Sunday, January 29, 2006

No football to entertain you this Sunday? How about ... exciting tax news and analysis!

Wages Earned in Antarctica Aren't Foreign-Earned Income

The Tax Court has held that the wages a U.S. citizen received while working in Antarctica can't be excluded from income using the foreign-earned income tax credit ... because Antarctica isn't a foreign country.

Dave Arnett v. Commissioner [.pdf] ; 126 T.C. No. 5; No. 8866-03.

Sex Change Operation Costs Aren't Deductible As A Medical Expense

The IRS has determined that the costs of male-to-female gender reassignment surgery and related medications, treatments, and transportation are not deductible as medical expenses ... "[The Tax Code] provides that the term 'medical care' does not include cosmetic surgery".

IRS Legal Memorandum 200603025

Healthcare Reforms to Come Through Tax Code, Breaux Says
Now that does not sound particularly encouraging.

Although President Bush has pushed for sweeping reforms to the tax code and the Social Security system, healthcare reform will likely come through "more incremental moves" and adjustments to the tax code, former Senate taxwriter John Breaux said January 20.

Breaux, who served as the vice chair to the President's Advisory Panel on Federal Tax Reform last year, told an audience at the American Enterprise Institute that healthcare is "the largest single expenditure in the tax code," with about $141 billion annually spent on healthcare through exclusions and deductions within the tax code. The income tax exclusion for employer-provided healthcare, itemized deductions for medical expenditures, and tax-preferred health savings accounts are just a few of the policies the federal government uses to promote healthcare through the code, Breaux said.

According to Breaux, more than 27 percent of the tax code's health benefits go to taxpayers earning over $100,000 a year.... [Tax Analysts]

A Broader Perspective on the Tax Reform Debate

-- by Michael J. Boskin, professor of economics at Stanford University, and Chairman of the President's Council of Economic Advisers from 1989 through 1993.


....I use five big-picture tests to judge tax reform proposals.

1. Will tax reform improve the performance of the economy?

By far the most important aspect of economic performance is the rate of economic growth, because that growth determines future living standards. The most important way the tax system affects living standards is through the rate of saving, investment, work effort, entrepreneurship, and human capital investment.

Modern academic public economics concludes that immense harm is done by high marginal tax rates, especially on capital income. That is a major reason virtually all prominent academic economists who have studied the issue recommend taxing consumption or that part of income that is consumed....

On those criteria, low flat-rate consumption taxes work best, high-rate progressive income taxes worst. A growing body of research suggests that replacing the corporate and personal income taxes with a low-rate pure consumption tax is the single most potent policy reform available...

An important dimension of economic performance is administrative and compliance costs, estimated by the Panel at more than $140 billion per year. Here the flat tax, retail sales tax, and the VAT do far better, and the SIT and GIT somewhat better, than current law if enacted as a replacement.

But if a sales tax or a VAT were added without removing the income taxes, large additional administrative and compliance costs would result....

2. Will tax reform affect the size of government?

It is important to control spending for its effect on tax burdens and economic performance. The economic harm done by taxes distorting private decisions to save, invest, work, and so on goes up with the square of tax rates. Doubling tax rates quadruples the cost.

The marginal cost is proportional to tax rates. Hence, each dollar of additional revenues costs the economy about $1.40. When it is spent - - as legislated by Congress, adjudicated in the courts, and administered by human beings -- some of it is wasted, some not narrowly targeted on the intended purpose. Perhaps $0.80 or $0.90 contributes to the intended outcome in a well-run program; only $0.30 or $0.40 in a poorly designed and administered program.

Further, some of that government spending crowds out private spending on the targeted activity. So the net government-financed increase in spending on the activity is even less. Thus, rigorous cost-benefit tests would reveal many spending programs badly in need of reform and retrenchment.

Tax reforms that more closely tie the payment of taxes to expenditures will promote a more effective and efficient government ... If everybody pays at a common rate, it will be harder to expand government and raise the rate, because a larger fraction of potential voters will have a stake in limiting the spending.

The more progressive the tax system becomes and the more concentrated among the few taxes become, the easier it is to expand government at the expense of a minority paying the bulk of costs. That was Milton Friedman's most important insight when he first proposed a flat tax in Capitalism and Freedom. That aspect of the case for a flat tax has unfortunately almost been lost in recent decades, as attention has focused on the important goal of simplicity, as in the postcard filing in the Hall-Rabushka (1983) flat tax.

Highly progressive rates also create an unhealthy dynamic in which revenues surge disproportionately in booms: The legislature spends it all (or more) and in the next downturn it is impossible to cut spending, leaving a growing fiscal gap and pressure to raise taxes to allow spending to ratchet up in the next boom. That is precisely what happened in California in 1999-2001 when revenues surged far more than rapidly rising income during the tech bubble, and state spending went up faster still. The inevitable correction led to a crisis with the state's credit rating below Puerto Rico's and the governor recalled....

