Thursday, August 09, 2007

Windfall profits, housing boom, bust and mortgage interest musings...

This weekend, our good friend CK sent me the following email:

Something that I find interesting in newspaper reporting is the titling of articles. For example, the title of this article is "House Approves $16bn in Taxes on Oil Companies". At the VERY end of the article, the reporter describes the tax hike as a rollback of tax incentives. Perhaps this is splitting hairs, but rolling back tax breaks is different than a tax hike in my mind.

In any case, the title did get me to read the article, so "mission accomplished".

[As an aside, the article basically says that Congress passed a bill that will eliminate some subsidies and tax breaks that oil companies have had for a number of years.]

My younger brother (Bro2), replied to CK's email with this:

CK, your feeble attempts to rile us up with a silly comment like "rolling back tax breaks is different than a tax hike" is just plain obvious.

Disguise it how you will, but raising taxes is still raising taxes (and what is this revenue going toward I might ask, I highly doubt its to a consulting study to eliminate government waste!). Next you'll tell me that when the government votes to raise capital gains rates back to ordinary rates it won't be a "tax hike", because they used to be that way. Well, I'll show you how much my taxes will increase from this non-tax hike.

Then you'll argue that raising the rate individuals pay on top earners to 50% wouldn't be tax increase because the rate was higher than that once. As a fine legal scholar like yourself must know, changing a law and then changing it back still creates 2 distinct laws. (See US Consititutional Amendments for a fine example). Much like creating government incentives to invest in an industry the government deems important (by lowering taxes) is one course of action and then raising rates (and decreasing a rational person's propensity to invest in the same industry) is an entirely separate course action.

So CK, take your hippie ways back to Canada with that bushleague tax hike comment.

My older brother, Bro1, followed that beauty up with this:

In the WSJ this week, there was a fine opinion / editorial on the US tax system and how until 1921 the Supreme Court did not consider capital gains income and had in fact ruled against the IRS's imposition of taxes on those gains. Dividends either. It is truly amazing how government creeps. The opinion really gets into the fact that the tax on capital gains is more of a wealth tax and why is there a difference between realized gains and unrealized gains. Based on the current take on capital gains, should they not just tax everyone's wealth? It would increase revenues just as those in power always seem to desire. It would allow the US government to continue unimpeded its 3% - 5% annual growth and it would kill a second bird by making it a great deal more difficult to become truly wealthy. Would it not be great if we could retard everyone's returns by a couple percentage points?

So, smelling blood in the water, and irked on by my brothers' comments, I composed the following:

I know you two are my brothers because as soon as I read CK's intro paragraph, I thought the exact same thing. As Bro2 alluded, CK, your description is effectively an argument for a flat tax. And your positioning is genius: any tax that has been lowered in the past (either explicitly, via incentives, or via subsidies (or via tariffs on foreign competition - ethanol)) cannot actually be "raised" in the future, it is merely an unwinding of the lowering. I'm not getting older, I'm getting less young! It feels so much better that way.

Bro1's point is something I've thought of often: why are only realized capital gains taxed? Economically, there is no dfference between realized and unrealized. The answer is because it's easier, which is of course an answer that inevitably leads to unintended consequences. Why is a "return of capital" not taxed currently (it merely reduces our cost basis) but a dividend is? What is the difference? Why are dividends considered income at all?

Bro2, as you may know, I take umbrage with your referencing of tax dollars as "revenue". It's not revenue - the government is not a business with sales. The government shouldn't be targeting Record Sales! Tax dollars are largely an involuntary confiscation of the money I earned taken under the precept that the government has a better use for it, societally speaking, than I do. The problem with using the word "revenue" is that it invokes traditional connotations: higher revenue is better and lower revenue is worse! Of course, in government, I challenge you to tell me why this is the case on the marginal tax dollar. Newsmen worry when the government has lower "revenue" in 2001 than it had in 2000. For the right reasons, lower tax confiscations is a great thing! Why do we assume the government is going to make good decisions with our money when time and time again it has been shown that they do not? Luckily, as Buffett says about businesses, when the reputation of management and the reputation of the economic quality of a business go head to head, it is often the reputation of the business that remains intact. Our politicians are our management and our country is the company. Luckily, our company has such a huge, deep sustainable competitive advantage that it is hard even for our morononic managment to fuck it up.

