Liberals Get Basic Economics Wrong (2010-10-25)

Liberals Get Basic Economics Wrong

(2010-10-25) by David John Marotta

Economics 101 is based on facts, not opinions. In a study by Zogby International, liberals and progressives would fail the class. They answered incorrectly to more than half of the basic questions. No wonder a liberal administration working with a liberal legislature has turned an economic downturn into a more permanent malaise.

The survey asked participants their opinion on eight statements. They could respond "strongly agree," "somewhat agree," "somewhat disagree," "strongly disagree" or are "not sure." But these questions were not really a matter of opinion. They were objective statements. Any college student in an economics class could have easily labeled them as either true or false.

The survey counted any statement of agreement or disagreement as correct or incorrect. Then it only used the number of incorrect responses. An answer of "not sure" was considered correct. Given how badly people did on the survey, more liberals need to move from "strongly agreeing" with the wrong answer to the humility inherent in being a little more "not sure."

As a true-or-false test in Economics 101, none of the questions would raise an eyebrow. "Minimum wage laws raise unemployment" or "Mandatory licensing of professional services increases the prices of those services" are both statements straight from a textbook. But asked as a personal opinion, many people felt remarkably free to disagree with economic fact. Our website has a link to all eight questions and the original study. You can take the test yourself or quibble with the answer key.

The average number of wrong answers was 2.98 for a score of 63%. That's a poor result, given that answering "not sure" on each question would have received a perfect score.

Participants were asked to self-identify as progressive/very liberal, liberal, moderate, conservative, very conservative or libertarian. Self-described progressives fared the worst. They missed an average 5.26 questions for a score of 34%. Liberals' economic opinions were also more wrong than right, missing 4.69 for a score of 41%. Even moderates scored worse than average, getting 3.67 wrong for a score of 54%.

About half those surveyed described themselves as progressive, liberal or moderate. The other half said they were conservative, very conservative or libertarian. These last three groups scored much better. Conservatives received a score of 78%. Very conservatives did the best with a score of 84%. Libertarians scored 83%.

The variation within these two camps was even smaller than the divide between moderates and conservatives. It reflects the polarized mood of the country. But the most interesting conclusion is that the debate is not debatable. There really is a right answer. For the economically aware, these issues are no more subject to compromise than the laws of gravity for a team of aircraft designers.

Progressives and liberals find this certainty maddening. Often they respond with invective and name calling but little content or economic dialogue. This disconnect is that what appears to be opinion for many liberals and progressives is not a matter of debate. They are simply wrong.

The authors of the Zogby study suggested their own explanation. "We think that, for many respondents, economic understanding takes a vacation when economic enlightenment conflicts with establishment political sensibilities."

A few other interesting insights can be gleaned from this study.

First, moderates are economic liberals. Moderates scored worse than average on each of the eight questions. Their scores were closer to progressive/very liberal than they were to conservatives. Liberals marvel that conservatives are actively trying to cleanse the GOP of moderates. They assume moderates are halfway between liberals and conservatives. But really they lean heavily liberal in the way they get economics wrong.

Second, a college education did not correlate either positively or negatively with correct responses. Perhaps the school of getting a job is as good a teacher as the modern university. Or perhaps the utopian environment of academia negates the positive effects of what students learn in their few classes in economics. Studying economics in college has been shown to move students in a slightly more conservative/libertarian direction.

It is interesting to see what did correlate with higher economic enlightenment. Voters for Obama and Democrats got 4.6 incorrect (43%). McCain voters missed only 1.6 (80%). African Americans (47%) scored lower than whites (63%). Asians/Pacific Islanders (68%) scored higher. Hispanics (59%) scored slightly less than the average (63%). Women (55%) scored worse than men (68%).

Other correlations included not living in a large city (60%) but in the suburbs (66%). Protestants did better (70%) than those claiming no religious affiliation (50%). But evangelicals or fundamentalists scored even higher (75%). Atheist/realist/humanists did even better (76%), probably due to the wide influence of Ayn Rand, author of "Atlas Shrugged" and the founder of objectivism.

Having a family member in a union hurt (55%), but a relative in the armed forces helped (67%). Not surprisingly, being an investor (70%) helped even more than earning more than $100,000 (67%). But even better was being a NASCAR fan (70%) or a weekly shopper at Wal-Mart (72%).

