Warren Buffett’s Tax Story Is Bogus

Great analysis by the Cato Institute on what are the actual tax rates payed by each income category. As is usually the case the facts do not hold any passing resemblance to the political talking points and assumed truths of the left. What I find most discouraging about this debate of taxes is that this country has lost the will to face facts and make informed decisions. We are rapidly becoming a nation where emotion plays a larger role in policy than fact. Sad and a true sign of cultural decline.

Warren Buffett’s Tax Story Is Bogus

Warren Buffett’s Tax Story Is Bogus

Print

For years, Warren Buffett has been claiming that his secretary pays a higher tax rate than he does. Recently, President Obama has taken that claim and run with it. I don’t know Mr. Buffett’s particular tax situation, but I do know that his claim as a general matter is bogus.

Let’s look at some numbers. The first chart shows IRS data for income tax rates by income group for 2009. These are average effective tax rates, calculated as income taxes paid divided by adjusted gross income (AGI). The chart shows that taxpayers with incomes above $500,000 had tax rates averaging about 25 percent. Middle-income taxpayers had tax rates of half of that or less. A few years ago, Buffett claimed that his secretary earned $60,000 and paid a 30 percent tax rate. But looking just at income taxes, that seems way off. (Note that this data doesn’t include the “refundable” portion of tax credits, which wipes out taxes for many people at the bottom end).

Perhaps Buffett was referring to the fact that his secretary pays a heavy load of payroll taxes in addition to income taxes. But when you look at data which includes all federal taxes, the system is still highly graduated with much higher rates at the top end.

Chart 2 shows CBO data for 2007 on average effective tax rates, including essentially all federal taxes—individual income, corporate income, payroll, and excise. Buffett’s secretary would fit into the fourth group in the chart, where the average tax rate was 17.4 percent. So if she is really paying 30 percent, then Buffett needs to show her some of his tax-reduction tricks. Note in the chart that Buffett’s peers in the top 1 percent paid an average rate of 29.5 percent, which is double the rate paid by middle-income taxpayers.

In 2007, Buffett said that he paid a 17.7 percent tax rate. Alan Reynolds notes that Buffett earns large amounts of capital gains, which are taxed at a maximum federal rate of 15 percent. People in the top income groups do report a lot of capital gains, which reduces their overall effective tax rate. However, capital gains are included in chart 1, above, and you can see that the top income groups still pay much higher tax rates than others on average. One reason is that a large amount of income at the top is small business income, which is hit by ordinary income tax rates of up to 35 percent.

You have to go to the extreme top end of the income spectrum in order for capital gains realizations to really push down overall effective tax rates. The IRS publishes data for the 400 highest-income taxpayers. For these taxpayers, the average effective income tax rate in 2008 was 18.1 percent.

Since the beginning of the income tax, we have nearly always had special treatment of capital gains for some very good reasons, as I discuss here. I point out that virtually all high-income nations recognize that capital gains are different and that special rules are needed. A number of OECD nations have long-term capital gains tax rates of zero, including New Zealand and the Netherlands.

Another important aspect to this debate regards the link between capital gains and dynamism in the economy and dynamism in tax payments. The political left makes it seem as if there were a permanent aristocracy at the top end of the income spectrum in America. However, IRS data show the exact opposite—the top 400 are a highly dynamic group. Notice first in IRS Table 1 that 57 percent of AGI for these taxpayers is capital gains. That is a key reason why the people in this group are constantly changing—large capital gains realizations are occasional events that rocket people to the top of the AGI heap. One example is when an entrepreneur sells her successful and longstanding business and retires.

The last table in the IRS document reveals the dynamism. The IRS traced the identities of all taxpayers who showed up in the top 400 anytime between 1992 and 2008. The IRS found that there were a huge 3,672 different taxpayers who appeared during that timeframe. Of these 3,672, fully 73 percent only appeared once in the top 400! And 85 percent appeared only once or twice.

So at the top end of our capitalist system is a continual generation of new wealth and new wealthy people, and that dynamism reflects the still-energetic and free-wheeling nature of our economy.

China's economic miracle - Coming off the rails?

