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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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Nov. 27, 2012, 3:40 a.m.

The major problem with this argument is that there is already 3 trillion dollars in cash sitting on the sidelines waiting to be invested. The problem is not investment capital but inadequate demand. Until consumers improve their own personsal balance sheets growth will remain slow. The real issue is not taxes but their unproductive use by our government and the inability of our elected officials to run surpluses in good time to allow deficit spending at times like these.

Nov. 27, 2012, 1:33 a.m.

Several comments on this site are missing the point entirely of the thought experiment.  And also showing those same certain biases.  The 40% tax rate is not the point.  It is an INCREASE in the tax rate that transfers MORE money from the private sector to the public sector.  Less money to invest in the private sector versus more money spent by the government to pay for entitlements and paying down debt.  Hardly a productive use of tax money.  This IS the point we’re talking about isn’t it:  how to wisely invest?

Additionally, I see comments about the virtues of government spending insofar as the spent money stays ‘on our shores’.  Given the interconnected and global economy, I see no evidence of that.  And there is a lot of evidence of the government’s spending on companies going overseas.

Businesses are pulling back in investing in increased capacity due to uncertainty about the future and the mercurial and punitive attitude of the government towards them (i.e. taxes, Obamacare, etc.).  Arguing for a demand side economy smacks largely of Keynes…of which the application of that school of thought is making things much worse. 

Like it or not, people, the government is a very large player in this economy for the time being.  And their handling of money lately is atrocious and, were it practiced in the private sector, highly suspect…if not outright corrupt.  Again…hardly the kind of thing a real investor(aka “the rich”) would want to associate themselves with.

Nov. 27, 2012, 1:10 a.m.

Richard, your post contains several assumptions that aren’t born out in reality.  Investing in stocks, in and of itself, doesn’t create a “bubble”.  Irrational investing and speculating stock prices to outrageous levels that aren’ support by their P/E ratio is what causes a bubble.  Stocks in a comnpany are not the same as the merchandies they produce and investing in them doesn’t cause commoditiy prices to rise (if I understand your meaning of “commodities”).  Second of all, the amount that millionaires pay in taxes is immaterial to the ‘unsustainable path’ that our government SPENDS us into.  That would be synonymous with me running up huge debts and blaming my employer for not paying me enough money.  Besides, your complaint doesn’t make the case for whether the rich should pay a little more than the rest of us…only that they should get us out of the hole we dug for ourselves.  Finally, the so-called rich DO invest in some of the things in your list.  What they don’t do is throw money down rat holes of politically correct causes.  The bankruptcies (plural) of such companies that were funded by the government should speak loudest to the financial acumen of our current administration.  Any honest person who has been paying attention to history will note that our economy HAS improved greatly due to the efforts of ecological groups and government in motivating companies to protect the environment.  Otherwise, we would be living in a sewage-filled, oil-sheen-covered wasteland.

Andrew McDaniel

Nov. 26, 2012, 8:05 p.m.

The Nov. 20 post-election panel liked putting money in US Treasuries. If the extra taxes on the wealthy were assumed to come out of money that would otherwise go into Treasuries, how would that change the argument?

The growth formula appears to be a linear approximation, casting doubt on its use to obtain any longer term implications.

Dion Johnson

Nov. 26, 2012, 6:07 p.m.

In the arithmetic, it seems like John means “five percentage points”, not “five percent”.  Am I missing something?

Richard Guldi

Nov. 26, 2012, 5:20 p.m.

When the intrepid millionaire invests most of his $300,000 in stocks of existing companies or in real estate, he simply drives up the prices of these commodities but does not create any new value producing asset. Eventually, these inflated assets become bubbles which break, to the detriment of everyone.  If our millionaire’s taxes remain low while the country borrows more and more money, we continue down the unsustainable path which plagues our children and grandchildren with insurmountable debt to finance today’s extravagance but affords nothing of value to them.  Why not invest money in things that create real value for society like solar and wind energy, more efficient transportation including mass transportation, energy efficiency of older buildings, more teachers per student especially in underperforming school districts, teacher’s aides, new programs to keep young people out of prison, programs that really rehabilitate ex-convicts, and petroleum pipelines that won’t rupture and contaminate local water supplies.

A. Dorrance

Nov. 26, 2012, 2:36 p.m.

1.) You imply that government jobs are paid for out of money that would be invested privately. This ignores the possibility of a virtuous circle in a high-unemployment economy, where putting currently unemployed individuals into government jobs would give them money to return back to the economy, and reduce the number on the dole. It also implicitly assumes that the money taken out of government will remain on our shores. I’d propose that money given to government employees are more likely to be spent here than money held by high-net-worth individuals.

2.) There is a third way to increase GDP, aside from growing population or increasing productivity: tapping unused capacity. Businesses are not investing into increased capacity because of lack of demand and excess capacity. By increasing demand (via increased employment), there is the potential to increase economic activity.

3.) The argument about increasing taxation of millionaires is off-base in two ways. First, high-net-worth individuals pay much of their income as capital gains and through financial management can even evade income tax entirely. To treat their income as salary is unrealistic. And to reiterate my first point: some of the untaxed wealth will go overseas, and it will not necessarily be repatriated.

And so I disagree with what you believe to be inarguable truths. I doubt I will be able to change your opinions, but I value your perspective, as a potential corrective to my own prejudices.

Arthur Dorrance


Nov. 26, 2012, 2:12 p.m.

Productivity is also dependant on the quality of the consumption ?  Today’s society, especially the wealthy,  often purchase in ways that waste the earths natural resources.  If the milliionaire saves the same, but makes wiser purchases in his consumption purchases, we will and this envirnoment will be better off.  Didn’t we just experience the downfall of excess consumption resources wasted in purchase of mansions and larger than necessary large homes where simpler smaller shelter would increase the amount of dollars available for capital formation used in much more productive less wastefull long term areas like education of our young, especially in the sciences and engineering ?  Productivity improvement comes from innovation based on increased dollars towards basic research.  At some point the earth natural resource depletion will limit growth, ie. lets grow slower so we can grow longer ?

David Samples

Nov. 26, 2012, 2:02 p.m.

On the topic of politics, some of us are willing to listen to the other side and work towards a compromise.  We just seem to be a very small minority these days.

Jim Reid

Nov. 26, 2012, 1:38 p.m.

I appreciate the insight offered into a complex and, for me, confusing situation.

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