Although all of these correlations are associated with self-identified political ideologies, they break many liberal biases of who understands economic principles correctly. This administration and this Congress have shown an amazing ignorance of economic principles. Much of the legislation passed by this Congress and signed by this president has been shown to do more harm than good.

For example, the Cash for Clunkers program was a complete waste of money. It moved the purchase of 360,000 cars ahead just seven months. And then it paid $3 billion to destroy perfectly good automobiles.

Extending unemployment benefits from 26 to 99 weeks also revealed a basic ignorance of economics. Paying people not to work for so long has increased and lengthened unemployment. It has kept the cost of hiring high. Many potential workers have opted to keep receiving benefits rather than take a full-time job paying slightly more than unemployment. While on the dole a mom can save money being a full-time homemaker. Or a couple could start a business and only report the income to the working spouse. To keep benefits going for nearly two years, people need only feign looking for a job.

The headwind of expiring, new and proposed taxes has created an economic environment that threatens to truncate productivity at $250,000 per year. This group earns a quarter of the reported income and pays half the federal tax. Thus changes in their marginal tax rate will have a significant effect.

The list of economic fallacies is as long as the list of liberal accomplishments. People currently in power talk about "fair share" and "spreading the wealth." But their policies impoverish everyone. Liberals simply get basic economic principles wrong. And when they legislate, they do more harm than good.

Obama declared last week that voters are turning conservative because they are scared and not thinking clearly. He claimed that facts, science and argument do not seem to be winning the day. The Zogby poll suggests exactly the opposite. Having been drunk on "hope and change," voters have now sobered up to the economic reality that socialism impoverishes us all.

Like physicians whose guiding tenet is "first do no harm," the first principle of good government should be a president of one political persuasion and a Congress of another. Thus a Democratic president and a Republican Congress will provide the best chances of creating deadlock that a libertarian can hope for next week.

from http://www.emarotta.com/article.php?ID=421

Seventy-Five Days Left for Tax Management (2010-10-18)

Seventy-Five Days Left for Tax Management

(2010-10-18) by David John Marotta

In just 75 more days the largest dollar-denominated tax hike in U.S. history will take effect. If you have been focusing more on the political solution on Election Day than your personal finances, you have work to do before the end of the year.

As a percentage of Gross Domestic Product (GDP), the Revenue Acts of 1941 and 1942 during wartime win the award for the biggest tax increase. Although the upcoming tax increases are not the biggest as a percentage of GDP, they will have an enormous impact on everyone.

On January 1, 2011, the 2001 and 2003 Tax Relief expires. Those across-the-board tax cuts lowered rates for investors, small business owners and people at every level of income. Undoing those tax reductions raises nearly every federal income tax bracket. The 10% bracket and 0% capital gains tax bracket will disappear. The lowest tax bracket will return to 15%, the 25% bracket to 28%, 28% to 31%, 33% to 36%, and 35% to 39.6%.

The only people who won't experience a tax hike are the 47% of households that pay no federal income tax at all.

Itemized deductions and personal exemptions will again be phased out. The math is complicated, but for higher income taxpayers it equates to increasing the top marginal rate from 39.6% to 41.6%.

Married couples and parents will get tax increases. The marriage penalty returns on the first dollar of spousal income. These narrower brackets virtually chastise people for marrying instead of just living together. The standard deduction for couples will no longer be double the single deduction. The child tax credit will be cut 50% from $1,000 per child to $500. Dependent care and adoption tax credits will be cut.

Last year the inheritance tax was capped at 45% and excluded for estates up to $3.5 million. This year it was repealed entirely. So far four billionaires have died owing nothing. Next year we will see the inheritance tax return at 55% for everything over $1 million. So a family that wants to pass on an illiquid farm or business worth $3.5 million, who would have been taxed nothing in the last two years, will be taxed $1.4 million in 2011. Forcing family farms or businesses to liquidate simply to pay inheritance tax is unfair and shortsighted.

These new policies will cast a pall on saving and investing. The tax on capital gains rises from 15% to 20% next year and to 23.8% two years later. The double taxation on dividends rises from 15% to 39.6% next year and up to 43.4% in 2013.

The Patient Protection and Affordable Care Act (Obamacare) further limits how Americans can spend their own pre-tax health-care dollars. Nonprescription over-the-counter medicine will no longer be covered using your health savings account (HSA), flexible spending account (FSA) or health reimbursement account (HRA).