This article perfectly highlights the statement I have been making for some time now; that the laws of economics will be adhered to.  It is just a matter of time before the correction comes to China.  In my opinion a better measure of China's GDP would be based upon consumption totals.  

China's economic miracle may be about to come off the rails

Largely invisible to a radar screen dominated by concerns over the US and eurozone debt crises, the Chinese economic miracle, one of the few apparent bright spots that remains in a world beset by trouble, has in recent weeks also been showing unnerving signs of strain. Indeed, it may even be about to come off the rails entirely – quite literally.

Last weekend, one of China's new bullet trains rammed into the back of another, killing 39 passengers and injuring nearly 200 more.  Photo: AP

By Jeremy Warner

9:01PM BST 28 Jul 2011

214 Comments

Last weekend, one of China's new bullet trains, a showcase of the country's growing economic prowess, rammed into the back of another, killing 39 passengers and injuring nearly 200 more.

The accident has raised questions, not just about the safety of China's vaunting ambition in high-speed rail, but about the sustainability of the country's break-neck pace of economic development in the round.

As Shen Minggao, chief China economist at Citi, has observed: "High-speed rail in some sense represents China's fast growth. When you care so much about speed, you sometimes pay less attention to the quality of the growth."

China's political leadership has long dreamt of an entirely new rail network, from the prosperous eastern seaboard to remotest inland China, and over the past four years they've set about building it with a determination which no other country would seem remotely capable of.

But in so doing, they appear to have put speed before safety, and economic ambition before commercial viability. It is not just the quality of the bastardised foreign designs, copied and botched together to feed China's insatiable appetite for growth, which is now being questioned.

RELATED ARTICLES

• China anger over rail crash inquiry 
  29 Jul 2011
• Debt crisis: America faces a decision that will affect us all 
  27 Jul 2011
• Remorseless logic takes Europe closer to fiscal union 
  21 Jul 2011
• Is the UK following Japan into a 'lost decade'? 
  02 Jul 2011
• China must change for the world to prosper 
  28 Jun 2011

The funding of this grand ambition is beginning to look increasingly shaky too. Financially, the project has already effectively broken the Ministry of Railways. At the last count, the ministry was nearly 2 trillion yuan (£200bn) in debt and clocking up losses at the rate of about £400m a quarter. On any Western definition, the ministry is completely bust. To meet the plan, another 2.8 trillion yuan has to be found in the next three and half years. Where's the money going to come from?

In recent debt issues, the railway has had to pay way above the going rate of interest, despite the fact that its bonds are implicitly and in some cases explicitly underwritten by the state. Of equal concern is that the newly opened links have failed to achieve anywhere near expected traffic levels. In the West, they would be dubbed a massive white elephant.

Concern over the new network's safety has created an even bigger hill to climb in terms of driving the necessary demand. Many of the trains are as empty as the ghost towns that sprout randomly upon China's vast open plains. For many Chinese, both are too expensive to contemplate.

The Chinese approach to development is to build the infrastructure in the expectation that the demand and economic activity will naturally follow in its wake. Yet in its impatience for economic advancement, China has ignored the dangers and cut corners. Last weekend's rail crash can be seen as a harbinger of wider economic catastrophe to come.

As everyone knows, progress never proceeds in a straight line, yet when it comes to China, many have managed to deceive themselves that it can and will. No one is more guilty of this delusion than the Chinese themselves. The swagger and arrogance of Chinese officialdom has all the hallmarks of pride before the fall.

Nowhere is the unsustainability of Chinese growth more apparent than in its spectacular real estate bubble. Prices have been growing like topsy, despite a growing overhang of vacant new development. Conscious of the dangers, the Chinese authorities have taken a number of steps to cool the overheated housing market. Early evidence is that it seems to be working. Prices have risen by "only" 7pc over the last year and transaction volumes are lower.

Unfortunately, it is not as simple as that. China is on a treadmill of unsustainable development which it knows not how to get off without damaging growth and thereby provoking political and social instability. Residential and commercial property development in China is such a big component of overall growth that anything that damages the property market threatens to upset the entire apple cart.

According to the most recent International Monetary Fund staff report on China, the property market directly makes up some 12pc of the country's GDP. Indirectly, it is a lot more, as the property market is highly connected to the output of basic industries such as steel and cement, as well as downstream industries such domestic appliances and other consumer durables.

