Big Dams = Big Drought? Ask China

Way way back in the late 70’s early 80’s I was working for Citi. One role I had was related to the construction of the Guri Hydroelectric dam in Venezuela (a minor involvement). The World Bank and Inter-American Development Bank provided a big chunk of the financing. All the big banks were lending money to the Venezuelan government and to the local electric company EDELCA. There were foreign contractors from every country involved. Money was moving in every different direction. I handled some of the FX transactions. As I result I became familiar/interested in this mega-construction project.


On paper, this was an absolutely beautiful project. A true perpetual energy machine was being created. The hydro dam was being located at what looked to be a perfect location. Two maps:

For millions of years the warm water of the Caribbean  produced huge quantities of moisture that rose into the air and drifted southwest over Venezuela’s high plains. When that wet air runs into the Andes mountains it creates rain. Lots of it. This pattern created big rivers like the Orinoco that bring the water back to the ocean.

This endless cycle created an ideal condition for generating hydro power. So Guri was built. A 10,200 MW facility that flooded an area of 1,641 square miles. That’s big.

The flooded area was greater than the state of Rhode Island. The lake was 25Xs the size of the District of Columbia, 70Xs the island of Manhattan.

Your average coal plant produces only 700MW. A big nuke like the two units at Diablo Canyon produce only 2,300MW. Fukushima Daiich (4 units. Top ten globally) produced at its peak 4,700MW, less than half of the capacity at Guri.

Anything you might read about Guri will say it was a successful project. But here is my side story:

Many years later I was wearing a different hat. I was on the ‘buy-side’. Investing in (very) distressed assets. Venezuela was in the crapper at the time and EDELCA bonds (owner of Guri) were trading at 30 cents on the dollar with 5 years of interest coupons attached for free. So I took a look. I noticed that the MW production was substantially below what had been projected. I asked a guy I knew at the World Bank about it:

BK: Where’s the juice at Guri?

WB: Bad question to ask. The rainfall that historically fed the region has changed its pattern and annual flow. There are some who think that the enormous lake that was created changed the way the rain fell. Less water, less electicity.

BK: Incredible! Has this been proven? It would create a big stink if this were to come out.

WB: There will be no study. The dam has been built. No one wants to hear any bad news about this project. There are too many others like it being built around the world. The World Bank is promoting hydro power. We don’t want to tarnish what we build.

I was struck by this conversation. Man bites nature and nature bites back. For years I have wondered about this. There has been plenty of anecdotal evidence that big dams might cause changes in regional weather patterns. For example:

Recently this very important story from China has been making headlines.

ZH story (Link)

The region below the Three Gorges Dam has been in severe drought ever since the dam was opened. This headline had me looking again at the correlation between big dams and weather changes. Sure enough, just last February, a collaborative effort by Tennessee Tech, Purdue, U. Georgia, U. Colorado, and Pacific NW Labs confirmed what I had heard 20 years ago. The existence of a dam is directly associated with regional climate change according to the study: (Link)

From the article:

"This research shows you the smoking gun"

The study marks the first time researchers have documented large dams having a clear, strong influence on the climate around artificial reservoirs, an influence markedly different from the climate around natural lakes and wetlands.

"We know a lot about how climate change affects reservoirs, but what we didn't know a lot about was what a reservoir could do to the local climate. We just reversed our thinking by saying that a reservoir and the activities it supports are just as important a player for climate as the larger climate is for the reservoir. Basically, it's a two-way street."

What are the conclusion(s) here? There is no energy creation mechanism that does not have big risks? That we are not as smart as we think we are when we build these giants? That China has lost a breadbasket forever?

I conclude that if you mess with nature you’ll get messed back. Hard.

NIH on Abbott Labs - "They lied"

If you watch TV you’ve seen these ads. They’re lies.

Abbott Lab's cholesterol drug, Niaspan, got a patent way back in 1997. The folks at Abbott have been selling a ton of this crap ever since. It is in the Top 50 of all drug sales. I don’t have the total cumulative sales, but in 2009 global revenue came to $717,000,000, in 2010 it was more than $900mm. Over the life of the drug, total sales are in the tens of billions. The stuff is worthless. It might even be bad for you.