Some proponents of the retail sales tax believe it would help control the growth of government spending by forcing an explicit transparent payment in support of spending on all consumers at the point of transaction, thereby greatly expanding the fraction of voters paying something to finance general government.

Others believe a broad-based retail sales tax or a VAT would collect so much revenue per percentage point that it would too easily finance government growth...

A new tax -- a broad-based consumption tax, like a European VAT, for example -- may just be piled on top of the existing taxes and used to raise revenue to finance government growth. That is what has happened in many European countries and is now a major detriment to their economic performance....


We have a rapidly closing window within which to have this great national strategic debate about the role of government in our economy, about the level and structure of spending and taxes.

In a few years, the demographics may drive an unstable political economy with an ever-larger fraction of voters demanding higher spending financed by higher taxes on a dwindling fraction of the population.

Witness how difficult it is for the Europeans -- with their larger ratios of benefit recipients to taxpayers -- to make reforms that we would consider trivial, even from much higher levels of spending and taxes.

Our collective interest is in keeping the hand of government in the economy light. In keeping tax rates as low as possible. In preventing spending, tax, and regulation decisions from gradually turning our society into the economic equivalent of France or Germany, for that would surely portend economic and social disaster.

Replacing the corporate and personal income taxes with the GIT or something still closer to a pure flat rate consumption tax that prevents the projected increase in the tax share of GDP would be an important step in doing so. [Economists' Voice]

Tuesday, January 24, 2006

Workus interruptus.

The demands of self-employment will keep this blog off line for two or three days.

Gotta pay the ISP bill.

In the meantime there's plenty of good reading at the latest Carnival of the Capitalists.

The most depressing day of the year.

Happy Depression Day.
You should feel like hell today - at least according to Dr. Cliff Arnall.

In a report published this month in the magazine Health, the British psychologist deemed Jan. 24 "the most depressing day of the year" due to an array of emotional and stress factors including lack of light, bad weather, increased debt from holiday shopping, the start of tax season and an overall state of self-loathing from broken New Year's resolutions...

"I really do see patients falling apart this time of year, there's a real sinking," says Dr. Kathleen Hall, a stress therapist and author of the book "A Life in Balance." ...
[NY Post]
The way my life is going, seems about right to me.

Saturday, January 21, 2006

How a tax credit can increase the cost of hybrid cars.

A new tax law this year provides a tax credit of up to $3,400 (varying by particular vehicle) to those who purchase cars with gasoline-saving "hybrid" gas-electric engines. But don't assume this credit will save you, the consumer, any money on the purchase of such a car. The fact is that it might cost you money.

Here are two steps to that unhappy result, through the Tax Code and supply-and-demand pricing.

First, the Tax Code. This going to be short: About 15 million taxpayers won't be eligible to take any "hybrid tax credit" at all in 2006 because they will be subject to the Alternative Minimum Tax (AMT). This is an alternative tax computation everyone must work through that generally imposes a lower rate than that under regular rules, but which also disallows many deductions and credits available under normal rules -- including that for purchases of hybrid cars. You must compare your AMT tax bill to the one computed under regular rules and pay the one that's highest. (The AMT story)

Who is subject to the AMT? People with higher incomes (over $75,000 or so) who have a lot of deductions, the prime one being for state and local income and property taxes.

That is, typically people who live in "blue state" cities and suburbs, where both incomes and local taxes are higher than the national average, and who have enough income themselves to spend a few extra thousand dollars to buy an environmentally friendly car for local driving.

In other words, the AMT targets exactly those people who are the most likely to buy a hybrid car, [update: incomes of hybrid owners, h/t The Chief] depriving them of the new credit for doing so. What Congress gives with one hand it takes away with the other (without exactly publicizing the fact).

That will be enough for many people -- before buying a hybrid while counting on this tax credit be sure you won't be subject to the AMT or the credit may be worth a big $0 to you.

But things can be even worse ... when you use a tax credit that turns out to be worth $0 to buy a car that has increased in price due to that very credit.

Second: supply-demand pricing. This is a longer story: Tax credits like this one are described by their proponents as reducing the out-of-pocket purchase cost paid by consumers, thus increasing demand, thus increasing the production of the favored product. But it doesn't have to work out that way.

By supply-and-demand we know that a car maker can sell a given number of vehicles at a given out-of-pocket price to purchasers -- say, 30,000 units at a price of $20,000. Adding a tax credit for purchasers to the situation doesn't change this at all. And this gives the producer the option of choosing to take 100% of the tax credit for itself as a gift from Congress, without increasing production at all.

Say the tax credit for purchasers is $3,000 per car. By still producing 30,000 units and raising the sales price to $23,000, the car maker closes the same number of sales at the same out-of-pocket price to purchasers, $20,000, as before. Purchasers net $0, production increases by 0, and the car maker collects a nifty $3,000 gift from taxpayers per car, $90 million total -- then sends a nice "thank you" note to its Congressman and extends the contract of its lobbying firm.