The banking sector is also highly exposed, having financed much of the recent development. Direct lending to real estate (developers and residential mortgages), accounts for nearly 20pc of all bank lending in China.

For a long time now, the Chinese leadership has been conscious of the economy's dangerously high reliance on investment and net trade to fuel growth. Economic and financial calamities in the West have convinced policy-makers of the need to move more swiftly than they would have liked to address these imbalances.

Yet despite the rhetoric, the country has failed appreciably to wean itself off the dependence. Domestic consumption still accounts for a woefully small proportion of the economy. In the round, public policy still overwhelmingly prioritises investment and exports over higher disposable incomes.

The longer China takes to make the switch, the more likely it is that China's present phase of investment-led growth will end badly. In high-speed rail along with much else, China is trying to run before she has properly learned to walk. Rampant corruption, cronyism and poor governance only add to concern over the sustainability of the present economic and social model.

So when China lectures the US on its absence of economic leadership and the suicidal tendencies the world's richest nation is displaying in putting political infighting before the interests of financial stability, it perhaps ought to look to the mote in its own eye. The imbalances China has deliberately created in its pursuit of economic advancement are a large part of the overall mischief that has taken place in the world economy this past decade.

By supporting its trade surplus through massive purchases of US Treasuries, China, one of the poorest countries in the world, has in effect been lending the US, the richest, the money with which to buy its goods. How stupid is that? Debasement of the vast dollar assets China has accumulated in the process is the least it can expect by way of payback for a flawed economic model.

Demographics and destiny, US housing edition

Great article.  The basic conclusion is that rental properties are and will continue to be great investment opportunities into the foreseeable future.  

Demographics and destiny, US housing edition

Posted by Cardiff Garcia on Jul 26 22:07.

This morning’s miserable new home sales report gives us an excuse to write about a theme we’ve been distantly following for some time: the possibility that the housing downturn has overshot the pre-crisis boom and will eventually provide an economic boost when it corrects.

Whether this turns out to be the case depends on whether demographics can trump the recent adjustments in household behaviour, as a recent paper from RBC explains:

Some investors have expected that population growth would drive new home sales back to prior levels. We believe that this view intuitively makes sense and agree that demographic trends will ultimately drive demand in the long-term.

In our opinion, however, other factors including vacancy levels, declining homeownership rates and an increase in household size are temporarily exerting a disproportionate influence on housing demand. …

Historical Trends in New Home Sales

Median new home sales have dropped precipitously since the recession began in 2007. The United States experienced a median of ~675,000 new home sales from 1980 to 2006. Since 2006, however, median new home sales have been 430,000 annually.

And here’s a graph from Calculated Risk updated to include this morning’s figures (click to expand):

The bullish case — the argument that eventually we’ll see a burst of construction activity after a reversion to previous levels of housing demand — is partly based on straightforward population growth. Eventually more households will have to form and we’ll start to see prospective buyers of new homes emerge.

Here’s more detail from RBC…

The United States population has increased by ~3 million people on average since 1990. It is currently projected by the US Census to increase from ~310 million people today to ~340 million by 2020. This assumes a growth rate of ~1% or ~3 million people annually.

… and in graphical form:

Of course, what also matters here is whether or not there’s a lot of excess capacity already in the market. This is difficult to say, but if you look at the pace of homes built in the last few years relative to the population growth, we can at least start to get a sense of whether or not there’s currently a housing shortage in the making.

Helpfully, Dan Indiviglio did exactly this last month:

As you can see, the rate of population change per homes created declined over the last ten years from the previous decade. It’s higher than the decade before that, but not by much — suggesting that, as Indiviglio writes, “if there’s still some excess capacity in the market, there doesn’t appear to be much.”

Now back to RBC and the factors likely acting as countervailing forces to demographic trends: an increase in household size, declining homeownership rates, and vacancy levels.

To take each of these in order…

First, after decades of a declining population per household (one impetus for new home starts and sales during that time), we’ve seen an uptick in the last few years:

The trend driving this is the number of jobless college graduates and young adults moving in with their folks. RBC: “The Harvard Center for Joint Studies on Housing estimates that the number of young adults (age 20-29) living at home rose by 1.6 million from 2005 to 2010.” Newly jobless adults of all ages moving in with relatives and friends are also likely contributors.

