Congress Has the Whole Tax Thing Wrong

According to Warren Buffett, higher taxes for the super rich doesn’t kill jobs.

This morning, I was very pleased to read the words written by a voice of reason: Warren Buffett. Buffett is one of the richest men in the world, a man who built his fortune through investing. This article in the New York Times, “Stop Coddling the Super-Rich,” is his attempt to talk reason to the U.S. Congress using facts.

He writes:

While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks.

While this isn’t news, what’s refreshing about it is that it’s being stated by one of the “mega-rich,” a man who paid $6.9 million (not a typo) in taxes last year. He points out that while his 2010 tax bill was 17.4 percent of his taxable income, other people in his office paid 33% to 41% (with an average of 36%) of theirs.

Tax PictureIt’s the percentages that are important here. Imagine a taxable income of $100K. 17.4% is $17,400. But 36% is more than double that: $36,000. Is it fair that someone with a taxable income of $40 million like Mr. Buffett, who gets to keep about $33 million of that after taxes, should be paying a lower tax rate than someone making $100K who only gets to keep $64K after taxes?

If you don’t know the answer to that question, maybe the picture I provided here for you will help?

(By the way, I’m all for a flat tax and still can’t figure out why we can’t have one. The rate would likely be low enough that folks earning under $200K would save money. And wouldn’t it be nice to figure out your taxes by yourself in an hour instead of paying someone else to do it for you?)

Mr. Buffett goes on to tear apart the argument that higher taxes for the super-rich prevent them from investing or kill jobs:

I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

These are facts from history, not vague guesses based on economic theories. And since Mr. Buffett has a reputation as someone with financial prowess, I’d tend to take his word on the situation before the word of the self-serving morons we’ve elected to Congress — career politicians who would rather lie to the American people than do what’s right for all of us.

Of course, all this makes me wonder why Congress is so insistent that taxes not be raised, even for the wealthiest Americans — people like Buffett who wouldn’t mind a tax increase if it helped the country out of its financial woes. Whose bank accounts are the members of Congress protecting? Their own? Their friends in major corporations who fund their campaigns?

They’re obviously not interested in protecting the bank accounts of the majority of the American people. With unemployment hovering around 9% nationwide, millions of people are tapping into savings, losing their homes, and giving up on the “American Dream.” Yet the government continues to subsidize the oil industry, which continues to reap record profits, offer tax breaks to companies that send American jobs overseas, and enforce a tax code that gives tax breaks to the mega-rich. (By the way, is it a coincidence that the oil industry donates generously to political campaigns? I think not.)

As the Debt Ceiling debates of July 2011 proved, the American Congress is dysfunctional. I really believe that all incumbents should be voted out of office in the next few elections. Start again with a clean slate, hopefully with people who care about their constituents.

But what can we do until then? Contact your Representatives and Senators. Tell them that you think Warren Buffett is right: that the mega rich should be paying the same percentage of taxes as the rest of Americans. If you email them, link to the New York Times piece I quoted here. Tell them to read it and learn. Remind them that they’re working for all of the American people — not the corporations who fund their campaigns.

We need to turn this country around and it’s obviously not going to happen if we wait for our dysfunctional Congress to do it for us.

And in November 2012, remember to vote for someone who has the American people at the top of his or her agenda — not partisan politics.

"Don’t Panic!" Footnote

I’m not the only one saying this.

A quick footnote to my “Don’t Panic!” post earlier today. I was reading the NYTimes online and stumbled upon an article by Alex Berenson titled “Those With a Sense of History May Find It’s Time to Invest.”

Not only does he refer to the tech stock bubble burst of 2000-2001 (as I do), but he claims:

Now investors have again convinced themselves that this time is different, that the credit crisis will push economies worldwide into the deepest recession since the Depression. Fear runs even deeper today than greed did a decade ago.

But in their panic, investors are ignoring 60 years of history. Since the Depression, governments have become far more aggressive about intervening when credit markets seize up or economies struggle. And those interventions have generally succeeded. The recessions since World War II, while hardly easy, have been far less painful than the Depression.

Read the article. It cites experts:

“I think in years to come — I wouldn’t say months to come — we will perceive this as being a great value-buying opportunity,” said David P. Stowell, a finance professor at Northwestern and a former managing director at JPMorgan Chase. “Two and three years from now, it will seem very smart.”

