnicutt at Investment News. Gupta will write UBS a seven-figure check.

The ratio of companies providing negative earnings guidance, to those providing positive forward guidance, has been rising. This is usually interpreted as a sign of excess optimism.  But Deutsche Bank's David Bianco writes that "investors should ignore these aggregated stats." 

"We have repeatedly argued that guidance ratios are noisy and unreliable. Only 20% of companies provide quarterly guidance, the mix changes from period to period, the ratio is not earnings weighted and does not differentiate between a 1% or 10% change in guidance.

"Bottom-up EPS growth and estimate revision trends are more insightful. Btm-up 3Q S&P EPS declined only 3.2% among the least in two years and est. EPS growth just prior to reporting is the highest in over a year at 4.1%. Our $28 3QE EPS implies the usual 3-4% weighted average beat."

Monday, October 7, 2013

Slow growth for next five years

 Expect slow economic growth for the next four to five years, says economist A. Gary Shilling.

“De-leveraging periods after major financial crises usually take about a decade. We’re five years into this, [and there’s] another five years to go,” Shilling says.

He and Martin Barnes, chief economist at BCA Research, each presented their market predictions at the CFA Society Toronto’s 56th annual forecast dinner Oct. 1.

But those who say a sluggish North American economy is here to stay are wrong, Shilling adds.

“That’s what I call theory follows fact,” he says, adding that those analysts are underestimating the long-term strength of the U.S. economy.

A higher birth rate than other developed countries, an entrepreneurial spirit and low union membership are some of America’s existing economic advantages, he says.

As the economy continues to recover—which he predicts will happen with a GDP growth rate of 2%—the dollar will also strengthen.

The country is also moving toward energy independence, and will rely less on foreign investment as consumers spend more, he adds.

Right now, Americans are paying down debt and saving cash, and that is cancelling out the effects of fiscal and monetary stimulus, he says.

Barnes agrees the economy will continue to improve, and predicts a slightly higher rate than Shilling.

“My bottom line on the economic outlook is that you’ll feel better in a year’s time, but you still won’t feel great,” he says. “We could get back to 3% [growth] in North America without too much difficulty.”

But says consumer debt in Canada–163% of income–is unsustainable.

Neither Shilling nor Barnes think inflation rates will rise.

“Inflation is going to stay pretty close to zero, or where it is now. The risk is that [we’ll] go into deflation, not inflation,” says Shilling.

They also agreed the stock market is due for a correction.

On bonds, Shilling and Barnes say they will rally.

“Ten-year bond yields will still be less than 3.5% in a year’s time. They will go up from here, but they’re not going to go up to a level that’s a problem, says Barnes.

The loonie could get back to parity with the U.S. dollar in the next year based on strong commodity prices, Barnes says.

But Shilling adds the U.S. dollar is due for a boost as the recovery continues. It will be helped along by the underlying strength of American financial markets, and the lack of an alternative currency for trading and investing.

But he’s concerned the credibility of the U.S. political system could affect the dollar’s strength as issues like government shutdowns and legislative gridlock become more common.

Sunday, October 6, 2013

Is there a disconnect between U.S. markets and the economy?

Gary Shilling, former Merrill Lynch Chief Economist and President of A. Gary Shilling & Company, says there is a “grand disconnect” between the robust stock market and the economic reality. His advice? Short stocks, buy treasuries and hold cash.