And, of course, any purchasers who have their credit disallowed by the AMT lose $3,000 in this scenario, compared to a situation where no credit existed and they paid the original market price.

Is such a thing likely in real life? Oh yes -- in the case of a product with inelastic supply that can't be readily increased, it is sure thing. Or if a producer chooses not to increase production for its own business reasons, the same will result. A tax subsidy purportedly for consumers will in fact be a disguised windfall bonus for producers.

(There's a moral here: Beware tax subsidies, they may not be what they seem. The fact that you take a tax break on your return does not mean that you are getting the benefit of it. But more on this another time.)

In the particular case of hybrid cars things won't happen to this extreme. Car makers are trying to build a market for this kind of car and increase production runs, so supply will be elastic, production will go up somewhat, this will mitigate the price increase to be less than the full credit, and the benefit of the credit will be shared with purchasers.

But we can be sure the car makes will be taking some of the credit. By supply-and-demand again we know that that for production to increase above the no-subsidy market level the car makers must receive a price above the original market price that purchasers would pay without the credit. And purchasers who were willing to pay $20,000 before, after being given a $3,000 subsidy, should be willing to pay somewhere up to $23,000 -- giving car makers that above-original-market price.

So we know that in reality this tax credit will increase the market price of hybrid cars, compared to what they would cost without it.

Let's look at some real numbers. Off-line data say Honda's suggested retail price for its 2006 Civic EX is $18,260, and for its Civic Hybrid, exactly the same car but for the engine, is $21,850, a difference of $3,590.

Is all of that $3,590 difference Honda upping its price to grab the tax credit? No -- but part of it is. (Note that none of the higher price results from any increased cost to Honda of the hybrid engine itself, compared to a conventional engine. Market price results solely from supply and demand -- cost of production plays no role but to remove from the market those producers who can't get a price that covers their production cost.)

So the bottom line is that the new tax credit for hybrid cars will increase the market price of such cars. That means the credit will be worth less than its dollar amount -- and if you are subject to the AMT it will cause you to take an outright loss on a hybrid purchase, compared to if there was no credit.

But look ... at this point you probably shouldn't be buying a hybrid for financial reasons, to save money, anyhow. For instance, to break even on gas savings after purchasing a Honda Civic Hybrid, gasoline would have to reach over $9 a gallon, according a recent report by, with similar gas prices needed for other hybrids.

If you are going to buy a hybrid -- as opposed to the same car with a conventional engine -- the reason that makes sense is not money but the personal satisfaction obtained from knowing one is beneficially reducing the world's gasoline consumption.

Of course, the news about that isn't all good either.
research has been picking other holes in the hybrid story over the past two years. Consumer Reports, a product-rating publication, tested 303 vehicles in real-life town and highway driving, and found that nine out of ten of them failed to achieve the fuel-efficiency claimed for them in tests by America's Environmental Protection Agency (EPA). In some cases the shortfall was as high as 50% and the worst offenders were the hybrids... [Economist]

Data ... indicates that hybrid cars get less than 60 percent of EPA estimates while navigating city streets ... the Civic Hybrid averaged 26 mpg in the city, while the Toyota Prius averaged 35 mpg, much less than their respective EPA estimates of 47 and 60 mpg. [Wired]
Be an informed consumer. Buyer beware.

By the way, if you really want to improve the gas mileage a car model gets on a cost-efficient basis there's a proven, simple way to do it: get it with a manual transmission.

"The average stick-shift vehicle gets 17% to 18% better gas mileage than an automatic" [Smartmoney]
You'll get a lower purchase price for doing so too ... until Congress enacts another tax credit!

Friday, January 20, 2006

Union members learn who's the boss.
Roger Toussaint learns who's not the boss.

Update: The members of the NYC Transit Workers Union have rejected the contract agreement that ended their illegal strike.
At the center of the rejection seemed to be a last-minute concession by the union, after the strike of Dec. 20 to 22, that its members pay 1.5 percent of their wages toward health insurance premiums in return for the authority's dropping its insistence on less generous pensions for new workers. Just how unpopular that change was with union members became starkly clear yesterday...

John Samuelsen, the chairman of the track division, one of 15 divisions in the union, said that the rejection of the contract was "a moral victory" for the workers. "Even in the face of bribes in the form of pension refunds, transit workers stood firm and refused to accept the idea of escalating 1.5 percent health care payments."
[NY Times]
Oh, this bodes real well for the coming Medicare crisis. Around 2025 is the whole country going to go on strike against itself rather than pay its own medical bills?

[/Update] ----------------------------------------

Members of the NYC Transit Workers Union, that is...
Unleashing a flurry of telegrams, phone calls and threats, transit-union boss Roger Toussaint stepped up his aggressive campaign to convince bus and subway workers to approve the contract for which they waged an illegal strike....

