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What We Read Today 09 April 2014

Econintersect: Every day our editors collect the most interesting things they find from around the internet and present a summary "reading list" which will include very brief summaries of why each item has gotten our attention. Suggestions from readers for "reading list" items are gratefully reviewed, although sometimes space limits the number included.

  • Tax Preparers Targeting Poor With High Fees (Campbell Robertson, The New York Times) A vast majority of tax preparers are ethical and serving clients well. But there are some who charge fees like a top corporate lawyer to prepare and file a return requiring 30-60 minutes of work. There are a range of problems in the tax prep field, ranging from incompetence to outright fraud.

US regulators have held out the prospect of more draconian measures after ratcheting up capital requirements for the biggest US banks - from JPMorgan Chase to Goldman Sachs - forcing them to hold at least $68bn in additional capital.

A new "leverage ratio" will force the eight largest US banks to hold a minimum of 5 per cent equity to total assets to absorb losses in a crisis and proposes adopting a more stringent way of calculating the rule.

The leverage ratio is supposed to be a backstop to other capital rules that are "risk-weighted". It does not allow banks to use their own models, which some critics have warned allows institutions to game the system.

"I don't think it can last," Ryan said of the law in an interview recently with Bloomberg Television.

Ryan this week unveiled a budget plan that seeks to repeal the 2010 law known as Obamacare and would scale back the U.S. safety net in an effort to eliminate the deficit in 10 years. The House will vote on the proposal next week. House Democrats will release their alternative as soon as Monday, April 7.

The Republican budget proposal will serve as a contrast with Democrats' fiscal priorities before the U.S. midterm election on Nov. 4. Senate Democratic leaders have said they plan to tie House members vying for Senate seats in Colorado, Montana and Louisiana to Ryan's proposal.

"This is the fourth year we've passed a budget like this, fourth year we've said here's how we plan on balancing the budget and paying off the debt," Ryan said in advance of next week's vote. Though it's expected to be close, party leaders in the House say they've secured sufficient support to pass the measure, probably with only Republican votes.

Ryan and Senate Budget Committee Chairman Patty Murray agreed in December on a two-year deal that sets top-line discretionary spending at $1.014 trillion for the 2015 fiscal year that starts Oct. 1. Ryan's budget total, including mandatory spending on entitlement programs, including Medicare and Social Security, is $3.7 trillion.

Today there are 13 more articles discussed 'behind the wall', including a "mini-article" discussion about 'Flat Tax' and 'Fair Tax' proposals.

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  • This Counterintuitive Pattern Tells You Everything You Need To Know About Investing In Stocks (Sam Ro, Business Insider) Earnings drive stock prices, right? Right, except when they don't. The pattern in this chart makes sense if the lowered earnings expectations were priced into the market before the expectations started to decline. That can happen when stocks are under valued. What's that you say? Stocks are overvalued by historical comparisons? Then all you need to know is that rationality is not always the stock market's strong suit in the short run.


  • Obamaís Quiet Offensive (Samuel Charap and Lee Feinstein, Project Syndicate) Is Obama the next American militarist? Maybe not in the mold of Johnson and the Bushes but more like Teddy Roosevelt? Based on this review of last week's NATO meetings, Putin must wonder how much farther his expanded Russian sphere of influence can go. Edward Luce, in the Financial Times (Obama's attention deficit diplomacy) has a less flattering view of the U.S. and President Obama. Luce sees U.S. influence waning, says that the process preceded Obama's presidency, but also faults the president for not reversing it.
  • Our Five Year Forecast Beginning February 20, 2014 (Kendall Anderson, Anderson Griggs, Advisor Perspectives) These projections are quite a bit more bullish than others we have seen. They also differ from historical patterns by predicting large caps will out perform mid-caps and small caps will bring up the rear. If the current yield is assumed to be unchanged over the five years, the S&P 500 will be at 2,630 on 20 February 2019. The strongest performing sectors (more than 10% compounded annually) are Technology (11.39%), Utilities (11.29%), Energy (10.82%) and Materials (10.33%). Weakest sector is projected to be Consumer Discretion (6.52%).


  • How big is Chinaís building bubble, again? (Houses and Holes, Macro Business) A measure of asset value escalation can be gotten from the difference between FAI (fixed asset investment) and GFCF (gross fixed capital formation). The later is the total of new capital formation (investment in new facilities and improvements); the former includes the latter and adds the increased value of transferred (resold) land and previously accounted new facilities. The former is a component of GDP whereas the difference between FAI and GFCF is not. An analogy would be new home sales and existing home sales in the U.S.. When all established capital changes hands at the original price FAI and GFCF are identical. The difference is a measure of the inflation of capital investment values. House and Holes says of this situation:

FAI is going to have to fall back to GFCF as China rebalances and that implies a world of pain for all things commodities.



