patrick.net

But if cap-gain tax is abolished we would not need #4.

Well, depends what you mean by "abolished." If we just tax cap gains at the same rates as other forms of income (abolishing the distinction in rates, but not the tax itself), then there is still a reason for these accounts.

Example:

Employee #1 earns $10K and puts it into a 401K which doubles to $20K, then withdraws the money, which is taxed entirely at 20%. Net result = $16K of retirement consumption and $4K of tax to the gov't when employee retires.

Employee #2 earns $10K and pays immediate $2K of immediate income tax, leaving $8K for retirement savings. Again, the money doubles, giving them $16K, but they still need to pay the flat 20% tax on their gains. 20% tax x $8K gain = $1,600 tax, leaving them with $14,400 of retirement money after paying a total of $3,600 in taxes. The other $2K disappeared because it is the lost hypothetical gain that the employee *would have* gotten if they had deferred their taxes. Instead, the government got the money sooner to do whatever it is they do with tax money. (Suffice it to say, it is unlikely that they invested it and doubled their money.)

I will be in SF next thursday. Would anyone be up for an early dinner of sushi?

Allow everyone to write off their first $20K of cap gains / interest from their 1040 and you might see an increase in the savings rate.

Good idea. Works sort of like an IRA with a high contribution limit--except that you should be able to get the money back out (if you so choose) before you are 59 1/2! And instead of tax deferral you actually avoid the tax altogether. This way, you could save for a downpayment on a house while waiting out the bubble... 401ks are fine, but no good for housing-crash savings accounts.

The idea here is that not only does it grow tax deferred it reduces your pre-tax income as well.

But if income tax is replaced by consumption tax we would not have to worry about that as well. :)

I will be in SF next thursday. Would anyone be up for an early dinner of sushi?

Will you be in the blog party on the 3rd? :)

Well, depends what you mean by “abolished.” If we just tax cap gains at the same rates as other forms of income (abolishing the distinction in rates, but not the tax itself), then there is still a reason for these accounts.

I still think it is best not to tax cap-gains at all. This should lead to more efficient capital allocation.

most securities are owned by a relatively small % of rich families.

And here I thought it was public pension funds and institutionals. Learn something new every day.

Perhaps I'm missing something, but I thought it was generally understood that the top quintile of HHs in the U.S. own the majority of securities & income producing assets:

http://www.pcf.org/venture_philanthropy/pdfs/ida_research.pdf#search=%22asset%20distribution%20U.S.%22

--The top 20% of all American households earn over 43% of all income but hold over 68% of net worth (all assets less all liabilities) and almost 87% of net financial assets.
--Ten percent of America‘s families control two-thirds of the wealth.
--The top 1% collected over four times their proportionate share of income, but hold over 11 times their share of net worth.
--The richest 1% possesses at least $763,000 in net worth, an amount 22 times greater than the median of the remaining 99%

I’m not going along with anything that eliminates my cushy SEP with it’s special small biz perks.

This is why tax reform is so hard to accomplish. Everybody has some piece of turf to protect.

Nevertheless, I would not be surprised to see some sweeping tax reforms in '07 (or at least an attempt to pass something). There have some rumblings about this, starting with the president's tax reform panel. But I think Bush probably blew it. The time to pass rational tax reform would have been when they passed the '01 and/or '03 tax cuts. It is much easier to swallow changes in the tax code when the taxes, overall, are being reduced.

It will be very hard, if not impossible, to sell changes to the tax code which negatively impact some taxpayers and do not benefit others during a recession with a lame duck President, a recession and an imploding housing market. Typical Bush, though, he left the hard work and heavy lifting for his successors.

I’m not going along with anything that eliminates my cushy SEP with it’s special small biz perks.

...and don't think about touching my kiddie tax credit. :-) Special interests forever.

Found Roubini's Blog (Krugman's reference):

http://www.rgemonitor.com/blog/roubini

Philosophical question:

Should we aim to improve social equity or should we improve overall standard of living?

On the other hand, eliminating cap-gain tax may incentivize everyone to save and invest.

Peter P-

I am not sure about the blog party on the 3rd, it depends on what my in-laws are up to. Right now it looks as if we will not be there.

However, I, am certain to be in SF on the 31st. If anyone is interested in sushi, I would be interested too.

Glen,

I see you're logic with the "double-taxation" on retirement savings cap. gains, though of couse NOT eliminating the tax write-off for IRA/401k/401b/SEPs would eliminate that problem.

Completely abolishing capital gains --while nice for those who get more income from investments than wages-- would perversely make the wealth disparity in the U.S. even worse than it already is. I don't see why Mr. Trustafarian should get a tax "pass" on his unearned passive gains, while I get hit for 30% a year on my meager earnings from actual work.