Toussaint sent a memo to the union's seven elected vice presidents and more than 100 other staff members threatening to dock their pay if they speak out against the contract.

Ainsley Stewart, a TWU vice president, said Toussaint docked him a week's pay — $1,701 — for his outspoken opposition.

"I don't understand, this is America," Stewart said. Stewart and others said they plan to fight over the cash. "I don't care what he says, nobody is going to mess with my money," said John Mooney, another TWU vice president.

Leaders said they found it troubling that the union president would prevent members from having an open debate on the merits of the contract. "He's determined to keep people in the dark about other viewpoints," Stewart said.

Toussaint's allies defended the blackout on dissension.

"We're not going to pay for someone to work against us," a source close to Toussaint said...
[NY Post]

Thursday, January 19, 2006

Enjoy a friendly face over coffee in the morning.

Get yours now.

Wednesday, January 18, 2006

Teaching to the test.


Stressed-out seventh-graders taking a standardized exam to determine whether they'll be promoted got an unusual English lesson yesterday: A means F, B means G, C means H, and D means J.

The lecture was repeated by teachers for about 72,000 pencil-gnawing city students who sat for the state English Language Arts test — and were given answer sheets rife with errors.

For five of the exam's 26 multiple-choice questions with answer options of A, B, C and D, the bubble sheet for recording answers offered students choices of F, G, H and J.

The mistake was magnified by the fact that the test for the first time is being used by the city to determine whether a student should be elevated to the eighth grade.

"Kids and teachers have been feeling the pressure of this test for months, and when the time comes, the city can't even get it right," said a teacher at MS 352 in Brooklyn...

Students across the state took the test, but the blunder was confined to the Big Apple [which] devised its own answer sheet ..."
[NY Post]
I don't see what the big deal is. This goes right along with the city's math test instruction for "forth grade" that teaches 10+15=24 and 0=6; and the summer school instruction that can't tell time from a clock face. Why should English tests be treated any better?

After all, it's not like things are a whole lot better with the teachers' own tests.

Tuesday, January 17, 2006

Chuck Schumer discovers the telephone tax.

The IRS is illegally collecting taxes from cellphone users to the tune of $9 billion over of the last three years, Sen. Charles Schumer said yesterday. Of that, New York City residents are owed $275 million — about $50 per customer, Schumer said.

The federal government started collecting taxes on long-distance calls way back in 1898 to help pay for the Spanish American War.

But several courts have recently ruled that the tax — which is 3 percent of the total bill — does not apply to cellphones, since they are usually billed by the minute, not the distance.

"The courts have now made it crystal clear that this tax is illegal, and yet the IRS continues to put it on everybody's cellphone bill," Schumer said during a press conference at his Midtown office yesterday.

Earlier this month, a third federal appeals court in Washington, D.C., declared the tax "null and void."

"They're violating the law," he said. "The IRS asks all of us not to violate the law. Well, now we're asking them the same."
[NY Post]

Of course it's not just the tax on cell phones that's been ruled illegal, but that on almost all long distance service, as was explained here more than a year ago.

Well, with the politicians finally joining the party this blog will be the lone public voice on this issue no more. Good, my work here is about done.

Monday, January 16, 2006

Monday morning briefs.

The Carnival of the Capitalists is up and has all sorts of posts related to capitalist-type things, this week and last week too. On thoroughly unrelated, lesser notes...

Gay marriage has got to be getting closer.

Modesty, thy name is Hollywood.

Speaking of Hollywood, there's celebrity death, and then there's making a contest of it.

Even if you're not a celebrity, beware those lifetime guarantees. (Hat tip, Tim Worstall.) Back in my scuba diving days I do remember there were firms selling anti-shark bang sticks with lifetime guarantees, which never seemed entirely convincing to me.

What I should have gotten for Christmas...
If you put a refrigerator in the garage, the compressor, which is designed to work at room temperature, shuts down when the air drops near the freezing mark. Then you have the absurdity of a device designed to keep things cold becoming warm inside because it's cold outside.

But never fear, suburban technology is here -- in the form of the new
Whirlpool garage refrigerator. The garage refrigerator contains a heater that warms the compressor when the temperature dips below freezing. Yes, a device designed to keep things cold contains a heater so it will continue to make cold air when making cold air is unnecessary because it's cold out.
.... product recommendation from the most eclectic of all NFL football columns.

Friday, January 13, 2006

Friday short takes

Price Controls 101. The lesson never learned. Now Venezuelans can't even gripe about their stock market over coffee.

Business 101 lesson of the day: When offered a monopoly on a popular, coming product, do not refuse it saying "We'd really rather have you offer it to Wal-Mart on a non-exclusive basis so we can compete with them on price." Or else!

Who says Germans have no sense of humor? Well, the British...

Tim Worstall points us to the best blonde joke ever. So blame him.

Fluorescent green pigs ... I wonder what this would do to a ham sandwich at midnight?