Regarding CK's article and the targeting of oil companies specifically. This has of course happened before (see the windfall profits taxes of 80 and 87) - article 1 and article 2. H-dub [a colleague of mine at work, also known as Hatch] predicted to me two years ago that these would be rolled out again and that is effectively what this legislation is. That said, I'm not saying it is a bad thing, but it is clearly a targeted tax increase. All of this is very two faced as corn ethanol is not a conservative (invoking the environmental/conservation definition, not the political/right-leaning definition) solution. I've seen compelling arguments that corn ethanol is actually worse from a carbon standpoint than traditional fossil fuels. Even if we assume corn ethanol is slightly beneficial vs. traditional fuels, I'd argue it is clearly negative as it utilizes important and scarce resources (farmland, crops, human effort, machinery, etc.) for what is basically a non-productive purpose. Sugar ethanol, which is proven hugely superior from a carbon conversion standpoint, is largely an import product but imported ethanol is heavily taxed (which is just crazy!). We are shooting ourselves in the foot on that front. Why we need to have oil companies pay subsidies to their future competitors is beyond me. It's so Randian that I can hardly believe it. Somehow our oil dependance is "big oil"'s fault. BS, of course.

Congress and the Senate are currently in the sweetest position. They basically have a put option at their disposal. They can write the most headline friendly, but functionally stupid legislation of their careers knowing that it will never get passed. They know Bush will veto this assinine shit and, ironically, that knowledge empowers them to push it forward. Knowing that they will never have to face the consequences of the downside of their legislation while getting to reap the publicity is a perfect political situation to be in if you are looking out first for yourself, second for your consituents, and third for America (which is the backward order to what ought to be).

While I'm ranting, how hilarious is it to watch all these congressmen worried about the poor subprime borrower? This was not some little scheme happening behind the scenes that nobody could possibly have seen coming. This was being advertised on every internet website I visited for the past three years. Dancing cowboys, hula'ing Martians, and bright flashing ads to REFINANCE NOW! Major, major financial institutions were involved. Teaser rates were advertised on TV, radio, print, and online (and by automatic recordinged spam phone calls to my home). It was written about, skeptically and idolically, by major media. I remember reading an article in the WSJ from 3-4 years ago about former truck driver-types that were making half a million dollars a year as mortgage brokers - did we think this was because they were helping Americans fulfill The Dream by fitting everybody in exactly the right mortgage for them? Sorry, but that's not a job that deserves $500k of compensation, so it was clear that something else had to be going on. Think about when that article was written - we are three to four years past what was already insane and probably six years into a bubble building - why does anyone assume that a 7% house price correction, which unwinds 2/3s of one year's recent appreciation, is going to be the extent of this unwind if this has been going on for six years? This could be an enormous, enormous correction. I could see nearly every house bought in the last two years ultimately being underwater. Last week, even for prime borrowers, banks like Wells Fargo hiked interest rates on jumbo prime rates to 8.0% on 30 yr. fixed - basically saying, "we don't want to make a loan." Supply of mortgages is evaporating - guess what will happen to the price of mortgages... As a new, prime buyer tries to get a mortgage and is faced w/ 8% rates, not only will the Plankton Theory (upward mobility in buyers needed to support home prices - see this PIMCO report) be on full display, but even buyers that were moving laterally won't be able to afford what they used to be able to.

The government ought to consider looking in the mirror when trying to place blame for problems in the mortgage market: in addition to sitting idly by (or outright encouraging the behavior), they lit the fire 15-20 years ago by isolating a tax deduction for home mortgage interest specifically - they are basically encouraging the trimuverate of higher prices financed largely by debt, the use of a home equity line of credit for as many purchases as possible, and the overall avoidance of building equity in lieu of debt. "I'm shocked, shocked, to find that gambling is going on in here!" Stunning that this incentive led to higher prices (what else could it lead to?)! They artificially lowered the cost of owning; check that, they artificially lowered the cost of borrowing against a house. Can I think of a more important asset the government should want me to not borrow against? Insane! All that tax break does is raise the price of houses and encourage taking on loads of debt against my house! Genius!



Hatch said...


Good to see you back. One of your finer efforts.


Hatch said...


Good to see you back. One of your finer efforts.


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