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Thoughts from the Frontline

Capital Formation and the Fiscal Cliff

November 26, 2012

Choose your language

In today’s economic environment, we often complain about volatility and uncertainty, but there is one thing I think we can be fairly certain of: taxes are going up. I constantly try to impress upon my kids, most of whom are now adults, that ideas and actions have consequences. In today’s letter we will look at some of the consequences of an increase in taxes. Please note that this is different from arguing whether taxes should rise or fall. For all intents and purposes that debate is over. As investors, our job is to deal with reality. We must play the hand we are dealt. Taxation is a complex issue, but let’s see if a few word pictures can help us understand what we face.

Two quick notes to begin with. The full video interview with David Krone and Rob Lehman, the chiefs of staff for Senate Majority Leader Harry Reid (D-NV) and Senator Rob Portman (R-OH), two of the key figures in the current budget negotiations, is now available online. This was not a debate but a thoughtful exchange of ideas and positions that occurred as part of our recent Post-Election Economic Summit. It is helpful to recognize that negotiations over the fiscal cliff were being conducted weeks before the election. Everyone knew what was coming, and the very professional staffs that are charged with coming up with a reasonable resolution to the issue were already hard at work, knowing that there would be a lot still to do after the election. Krone and Lehman are two men at the very center of that debate.

If you want to get some real insight into the congressional process, this is an excellent way to do it. I’m grateful that they agreed to sit down for this rather unprecedented sort of interview. You can watch the full interview. You can also view an edited version of the entire Post Election Summit, with Mohamed El-Erian, Dr. Gary Shilling, Rich Yamarone, Barry Ritholtz, Jim Bianco, Barry Habib, and myself. It has been getting rave reviews, and I trust it will be worthy of your time.

I’m also pleased to announce that my very good friend Dr. Lacy Hunt has agreed to do a special Fireside Chat with me on December 4. Regular readers of Outside the Box are quite familiar with Lacy. As always, we will cover a wide variety of topics, but I’ll make a point of getting his views on where the economy will be going for the next few years. Lacy is one of the finest economists I know. I am always amazed at the breadth of his knowledge and the depth of his insight. This webinar will be available to members of the Mauldin Circle. If you have already joined, you will get a notice of the event details. If you have not yet joined, you can go to This webinar is sponsored by my partners at Altegris Investments and is for accredited investors. (In this regard I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.) Now, shall we dive off the fiscal cliff?

Your Perception Is Your Reality

There’s a very interesting article in The Atlantic this week, called “How Partisans Fool Themselves Into Believing Their Own Spin.”  While the author, Alesh Houdek, engages in some spin of his own, he makes some very good points that we should keep in mind not only as we look at the potential effects of a tax increase but as we tackle new ideas and accompanying “facts”…

Discuss This


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Ronald Nimmo

Dec. 3, 2012, 8:55 p.m.

GDP growth does not equal Population growth + Productivity increase in today’s world. More population really translates more into more liability for the support of people for whom there are not even enough existing jobs. There will not be real income for them to spend, only money created by debt, which will sooner or later demand it’s requitance. Grantham’s comments on the reluctance to invest in capital goods gives us important clues to understand this condition, which is linked to excess world production of goods.
  We should drastically reduce legal immigration and stop illegal immigration entirely rather than encouraging it as the Great Panderer, President Obama does. As far as this statement is concerned:

We need to give anyone who gets a degree from a US university a green card with his diploma.

I think this is an idea so lacking in good sense as to suggest mental incompetence. In the first place there are many Americans with a degree who can’t get a job in their field. John himself painstakingly documented this syndrome a couple of weeks ago.  What we should do is completely eliminate the family preference immigration quota, the idiotic lottery quota, and the asylum provisions which are in 90% of cases, just fraud and abuse. We need to just a allow a few people a year into the country that have education or skills that are undeniably absent in the US workforce. And I don’t mean that the government should rely on the mendacious data provided by corporations about the lack of qualified American workers, but truthful information based on objective studies. Does anyone remember the terrorist who tried to kill thousands of people in Times Square two years ago. He came here from the Middle East and took a job as an accounting clerk under an H1-B visa. In other words some company certified that there was no one in the USA qualified to be an accounting clerk (with all due respect to the accounting profession); thus we needed to bring this murderous lunatic into America so that our economy could continue to function! This clearly demonstrates what a travesty the whole foreign worker program is. It is so harmful to the US in so many ways and beneficial only to employers who want workers who can be exploited and politicians who receive campaign contributions from these companies for selling their fellow Americans down the river!