Just seems regressive, a poor incentive structure, unfair and bad tax policy IMHO.

Should we aim to improve social equity or should we improve overall standard of living?

If you mean through the tax code, then neither should be the goal. Taxes should be raised in order to fund government spending. The simpler and more transparent the system for doing so, the better.

If the government wants to support a particular activity, then they should subsidize it. If they want to disincentivize some activity, they should impose fines or criminal penalties. Other than that, let people decide how to spend their own money. Monkeying with the tax code just gives politicians cover for discretely funding favored special interests, which requires everyone else to pay higher taxes to fund these interests.

Mr. Schmoe, a word of advice, don't pick Peter P's sushi bill :)

It is typically larger than the GDP of Angola. He is rumored to have eaten an entire blue fin tuna himself.

"pick up"

Completely abolishing capital gains –while nice for those who get more income from investments than wages– would perversely make the wealth disparity in the U.S. even worse than it already is.

But the investments were already taxed at the corporate level.

He is rumored to have eaten an entire blue fin tuna himself.

The rumor is greatly exaggerated. :)

It is typically larger than the GDP of Angola.

Not really. But the bill is usually much higher than the net worth of many FBs. :)

But a Big Mac costs more than the net worth of many FBs.

Taxes should be raised in order to fund government spending.

It can also be argued that government speding to be reduced in order to lower taxes. Spending is a means, not an end.

On another note, here's a case where life imitates art:
http://tinyurl.com/f4n45
I wonder if they'll ever make a movie out of our housing bubble bust, and if so, I wonder who will play the FED?

I don’t see why Mr. Trustafarian should get a tax “pass” on his unearned passive gains, while I get hit for 30% a year on my meager earnings from actual work.

HARM,

I totally agree. If you earn $100K in salary and Trustafarian earns $100K on the sale of stock, you are both better off by exactly $100K. If the gov't needs to collect $60K, they could tax each of you $30K, or they could collect $20K from Trustafarian and $40K from you. Which is more fair?

Sure, the lower cap gains rate may persuade Trustafarian to reinvest his money in more capital assets instead of blowing it on coke and strippers. But what about you? Aren't you likely to take a break from the rat race and stop working so hard next year?

It is also weird that if you buy stock which appreciates, you pay cap gains. If you earn dividends, then you pay "dividend rates" (depending on the kind of dividend). If you earn interest income, you pay ordinary income tax. Too many rate structures, too much complexity, in my opinion.

At this point, the incentives are so complicated and nuanced that most taxpayers couldn't make maximum use of them, even if they tried. An example of the confusing questions consumers face:

1. Roth or regular IRA (depends on highly unknowable future income tax rates)?
2. Pay down debt or contribute to retirement plan (depends on after tax cost of debt vs. savings from tax deferral)?
3. Stocks that pay dividends or interest-bearing bonds?
4. Sell now and take short term capital gains since I am bearish on future prospects of my stock or wait and pay LT cap gains later when stock may have fallen?
5. Sell house now and take easy bubble money? Or wait until two years have passed to get cap gains exclusion?

Etc., etc... Not even a highly competent professional financial planner can give a definitive answer to most of these questions. Some incentives.

I wonder if they’ll ever make a movie out of our housing bubble bust, and if so, I wonder who will play the FED?

Huh?

It can also be argued that government spending to be reduced in order to lower taxes. Spending is a means, not an end.

Absolutely --and good luck getting that to happen. We've had a "conservative" Republican-dominated government for nearly 6 years now. So how have those "starve the beast" spending cuts been going so far? Any Congressmen or Senators out there ready to sacrifice YOUR state/district's pork-funded jobs or farm subsidies?

Anyone, anyone.... Bueller?

Hmmm... perhaps a new theory may be in order.

Glen,

I'm with you! I've been pulling for this for years. The way I set up SEP's you can daytrade for all I care. I have ONE rule though, if I get fired b/c you're too distracted I'm gonna make sure YOU get fired first!

You should see some of the stuff on my books! Alternative energy, Canadian mining stocks, pennys you name it. I just remind these guys, "you're the CFO here right?" You're a big boy, right? So there's no crying in baseball and there's no crying on Wall Street, right?

Have at it my friend!

Default kick-backs can be remedied by making the default random. Don't like what you're in? Here's our 1-800 number.

I said:

Taxes should be raised in order to fund government spending.

Then Peter said:

It can also be argued that government speding to be reduced in order to lower taxes. Spending is a means, not an end.