Second, the national homeownership rate has dropped from a peak of about 69 per cent in 2004 to 66.4 per cent now. Even more worrying is that the biggest decline has come in the under-35 category, which “contains the largest proportion of potential first-time homebuyers”, according to RBC:

Third, high vacancy rates matter because prospective homebuyers could opt to buy cheaper existing homes, including those foreclosed on, rather than new homes. So higher vacancy rates now would imply a longer time before demand for newly built homes returns.

The estimates on vacancy rates tend to vary considerably by economist, making this the haziest of the three factors listed above.

Karl Smith, the most comprehensive and articulate blogger making the case that a housing shortage exists, is sanguine (see also here):

The census bureau tracks that number. However, its month-by-month estimate was well out of whack with the preliminary data coming in from the formal 10-year Census.  Still a credible guess is that there might be in the range of 1.5 million “excess” vacant homes. That number includes empty rentals as well as homes for sale. Even in the best of times some homes are vacant, but there are roughly 1.5 million more than there were in 1990, adjusted for population changes.

That 1.5 million number is less than our estimate of the number of missing households. Somewhere around 500,000 new homes are scheduled to be completed in 2011. However, typically around 200,000 to 300,000 homes are demolished each year as they become unlivable.

This suggests our total inventory of available homes is less than our total number of “shadow households” and is not about to catch up anytime soon.

RBC, for its part, pegs the number a little higher…

… and is less optimistic:

Based on anecdotal evidence from the National Association of Realtors (NAR), we believe that remarketed foreclosures are being priced on average at a 20% discount to new homes. The large size of this discount suggests to us that many consumers will elect to purchase foreclosed properties as opposed to investing in a new home even if homeownership rates remain constant. We expect that the level of vacancies will remain stable at ~2 million homes which is meaningfully above the long-term average.

There’s a chance that vacancy rates could be high very high now and remain high if homebuyers were to simply express their choice for new rather than existing homes. But this is certainly not what’s happened lately, as the percentage of total sales that new home sales has accounted for continues to decline:

On these points, it would seem that RBC economists are right to be pessimistic — to think that too many current trends will continue to overwhelm natural demographic pressures for more housing construction. And if you really want to pile on, check outScott Sumner’s recent post on why previous household formation trends won’t return anytime soon.

Sumner notes that along with young people moving in with their parents, another problem is something that we previously worried about in this space: less immigration, caused both by recent crackdowns and by less incentive to move here because of the stalled economic recovery.

But as ever, the whole story is actually a bit more complicated.

As both Smith and Indiviglio have noted, the pre-2006 boom in housing took place almost entirely in single-family homes, while new construction of multi-family residential buildings stayed flat (chart from Indiviglio):

Multi-family structures, of course, are those that typically rent out their units. We’ve seen a significant climb in rents inflation in the past year or so, which makes perfect sense: increased demand for rental units coincides with the lower homeownership rate. Indiviglio adds that once young people finally do decide to move out, it will likely be to rentals, given their limited credit histories and tighter standards for buying homes. The same would apply to the jobless who have stayed with friends and, especially, to those previously foreclosed on — given their damaged credit histories. So there’s a good chance this pattern will remain.

All this has obvious implications for the possibility of new construction activity. Given that there never was a boom in multi-family buildings, this is precisely where the shortage would be (Smith’s case all along) — and if demand for rentals continues, at some point you can expect to see a supply-side reaction, ie more construction. In addition, existing single-family homes might be turned into rentals, which would (helpfully) reduce the amount of shadow inventory. All of this would also be entirely consistent with a more fundamental shift among Americans in the perception of the value of owning homes versus renting, if there’s been one.

At any rate, we find the case persuasive, so we’re not ready rule out the possibility of a meaningful increase in housing activity just yet. It’s too early to know what will happen, and as Ryan Avent explains, construction cycle operates with a big lag on increased demand, so we wouldn’t see much progress for a while, maybe a year or two.