The National Institute of Health did a five-year study. The conclusion:

"The lack of effect on cardiovascular events is unexpected and a striking contrast to the results of previous trials and observational studies," said Jeffrey Probstfield, M.D.

NPR had this guy (another expert) on air to discuss the findings. When asked to comment on the results of the NIH study he had this to say:

"The drug did not change the health outcome at all."

"We’re not as smart as we thought we were."

The Congressional Budget Office did a write up about this last week. The CBO found that in 2008 spending for drug promotion came to $21 billion in just the US. Of that ¼ was spent on ads to consumers. The CBO raises the very legitimate question of whether this promotional effort by the drug companies is actually educating the public or just manipulating the public to buy drugs that are either not needed or simply don’t work at all.

I bitch and moan about the banks, the Fed, Treasury, the SEC and the other financial players that seem to be lying and cheating us on a regular basis. Add to that list the drug companies. The big pharmas are the same as the banks. They don’t really care about their customers. They just want to sell pills and make profits. They have the FDA in their pocket. As usual, the average citizen gets thrown under a bus.

“We want our secrets kept secret” – FHFA Director

The administrator of Fannie and Freddie, Edward Demarco, had this to say yesterday regarding a bill to open the GSE’s to the FOIA:

H.R. 463, introduced by Representative Chaffetz, would subject the Enterprises to the Freedom of Information Act (FOIA). FOIA’s “core purpose” is to:

1) Enhance “public understanding of the operations or activities of the government;”

2) FOIA is “often explained as a means for citizens to know what their Government is up to."

This core purpose is not served by applying FOIA to Fannie Mae and Freddie Mac, which are still private companies operating in conservatorship. They did not cease to be private legal entities when they were placed into conservatorship, nor did they become part of FHFA.

Still private companies? That’s the reason they are shielded? After the taxpayers shelled out $200b (and counting)? Bullshit.

I’m going to give DeMarco a D- on this one. I can think of a half dozen areas in Fan’s and Fred’s checkered past that should be exposed and made public. There is no way the dirt over at F/F should remain hidden. There is one area of inquiry that I think should be correctly viewed in the history books. Allow me a ramble.

In his memoir, former Treasury Secretary “Hank’ Paulson made the following comments. (This covers a time period May – August 2008)

Treasury had been getting nervous calls from officials of foreign countries that were invested heavily with Fannie and Freddie.

Foreign investors held more than $1 Trillion of debt issued or guaranteed by the GSEs, with big shares held in Japan, China and Russia.

Okay. We know this. The likes of China and Russia had Paulson by the balls. And they squeezed. Hank does not give a source for the following information. It was conveyed to him August 8th – 10th , 2008. Hank was in Beijing watching Michael Phelps win medals at the time. Take a stab at where he might have learned this:

Russian officials had made a top-level approach to the Chinese suggesting that together they might sell big chunks of their GSE holdings to force the U.S. to use it’s emergency authorities to prop up these two companies.

Here’s how I think this went down. Paulson was connected in China. He was the CEO of Goldman. He was Treasury Secretary. He had his own access to “top-level” Chinese officials. One of them called and invited him over for a tea.

China: 

The Russians see that you are vulnerable. They want to take you out financially. They want to force you to default as they did in 1998. They want China to join them and push you to your knees. There are some leaders here who are in favor of this plan. Others are not. Can you offer me something that I can use to change the outcome of this?

Paulson:

I understand your position. Try to understand mine. Not one penny of the F/F bonds that you hold is guaranteed by the US government. It says so right on the front of the Bond Indenture.

China: 

We know the law. But now I tell you our law. If you stiff us with these bonds we will be at economic war with America, and we will win.

Paulson: 

Okay, okay, okay. I got you. I see the picture. Here is my response. I will make a promise to you. I will make you money good on these bonds. I will arrange a buyback. I will get the Fed to do this. I will see to it that the amount of the buyback is a bit over the $1T that is now in foreign hands. The US will eat what it does not deserve to eat. You have my word that this will get done before I leave office.