Oh, my god. Women's magazines LIE ABOUT SEX!...
The former Mademoiselle checker says of the sex articles, "When I first got there, I would try to check those first-time-I-had-sex quotes. You know, 'It was Christmas Eve, we made a fire ....' And I would get blank looks" from editors. "They'd say, 'Um, you want to call these people?'" ...

"I don't think I ever made anything up wholesale," the ex-Cosmo editor says ... The anecdotes, she says, "were always things that could have happened."
Who can I trust now?

Thursday, January 12, 2006

The New York Times, now 28% a New York newspaper.

The New York Times lost almost 20 percent of its readers in the five boroughs between 2001 and 2004 as the paper pushed to reinvent itself as a national publication. The Times' daily circulation in New York City dropped 18.7 percent during that period ... according to figures obtained by The Post and confirmed by the Times.

This means the Times' readership in the five boroughs is roughly 28 percent of its overall circulation.

Since the mid-1990s, the Times has embarked on a strategy to expand nationally ... As part of that plan, the Times targeted national advertisers and eventually stopped breaking out numbers for circulation within the city...

"It must be a strategic decision," said Edward Atorino, a media analyst with Benchmark Co. in New York [who attributes the decline] to a deliberate decision to target upscale readers while scaling back on distribution in less affluent areas...

Times executives indicated during a recent media conference that the decline in New York City had continued into 2005, offset by increases at the national level.

The reaction among advertisers and media buyers depends on whether they are trying to reach a national or a local audience...
[NY Post]
The "New York" Times' readership is now 1.1% in the Bronx, 0.5% in Staten Island, and 3.2% in Brooklyn, the "non-rich elite" areas of New York.

Well, editorial must be directed to those a paper is sold to, of course. And the Times is no longer being marketed to the population of a great and diverse city, but to those who drive Beamers and buy Prada handbags, wherever they are.

So this may explain a lot -- from its having the likes of Maureen Dowd and Frank Rich as political columnists, to the odes of praise for college football coaches in Texas.
"The local retail advertiser will care because they've been paying advertising increases of 6 to 9 percent a year every year since 2000," said Shelly Kravitz, president of Plus Media Buying Services in New York.

That means local advertisers are paying 30 percent more to reach a New York audience that has shrunk by almost one-fifth, Kravitz said.

"I'm just amazed at that," he added...
And I bet a lot of local businesses will be real happy to be learning it from the Post.

The other shoe boot drops on the IRS re the telephone tax.

Here's a first -- a class action lawsuit filed against the IRS! This could be fun...
A potentially enormous class-action suit has been filed against the government on behalf of corporations and individuals who have paid the telephone service excise tax on flat-rate, long-distance services for which the charges did not vary by both the distance and duration of a call.

The complaint, which was filed January 10 in the Court of Federal Claims by the law firm Baker & McKenzie on behalf of RadioShack and an unnamed class of corporate and individual taxpayers, alleges that the government has illegally collected and retained between $4.8 billion and $9 billion in overpayments of the telephone service excise tax...

The class of plaintiffs in the complaint would be immense, covering all corporate and individual taxpayers who erroneously paid the excise tax on flat-rate services, not just those who have filed refund claims....
[Tax Analysts]
Ten courts, including three federal Courts of Appeals, have ruled the long-distance telephone tax to be illegal as typically collected by the IRS. The IRS has won zero cases (one at trial, overturned on appeal). The IRS itself has said in court that $9 billion of tax refunds are at stake. And it has stonewalled, refusing to pay refunds and insisting that phone companies still collect the tax.

But in a nation so hyped about taxes, so far as I know this blog has been the one and only public news source covering this story. Nobody seems to care about a real tax cut, as opposed to a politically argued one -- or about the government's real stonewalling of the courts, as opposed to fantasy stonewalling when some hot button political issue of the moment involved.

Well, a class action lawsuit against the IRS filed on your behalf -- as well as on the behalf of every newspaper and TV station in American -- may finally get some public interest!

Here's more information on recent developments (such as the phone companies taking the tax off of phone bills upon request) and legal explanations and court citations.

Wednesday, January 11, 2006

Cool science.

"To infinity and beyond ... very fast." OK, the fact that the US Air Force is spending money on this may not mean it's not nuts -- but pure crackpot ideas don't get many awards from the American Institute of Aeronautics and Astronautics and 2,400 word stories in New Scientist.

Meanwhile, down here on the ground, Schrödinger's cat used to be the subject only of theoretical speculation and epic poetry. But if they keep getting larger numbers of atoms to purr like this (nifty animation) they may end up needing to find a pet store selling quantum cat food.

Celebrities' pets' names.

Senator Ted Kennedy has a dog named "Splash", who's the co-star of the Senator's new book. (Hat tip, The Chief.)

Well, one imagines that "Chappaquiddick" isn't very doggy, and "Mary Jo" was right out.