Simon Maughan 48114

Nov. 30, 2012, 4:19 a.m.

A very thought provoking piece. Anyone who has watched the rise of Fox news should know that we migrate to the arguments that we believe to be correct. However, in the spirit of challenging pre conceptions, surely John can appreciate that healthcare spending is not only “good” in some abstract way, but also for productivity. Redistribution and propensity to consume mean that raising taxes on the rich will reduce saving, but is likely to increase consumption. And why is unfettered growth good, if simply driven by immigration; might we have gained more investing in the immigrants’ home countries?

Finally, continuing in this vein, at what point does El-Erian step back and say that if he is wrong on Europe, interest rates are going up and Pimco is way too exposed to bonds. Liquidity is already drying up before any panic selling and new regulation forcing trading on exchange will do what it did for equity, narrow spreads and crush average ticket size. If Pimco gets Europe wrong, they’ll never get out in time. Hence they are increasingly vocal telling everyone else the world is ending.

Nov. 28, 2012, 10:29 a.m.

Your analysis of “Net” capital formation is very misleading.

Since 1980 Info tech and software has grown from a negligible share of business fixed investment to over half of the total.  But IT and software have a much shorter lifespan than traditional capital equipment,  As a consequence depreciation has grown until it now offset a major share of new capital spending. this is the reason “Net” capital spending has fallen, not the reasons advocated in your article.

What I have trouble understanding is someone as knowledgeable as Granthan could be taken in by this bad analysis.  This is especially true since if you go to the original source at the BEA the depreciation data is in he same table and the BEA makes very clear how the net figure is derived.

I would be glad to provide you the data in an excel file with nice charts already built.

Nov. 28, 2012, 7:04 a.m.

John, I liked your statements about Partisans fooling themselves so when you started the analysis of the effects of taxing a millionaire I was looking forward to some sort of conclusion based on facts.  However, I only got from your analysis that increasing taxes on a millionaire can put a drag on the GNP but isn’t that true of all taxes? The real non-partisan conclusion that you made me hope for was whether it is better for the economy to increase taxes the rich or middle class independent of any discussion of “fairness”.  Clearly the middle class will be more likely to cut back on spending rather than savings but which do you think has a bigger effect in the short term and long term for the economy?

David Oldham

Nov. 27, 2012, 9:42 a.m.

John, Whilst I have had no trouble watching your interview with Krone and Lehman—the link provided worked, the video worked well, the content was very interesting—thank you, I cannot say the same about the Post Election Summit webinar or subsequent recording released thereafter.

The former real time event failed to work for me as the video kept buffeting every 10 secs (in spite of a strong connection my end). Links sent out for the subsequent recording failed to connect me but instead threw me straight into Ed D’Agostino’s sales pitch.

Talking of which your comment in this week’s letter—- “Given that my readers are just about the most well-informed and politically engaged group of people anywhere”—- this suggests you regard your readers of at least average intelligence, if not elites.

I find your new publisher D’Agostino an insult to my moderate intelligence. I frankly don’t need his darned 30 page sales pitch popping up every time I click on a link. 30 odd pages of highly repetitive hype for what could easily be said in just one page. I don’t mean to be rude John but having followed you for many years and recommended you all over the globe I worry about your judgment in this respect. I hope you take this in the spirit intended.

Bruce Dawson 97743413

Nov. 27, 2012, 8:16 a.m.