Don’t panic. It might just be the time to go bargain hunting on Wall Street.

Don’t Panic!

Understanding how your investment transactions affect the market.

I really didn’t think a post like this was necessary, but after speaking with two different people about portfolio management in these troubled economic times, I realized that the average investor doesn’t have a clue about what a mutual fund is and how it works.

A Transfer is not Just a Transfer

Conversation One went like this:

Him: I’m thinking about transferring my Fidelity balances to bonds or t-bills.

Me: Don’t sell when the market is low.

Him: I’m not selling. Fidelity has bond and t-bill funds. I’m just transferring. When the market starts coming back, I’ll transfer back.

Conversation Two was remarkably similar:

Her: This week, I transfered all my mutual funds to a money market account.

Me: You sold your mutual funds? Now? When the market is in the toilet?

Her: No, I didn’t sell them. I just transferred them from one Putnam account to another. When the stock market starts going back up, I’ll just transfer the money back.

What followed was my attempt to explain that the “transfer” was, in reality, the sale of one mutual fund for the purchase of another. In both instances, my loved ones — yes, they are both related to me — were selling shares in a mostly stock-based mutual fund that had taken a beating with the Dow’s plunge and using the meager proceeds to invest in a different mutual fund based on less volatile (or more conservative) investment types with the same investment firm.

They didn’t see it this way because they mistakenly think that they are invested in the investment company: Fidelity, Putnam, Janus, Dreyfus, etc. They don’t understand that each mutual fund really consists of huge investments in regular publicly traded companies like GM, Washington Mutual, AIG, and countless other firms that have yet to hit the news. When they sell shares of a mutual fund that includes investments in, for example, GM, they are effectively selling GM stock. If everyone is selling, the price goes down.

Panic Feeding the Decline

Clearly, investors are the ones causing the stock market decline. Their panic sales are what’s driving down the prices, thus feeding the panic. The worse the prices get, the more people panic. Every one who cashes out — even by transferring stock based mutual funds to money market funds — is making the situation worse.

Take, for example, GM. On october 12, 2007, its shares were selling for $42.64 each. Although share prices declined slowly throughout the year, the panic of this past week really hit home. On Friday, GM shares closed at $4.89. You can see the decline in this chart:

GM.jpg

Let’s look at the reality of this. According to market valuation of GM stock, GM lost nearly 89% of its value in a year. What happened? Did a UFO hover over a few GM plants and suck them into the sky, leaving a gaping hole? Did GM inventory get spirited away by pixies in the middle of the night? Were all of GM’s cash reserves shredded for some kid’s hamster cage? Were GMs huge asset investments in equipment scrapped for their recycling value?

Of course not. GM’s company value is not just 11% of what it was this time last year. While the original stock price may have been inflated — I can’t say because I’m not an analyst and have not studied GM’s financial statements — there’s no way in hell that the company can be worth a tenth of what it was twelve months ago.

But do investors believe that GM’s total value has declined by 89% in a year? I don’t think so. I believe they’re just panicking, trying desperately to save their finances by cutting their losses. They’re running — screaming that the sky is falling — away from stocks and the declining mutual funds that are based upon their values. As a result, they’re causing much of the mayhem.

More About Mutual Funds

My personal portfolio has declined in value by at least 40% in the past year. I can’t tell you the exact amount. I haven’t looked since Monday. I’m afraid to.

My portfolio includes my retirement funds. And yes, most of them are mutual funds. Most of them were doing very well — one was posting consistent gains of 25% a year and had doubled in value in five years. Like most Americans, I’m a lazy investor. Why do all my homework to handpick investments and then watch them from day to day when an investment firm has experts who can do that for me?

But at least I have an idea of what’s in my mutual funds. Fund names often have a clue. For example an S&P 500 fund is directly tied to the securities that make up the S&P 500. If the S&P 500 goes down 5 points, so does my fund. Pretty simple, right? Another fund name might include the words “Small Market Cap.” That fund is invested in stocks of small market capitalization companies.

Let’s say, for example, that Maria’s Big Cap Fund includes investments in 10 stocks named A – J. (In reality, it would likely include investments in far more securities, but this is a simple example.) Let’s also say that 1 share of Maria’s Big Cap Fund consists of one share each of companies A – J. When I sell a share of Maria’s Big Cap Fund, I’m selling 10 shares of stock — one each in companies A – J. If I have 500 shares of Maria’s Big Cap Fund and I “transfer” my investment to Maria’s Great Money Market Fund, I’m really selling 500 shares each of companies A – J and buying the equivalent dollar value investment in a money market.