If anyone has any other ideas about what various celebrities might name their pets, that's the sort of thing that the newly added Haloscan comments are for. ;-)

Robert Kuttner debates Milton Friedman.

About health care, school vouchers and other things. Friedman remains remarkably active and sharp for a guy who's 92 1/2 years old. But he'll still be able to out-debate Kuttner when he's in the shape Ted Williams is in.

Thank you, Hugo Chavez.

The Economist.

Update: Thanks for the cure for caffeine addiction too.

Monday, January 09, 2006

You thought the 2005 federal budget deficit was $319 billion? How about more than $3 trillion, by the accounting rules the private sector uses.

[Update: The 2007 deficit. ]

The US government's budget deficit for 2005 was $319 billion, as officially reported by the Treasury. That's the number in the newspapers that everyone editorializes and op-eds about, representing the increase in the government's net liabilities, basically in the form of additional government debt issued during the year. And it's been reported as good news, being down from the $412 billion of 2004.

But wait ... the Treasury has published another analysis on its web site, in its 2005 Financial Report of the United States Government, that gives a very different number for the increase in its net liabilities, albeit one that receives very little publicity: more than $3 trillion.

How can two such hugely different numbers -- on ten times larger than the other -- be provided by the US Treasury for the same thing?

The answer lies in accounting methods: the difference between cash and accrual accounting.

Cash accounting is what individuals use and most people are familiar with. It counts the difference between cash in and cash out during a given time period. The difference is net income or loss. Done.

That's fine for the simple finances of most individuals, but in even moderately more complicated situations it can be highly misleading and is easily manipulated. This is because it ignores accruing legal rights to receive income, and legal obligations to make payments, in the future.

As a simple example, say a firm makes a deal in which it receives $1 million from another party today, in exchange for making a legally binding promise to pay $10 million to the other party five years from now. Obviously that's a loser. Accrual accounting -- which recognizes accruing future liabilities and rights to income -- reports this truth: $1 million receivable today minus the current value of $10 million to be paid five years from now (at a 5% discount rate, about $7.7 million) shows this transaction to have a net cost of about $6.7 million.

But under cash accounting it is a winner, for only the $1 million of income is counted. The attached $10 million liability is ignored. Sure it'll have to be paid someday (or the firm will go bankrupt due to it) -- but that will be somebody else's problem. In the meantime you've boosted the firm's profits by making this deal, so you get a raise and a bonus!

Well, that wouldn't be good. So to prevent such situations the government prohibits cash accounting and requires accrual accounting for all but the very smallest businesses and organizations.

If you use cash accounting anyhow to report income while keeping related liabilities off the books, you are Enron ... or you are the US government. For the government exempts itself from the accrual accounting rules imposed on everyone else, and uses cash accounting to figure its own deficit: that $319 billion for 2005.

OK -- so what is the US government's deficit under the accounting rules that everyone else in the country must use? The Treasury itself tells us. As a "good government" reform -- and in response to plenty of criticism about its accounting methods -- it began publishing these numbers as supplemental information to the official budget a few years back.

The official $319 billion cash basis deficit excludes a host of accrued liabilities, three of which are really big: Medicare, Social Security, and federal employee/military retirement benefits. Here are the numbers, from the 2005 Financial Report...

"Present value of future expenditures less future revenue [p.42] :"

That's $2.333 trillion dollars just for Medicare and Social Security.

Then add a $430 billion one-year increase in Federal employee/veteran benefits payable (to $4,492 billion in 2005 from $4,062 billion in 2004).

And then add the $319 billion official budget deficit.

The total so far is over $3.08 trillion, and we're still not counting lots of things. (The cost of federal employee retiree health benefits isn't computed. Smaller multi-billion dollar items like FEMA, the PBGC, etc., I haven't bothered to add.)

Interestingly, the official budget deficit is the smallest of all the above items ... and while so many people worry about paying future Social Security and Medicare costs, few ever mention the unfunded federal employee/military retiree costs that are as big or bigger.

Some more perspective:

[] All federal income taxes (personal and corporate) totaled $1.2 trillion in 2005. To cover the accruing deficit, income taxes would have to be increased to 3.6 times what they are today (with the increase "saved" somehow in an interest bearing account for future use).

[] All federal receipts (including payroll and excise taxes, tariffs, national park user fees, whatever) totaled $2.1 trillion in 2005. The accruing deficit is 50% larger than that -- so total revenue would have to be raised to 2.5 times its current level to cover it.

[] The total US national debt held by the public is $4.7 trillion -- but the government's unfunded debt to its own employees and military personnel for retirement benefits matches it, exceeding $4.5 trillion (remember, health benefits aren't included in this number) and is growing faster.

[] Total US national income (to individuals, businesses, everyone) in 2005 was $10.7 trillion. The accrued deficit was almost 30% of this. To close it, taxes would have take almost another 30% of national income -- in addition to the about 30% that currently goes to fund federal, state and local government combined.

