Dollars and Jens
Thursday, April 26, 2007
marginal capital gains tax rates
The big supply-side economics idea was that marginal rates are what matter for creating incentives, and we should focus on lowering marginal income tax rates, getting rid of deductions and credits if we have to. I've been thinking for quite a while now about the idea of taxing capital gains as ordinary income, but indexing cost bases for ... well, for the time being, pretend I'm thinking about indexing them for inflation. Economic growth is particularly sensitive, it turns out, to marginal tax rates on capital, and it seems here as though I'm replacing a marginal rate of 15% with a marginal rate of 28%, so this seems like a bad idea from that standpoint. But — let's suppose this is approximately revenue-neutral — I'm not sure that's actually right. What are the incentive here?

It seems to me that the average dollar saved is likely to pay about the same amount in taxes, assuming the revenue neutrality, as currently. As far as creating an incentive to save and invest, this scheme should be just as good. Because of the higher marginal rate, I am reducing the incentive to make sure it's invested well; once I've decided to invest a dollar, it's worth more effort to make sure it's put to best use if I keep 85 cents of every dollar of outperformance generated than if I only get 72. I've increased the attractiveness of longer-term investments as compared to shorter-term ones, I assume. I've also eliminated the inflation tax risk that investors face, where, even if a project is fairly safe in terms of real returns, an investor is exposed indirectly to inflation risk because his taxes are higher if there's inflation than if there isn't. That would seem to be attractive to capital and reduce overall risk, which is the sort of thing that tends to promote efficiency, but it feels like a small effect. What else am I missing? What's the net result of all of this?

Wednesday, April 25, 2007
Social Security — progressivity done correctly
I dislike the societal notion that "retirement" as such should be normal, to the point that not quitting what you do until you're sixty and making almost no money after you're seventy is abnormal, and I particularly dislike the government entrenching this idea by moving massive amounts of money around, but one of the things I like about Social Security is that it is progressive in a much better way than the income tax is: it is progressive with lifetime earnings, rather than one year's earnings. The numbers that follow, to illustrate, are my estimates, and are likely not to be too close to correct, but will certainly share the qualitative characteristics of the correct numbers, and should help me clarify my point.

A person making up to about $8,000 per year receives much more in Social Security retirement benefits than he's paying; in fact, the net Social Security tax is at a marginal rate of around -25%. From $8,000 to about $50,000, you're facing a marginal rate just a bit above 0; it's only from $50,000 up to $100,000 that you're paying closer to 8%. The income tax does this incorrectly: a person who makes $30k one year and $70k the next will pay a higher tax rate on the $70k than on the $30k, and will pay more in income taxes than if he had made $50k both years. For Social Security purposes, though, he will end up with the same net cost/benefit either way. Instead of penalizing volatility in earnings, it just becomes a transfer of wealth from people who made more than $50k per year on average over the course of their lives to people who made less than $50k, particularly to those who averaged around $10k.

Of course, a similar effect could be achieved with a progressive income tax and more liberal rules on tax-deferred savings; still, among those taxes that actually exist, the Social Security tax manages to be highly progressive without punishing people for having fluctuating income.

Tuesday, April 24, 2007
Executive Compensation
I've heard it suggested (by, among others, Warren Buffett) that disclosure of executive compensation drives envy, which drives salaries up, rather than making compensation committees and executives more accountable to their shareholders. Professor Bainbridge points to a study that finds that, while disclosure does correspond to an increase in executive compensation, this is entirely explained by an increase in performance-based compensation and an improvement in performance.

If you have access to SSRN, you can read the paper here.

dual-class share structures
"New York Times Co. management said Tuesday they would not change the publisher's control structure ahead of an annual meeting where shareholders planned to protest its dual-class share system."
According to the Times, a total of 124.2 million Class A shares had been voted at its annual meeting in New York to approve four designated Class A directors on its board.

Under a dual-class share system, the Times is controlled by the Ochs-Sulzberger family, which appoints nine additional Class B directors to the company board.
I have some sympathy for the class A shareholders, and some intuitive sense that it's generally best that control be allocated in a manner roughly commensurate with the attendant economic risk, but there's a significant "coming to the nuisance" aspect to this, too, and I don't think a private company should be forbidden to sell off shares in future earnings without really, really "going public".

On the other hand, claims that this structure helps preserve editorial independence are simple, straightforward hooey. Well, sure, it's independent of pressure from the public shareholders; instead, it's under pressure from the families.

subprime bailouts
Apparently a number of states are getting into the mortgage business, providing generous refinancing terms for borrowers with high interest rates, but insisting they don't intend to lose money. Well, their borrowing costs are likely lower than that of private mortgage lenders, and it's possible they've found actual market failure in which good credit risks get mixed in with bad ones,
Maryland also requires that the home be a primary residence and that the loan not exceed 85 percent of the value of the property.
but it's also more than possible they're improperly more optimistic about how the market is going to develop in the near future, or that they're simply cherry-picking the mortgages that have turned out to be profitable instead of those that haven't:
In addition, their old lenders may have insisted on enforcing the onerous terms of their original agreements, such as prepayment penalties. The state has more leverage with lenders to compel them to co-operate with the program.
"Co-operate" = "give up the contract terms that allow them to profit on some of the loans to make up for the loans on which they lose money". Heads I win, tails you lose. This may inspire lenders to be less eager to make such loans in the first place; of course, at this point, that's the direction the political pendulum has swung, anyway:
To avoid future crises, Maryland is also trying to discourage irresponsible or unscrupulous lending, according to Thomas Perez, secretary for the Maryland Department of Labor, Licensing and Regulation.
In five years, no doubt, they'll be back to complaining about "underserved communities", probably with the traditional lack of creativity in coming up with theories as to why such communities are underserved.

Wednesday, April 11, 2007
mortgage market problems contained
Alt-A mortgages are still in plentiful supply. There's no mention in the article of interest rate spreads, which I would imagine would have to widen a little bit eventually, but the recent problems with subprime mortgages and subsequent dramatic tightening in lending standards -- and 400 basis point widening on mortgage securities -- have been confined to the worst of the worst from an underwriting standpoint.
Jim Moore, a mortgage broker in Grand Rapids, Michigan who also writes about mortgages for, said he recently completed a $3 million refinance on a second home for a borrower who was out of work. "This wasn't even a no-documentation loan," says Moore. "This was a no-income loan, and the lender knew it."
If you need a mortgage that isn't purely speculative on the lender's part, you can still get it.

Thursday, April 05, 2007
housing price information in roller coaster format
U.S. housing price roller coaster.

Wednesday, April 04, 2007
This time, no doubt, it's different
Fitch said properties were also increasingly financed with no money down or even with loans for more than 100 per cent of a property's value as owners borrowed greater amounts upfront to pay interest costs,
Sound familiar? Well, it rhymes, anyway:
betting that cash flows would improve quickly enough for the property to be self-sustaining.

"Real estate professionals are structuring loans today with the expectation that cash flow will continue to rise in a commercial real estate market that has already experienced dramatic upward trends," said Eric Rothfeld, senior director at Fitch.

"Fitch is seeing the market financing the higher value prematurely, based on the expectation that it will occur, but well before it does or does not come to exist," he added.
As the Financial Times notes,
Unlike the residential market, commercial property values are still rising. But Fitch said the recent downturn in the market for subprime residential mortgages "should caution investors about the dangers of mixing aggressive underwriting with reliance on continued price appreciation".

þFelix Salmon

Powered by Blogger