China: 

How much time do you need to make these arrangements?

Paulson: 

Give me four months. I will get this buyback agreed to as soon as I can. But I, I mean the Fed, can’t go public with it until, say, two weeks after the big election. Give me till the end of November.

This could swing an election. I need some room to get this done. This is very political. Understand?

China: 

We will hold off on the decision for a few months.

Paulson: 

Do me a favor. Tell the Russians to go shit in their hat.

China: 

You have until the first of December.

Four months later, two weeks after that big election; we get this:

Here is how the Fed describes the goal of QE1 (the F/F buyback):

Nothing about balls getting squeezed and side deals with China. If I’m right that this tale played a hand in the how and why of QE1 then it would add a great deal of ‘color’ to the story.

Let’s be clear on few facts. A) The US was never on the hook for F/F. B) If the Fed thought it was necessary to provide a monetary jolt it could have bought Treasuries versus Agencies (that is what they did with QE2). QE1 was a debt buyback that was forced on us. That is a very different kettle of fish than how it was sold to the public. If Paulson had a hand in how this played out it would taint the Fed and the way they conducted policy. There is nothing in the Fed’s duel mandate that says they are supposed to being doing buybacks to bail foreign central banks.

Like I said, this is all just my read of the history. I don't want to see that our good pals at F/F get a free ride on this. If there were a  FOI window for these bums I would be most anxious for them to open their files on who said what to whom regarding these buybacks. My guess is that it started back in August of 2008. Right after Hank got back from China.

Let me remind Mr. DeMarco of the purpose of the FOIA:

A means for citizens to know what their Government is up to.

The details of the GSE buyback need to be known and understood. I want to know what my government, in particular the Fed, is up to. I want to know what brought about QE1. I flat out don’t trust them. That’s why the FOIA in the first place.

Joplin – Nino did it

Another 89+ dead. So far this year the total is 453 (55 average). In 2011 there have been 49 killer tornadoes, the average for a full year is only 22. So what’s going on? There is no question but that the rapid transition from La Nina to El Nino conditions is responsible for the violent weather.

From the May 23, NOAA update:

The transition from La to El is happening in all of the ENSO regions:

What this means is that warmer water is building up on the Pacific coast and the Gulf of Mexico. These pics show the transition from 3/2 to 5/18. Note the buildup of color in the GoM.

 

With the heat and moisture comes the rain (storms) that go though the South and the Ohio Valley all the way up to the North East. We are experiencing unusual conditions in this entire area:

 

The long-term chart shows that the cycle of El to La conditions has happened repeatedly in the past. The most recent cycle is notable because of the extreme trough that was achieved back in November and the very rapid transition from La to El.

The ENSO weather cycle is a bit like the stock market. It produces extremely choppy conditions during peaks and valleys. It can be downright deadly when it changes direction.

SS - The interest issue

It’s been ten days since the Social Security annual report to Congress has come out. I’ve been waiting for the devotees of SS to write something cheery about the report. For the most part the cheerleaders have been silent. That’s with good reason. The report stunk. There’s nothing in it to write home about.

The exception has been one of the principal defenders of SS. Dean Baker of CEPR wrote this article. The headline intends to create an air of optimism.

I got a chuckle when I got to the part where Dean spells out what he thinks is the “good news”:

In the 2011 report the trustees assumed that we would enjoy substantially longer life expectancies than they did in the 2010 report.

I would agree with the notion that extending average life is “good news”. But, as Dean goes on to explain, this increase in longevity is just more bad news for SS. Dean describes the increase in life expectancy as the “main” reason for the financial deterioration at the Fund. That’s simply not correct. There is evidence of deterioration in all the fundamentals at SS. The bottom line is: Not even one of SS strongest defenders can find anything positive to say.

I think that the SS defenders are in shock. They have held up the annual report for decades and each time said:

“See! It’s solid as a rock!” 

