Do Blue States Subsidies For Red States Indicate Their Fiscal Superiority?

The realization that nearly 40% of President Obama’s electoral support came from the five fiscally disastrous and chronically blue states of California, Illinois, Michigan, New York and New Jersey apparently hit some raw nerves. Some critics countered with the fair point that red states recover more federal tax dollars then they pay and are consequently subsidized by blue states that pay more than they receive. That assertion is arithmetically correct but the interpretation that somehow red states should be thankful for the generosity of blue states and are financially or fiscally inferior to blue states is fanciful.

First, a significant portion of federal tax revenues flow back to residents of all states as Social Security and Medicare payments, which for the most part have been earned by recipients who paid into those programs during their entire working lives, so they should never be confused as gifts of charity and are certainly not the result of the beneficence of blue states. States also receive significant federal tax revenues for national defense and military spending, which protect everyone, especially coastal blue states, at least more so than interior red states.

Second, blue states generally pay more federal taxes than they receive because their residents and businesses are more affluent. Ironically, if President Obama wins the fiscal cliff negotiations and raises taxes on the wealthy, that blue state-red state tax disparity will widen, but, not to worry, that effect should be short-lived as long term trends show that affluent folks continue to leave high tax/high cost blue states for red states; over time the disparity should narrow.

Third, blue states, not red states, need a financial overhaul. The five states identified herein recover federal tax revenues ranging from only 61 cents (New Jersey) to 92 cents (Michigan) per dollar their residents pay in federal taxes, with the remaining three states receiving approximately 75-80 cents per tax dollar they pay. Those states are trying desperately to stay financially solvent by raising state and local taxes, which for New York, New Jersey and California are already among the nation’s highest.

Those states carry enormous debt epitomized in the extreme by California’s whopping $618 billion; they carry debilitating budget deficits, epitomized by the nation’s worst at $44 billion in Illinois; and carry smothering unfunded state government worker pension and healthcare liabilities that amount to as much as 43%, 37% and 31% of the respective state GDP’s of Illinois, New Jersey and California.

If allowing those states to keep more of their federal tax dollars would enhance their financially viable, such a policy should be considered, but let’s not kid ourselves, there will be no quick fixes to their problems.

Media Bias: Was History Channel's Postponement of Series Finale Politically Motivated?

The History Channel just completed an eight hour series, The Men Who Built America, about five influential capitalists that almost single-handedly transformed a broken, tired post-Civil War America into a global super power: Vanderbilt (Shipping/Railroads), Rockefeller (Oil), Carnegie (Steel), JP Morgan (Finance), and Ford (Autos). Capitalists will cheer and communists will jeer these men but all will enjoy this extraordinarily interesting story of their lives, their deals and their interactions with each other as they propelled America into the world’s top economy and amassed unsurpassed personal fortunes. During the height of their careers Rockefeller, Carnegie and Morgan were collectively worth in today’s currency some $1 Trillion.

This is an excellent series that everyone should see. However, it is particularly curious that its finale was scheduled to air two days before Election Day but was postponed at the last minute until November 11th because of “unforeseen circumstances.” After viewing the finale, one must wonder if those “unforeseen circumstances” included the potential for that episode to inadvertently help republicans during the elections two days later. The 50-year period depicted in the series touches upon many themes relevant to the election narrative this year, including the role of capitalism, class struggle (99% vs. 1%), labor unions, the role of government regulation, to name a few.

The first six hours of the series, which aired repeatedly during October, clearly made the case for the incumbent president and democrats. Those “robber barons” were depicted as greedy and ruthless and were reviled by nearly everyone in their time; they screwed their customers, their workers, their partners and each other, a pattern that supports the democrat agenda to expand the role of government to reign in and regulate the wealth and influence of the rich and powerful. Given the relentless and slanderous attacks against Bain Capital, Mitt Romney and republicans generally as self serving, greedy capitalists, viewers are likely to draw comparisons between those men and today’s republicans.

However, by delaying the finale, viewers must wait until after the election to find out that those titan figures set up foundations to distribute much of that wealth for the benefit of mankind, through charitable organizations that survive to this day. Additionally, despite all the brutality and hardship inflicted by those men, those men made America the unrivaled economic and military superpower of the 20th century; a nation positioned and destined to defend the free world against tyranny during two world wars.

