Wednesday, March 16, 2005

Social Security Reform and your Investments

Will it Wipe out the current “Trust Fund�?
Mr. Bush and the début of Social Security reform and, particularly, its privatization has not exactly heralded celebration in some sectors lately. Mr. Bush inherited a severely busted system that needs to be repaired. It’s time for clarity, not lugubrious scare tactics and naysayers.

First of all, the legendary Social Security Trust Fund is a fiction. There is no fund, because it doesn’t have a scintilla of funds in it. Ever since its inception, way back in the days of 1935, current tax dollars put into the system go right back out to the current Social Security recipients or as dollars for congress to spend. That’s where the story would end, but there’s more. The Trust Fund is supposedly backed by government securities. That doesn’t mean anything because the money does not have to be repaid. For example, if I hold a government bond, I have an asset that pays interest or has the liquidity to sell at any time. If the government holds a bond, however, it has no obligation to pay itself. It is meaningless.

Nothing has ever been saved in the Social Security Trust Fund or put into reserve. So there is no trust and no fund. The trust fund consists of IOU's from Congress, which keeps spending the money. Social Security taxes have been used, (read borrowed), to offset the federal budget deficit. A surplus in the Trust Fund means they took in more tax dollars that year than they had to pay out that year. In years when the Social Security trust fund was operating in surplus, as happened in 1995, the extra revenues were used to buy Treasury bonds that financed the general operating costs of government and to lower the deficit. They used the Trust Funds to pay the bills. This amounts to legal embezzlement. Representatives in government have been supporting the fiction of a Trust Fund for too many years.

Secondly, the maiden proposal is to allow the option, not the requirement, for tax-payers to put 4% to 12.5% of their FICA tax into their own personal retirement accounts with a cap of $1,000 a year rising $100 a year thereafter. Talk about going slow, this is a very soft first step! Funds will still be available for current retirees through the remainder of FICA collected plus selling more bonds to finance the transition.

Can we Afford the Transition?
Good old Uncle Sam has a net worth of about $50 trillion, ($80 trillion in assets minus $30 trillion in debt). Social Security reform is slated to cost approximately $2 trillion or about $200 billion a year over a number of transition years. To bring it down to numbers we can recognize, it is equivalent to saying; – does someone with a net worth of $50,000 have enough credit-rating to borrow $200 a year. The answer is, well in most cases, yes.

How will it Affect your Investments?
No one really knows what private Social Security accounts will do to the Financial Markets. Three things come to mind. First, we can only surmise that it, like tax-reform, it will increase the savings rate in America. If more savings are available then more capital will be available for future growth productivity growth. More savings also provide a buffer to inflationary tendencies in the economy since it mitigates shortages in the money supply.

Second, reducing retiree and other recipient’s dependence on the government can only foster more self-reliance and accountability on a public and governmental scale. Social Security individual fraud and governmental fraud would cease to exist when you take the government out of the game. The fictitious Trust Fund, that never existed anyway, would no longer be a source of extra borrowing for the government.

Thirdly, the influx of money may give certain markets increased demand and thus an increase in prices. This, steroid-like, shot in the arm may or may not have lasting effects as the initial exuberant run-up wears off.
Social Security, - it's time to change it. Perhaps more insidious and damaging, if we have no reform we can look forward to more taxes and more governmental hiding behind FICA spending. Hopefully, this administration may be our last hope if it has the fortitude to ignore the duplicity of fear mongers and get the job done.

posted by Ed Newcomb @ Wednesday, March 16, 2005 0 comments

Thursday, March 03, 2005

Tax Reform and your Investments

The System
At this time of year to say the tax system in the U.S. is bewilderment to all who approach it is an understatement. Working people making $50,000 may have around 25% taken for taxes every pay-check. That’s $12,500 paid each year! These legendary tax-payers may even end up owing taxes at the end of the year if they dared to make money through investing in companies who hire people and help make our economy grow.

What the Fed is Saying
So, what is tax reform about? What is on the table? Do we have place-mats or do we have some utensils to work with? Invariably, Alan Greenspan had something to say about the issue. The story broke today, the influential Fed chief said that replacing the tax on income with one on spending could boost growth, but likely opposition means that a hybrid may be the best approach to reforming taxation.

Clearly, Mr. Greenspan is talking about putting a tax on spending, (some form of a Federal sales-tax system), instead of the present IRS 1040. More specifically he’s backing a mixture of the two ideas and believes that a tax on consumption will foster growth. Just as clear, is that we need to reform and simplify the tax code.

The White House Council of Economic Advisers put out a report last month that basically agrees with Mr. Greenspan’s sentiment. They advised, as advisors tend to do, that incremental change would be better than a more sweeping shift to a national sales tax.

A Federal Consumption tax
Some are saying that a consumption tax would place an unfair burden on lower-income Americans who would end up paying more for the basic necessities of life. To counter this fear, the proponents are proposing a progressive system that would either exempt some income levels or exclude certain product categories like food.

Besides the April 15th deadline we are all familiar with, Mr. Bush has made a July 31st deadline for the tax panel to make some solid recommendations for tax reform. As far as I can discern, it appears that the proposal of merit will include a progressive consumption tax.

How will it effect your Investments?
We all know that time is money. But, is money time? Will it have a positive effect? Well, yes. An unbalanced amount of time and money is spent on compliance with and on gaming the current tax-code. With a simplified consumption tax system those vital resources would be freed to more productive capacity.

What else? Will it send the markets shooting up? The individual savings-rate has been too low in the U.S. for too long. A larger cumulative savings-rate provides a pool of funds for firms to reinvest toward growth. The tax reforms will increase savings, since savings won’t have such a tax penalty on interest and dividends. Lower rates on income – especially on investment income – will encourage investment and arouse the, presently slow-moving, economy.

posted by Ed Newcomb @ Thursday, March 03, 2005 0 comments