But they can’t say that any longer. The Trustees (finally) acknowledged that the SSTF had entered a period of perpetual annual cash deficits. This is a very critical milestone and the Trustees of the Fund didn’t see it coming. They missed this tipping point by six years.

A reader sent me this summary of the Trustee’s prior estimates of when we would cross into the dark zone of deficits. They missed by a mile, is all I can say.

2011 - shortfall is permanent

2010 -shortfall is a one year occurrence, 

then back to cash flow positive

2009 - shortfall begins 2015 (6 yrs away)

2008 - shortfall begins 2017 (9 yrs away)

2007 -shortfall begins 2017 (10 yrs away)

2006 -shortfall begins 2017 (11 yrs away)

2005 -shortfall begins 2017 (12 yrs away)

2004 -shortfall begins 2018 (14 yrs away)

2003 -shortfall begins 2018 (15 yrs away)

2002 -shortfall begins 2017 (15 yrs away)

2001 -shortfall begins 2016 (15 yrs away)

2000 -shortfall begins 2016 (16 yrs away)

The question that has to come to mind is, “If the Trustees missed the first critical milestone on this slippery slope, how much faith should we put into their “Drop Dead Date” where SS runs out of money?”

IMHO one should put little faith in that 2036 estimate. It could be a decade earlier.

A big “Pro SS” argument you hear is that there is a big surplus in the Trust Fund. That this Fund is as big as it is because workers have been paying into it for years. “They deserve the money back”, is the thinking. At the end of 2010 the Fund was, in fact, very big. It stood at 2.6 Trillion. But who actually did contribute all that dough? Not what you think.

The SSTF has enjoyed cash receipts greater than expenses for years. These annual surpluses were invested in Treasury Bonds. The Trust Fund is equal to the sum of prior year surpluses + interest (and interest on interest). If you apportion the prior years surpluses between contributions by employers and employees you get this pie (in the face) chart :

Note that interest income at the Fund is greater than all the prior year surplus taxes from workers/employers. Note that the excess payments by workers for the past 23 years comes to only 22% of the total.

Another big lie you hear from the lovers of SS is, “SS is self funding, it doesn’t add to the deficit”. This is simply a false statement. Every penny of interest paid to the Fund is expensed in the current year budget. It is a very big number today. It gets scary big in the future. This looks at past and projected future interest due to SS from taxpayers (SSTF “Intermediate” or Base case assumptions).

The annual toll reaches $204b in 2025 (up from $118b in 2010).

Now add it up. From inception (1987) to “big bang” (2036) the interest tab will come to a very lumpy $5 trillion. The bulk of that ($3.5 Trillion) is staring us in the face.

I don’t have a problem with the notion that the workers who contribute to SS should get a fair return on their money. But as you look at the SS picture and realize it is so highly dependent on interest income, it has to raise some red flags. Central to this is the question, “How fair is that “Fair” rate that SS has (and will) receive?”

I think that the fairness issue is (and has been) a problem. The way the system works there has been a subsidy. Consider these two charts from the US Treasury and decide if this looks fair to you.

Note: The $4.6T Intergovernmental account consists of SS, Civil Servants Retirement Fund and Military Pension Fund. All of these Funds enjoy the same implicit interest subsidies from general taxpayers:

The intergovernmental liabilities represents only 32% of total debt, but the interest expense in nearly 50%. There's something very wrong with that.

H/T Urban Redneck

CBO report – “FHA ripping off taxpayers by $5 billion a year!”

When Fannie and Freddie went down for the count way back in 2008 their (then) little sister, FHA, stepped up to the table in a very big way to fill the void. They succeeded. The FHA book of guaranteed mortgages has exploded since those dark days. From 2007 when FHA had a lousy $50b in new annual issuance they jumped seven fold to $350b in 2009. Where they once had a sleepy 2% market share of US mortgages they now have a very impressive 18%. Their total book of mortgage risk has grown from $427b at the end of 2007 to a very lumpy $1.05 Trillion three years later.

It’s hard to look at those results and call it anything but a screaming success. FHA has been the fastest growing financial institution (by asset size) in the world for the past three years. Way to Go!