I think most would agree that any tax increases result in some drag on GDP, and that cutting spending and raising taxes too quickly risk worsening the debt.  Economic growth is dependent on increased demand, thus population growth does contribute to growing GDP.  Improved living standard requires increased productivity which allows for more consumption per capita without inflation.  In a deleveraging economy, I don’t see a high correlation between more capital availability and more jobs when there is already an excess of both labor and manufacturing capacity.  More revenue is needed to pay down our accumulated debt, and if we don’t want to burden the highest earners with higher taxes, then who should we ask to contribute more.  Making the effective tax rate more progressive seems the least onerous way to begin to get to fiscal sustainability.  Of course government spending and entitlement reform have to be part of the solution.  A dogmatic adherence to a philosophy of no tax increases just adds to uncertainty as to whether we as a nation are capable of dealing with our long-term debt, and is in itself a drag on economic growth and job creation.

Nov. 27, 2012, 6:22 a.m.

The sign of a great mind is to hold two opposite positions in one’s mind at the same time.  It would be interested to consider the impact to the economy if the 98% had an increase in taxes or decrease in services.  Seventy percent of our growth coming from consumer spending by the 98%.
Both increasing taxes or decreasing services always creates stress.  The key is to balance growth and productivity, government investment and protection, and a successful national future for all our citizens. My current belief is that we should all take a tax increase (slowly), we should fix health costs with a challenge to the Doctors, Hospitals, Insurers and Drug Providers to bend the health care cost of GDP to 10% by 2030, defense should be rationalized to the 50 year threat and also what we can afford, and Social Security should be indexed to the CPI. May not fix everything but it would move us in the right direction.

Bob Lievense

Giovanni Isaksen

Nov. 27, 2012, 4:58 a.m.

Yes increased taxes will/could reduce investment but given that we are facing the endgame of the debt super cycle how do we keep Treasury buyers here and around the world willing to buy our paper? Reducing government spending always sounds good but neither wing of the Let’s Get Re-elected party has been capable of anything but the opposite. People have been chattering about ‘starve the beast’ since the Reagan days but that diet clearly doesn’t work. Therefore taxes have to go up.

Maybe they have to go up until enough people decide to get on the ‘starve the re-election campaigns’ diet. But in the meantime we’ve been living on borrowed money and in order to keep rolling that debt over we need to show that we’re serious about not becoming a banana republic… or at least being perceived as one by the folks around the globe who buy our Treasury paper.

Let’s also remember that while any tax increase is painful we’re not talking about going back to the 1980’s when the top Federal bracket was 50%, or the 70’s when it was 70%, or the 50’s and 60’s when it was 90%.

Nedland Williams

Nov. 27, 2012, 4:26 a.m.

I would revise the equation as follows:

Growth = Non-government working population + productivity

In addition, I contend that taxes on investment have a bigger impact on growth than taxes on income, since accumulated wealth is far larger than annual savings from income.

Liberals point to higher income taxes during the Clinton years, but ignore the reduction in the capital gains rate in 1997, when start-up capital stimulated internet start-ups and the economy roared.

One final point: If savings are cut by 20%, it is highly likely that investment in new ventures takes more than a 20% hit, in that the last dollar saved is more likely to go into higher risk ventures.

Gordon Davis Jr

Nov. 27, 2012, 4:02 a.m.

Many interesting comments.  My concern is this entire discussion is of little revelance to our economic woes if we fail to address the problem of unsustainable entitlements. Right now, it is fairly clear that any solution to the “fiscal cliff” issue will not include reeling in entitlement spending. As John has said so eloquently, things that can’t happen won’t.  Well, the only way entitlements can continue on their current track is for our government to continue creating trillions of dollars from nothing and that will certainly end badly and probably sooner than we think. When inflation rears its ugly head and the dollar begins its downward spiral, discussions on the merits of raising taxes on the rich will be a fond memory. Clearly, the unwritten policy of our government and the Fed is to inflate and thereby debase the currency. This will result in the cruelest tax of all.  That being a slow, grinding decrease in our standard of living that effects every income level. The reason this is attractive to the political class is that they will be largely uneffected financially, and such a strategy allows them to escape much of the responsiblity for the resulting malaise. There is an increasingly popular opinion that deficits and debt are no longer relevant to our situation and can be ignored. We may soon see whether or not this hypothesis is a remedy for our decaying economy.

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