(By the way, if you think a $3 trillion deficit is bad, the 2004 accrued deficit was $11.1 trillion, thanks to the $8 trillion accrued start-up cost of the Bush-Republican drug benefit plan, Medicare Part D. So much for Republican fiscal conservatism!)

These numbers are so big that when I mention them even to generally well informed people, they simply don't believe it. Yet they are published every year by the US Treasury itself.

Now, I'm very sorry folks -- but we can't increase the national debt by 30% of national income every year for a generation off the books to fund retiree entitlements, and then expect to be able to pay it off, any more than we'd be able to increase the debt on the books by $3 trillion a year and pay it off. It ain't going to happen.

That being the case, why don't Senators and Congressmen stand up and make an issue of these published numbers every day, demanding reform? Why didn't George W. Bush highlight them to educate the public to the urgent need for entitlement reform, starting with Social Security?

Well ... if Democrats suddenly admitted that the entitlement programs that cement the base of their party together are in fact driving a 30%-of-national income deficit, on course to bankrupting the nation, they could hardly defend those programs as being "sound" and untouchable, eh?

And if Republicans suddenly admitted that the real deficit is ten times larger than they've claimed, they could hardly make enacting more tax cuts to make such yawning deficits even worse their key issue. Much less claim to be fiscal conservatives while larding on new multi-trillion entitlements of their own.

Both parties want to keep their key issues working in the next election. So every year the politicians push another $2.7 trillion (and growing) of debt off the books and out of sight, the super-Enron of all time. Sure, these trillions will have to be dealt with some time in the future, or the nation will go broke ... but that will be years from now, and it will be somebody else's problem.

And when that day arrives, a lot of people aren't going to be getting a lot of the retirement benefits that they think they've been promised.

Prepare for it now.

I close with words from GAO as quoted in the Treasury report:

The federal government’s gross debt in the consolidated financial statements ... excludes such items as the gap between the present value of future promised and funded Social Security and Medicare benefits, veterans’ health care, and a range of other liabilities (e.g., federal employee and veteran benefits payable), commitments, and contingencies that the federal government has pledged to support.

Including these items, the federal government’s fiscal exposures now total more than $46 trillion, up from about $20 trillion in 2000. This translates into a burden of about $156,000 per American or approximately $375,000 per full-time worker, up from $72,000 and $165,000 respectively, in 2000...
All more than double in only five years. That's growing a lot faster than the economy. Things have not stabilized, they are getting worse, fast.

Continuing on this unsustainable path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security...

Given the size of the projected deficit, the U.S. government will not be able to grow its way out of this problem -- tough choices are required.

Traditional incremental approaches to budgeting will need to give way to more fundamental and comprehensive reexaminations of the base of government.
It's time to start such thinking now, folks.

And it might not hurt to supplement your own savings for retirement a little bit, just in case someday you might need more than you expect.

Saturday, January 07, 2006

How to get poor fast.

I turn on TV for a moment today and find the "make money in real estate" infomercials that've been running forever have finally been topped by a make money in leveraged foreign exchange infomercial, for a thing called "4X Made Easy"

A guy is pointing to a line on chart of the Canadian dollar and gushing: "If you had bought at this point [low] and sold only three days later at this point [higher] you'd have made five times your money -- that's the power of leverage!"

Then a girl breaks in: "Let me break in, you can invest for longer periods. If you had bought the Euro at this point [low] and sold at this point [higher] eight days later, you'd have made twenty times your money. You can't get that trading stocks! That's the power of leverage!"

Nobody exactly says: "If you had bought at this point [high] and followed this line down for just one day, then just that one day later you'd have lost one times your money and be totally wiped out -- that's the power of leverage!"

Although they do address the picking winners issue with a testimonial: "I used to be a chess player, and chess is all about pattern recognition, you look at a position and know it is a win, a loss, or a draw. It's just the same here, you look at the charts and can see whether a currency is going up or down. Then you know what to do. I love it!"

Well, I used to be a tournament chess player, and while there is indeed plenty of pattern recognition in the game the "what to do" suggested by the patterns usually isn't so clear until near the end, and often clarifies out then as: "bend over, because you're about to get your butt kicked."

Of course, the question to be asked of all sellers of "make money by [whatever]" programs is: "If it's so easy to make money that way then why aren't you doing it instead of trying to make money in the sales business, buying TV time for infomercials, renting hotel meeting rooms, printing books, paying salespeople and shills to push this stuff..." As an observer at a 4X Made Easy fan site notes:
if this program made SO SO SO much money, 4X made easy wouldn't exist, because the creators would be making billions themsleves and not need to sell any BS software.
The realistic answer comes from another testimonial there...
It costs $3,000 and you need a data feed that costs $99 per month.
$3,000+, yikes! But apparently Barnum was right enough for it to be easier to make money selling stuff like this to people futilely looking for a football game on a Saturday afternoon than, well, honestly.