But now the bad news. The folks over at the CBO took a look at all this. They did an analysis that looked at how FHA values its book and compared it to Fair Market. Why on earth would the CBO do that? No other financial institution (public or private) has to measure their book based on fair value. So why look at FHA on that basis? Simple answer. The CBO thinks that fair value versus the FHA accounting is a good proxy for the imbedded losses at FHA. From the report:

FHA’s mortgage guarantees expose the government (and ultimately taxpayers) to a significant amount of market risk.

FHA offers guarantees on mortgages with high loan-to- value ratios, which makes the likelihood and severity of defaults very sensitive to even moderate declines in housing prices.

If losses from defaults increase, the increase is likely to occur when the overall economy is weak and the cost of resources to cover those losses is high—a risk that would be reflected in fair-value estimates.

The full analysis by CBO is here (link). You can draw your own conclusions. I’ll cut to the chase and give you the last sentence:

The difference (between FHA and fair value)—1.5 percent of the initial loan amount—is the fair-value subsidy rate for the program.

At a rate of $300b+ of new business a year the FHA subsidy is pushing $5b a year.

In its annual report the FHA proudly showed this chart of the cumulative issuance of Ginnie Mae securities (FHA gteed loans). The total is a whopping $3.7 Trillion. If the 1.5% subsidy is applied to the entire book of business it comes to $55 billion. Anyone wonder why we are going broke?

 

BK to Tim G. – “Prove it!”

John Bellows over at the Treasury department wrote a Blog that called for a return of the Build America Bond (“BAB”s) program. He used some "facts" to make his point. I don’t think he has the facts at all. I’ll let you decide. I’ll also ask the Treasury department for a clarification.

This is the sentence that I’m calling them on:

The President’s Budget proposes to make the BABs program permanent at a 28 percent subsidy rate, making the program revenue-neutral compared to tax-exempt bonds, meaning it will not have any effect on the Federal Budget deficit.

The 28% cited is the critical issue. If the IRS collects income from BABs bond holders that equals the 28% that is rebated back to the states then the statement made be Treasury is correct. If the IRS collects less than the 28%, the Treasury statement is incorrect.

I have maintained from the get-go that BABs bonds went to tax free hands. Insurance Cos., pension funds, foreign investors and tax protected individual accounts were all big players

I can’t prove the actual IRS tax collections, but neither can Treasury. I wrote about this back on 3/15/11 (my link). At that time I had inquired directly with the IRS. They confirmed to me (in writing) that they do not keep records of BABs related tax income. The IRS response:

In response to your request for the percentage of tax collections from bonds associated with Build America Bonds, we will not be able to answer your request. Unlike tax-exempt bonds build America bonds are taxable, but the IRS Tax-Exempt area collects no data on the tax obligations associated with them.

What might be the actual IRS receipts related to BABS? Once again the IRS gives us some answers. Assume the most optimistic case for the Treasury Department. Assume that not one penny of the BABS bonds went to tax protected hands. Assume that the IRS collected the effective marginal rate on every penny of income related to BABs interest payments. In this extremely unlikely scenario the net tax receipts would be equal to the marginal tax paid by the income group that owned the bonds. The answer is that the marginal Federal rate for all income groups is substantially below the 28% claimed by Treasury. The IRS information:

In the rediculously unlikely case that 100% of all BABs bonds went to the top 1% of earners it still would only generate 24% versus the 28% that is claimed in the Blog.

Bottom line:
Treasury does not have the data to back up its claim. Their own organization (IRS) has proved that. In addition there is no reasonable claim that the estimate for the BABs tax collections are even close to 28% (IRS data). A much more reasonable claim would be that the level is below 20%. BABs make no economic sense at a rebate level of 20% or below. That is why the 28% is critical.

So why is Treasury pushing so hard on this? Why are they willing to fib and play fast and lose with important numbers? That’s easy to answer:

The big names in this lobbying effort? Surprised?