After 2012, a cap of $2,500 will be imposed on health FSAs. Families with staggering medical expenses because of children with special needs will bear the brunt of this new policy. Rather than being able to pay with pretax dollars, their excessive medical spending will be subject to their top marginal rate, and they will have to use whatever is left over.

These tax rates will impact negatively on the country's success. But you do have control on how you manage your personal taxes. With legislation coming and going and rates rising or unstable, you should consider ways to shelter wealth from the government.

You can implement two essential strategies between now and the end of the year. First, accelerate income into 2010 and delay deductions until 2011. Second, structure your finances to reduce taxable interest and dividends until we see more favorable legislation.

Of the many ways to accelerate income into 2010, the largest and most effective is a Roth conversion, which I've written about extensively. But now there is a new and equally great opportunity.

Just three weeks ago, the president signed a provision of the Small Business Jobs Act that allows participants in 401(k) plans to roll over a portion or all of their account balance into a Roth 401(k) plan offered by their employers. Plans must be amended by the end of the year.

The ability to convert your 401(k) to a Roth 401(k) can have a considerable effect on retirement benefits. The new provision is especially advantageous for people at the upper income levels. This opportunity deserves its own article, but the details are still being released. It is important to start the process of amending your plan now.

There are many ways to put off deductions until 2011. Business owners could delay significant purchases or expenses until January 2011. Bonuses could be paid in January 2011 instead of December 2010. Additional hiring could be deferred too.

End-of-year charitable giving can also be postponed until next year. Giving in January 2011 instead of December 2010 makes little difference to the charities involved but may save you significantly by doubling your charitable deduction next year when rates are higher.

This method also works any year for families who don't have a home mortgage and therefore can't itemize their deductions. Normally they are only allowed their standard deduction each year because without the addition of home mortgage interest, their charitable giving is slightly less than their standard deduction. But twice their annual charitable giving could add up to more than their standard deduction.

One year they should take the standard deduction, and then the next combine two years of charitable giving, allowing them to take more than the standard deduction. One year they give in January and December. The next year they give nothing. Their average annual giving is the same, but every other year they can take more than the standard deduction.

Get your asset allocation and investment mix structured to avoid capital gains and dividends in your taxable accounts. Change your taxable account so it uses mostly exchange-traded funds (ETFs). These investment vehicles are tax efficient and won't kick off capital gains until you decide to sell them. Invest them so you won't need to make changes for several years.

Put investments paying interest or dividends in traditional or Roth accounts, respectively. These accounts can defer or avoid taxes until a more favorable administration.

A dollar saved on taxes is better than a dollar earned. If you save a dollar on taxes, you can keep all 100 pennies. But if you earn a dollar, the government will tax it at your marginal rate. Going forward, tax management will be as significant as investment management in a comprehensive wealth management plan.

As part of the nonprofit NAPFA Consumer Education Foundation, we are offering a presentation titled "Tax Management: Pay Less, Keep More" at the Charlottesville Senior Center at 1180 Pepsi Place on Thursday, October 21, from 5:30 to 6:30 p.m. The talk is free and open to the public. Bring your questions!

from http://www.emarotta.com/article.php?ID=420

Getting the Most from Your 401(k) or 403(b) (2010-10-11)

Getting the Most from Your 401(k) or 403(b)

(2010-10-11) by David John Marotta

For many workers, their retirement account is their largest asset. Having so much of your nest egg in one place means you should watch carefully how it is invested and monitor it regularly. Unfortunately, the average family spends more time planning their annual vacation.

The secret of making it financially used to be joining the right company, earning big bonuses and promotions and letting the firm provide for you in retirement through its defined benefit program. Your benefit in retirement was typically defined by your earnings over the course of your career. But as we all know, those days are over.

Today's average worker will have a dozen employers and work at each job for less than four years. Your career is now your responsibility, and so is your retirement plan.

Instead of a defined benefit program, most companies have defined contribution programs such as a 401(k) or a 403(b). In these you reap what you sow and the growth is subject to the weather of the markets. Nothing is defined.

A 401(k) and a 403(b) are virtually indistinguishable, named after the sections of the IRS tax code that define them. Businesses use a 401(k); schools and nonprofits use a 403(b). Most of the principles for evaluating and managing them are identical.

Some 403(b) plans and many 401(k) plans offer an employer match. Formulas vary, but the most common is to match the first 3% of your salary that you contribute at 100% and the next 2% of your salary at 50%. So if you put 5% of your salary into the company's plan, your employer will give you an additional 4% of your salary.