Now say that Maria’s Big Cap Fund is really popular and there are 50,000,000 shares of it held with investors. As those investors panic and “transfer” or sell their shares in Maria’s Big Cap Fund, they’re really selling lots and lots of stock. As stock is unloaded in bulk, its value decreases. As value decreases, its price goes down.

This is part of what’s making the stock market so screwed up right now.

No Loss Until Sold

But what’s worse is that many investors are unnecessarily taking losses on their investments. They bought at one price and, as prices drop, they may be selling at a lower (or much lower) price. That’s a loss.

But if they held onto their investments and didn’t sell (or “transfer”), they wouldn’t have a loss — at least not yet. Sure, it would look horrible on their account statements or in Quicken or on whatever online service they might use to track investment value. But until the stock is sold, there is no loss.

I need to say that again, in some different words for those who might not have understood the previous words:

If you do not sell your stock, you do not lose any money.

You can argue this all day long but you will not win. A loss is only on paper until the sale is made. Paper losses aren’t worth the paper they’re printed on. (Pun intended.)

Remember “Black Monday” in 1987? At the time, it was the largest one-day percentage decline in stock market history. Remember when the dot-com bubble burst? Wikipedia even has an exact date for it: March 10, 2000. How about the market right after September 11, 2001? These are just three examples of disaster in the stock market.

But guess what? In each case, the market rebounded. Sure, a bunch of companies were shaken out of existence — primarily after about 50% of the dot-com startups were revealed to be based on ideas that couldn’t generate enough revenue to warrant their market values. But the market that emerged after these disasters was stronger. Values for most “good investments” came back.

I’ve been actively investing in the stock market, through both individual stock purchases via an online brokerage firm and mutual funds. As I mentioned earlier, my entire retirement portfolio is in a variety of diversified mutual funds. I survived as an investor through the dot-com bubble burst — my investments recovered their value within two years. And I fully expect to survive as an investor from the current market madness.

Why? Because I’m not going to sell.

I’m lucky, in a way. Although I’m not a kid, I’m still 15 years away from minimum retirement age. I have time to let my portfolio recover.

Not everyone is that lucky. Some people are just getting ready to retire. Other people — like my mm and stepdad — are already retired and tapping into that investment nest egg to meet their financial needs every day. These people are pretty much screwed — unless the stock market rebounds in a hurry.

And the stock market simply won’t rebound if everyone panics and keeps selling.

Pardon Me While I Gloat

And they thought I was nuts.

The last time I bought Apple stock, it was trading for $15/share (July 18, 2002). I bought 100 shares.

Apple wasn’t doing very well back then. Everyone said I was nuts, that I was throwing my money away. I was starting to believe them. I was starting to wonder whether my Mac how-to book writing days were numbered.

Since then, Apple stock has split once (February 28, 2005), turning my 50 shares into 100 shares. And as I type this, it’s trading for more than $110 per share. And, with the exception of two downturns — a small one starting right around the time of the stock split and another larger and longer one starting in January 2006 — it’s been a pretty smooth right up. This chart from my Quicken data file, which I I use to track all my investments, tells the story for the past five years:

Apple Stock for the past 5 years

In the image, the red S’s indicate where I sold stock. The split is also marked, but can’t be seen clearly in this tight graph. I’ve owned Apple stock since 1996 and tend to buy and sell periodically as my personal cash flow varies.

Right now, I’m hoping for another split. I don’t want to sell the certificate for 50 shares that’s in my safe; it’s an old certificate and features the 6-color Apple logo. I don’t know what new certificates look like, but it wouldn’t surprise me if Apple did away with the logo on its stock, too. The certificate is a collector’s item — one currently worth at least $5,500. I’d pull it out and scan it to show it to you, but the safe is locked and I don’t have the combination.

Do they even issue stock certificates anymore? I haven’t gotten one in ages. And I don’t even remember where this one came from. Could it date back to my pre-online broker days? It seems likely.

Anyway, seeing the current price of the stock made me feel like gloating just a little. When everyone else was dumping their Apple stock, a few of the faithful remained — well, faithful.

And right now, that looks like a good business decision, too.