Our entire way of life today began with the achievements of those men; railroads unified the nation and along with steel made our dense cities possible. Oil and autos made subsequent suburbanization inevitable. Those men also gave us companies that today are known as General Electric, Exxon, Chevron, U.S. Steel, Ford and scores more. The series also makes the point that brutality and ruthlessness was the by-product of the speed with which those industries were expanded and consolidated. We can never know whether a slower, more genteel, less disruptive evolution would have ultimately yielded similar prosperity. Series closing commentary underscores the point that those men and their entrepreneurial spirit “built” modern America, despite our president’s claim about today’s entrepreneurs to the contrary. All of those mitigating factors must weigh into the evaluation of the critics of capitalism.

Was the finale’s postponement an unfortunate coincidence or a deliberate attempt to influence the election? We may never know. If finding politics in a seemingly innocuous postponement of a TV series sounds far-fetched, it is at least consistent with other seemingly innocuous delays by this administration, including and most recently the stonewalled investigation into the Libya attack (Sept 11), the attempted Iranian attack on our drone (Nov 1), and most recently the resignation of CIA Director (Nov 9) for transgressions obviously known well before the election. The American people still wait for adequate answers by this administration. In that light, questioning the motivation for postponing the finale of this politically relevant series is probably not as far-fetched as it might initially seem.

Re-elected President Obama now faces “Sophie’s Choice” on Fiscal Cliff

Re-elected President Obama has a difficult choice to make during his second term. He can stick to his principles and remain loyal to the majority of folks who re-elected him, and hope for the best. Many think that will likely fail him and the nation, leaving America foundering economically and him with a miserable legacy as a failed president. Or, alternatively, he can put the welfare of the nation above his personal ideals, work in earnest with republicans, just as President Clinton did in the 1990’s. That approach worked for Mr. Clinton and just might spur a robust economic recovery, thereby leaving him with a presidential legacy to rival the best in history.

The President’s management of the economy during his first term was at best disappointing. Many think that continuing his liberal agenda with more big government, characterized by more spending, more taxes and more regulation will yield more debt and more deficits and ultimately more disappointment. A large part of the President’s political base hails from states that not only want more of the same, but indeed practice what they preach; so much so that it has lead many of them to financial ruin. Many of the blue states are a fiscal disaster. Five states, which account for approximately 40 percent of electoral votes that re-elected the President, are among the fiscally weakest in the nation: California, Illinois, Michigan, New Jersey and New York. Those and other blue states will continue to weaken as the exodus of population and business from those bastions of big government to fiscally strong red states continues. It is inevitable that the Federal Government will be called upon at some point to bail out many of those blue states, but who will bail out the U.S Government if the nation follows their lead into financial oblivion?

President Obama was re-elected by a narrow margin at this particular point in time by the narrowest of popular margins, by a voter base that represents about 25 percent of the adult population that could potentially have voted in that election. However, millions of businesses and residences have been electing for years to leave blue “big government” states in favor of red “small government” states. The lesson is simple and clear. Instead of fighting republicans that have proven they know how to manage their own fiscal affairs, the President should seek their advice and counsel. Otherwise, and if he emulates the fiscal practices of the states that by-in-large elected him, he is likely to fiscally weaken the nation further and irrevocably, which will be a disaster for the nation and his legacy as President of the United States.

Private Equity Funds Are Good for the Economy but Should Pay More Taxes

Mitt Romney and Bain Capital have been attacked by the opposition as greedy rich folks that destroy the economy and the lives of average Americans. However, more than 90 percent of the capital invested in private equity funds like Bain is actually supplied by huge institutions such as public and private pensions whose pensioners typically receive 80 percent of fund profits.

To earn those profits, private equity funds target and acquire dysfunctional companies, add capital, inject management know-how and then recycle prosperous businesses to the economy. Most acquisitions are not hostile or forced by acquirers and target companies often recognize that their survival may hinge upon the acquirer’s capital and management talent. Many recycled companies are transformed into profitable and productive employers for the economy.

The owners of successful private equity funds make superhuman returns and tons of money because they buy good businesses cheaply from distressed sellers motivated to save their companies, leverage their tiny equity positions with huge amounts of debt and other investor equity and further enhance returns by recycling target companies to profitability quickly.

Whether private equity funds are moral or fair is for philosophers to decide. However, those activities are legal and they are as moral or as fair as anyone seeking to buy a home in this distressed real estate market by seeking out a short sale from a motivated seller eager to shed the weight of an upside down mortgage; or as fair as buying a home needy of repair or improvement with an eye toward flipping it quickly for a tidy profit; or as moral as a buyer taking on a mortgage as large and as cheaply as possible. Isn’t that essentially what private equity funds do with businesses?