This is easily the fastest 80% return on your money. No one should pass up an employer match. If you are in the 25% tax bracket, each dollar you contribute will only cost you 75 cents. If you earn $50,000 and contribute $3,000, it will reduce your paycheck by only $2,250, and you may receive an employer match of $2,500. In other words, for $2,250 less in your paycheck, you can get $5,500 more in your retirement account.

Everyone should take advantage of matching plans and contribute at least the minimum amount required to receive a full match into the company plan. Unfortunately, many workers don't. In our example, between age 20 and age 72 at 6.5% return above inflation, the match would grow to more than a million dollars. Your first priority in saving should be to get the entire match.

The next step would be to fund your Roth account, make sure you are growing your taxable savings, and then return to contribute more to your company's retirement account. As we will see, there are good reasons not to contribute everything to your company plan.

The advantage of contributing to a Roth account is that your income (and therefore your tax rate) is probably increasing over the course of your working life. I've written extensively on the benefits of a Roth conversion this year, and that same reasoning makes funding a Roth IRA a good idea.

Many employers allow contributions to a 401(k) or 403(b) Roth. The more common pre-tax contributions are called a "traditional" 401(k) or 403(b) to distinguish them from Roth contributions. You should consider designating the portion you contribute toward a Roth. The portion your employer contributes, either matching or profit sharing, is always put into a traditional account.

If your income is significant, consider maximizing your contribution. The limit for 2010 is $16,500 a year. If you are older than 50, the limit rises to $22,000 to help you catch up on your retirement savings. In addition to your contributions and your employer match, companies sometimes pay bonuses or offer profit sharing as an additional pre-tax contribution. The total allowable contribution for 2010 is $49,000.

Given the amounts of money in retirement funds, it is important to invest them wisely. Every additional 0.01% return lets you retire nearly a month earlier. Thus fees matter, especially the expense ratio of your plan's fund choices. Most plans have funds laden with fees. Some share this revenue with plan sponsors, enticing them to pick more expensive funds to subsidize the costs of the plan or even make a profit.

But after you retire or leave that company's employment, you should almost always roll your 401(k) into an IRA for better investment choices and lower fees. Few plans have choices in every asset class and subsector.

When trying to craft an allocation when the choices are anemic, start by looking at your top-level asset allocation before selecting specific funds. For example, imagine you have decided on an asset allocation of 8% U.S. bonds, 7% foreign bonds, 34% U.S. stocks, 38% foreign stocks and 13% hard asset stocks. The next step is to look at the choices your plan offers.

You may find three U.S. bond funds and no foreign bond funds. One might be inflation protected, one might be intermediate-term treasuries and the other might be high-yield with a higher than normal expense ratio. You might combine the allocation to U.S. and foreign bonds and then split that amount between the first two bond funds, avoiding the third altogether.

There might be a dozen U.S. stock funds and only two foreign funds. The bulk of your asset allocation may fall in one or both of the foreign funds. And you may have to split the allocation to hard asset stocks between the U.S. and foreign choices. Your financial advisor can help you integrate your 401(k) selections with the rest of your portfolio. And as always, you want to evaluate each choice, looking closely at fees and expenses.

As part of the nonprofit NAPFA Consumer Education Foundation, we are offering a presentation titled "Get the Most Out of Your 401(k) or 403(b)" at the Charlottesville Northside Library at 300 Albemarle Square on Thursday, October 13, from 7:00 to 8:30 p.m. The talk is free and open to the public. We will be building ideal allocations and distributing sample portfolios for the University of Virginia's 403(b) options. Bring your plan's options and your questions!

from http://www.emarotta.com/article.php?ID=419

Umbrella Insurance Is Always the Right Answer (2010-10-04)

Umbrella Insurance Is Always the Right Answer

(2010-10-04) by David John Marotta

If you have a personal umbrella insurance policy, congratulations. If you don't, you must not have a lot to lose. This important insurance can extend your liability coverage beyond your home and auto insurance by millions of dollars.

We live in a litigious society. Anyone can sue you for any reason. Those with money are targets simply because suing someone without assets is pointless.

Car and home insurance are required, but even $300,000 liability coverage won't protect you in the event of a catastrophe. Your teenage driver is at fault and young people in both cars are seriously injured. Your dog bites a child. You chaperon a class trip and are judged negligent when one of the students tragically dies. You cause an accident on the freeway and a truck filled with expensive cargo is involved. A neighbor slips on your steps and sues you. You write something reckless and unwarranted on the Internet about a certain financial columnist, and he sues you for slander and libel.