What everyone writing on the matter seems to agree on is that a higher level of economic growth would be needed to launch the construction takeoff. Growth — and jobs in particular — is needed to rejuvenate household formation, get young people to strike out on their own, reduce vacancy rates, and attract immigrants. Once this happens, the demographic trends will do the rest of the work.

But that’s an awfully big “once”, as the prospects for higher growth in the next few quarters remain uncertain. So although we tend to agree with the idea that there’s a burgeoning housing shortage, we remain agnostic on when the eventual correction will begin.

China, and Overdone Green Energy Hysteria

China, and Overdone Green Energy Hysteria

This strikes me as a tremendous investment opportunity if you can find a firm that is a pure peaker power play. If there is no such thing I could see a REIT type structure that purchases, builds and operates these plants. All signs point to continued political manipulation of energy markets so that the consumer/regulated utility is forced rely on unreliable renewable energy sources. This to me logically means that there will be more of these so called peak moments where demand exceeds supply because supply will be less stable and less available. Since this is the case holding an assets that is highly profitable at peak usage/demand moments could be an excellent investment/business. Now if I only had several hundred million to play with :>)..

China, and Overdone Green Energy Hysteria

By Steven Hayward

Of all the verses in the "China-is-Awesome" hallelujah chorus, none is chanted louder than the fact that China is leaving everyone in the dust in "green" energy, especially wind and solar power. The latest Clean Energy Report from the Pew Charitable Trust gushes, "Private investment in China's clean energy sector increased by 39 percent in 2010 to a world record $54.4 billion. China also is the world's leading producer of wind turbines and solar modules. In 2009, it surpassed the United States as the country with the most installed clean energy capacity."

On the surface the numbers sound very impressive: "With a staggering $45 billion invested in wind, China was able to drive installation of 17 GW of additional wind energy generating capacity. Another $4.7 billion was invested in the solar sector, as China begins reaching for its new goal of 20 GW of installed solar energy by 2020. It also has a target of installing 150 GW of wind power by 2020." And if you look at the numbers compiled in BP's recently released Statistical Review of World Energy, it sounds even more eye-popping.

China's wind, solar, and biofuel energy output increased 1,545 percent between 200 and 2010, while their coal-fired energy output only grew by 132 percent. Green energy is obviously rocking the Middle Kingdom. (Never mind that there are reports that many of China's new windmills aren't even connected up to their electricity grid; like their ghost cities with empty high rises, office buildings and malls, China apparently is putting up windmills just for practice.)

Anyone with a single wit of statistical sense will smell the obvious rat in these numbers, as they are the simple tricks of radically different baselines. If someone with ten units of something increases to 11 units, they've had a 10 percent increase, while someone with 100 units of something who goes to 102 units only has a 2 percent increase. But who has the larger real increase in output? The person who went from 100 to 102.

In the case of China, the real action is revealed when the absolute numbers are posted up. Buried in the data tables of BP's energy report is the staggering fact that new energy supply from coal alone was 85 times larger than new energy from wind, solar, and biofuel. Add China's growth in oil consumption, and old-fashioned energy accounted for more than 100 times as much new energy as the "green" sources.

Here are the actual numbers, as measured in the common unit of Million Tons of Oil Equivalent (MTOE) in BP's report: Between 2000 and 2010, China's total non-hydro-renewable energy increased 11.4 MTOE, while their coal energy output increased 976.4 MTOE, and oil increased by 204 MTOE.

Figures for how much China spent for new coal and oil energy are hard to come by, but one suspects that $45 billion spent for wind power looks like a poor return on the investment compared to coal. Pew and other China cheerleaders trumpet the fact that China added about 50 terawatts of new renewable electricity production over the last decade, but they leave out that China's new coal-fired electricity built over the last decade amounted to 4,200 terawatts - 84 times as much as renewable electricity. China now accounts for 48 percent of the world's total coal consumption. Does this sound like an authentic "green" energy juggernaut?

The right term to apply to the whole green energy scene, whether in China or in the U.S., is ironically the favorite green term of art: unsustainable. Right now the green energy cheerleaders trumpet falling costs for renewable energy, wind power especially, with figures showing that some onshore wind power is almost competitive with coal and natural gas electricity the basis of what the trade calls "levelized cost," that is, the total lifecycle capital cost of equipment and fuel cost over a 20-year time horizon. Wind (and solar) power is more expensive to build than coal or natural gas, but has no fuel cost once built, which would seem to be in its favor.