SIFMA 

(Securities Industry and financial Markets Association)

ABA 

(American Bankers Association)

Goldman Sachs

Citi

BoA

Treasury’s big push for BABs has nothing to do with good economics or solid budgeting and forecasting. It's about the money. In this case it's about money for re-election campaigns and banker's pockets.

D.C. – “We want it both ways”

This is a minor matter that rubbed me the wrong way. What do you think?

Last week, the Patent Office granted Chainbridge Software Inc. a patent on a method for identifying companies that are avoiding state income taxes by shifting income to low tax states or foreign subs in non-arm's length transactions, and estimating the amount of state tax underpayments.

I guess it is hard to argue with this. Every state is starved for revenue these days. A software program that would help maximize that income seems like a good idea, right?

But while the good old Patent Office is hard at work on behalf of Chainbridge and those state tax revenue folks the House and Senate are pushing hard on new legislation. They are pushing for passage of a new law, H.R. 1249, S.23.

So what is the intent of the new law?

It would prohibit patents on strategies to avoid, reduce or defer federal, state, local or other taxes.

The word "ludicrous" comes to mind. Software to collect taxes get patent protection while software that would minimize taxes is made illegal. The folks in Washington are trying to have it both ways. And they will succeed.

I can’t think of a better example as to why we should rip up the tax code and do something dramatically different. The system is a joke.

CBO Report – “Get used to the potholes!”

Joseph Kile from the CBO testified before congress today. This was a discussion of the Federal role in maintaining/building the nation’s highway system. Central to the presentation was the status of the Highway Trust Fund. Like all the other government Trust Funds (Social Security, Medicare) The Highway Fund (“HF”) is, well, running out of gas. This chart shows the problem:

Note the dark blue line on the bottom. It goes negative in about one year. That is because gas tax receipts and other revenues are falling behind expenditures. The CBO sums up the problem:

Under current law, the Highway Trust Fund cannot incur negative balances.

Hmmm. If the law prohibits the HF from running red ink why is the CBO showing all the deficits? The CBO explains:

Highway Trust Fund balances once were stable, but over the past decade, the fund’s receipts have fallen behind its expenditures.

The trust fund will be unable to meet its obligations in a timely manner by the summer or fall of 2012.

Jeepers! Another trust fund going broke. In a year! Actually, these trust funds don’t go broke, they just cutback on what they are paying out. How big a cutback?

Cuts would need to decrease spending by about one-third.

Cutting spending by 1/3 would add to those potholes. It would also be a drag on the economy. Given that this bad news is going to hit in the middle of a presidential election year I think it is unlikely that the administration is going to allow spending to fall by this much. So what are the options? The CBO always has the answers:

If the Congress chose to boost revenues, it could do so by increasing taxes that are dedicated to the Highway Trust Fund or by making transfers from the Treasury’s general fund.

Ah! We can raise the tax on gasoline and diesel (89% of the HF’s revenues) or we can do more deficit spending. Well, neither of those things are going to be very popular, so they won’t happen. The consequence of these dominoes falling:

The Department of Transportation has stated that if the fund faced a shortfall, it would ration the amounts it reimburses to states.

Welcome to America. The land of potholes.

Two Notes:

Go back to the CBO chart and look again at the top two lines. Compare them with history. Note that ‘planned’ expenditures are greater than ‘revenues’. Generally speaking that has not been the case in the past. It is the rule in the future. Every economic forecast that is made in D.C. is based on the assumption that more debt is incurred. Don’t trust those forecasts, is my take from that.

This business of the HF is really not that big a deal. It comes to $30-40b a year as a possible shortfall. That’s peanuts in the scheme of things. I think this will be glossed over for another few years. They will not raise the gas tax. The shortfall will be funded with debt.

I do think the status of the HF is worth noting as it is symptomatic of so many of the federal programs that exist. They are all running on empty.

Sock it to the Billionaires!

Note to readers: This blog was posted a week ago. Blogspot blew up and somehow the article disappeared into the ether. How can that happen? Anyway, for the historical record I redo it.