The good news is that these events are relatively unlikely. The bad news is that any one of them could result in a judgment well in excess of your liability limits. Your insurance company will just pay their $300,000 share and leave you to defend yourself in court for the remainder. If the judgment doesn't ruin your finances, the legal fees will.

If you receive a judgment for more than your net worth, you could lose everything. Your taxable investments and savings may be subject to the claim. The equity in your house may be at risk. A large judgment can also garnish 2.5% of your wages for the next 10 years and/or any current or future inheritance you receive. Any inheritance left in a generation-skipping trust offers protection against creditors and failed marriages, but many families leave an inheritance outright instead.

You don't want a single accident to wipe out your life savings. Umbrella insurance helps protect you against that possibility.

Personal umbrella insurance sits on top of your auto and homeowners insurance. To get umbrella coverage you must first increase your home and auto insurance liability coverage to where the umbrella policy begins, usually $300,000. Only then can you get additional coverage of $1 million or more. If you get sued for $1.3 million, you would first pay your $1,000 deductible. Your home or auto insurance would pay $299,000 to reach the $300,000 liability on the policy. The umbrella insurance would pay the final $1 million. You would pay nothing more than the initial $1,000.

Being sued for more than $300,000 is not a remote possibility. For example, with today's more effective air bags, surviving an auto accident even with serious injuries is much more likely. As a result, the cost of life insurance policies is decreasing while medical expenses continue to accelerate. We've made cars safer and more people survive the accident. They survive, and then they sue for damages.

Anyone with assets they don't want to lose will benefit from umbrella insurance. Many accidents are the fault of someone with no assets to lose. Unfortunately they can simply not pay or at worst declare bankruptcy and lose nothing. If you are saving and investing, you have something to lose. It isn't clear at what level of assets you should get protective umbrella coverage, but financial pundit Dave Ramsey recommends it for families who have more than $200,000. It certainly isn't just for the ultra rich.

Consider buying more than $1 million in coverage. Getting the same amount of coverage as you have assets won't protect the assets you have. For example, if you have $1 million in assets and you purchase $1 million of coverage, you will lose all of your savings in a $2 million judgment. Thus you need to have enough coverage to satisfy the worst judgment you might receive. Coverage of $2 to $4 million will suffice for most of today's lawsuits.

I am usually not an advocate of insurance products. Umbrella insurance is the exception. It is designed to cover very unlikely but very costly events, exactly what insurance is supposed to do, at a reasonable price. In review courses for the certified financial planner (CFP) exam, prospective advisors are told, "Umbrella insurance is always the right answer."

About 12% of homeowners purchase umbrella insurance. For the wealthy, that number grows to about 50%. The tragedy is that half of wealthy homeowners are betting their entire net worth against the odds of a freak accident, which unfortunately do happen.

Insurance companies will only write an umbrella policy if they also provide your home and auto insurance. They want to know if the underlying coverage gets cancelled for any reason, and they don't trust another insurance company to defend their interests.

Another excellent feature of an umbrella policy is that the insurance company is obligated to provide your legal defense, and the legal costs are paid in addition to your coverage.

The first million dollars of coverage usually costs the most. A typical annual premium might be $150. Subsequent costs are about 65% of the first million for each subsequent million. So $2 million of coverage would cost about $248, and $4 million would cost $443.

Premium costs vary and are subject to a host of issues. When you apply for an umbrella policy, your answers to a number of questions may raise your rates or even disqualify you. Own a Rottweiler or a have been recently convicted of reckless driving and you may not be able to get umbrella coverage. If you serve on a board, you may not be able to get coverage for more than the board's coverage. And if you have a driver younger than age 25 or have a very poor driving record, coverage may cost a $100 more per million. Even if you don't plan on getting umbrella insurance, you might want to apply just so you know what behaviors may limit your likelihood of being sued.

Remember, personal umbrella liability insurance covers only nonbusiness activities. Umbrella policies are also available for businesses and well worth the money. Any umbrella insurance won't cover intentional acts or punitive damages.

For the cost of a splurge on a not particularly memorable restaurant meal, you can enjoy the protection of a $1 million umbrella policy. Insurance agents don't make much commission on an umbrella policy. So you have to call them. Just do it.

from http://www.emarotta.com/article.php?ID=418