However, this assumes a chalkboard world of uniform electricity demand and pricing, like the market for gasoline or diesel fuel, which varies little from producer to producer or time of day. While wind power might compete with coal and gas at the average price of electricity, the actual market price for electricity varies widely by time of year and time of day, with huge spikes in demand occurring in circumstances like last week's heat wave. At such times of peak demand, spot electricity prices are often ten to fifteen times the average price. This is why "peaker" gas power plants can be profitable even if they only operate a few days per year.

And it is exactly under these circumstances where intermittent wind and solar cannot compete with coal or gas, because they are not reliable sources of dispatchable, peak-demand power, and never will be unless someone invents a magic battery. For investors, this is why a gas power plant promises higher returns than a wind or solar facility, even allowing for the subsidies wind and solar power enjoy. And this is why China is going to continue to build fossil fuel energy over renewable energy at a ratio of better than 50 to one for the foreseeable future, even as they create a new export industry to sell wind turbines and solar panels to politically driven markets like ours.

This crucial distinction between average and peak period prices and the need for dispatchable baseload power is lost on most of the public, let alone politicians who want to meddle endlessly to "level" the playing field between renewables and fossil fuel energy with subsidies and mandates. But investors and analysts who want to understand where the real energy action is in China should look at where they're really getting their new energy supply from, rather than getting excited about the hype about "green" energy.

Too much, too young

Too much, too young

Watch your wallets: the baby-boomers are beginning to retire

WHEN MOST LABOUR was agricultural, people generally toiled in the fields until they dropped. The idea of formal retirement did not become feasible until work moved from farms to factories. In 1889 Otto von Bismarck famously introduced the world’s first (modest) pension scheme in Germany. In the 20th century, when universal suffrage became widespread, a period of retirement after work was seen as a mark of a civilised social democracy.

After the second world war pension provision increased markedly, but the number of elderly people was still quite small (see chart). In the 1970s and 1980s caring for them seemed easily affordable. Many countries even reduced their retirement ages.

The demographic picture looks different now that the baby-boomers are starting to retire. In 1950 there were 7.2 people aged 20-64 for every person of 65 and more in the OECD. By 1980 the ratio had dropped to 5.1. Now it is around 4.1, and by 2050 it will be just 2.1. In short, every couple will be supporting a pensioner.

There are ways of reducing the burden. The current generation of workers could save more now. If they put more money into funded pension schemes, the extra saving might encourage more investment and thus boost economic growth. A wealthier society would find it easier to afford paying pensions. Countries with PAYG schemes could raise taxes now, reducing the deficit and thus the debt burden on the younger generations.Europe and Japan are facing the biggest problems. The average dependency ratio in the European Union is already down to 3.5, and is heading for 1.8 by 2050. In Italy it is forecast to be nearly 1.5 and in Germany nearly 1.6 by then. Japan is on track for a startling 1.2. Since the average pensioner currently draws a total of about 60% of median earnings, from government and private sources, the system is likely to become unaffordable. In a sense, it does not matter how the benefits are paid for. If they are unfunded, they come from workers’ taxes; if funded, they come from investment income. But the income has to be generated by someone.

We want it now

But more savings or higher taxation now would require those currently at work to defer consumption. They may not be willing to do so. And given the weakness of developed economies in the wake of the financial crisis, governments may not want to see consumption go down in the immediate future.

In the OECD public spending on pensions benefits has been growing faster than national output, rising from 6.1% of GDP in 1990 to 7% in 2007. It is forecast to reach 11.4% of GDP by 2050. Those forecasts already take into account the planned rise in retirement ages and a likely drop in replacement ratios and thus assume that voters will approve of pension reform even as the baby-boomers become a potentially powerful voting block of retired people.

But that assumption may not be safe. Turnout in elections tends to be higher among the elderly than among the young. As Neil Howe and Richard Jackson of the Centre for Strategic and International Studies in Washington, DC, have written: “In the 2020s young people in developed countries will have the future on their side. Elders will have the votes on theirs.”