My post may have been ambiguous. When I said "raised" I did not mean "increased." I meant taxes should be collected to fund whatever level of spending is deemed appropriate by the powers that be. I was just trying to make the point that the sole function of the tax system should be to collect money, not to engage in social engineering. A good system of taxation is fair, economically rational and administratively feasible. Our current system fails on all three counts.

It is also weird that if you buy stock which appreciates, you pay cap gains. If you earn dividends, then you pay “dividend rates” (depending on the kind of dividend). If you earn interest income, you pay ordinary income tax. Too many rate structures, too much complexity, in my opinion.

At this point, the incentives are so complicated and nuanced that most taxpayers couldn’t make maximum use of them, even if they tried.

Glen,

We are in 100% total agreement on this. Current tax code is insanely complex and so byzantine precisely beause it attempts to "incentivize" everything to death, and because every business/interest group out there lobbies for its own loopholes/"special status", ultimately defeating the original purpose of special exceptions. This is why I'd much rather see a greatly simplified income & asset-class neutral structure.

I meant taxes should be collected to fund whatever level of spending is deemed appropriate by the powers that be.

I see. :) But that would still mean that tax should be collected to support an arbitrary level of spending. This is dangerous.

I wonder if they’ll ever make a movie out of our housing bubble bust, and if so, I wonder who will play the FED?

There will be such a movie.

I see. But that would still mean that tax should be collected to support an arbitrary level of spending. This is dangerous.

Well, I have my own views on the appropriate level of government spending. But these views are independent of my views on the purpose of the tax code.

My guess is that we could reduce rates meaningfully if we broadened the tax base by eliminating special loopholes, carve-outs, exemptions, credits, deductions, "incentives," etc., etc...

Rates could be reduced further if we actually managed to cut spending. But I think it would be easier to cut spending if all the special tax favors were itemized as line items in a spending bill, instead of being tucked into an obscure tax code provision. It is easier for Joe Public to understand that his money is being collected and distributed to an oil company than it is for him to understand that a special tax break for the oil company invisibly raises taxes on everyone else. Just look at the difference between the press coverage on spending for Halliburton and other war contractors vs. invisible spending in the form of tax "incentives" for, eg, accelerated depreciation, oil well depletion allowances, etc....

HARM,

In 1986 the government radically transformed the tax code by wiping out tons of special rules, loopholes, etc. from the tax code in one fell swoop. It was a victory for bipartisan rationality. Bill Bradley (D, NJ) authored the bill and helped shepherd it through the Senate. Reagan and other Republicans supported it and helped get it through. The '86 tax bill eliminated all kinds of loopholes (eg: unlimited "passive loss" deductions, etc.) which had distorted the code. Naturally, the beneficiaries of these loopholes were pissed.

Then Congress got back to the business of handing out favors. Twenty years later, the code is far worse than it was in '85. But it will take some kind of miracle for bipartisanship and the public interest to prevail over partisanship and special interests in the coming years, I'm afraid.

My guess is that we could reduce rates meaningfully if we broadened the tax base by eliminating special loopholes, carve-outs, exemptions, credits, deductions, “incentives,” etc., etc…

How about merging the "regular" tax with the AMT, so everybody pays the AMT at a slightly higher rate? This would become a slightly progressive "flat" tax.

How about merging the “regular” tax with the AMT, so everybody pays the AMT at a slightly higher rate? This would become a slightly progressive “flat” tax.

Could be a start, but I would go further than that. I believe the AMT still allows a couple of deductions (like mortgage interest). In my view, they either need to phase out the mortgage interest deduction or allow a certain amount of rent to be deductible in order to level the playing field and achieve neutrality between owners and renters. Oh, but I forgot, we need to "encourage home ownership" because so few people own homes in this country and we need more FBs to take the plunge....

SF Woman wrote:

> FAB, What is the legal difference between a coop and
> a TIC. I know that TICs tend to be entry level places,
> and the coop I almost bought had a high down payment
> and an income/asset test and the members voted on
> you, but is there any other difference?

A Tenants In Common aka TIC is a way that any number of people can own Real Estate. From a RE dictionary site:

"Tenants in Common: property owned by two or more persons at the same time. The proportionate interests and right to possess and enjoy the property between the tenants in common do not have to be equal. Upon death, the decedent' s interest passes to his/her heirs named in the will who then become new tenants in common with the surviving tenants in common. Words in the deed such as "Peter, Paul, John and Mary as tenants in common" establishes tenancy in common."

If three TICs own a building with a single loan and one stops paying the other three will have to make the payments or loose the property to the bank.