The President gave a speech down in Austin recently. This was all about politics. Obama hit on a very popular theme with the DNC folks. He wants a tax increase on wealthy people. There is little doubt but that he will get what he is asking for. The section that I thought was important:

"If we want to reduce our deficit, our sacrifice has to be shared. And that means even as we're making spending cuts, we also have to end the tax cuts to the wealthiest 2 percent of Americans in this country. (Applause.) It's not because we want to punish success. It's because if we're going to ask Americans to sacrifice a little bit, we can't tell millionaires and billionaires that they don't have to do a thing.”

How could one argue with this kind of talk? Millionaires and billionaires are not carrying their share of the burden so we should tax the hell out of them.

The audience that I write to doesn’t like Obama very much. They also don’t like big government; they hate the financial institutions and the fat cats with big bonuses. So I’m interested to hear what might be said on this topic. Is Obama striking a chord with you? I understand if he does. But you need to look where this is headed. If you are young, with children, and have debt from education or a home and aspire for some degree of success in your life; beware. What Obama is proposing is headed your way.

When Obama talks of taxing millionaires and billionaires he is missing the mark. He is pushing for a higher tax on income. What he doesn’t get is that millionaires and billionaires actually don’t have that much income. Yes they have wealth, but it is very easy to avoid paying taxes on wealth. The people who will pay higher taxes are young people, not the rich old fogies that have bundles in the bank. I got this note from a young professional who works very hard and is far from wealthy. He does make a decent income and that income will get squeezed by the higher taxes that are coming.

I love it when Obama talks about taxing the "wealthy" when he talks of high taxable income. Since he targets people with high wage income, he's targeting young people without much wealth that have a lot of debt (student, home, etc). The wealthy are mostly older folks, many of whom have lots of their money in muni bonds and assets throwing off capital gains. The wealthy are also foreigners who can invest in the US without US tax on their capital gains, and reduced US tax on dividends if a treaty applies, and generally, no US tax on interest income.

If you want to hike taxes on engineers, doctors, lawyers, accountants, airline pilots, and others with householders in high-earning brackets, fine. But it takes balls to call them millionaires and billionaires.


In the President’s speech he had this to say:

I don't want a $200,000 tax cut that's paid for by asking 33 seniors each to pay more than $6,000 in extra Medicare costs. I don't want that. I don't want my tax cut paid for by cutting kids out of Head Start or doing away with health insurance for millions of people on Medicaid, seniors in nursing homes and poor children and middle-class families who are raising a child with a disability like autism. That's not a tradeoff I'm willing to make.

These sure sound like popular views. The President has defined the debate here. This is about billionaires on the one hand and seniors, Medicaid and Medicare recipients even kids with autism on the other hand. But actually the proposal to increase income taxes will hurt a different audience than those billionaires. Those that are going to get hit, the young lawyers, doctors, airline pilots and business people of all stripes are going to respond with their feet. They will not vote for leadership that puts the tax burden squarely on them.

The end result will be that the political pendulum will shift to the extreme right. The House, Senate and the White House will belong to conservatives. When that happens there will be a great unwinding of the social programs that Obama champions. And all those who think the solution is to tax wealth will be very disappointed with the outcome.

Social Security TF – “We lost $1.1 Trillion last year!”

Yes, that is a correct headline. In its annual report to Congress last week SS acknowledged that its condition had sharply deteriorated in 2010. This sentence from the report is all you really need to know about what the status is:

The open group unfunded obligation over the 75-year projection period has increased from $5.4 trillion (present discounted value as of January 1, 2010) to $6.5 trillion (present discounted value as of January 1, 2011).

Note that this is a present value calculation. The total unfunded obligation has grown by a cool $1.1 trillion in just a year. In other words, if we had to shore up the TF to the level that it was just a year ago the USA would have to write a check for $1.1 T. The unfunded status was a disaster a year ago at $5.6T, it got worse by 20% during 2010. The cost of “fixing” SS goes up as a result. To put things in balance one of these two extremes are now required:

For the combined OASDI Trust Funds to remain solvent, the payroll tax rate could be increased an immediate and permanent 2.15%, (or) scheduled benefits could be reduced by an immediate and permanent 13.8%.