The thing was, I really found the whole production very entertaining. Everyone was so upbeat and happy and enthusiastic (actors, I presume) while being so transparent... "Just buy low and sell high! Leverage up! Go for it!" I'd have watched it as a show if it was paid for by real commercials for soap. It was like watching World Wrestling Entertainment after it changed its name and admitted all its matches are scripted to please. Except these people were scamming, in broad daylight on television.

Where the heck is Elliot Spitzer when we need him?

Friday, January 06, 2006

Updates and thank-yous.

This little blog has been functioning more or less steadily for just over a year now. The "under construction" sign figures to be up as long as it exists, since what I originally planned here -- more a web site than a blog -- is coming along slowly, very, very slowly. Imperceptibly. Real life interferes. If only I was still a student, or a tenured professor...

I have just added basic commenting -- it seems the Internet ought to be interactive -- and updated the lists of what have been the most-read posts here (over in the left column).

Nothing would have been read here at all but for other bloggers who have referred people here, so I want to thank all those who have been kind enough to do so -- especially "Minuteman" Tom Maguire, Don Luskin, Tim Worstall, the Viking Pundit, Eric Lindholm, the good people at QandO, especially John Henke, and that Skeptical Optimist, Steve Conover.

Special thanks to Natalia McLennan, our "Smart Hooker of 2005", who brought twice as many people here in one day via Google searches as arrived total during my sole Instalanche -- and did it twice!

My first comment to everyone in 2006 is to wish all a great, happy and healthy new year.

Sunday, January 01, 2006

Bowl game Monday football foibles: The Times fumbles an obit, and how the Ivy League got its name.

After recently carping* about the NY Times' football writing, should one so soon pile on with another complaint? Sure! For inspiration there's no need to look beyond the first line of a December 31 obituary...
John Druze, the last surviving member of Fordham University's football offensive line of the 1930's known as the Seven Blocks of Granite, died Tuesday in Scottsdale, Ariz. He was 91...
The Seven Blocks may well have been the most famous football line ever (its members including Vince Lombardi as well as NFL Hall-of-Famer Alex Wojciechowicz and college Hall-of-Famer Ed Franco) but it wasn't an "offensive line". In the 1930s, of course, linemen played both ways -- and the Seven Blocks were famed for being impenetrable on defense. Who would compliment an offensive lineman by comparing him to a block of granite? ("That guard Lombardi sure pulls and turns upfield fast, just like a block of granite!") Shouldn't a football writer (even on the obituary beat) know this by common sense?

The 1937 "Seven Blocks" Fordham team finished #3 in the nation while giving up only 16 points in eight games, with five shutouts, going 7-0-1, the tie being 0-0 with #1 Pittsburgh. That was defense (even by the standards of that low-scoring era).

Which leads to how the Ivy League got its name.

That 1937 Fordham-Pittsbugh game, held at New York's Polo Grounds, was the game of the year. At the New York Herald-Tribune, Caswell Adams, sportswriter, instead drew the assignment to cover the Columbia-Pennsylvania game at Columbia's Baker Field. He complained to his editor, "Why do I have to watch the ivy grow every Saturday?"

The Ivysport History page continues...
Stanley Woodward [the paper's #1 football writer], at a nearby typewriter, did not forget. He had heard a new phrase. "Ivy-covered? Ivy group? Ivy League?" These old schools of the East did not like leagues. They had long shunned the conference idea. Stanley likes to ruffle them occasionally and chuckled when he did so. Why not call these colleges the "Ivy League"?...

So a few days later, though not on the Monday morning immediately following, there crept unobtrusively into a Woodward football essay the phrase "...and in the Ivy League..." as introduction to a discussion of what was happening on the fields of the East's oldest colleges which, even then and without a semblance of formal grouping, were natural and traditional rivals. Set down alphabetically, they were, of course, Brown, Columbia, Cornell, Dartmouth, Harvard, Pennsylvania, Princeton, and Yale. The phrase caught on....
So a disgruntled sportswriter, peeved that he couldn't get to the Fordham game, named the Ivy League.

On this Bowl day one might add that Fordham won the 1942 Sugar Bowl by the score of 2-0, which was really winning with defense.

OK, I'll also add that the first televised football game ever was a Fordham game (1939), and the NFL's St. Louis Rams were named after the Fordham Rams when the franchise joined the NFL in 1937.

And where is Fordham football today, on Bowl Day 2006? Buried at the bottom, the very bottom of Division I, 218th of 239 teams by Sagarin.

Never has a school built so little on so much tradition.
* FN: Update: The NY Times/Michael Lewis-designated Einstein of Offense directed his Texas Tech team to all of three points during the first 57 minutes of the Cotton Bowl today, losing to Luddite "run it up the gut and play D" Alabama, 13-10 (with his offense outgained by the Luddites, 420 to 329). But this could be good news for him. By Lewis Logic, if he's no longer seen as being the smartest coach around, it'll make it easier for him to get a better job.