Private equity funds should not be vilified for what they do. However, they should pay higher taxes. Not because they are rich, but because the capital gains tax they pay for most of their income does not derive from their capital gains. Preferential tax treatment for capital gains was enacted because of the realization that for most investors the capital they invest has already been taxed to them previously as wage or other ordinary income and because they need some additional incentive to take the risk of losing their money in investments. As indicated herein, 90 percent of private equity fund capital comes from third party investors who bear the risk of any investment losses, so most of the income earned by private equity fund owners is really contingent fee income for a job well done, and that should be taxed as ordinary income.

Citizen Romney Must Take Charge of the Presidential Debates

Mitt Romney needs to accomplish three objectives at this Wednesday’s debate with President Obama. First, he needs to show that he can relate to average Americans, and that he is indeed one of us, with the same concerns, doubts and fears about the future of our country. Second, he needs to induce the President to answer questions about his economic policies and take responsibility for his numerous failures during his first term. Third, he needs to accomplish one and two by neutralizing the debate moderators that are, for the most part, egregiously biased in favor of the President, and likely to lob him creampuff questions and/or accept answers filled with rhetoric and pabulum.

Mr. Romney can accomplish all three objectives by not merely being presidential candidate Romney, but also Citizen Romney. Americans need to see him as a concerned citizen first, and a political candidate second. Romney needs to refocus the President’s narrative to answer the tough questions about the economy and get the answers we as Americans need to make an informed decision on Election Day. Candidate Romney must then layout his economic plan and vehemently and specifically contrast how the American economy and how middle class Americans will benefit from the new economic policies of a Romney administration. Americans are frustrated with the lack of serious media coverage of the shortcomings of this administration or its Republican challenger’s ideas for improving our situation, and Mitt Romney will be performing a great service to us and our political system by cutting through the president’s rhetoric and the mainstream media bias against him by engaging the President in a serious substantive debate about the economy and our future.

Mr. Romney needs to channel a bit of Newt Gingrich, when Mr. Gingrich challenged debate moderators and highlighted the liberal media biases during the Republican primaries debates, and a bit of Jorge Ramos and Maria Salinas, Univision TV anchors during a recent interview, when they relentlessly demanded that the President answer tough questions about immigration. A bit of respectful pushback against the media and the president will go along way to shedding some desperately needed light and balance on what has thus far been a dangerously one-sided narrative in favor of the president.

Without compromising too much of an otherwise even-keeled demeanor, Mitt Romney needs to approach this first debate with extreme urgency, not only because his political career may hinge upon it, but because the fate of our country and indeed the free world may also depend upon it. If Mr. Romney follows this prescription, and repeats it in subsequent debates later this month, he will succeed in winning the hearts and minds of undecided American voters.

Fed’s Short Term QE3 Fix May Cause Economy’s Long Term Demise

The Fed’s decision last week to resume monetary easing with Quantitative Easing 3 (QE3) is unprecedented in both its timing and duration, and is a clear indication that our economy is in dire straits. It is a direct contradiction to the assertions from President Obama and former President Clinton that our economy is on a slow path to recovery. Who should you believe, politicians trying to eke out a win for their party, or Fed head Ben Bernanke, a leading expert on the economy and the Great Depression?

Ironically, the move by the Fed may actually help re-elect President Obama. The flood of new money expected will increase real estate and stock market prices and may create the illusion that American wealth is increasing and that the economy is indeed recovering. However, all that new money will also devalue the dollar and thereby increase the cost of oil and other dollar-denominated commodities, which costs will increase headwinds for the recovery.

The re-election of the President is also likely to dampen the prospects for a long term recovery too, as the President apparently intends to “stay the course” and continue policies that have thus far failed to produce meaningful economic growth. In addition, given the President’s apparent inability to work with congress, it is unlikely that there will be the required entitlement, regulatory and tax reforms needed to affect meaningful reductions to the budget deficit and the national public debt, reductions necessary for a sustained and long term economic recovery.

Ben Bernanke certainly knows all that. So why would he announce QE3 now and risk politicizing the Fed with presidential politics? Why risk causing the re-election of an incumbent President who has thus far proven ineffectual in spurring an economic recovery? Why not continue a “ready to act when necessary” posture that has kept markets stable for the past several months?