If you think this a ho-hum result, think again. If benefits get cut across the board by 14% we will have many seniors who will fall into a hole. An increase in payroll taxes of 2.15% is simply not going to happen anytime soon. There is no support in Congress for an increase like that. It would mean that taxes on all workers/employers would have to go up by $110b in the first year and rise every year thereafter. This would be a very regressive tax increase that hurts lower end workers the hardest. For 2011 there is already a payroll tax holiday of 2%. If the required increases take place in 2012 it would mean a 3.2% reduction in wages. Kiss the economy goodbye under that scenario.

I underlined the TF’s use of the words immediate and permanent as this language highlights the fact there can be no delaying on the fixes necessary at SS. One thing that you can take to the bank is that nothing will happen with SS in 2011 or 2012. This is a problem that will simmer for at least another 24 months. This delay will prove to be very costly for all involved. Both the required tax increases and/or the required cutbacks will be much larger than today.

The NPV of the unfunded liabilities at SS are now growing by at least $100b a month. One would think that this massive cost would spur some response in D.C. Don’t count on it. As a result, SS is going to come off the rails in about two years.

Obama on Corporate Taxes – “Whatever GE wants”

Jeff Immelt, the boss at GE and the President's Best Executive Friend Ever ("BEFE") had this to say about reforming corporate taxes:

Our system is old, it’s outdated, it’s complicated -- and all of us are for closing the loopholes. Absolutely, a lower corporate tax rate, and a territorial system, just like our global competitors have.

I love it when 'Jeff Boy' says “all of us”. Who is he referring to with that? American citizens in general? Not the case. Employees of big companies like GE? No, not them either. The “Us” that Jeff is referring to is America’s CEO’s and top exec’s. That lucky group comes to about 0.01% of the population.

Unfortunately, guys like Immelt have the President’s ear. That Jeff Boy is actually a formal adviser to the president while at the same time he is pushing a tax plan to benefit himself and another 30,000 execs is over the top. From GE’s top bean counter, Gary Sheffer:

GE favors closing loopholes, a lower corporate tax rate, and a territorial system in line with every other developed country in the world.

So GE and the rest of the execs are willing to give up loopholes, but in exchange they want a lower marginal rate and they want a territorial system.

This territorial system that is being pushed means that companies like GE will not be taxed at all on any of their foreign income. These companies will be tax motivated to build new productive facilities in the lowest tax haven. A territorial system will just push productive assets (and jobs) offshore until the US tax rate falls to a level that is equal to (or less than) another country. As a result of this proposal, the big US companies will hold the country hostage. Either they get the lowest marginal tax rate, or they just ship off some more jobs abroad.

Truly global companies like GE will be able to drive a truck through these new rules. They will push profits offshore so they will not be subject to even the new lower US rates.

This chart from the CBO shows the tax contributions of US corporations. Does it surprise you that all of our successful companies combined pay about 1/8th the amount that individuals do? If the proposals put forward by Immelt are adopted, the amount that those companies will contribute will fall further.

Lower taxes is exactly what the “Us” crowd wants. That’s understandable, they are Us’s. But for the life of me I can’t understand why Obama has joined with the Us’s. If voters actually figure out who is calling the shots on tax and economic policy they will turn on the Big O. Having Jeff Boy as the President’s BEFE is the worst conflict of interest I can think of.

Note:
As an individual (and US citizen) you are subject to taxation on a global basis. If you invest in Australia and make a buck, you owe taxes to Uncle Sam. If you went over the border to Canada to work for a year, you would owe taxes in the US.

Assume that individuals had a territorial system on tax as the Execs are pushing for. What might you do? You might be inclined to work outside of the US and you certainly would have a motivation to put your money to work some other place.

These tax motivations would be very much to the disadvantage of the US. The economy would suffer and tax receipts would fall. Of course there is no discussion for individuals to be taxed on a territorial system. That carve-out is only for the big shots in the S&P 500.

If it’s not reasonable or fair for individuals to be taxed on a territorial basis how could it possibly be fair for the S&P 500? Answer: it can’t be.