Ownership of a traditional co-op is not actually ownership of Real Estate. People that "own a co-op" are actually just shareholders of a corporation that owns Real Estate. Traditional Real Estate lenders will not make co-op loans and some of the more exclusive co-ops have "kept out the riff-raff" by prohibiting any pledge of the stock in the co-op as security for a loan (not many people have $5mm cash to buy in to a co-op like that)... The Wikipedia has a lot more info if you search "Housing Cooperative"

Wow.... if Lereah is conceding a hard landing then we are really in for it! Maybe 20% decline nationally and 50% in bubble markets?

SFWoman Says:

I just listened to my telephone messages up in the country (where to meet friends for dinner?) and I got three mortgage people calling.

Interesting. Before we sold, we got tons of mortgage refi cold calls, and enough junk mail about refinancing to fill a McMansion. Now that our mortgage has been reconciled, no more of this crap. Yes, I realize this is just mass marketing, but the funny implication is of course that every mortgage holder is a potential refinancer/equity extractor/FB.

One called, introduced himself as David Clark at 1-888-699-0692 and wanted to talk to me about the 30 year 1.5% mortgage application that he had received from me. He needed to talk to me to get it funded ‘right away’. Yeah, right.

Let me guess... he probably said it was a "30 year fixed 1.5% rate"...as in "30 year loan, fixed until December."

I have heard real estate call-in shows use the term "fixed" to apply to just about any loan that doesn't have a rate that starts floating on the day you close your loan. Is anybody really fooled by this?

Glen Says:

I have heard real estate call-in shows use the term “fixed” to apply to just about any loan that doesn’t have a rate that starts floating on the day you close your loan. Is anybody really fooled by this?

Given this bubble and the FB stories we all hear about, I'd say the answer is resoundingly, YES.

Given this bubble and the FB stories we all hear about, I’d say the answer is resoundingly, YES.

I don't think the FBs were fooled by anyone other than themselves.

BTW, do you think they have fineprints saying something like "loan fixed at various interest rate for the entired 30-year term"? :)

Oh man... we are really in for it.

The "virtuous cycle" for housing will turn into a vicious feedback loop....like dominos...

1. MSM continues stories about the HB...
2. Flippers panic and cancel their next flips, forfeiting their 1-3% deposits en masse (cancellation rates have been huge over the last couple of months...and getting worse)...
3. Builders, who claimed they were safe this time (vs. early '90s) because they don't start building until the contract is signed, realize they haven't reserved nearly enough for contract cancellations...
4. Builders inventory piles up massively and builders forced to take big write-downs on inventory. Some of the aggressive builders find that they are insolvent. They sell off houses and land in bulk at fire sale prices...
5. Builder liquidation sales!....
6. Existing homeowners who still have some equity to salvage realize that they must compete with new home prices and start discounting more aggressively...
7. FBs with negative equity realize they have no hope of selling and send "jingle mail" to the banks...
8. Uh oh... MBS market takes note of the exploding default rate and starts "pricing in" much more risk for MBS securities....
9. Lenders who kept loans on their books find themselves with lots of bad loans and lots of REOs to liquidate and start slashing prices...MORE inventory....
10. Lenders who sold loans in the MBS market face massive lawsuits from pension funds and others who purchased mass quantities of bad loans... MBS's jack up rates and implement extremely strict guidelines on mortgages...
11. Failure of one or more major financial institution (WaMU? Barclays?)...
12. Derivatives meltdown???....
13. Unpredictable fallout...things that seemed safe (like certain money market accounts--not FDIC insured--holding MBS securities) inexplicably fail, leaving conservative investors (among others) holding the bag...
14. Buyers refuse to buy houses because: (1) economy in full blow recession and jobs are scarce; (2) scared s**tless because of horror stories from friends and family; and (3) most importantly, can't qualify for a loan...
15. Articles appear stating that "Sell now! They aren't making any more qualified buyers!"...
16. Lots of hand-wringing...
17. Tons of lawsuits by and against consumers, borrowers, lenders, regulators, buyers, sellers, builders, pension plans, banks, etc., etc...
18. At this point, depending on how apocalyptic you feel, we either have (a) massive dollar crash and massive wealth destruction (bank account? Gone. Brokerage account? Gone. Houses? Burned to the ground.), hyperinflation, riots, massive crime wave, martial law, suspension of civil liberties and the rise of fascism backed by US military might; or (b) resumption of normal market conditions, followed by Congress passing the Omnibus Housing Clearance, Reconciliation and Accounting Procedures act of 2011 (OH CRAP) WAY too late... Or maybe something in between....

hey, what about the fundamentals?

You should buy a home that you can enjoy. It needs not be viewed as an investment.

Of course, you must stay within your confort zone financially.