The bottom line is that large sustained external imbalances are something that global policymakers do need to monitor closely, because, as the US housing bust showed, they can be an indicator of problems that need to be investigated more deeply. And critics of the surplus countries are right that there are two sides to every balance, and that policies in both surplus and deficit countries should be subject to review. But it is wrong to believe that simplistic answers, such as more fiscal stimulus or more austerity, are a panacea; more often, the underlying problems relate to debt, structural rigidities, low investment, and weak competitiveness.
  • Tax Reform: Dueling Plans from the GOP (Ira Stoll, Hat tip to John O'Donnell. Good summary of flat tax and value added tax proposals. What is not discussed in what if any efforts various proposals will make to avoid extreme regression. The latest data from Fred indicates total personal income in February was approximately $14 trillion. A flat tax of 19% would create revenue of $2.66 trillion. The Tax Policy Center estimates that federal personal income taxes will generate $1.3 trillion in revenue in 2014. Obviously if everyone paid 19% flat tax the government would take a lot of money out of the economy unless government spending was increased to put the dollars back in. So why tax it away to begin with? It only makes sense if it was part of an income redistribution plan - and that is not likely the motive of the Republican sponsors.

House Resolution 1040, the Flat Tax Act, introduced by Congressman Michael Burgess of Texas ... would give Americans the option of choosing to file with an optional one-page tax return, at a rate of 19 percent for the first two years and 17 percent for the years after that.

So who would chose to pay the 19%? The table below indicates it would only be the top 1%. The 17% flat tax? The same top 1% plus a few of those in the top 10%. Those are the people who would get a tax cut. All others would pay the old tax formula or pay higher taxes. We can bet they will chose lower taxes and stay with the old code. As explained the flat tax proposed is an attempt to lower taxes for those with the very highest incomes while raising or not changing taxes for everyone else.

What about the Fair Tax?

House Resolution 25, the Fair Tax Act, offered by Congressman Rob Woodall of Georgia ... would repeal all federal corporate and individual income taxes, including payroll taxes, capital gains taxes, and the death tax. It would replace them, and fund the government's operations, with a new federal consumption tax on goods and services at a 23 percent rate.

With PCE (Personal Consumption Expenditures) at $11.7 trillion annual rate at present (St. Louis Fed Fred data) the revenue produced would be about $2.7 trillion. The Tax Policy Center estimates that under current law total receipts for 2014 will be about 10% more than that, about $3.0 trillion.

So the Fair tax is a 10% federal tax cut. And whose taxes will go up? Someone making $50,000 (near median household income) virtually all after-tax income (about $44,000, see calculation next sentence) is spent and therefore the Fair Tax will be about $10,000. This will replace less than $5,800 to $6,200 paid today ($3,750 FICA plus estimated income tax at 5-6% of estimated AGI).

So the Fair Tax will get about 67% more tax revenue from the median income household and will cut tax revenues by 10%. Even the poverty level household will contribute. Family of four poverty level in 2014 is $23,850. Almost all ($22,000 after FICA) will be spent on personal consumption expenditures producing a tax revenue of more than $5,000. This household is probably paying negative income tax in many cases (earned income tax credit), but ignoring that the tax increase here is about 280%.

Guess who will benefit from the reduced tax collections? Unless the top 1% spend all their income on personal consumption expenditures that cohort will see their taxes reduced. If someone making a few million dollars spends only half of his income on goods and services he could see his federal taxes cut in half.

These proposals are regressive without a lot more work put into the details.

  • U.S. Wind Power Blows New Records. Again. And Again. (Tom Randall, The Grid) Wind power electrical generation was 4.8% of the U.S. total power for January, the highest ever for that month and the fourth highest for any month. The cost of electricity from wind has remain constant over the past four years while some other sources (coal and natural gas) have risen. Today all three are very near to the same generation cost. The cost of solar has declined by about 1/3 over the same time period, but almost 90% higher than the three competitors.



  • Bargain Hunting in the Emerging Markets (Stan Luxenberg, Wealth Management) The BRICS are in a pile of rubble and other emerging market stocks have been slammed as well. Is it time to start looking through the mess for salvage? This author thinks so and suggests some mutual funds to consider.


  • Asset Allocation Implications of a Flattening Treasury Yield Curve (Martin Pring, Advisor Perspectives) While it is true that a flat yield curve (and even more so an inverted one) usually precede a recession, during the flattening process stocks are usually very strong. This is especially true during the early stages of flattening, which is where we are right now.

Click on graph for much larger image.

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