Cynics believe Mr. Bernanke’s move was a deliberate attempt to re-elect the President, so he too can keep his job, which is certainly safer with a second Obama administration than it would be with a Romney win. However, given all the recent evidence of a global economic slowdown, it is just as plausible that Mr. Bernanke fears that without the swift, decisive and unprecedented action he took last week, the US economy would be risking a major economic backslide sometime this fall. In that scenario, it is understandable that Mr. Bernanke would be unwilling to wait to act and even be willing to risk assisting the re-election of the President. Further, he would be risking the long term success of his own QE3 program and long term recovery in order to stabilize the economy during the economically significant last quarter of the year.

President Clinton's TV Ad Needs a Reality Check

Bill Clinton’s TV ad supporting President Obama’s re-election is ironic on so many levels, but it grossly distorts reality too. Clinton says that republican policies under the Bush administration is how “we got here” and that the only way out is to continue with “President Obama’s plan.” So far I have not heard a plan for the future; his convention speech was a plea for Americans to “rally around his goals for the future,” which certainly is not a plan and sounds as though he wants us, collectively, to do his job for him.

As for how we got here, President Clinton says it’s Wall Street greed and republican policies, but there are other major reasons banks ran wild and the housing market boiled over, which the former president knows intimately. First, under his watch, Glass-Steagall was repealed; that was the banking law enacted during the Great Depression designed to explicitly prevent the banks from venturing into high risk businesses that could bring about their demise. Second, under his watch the Community Redevelopment Act, originally enacted under the Carter administration was aggressively advanced during his presidency, and encouraged banks to make home loans that did not meet traditional underwriting standards.

President Clinton says President Obama inherited an economic mess from President Bush, which is true, but history also shows that he himself passed a declining economy along to Bush in 2001. The stock market, a leading indicator of the economy, peaked in early 2000 and was on a clear downward trajectory by Bush’s inauguration, and completely capitulated after the events of 9-11, during President Bush’s first year in office.

Probably too much weight for our nation’s economic prosperity is attributed to the policies of presidential administrations. In recent history great economic success came from a republican and democrat president, Reagan and Clinton, who clearly set different economic agendas and visions for our nation, but each had one major trait in common, namely the ability to work with the opposing party in congress.

Going forward the most important lesson of the Clinton legacy for this president is the fact that Clinton’s success came mostly from his second term in office, when he reached across the aisle and decided to work with republicans. This president has thus far been unwilling or unable to do that and regardless of where the fault lies for that fact, it’s the president’s job to make that happen and get things done. If he is unable or unwilling to do that, the prognosis for a successful second term can not be encouraging.

Hedge Funds Earn Extraordinary Amounts of Ordinary Income

Investment funds, such as hedge funds and private equity funds, and their managers earn most of their income from profits on invested capital that is taxed at a preferential capital gains tax rate of 15%. Investment managers argue that they invest like everyone else, albeit on a grander scale and that they should not be penalized with higher taxes merely because they earn lots of money. Everyone else thinks it is outrageous that the very wealthiest among us should pay a preferential tax rate on their enormous incomes. Those investment managers should not pay higher taxes because they are wealthy, and most of their income does derive from capital gains. However, most of their income does not derive from their capital gains.

Preferential tax treatment for capital gains was enacted because of the realization that for most investors the capital they invest has already been taxed to them previously as wage or other ordinary income and because they need some additional incentive to take the risk of losing their money in investments. However, typically 90 percent or more of the equity capital invested by investment managers comes from third party investors who bear the risk of any investment losses. So why should those investment managers get preferential tax treatment for income they get that is derived from profits on another investor’s invested capital? Isn’t that income more realistically contingent fee income for a job well done? And shouldn’t that income be taxed as ordinary income?

No? Then maybe all companies should structure a portion of employee compensation as “capital gains” too. That compensation could be based on the value employees add to the value, or stock price in the case of a publicly traded company, of their companies. That income could then be taxed at preferential capital gain rates too. Critics might correctly point out that employees do not invest their own capital in such a scenario, and consequently are not eligible for capital gains treatment for any income earned. But isn’t that exactly what investment fund managers are doing?

Hedge funds and other investment funds earn an extraordinary amount of ordinary income. The proposal implicit in this commentary is less that the law should be dramatically overhauled, but more that it be slightly amended to coincide with the original intent and reasoning for the favorable tax treatment in the first place: that investors be encouraged to take investment risk.