Leverage

I know a man who represents the classic American story.  He was the son of an immigrant family who struggled to pay rent from month to month.  He loved cars from a very young age, and enjoyed working on them and talking about them.  He is an energetic guy.  In current day, he might have been diagnosed as having ADHD, but his family just diagnosed him as having “ants in his pants”.  He was unrefined - he cussed terribly, smoked cigarettes, refused to cut his hair, did poorly in school, and was generally expected not to do well.

When he was in his early 20’s, he was the passenger in a serious car accident.  The car he rode in was smashed by a cement truck, causing dramatic injury to his head and face.  He was permanently scarred.  He later received $50,000 as a settlement from the cement company.  Unlike many Americans, he did not reward himself with the best new car he could afford.  He did not throw a party, nor flaunt his new money.  In fact, he did not waste a penny.  He invested every dollar in used cars for resale.  After selling those cars for a small profit, he did it again, and again, and again.  He was passionate about his work.  He sometimes rose at 4:00 am to be the first in line to buy more cars, and then he would work late into the evening to prepare his cars for the next day. 

Fast forward 15 odd years and you find that he is a millionaire, owning the largest used car dealership in his city - true story!  This story is the coming together of four key ingredients – knowledge, discipline, hard work, and leverage.  Without any one of these ingredients, this story would not have been possible.  The leverage came as a result of a tragic accident from which he encountered a windfall of $50,000.  Many of us would have spent that leverage, or invested it in risky enterprises that won't pay off, but he didn't.  This fact, combined with his other three attributes, enabled my friend to make a over million from his leverage.    Surprisingly, this man is not the only person I know who has utilized leverage in such an extraordinary way.   I know several people of this ilk, and all of them share the same unique and respectable qualities.

As you recall, some of my blog posts suggest higher taxes on the wealthy.  Conservatives label this attitude as “class warfare”.  I’m writing this post is to explain why I take such a position despite my respect for these great people.  The key here is leverage.  As you have read, our true life hero has taken $50,000 in leverage and very carefully increased it to over a million dollars.  I respect this man, and I would not take a single dollar from him.  That said, I do have a different attitude regarding his future earnings.  Because of his hard work over the last 15 years, he currently has hundreds of thousands in leverage, which is likely to earn him his next million in just a few years.  Once he’s earned that million, the added millions can come with comparably little work.

Does he deserve to be wealthy?  Sure!  Does he deserve to continue getting wealthier?  Without a doubt!  Is it possible that he didn't earn every dollar honestly?  Well, he is a used car salesman after all, but that's not my point here.  The heart of the question here is whether he deserves to become wealthier at the highly accelerated pace afforded him by his leverage.  Contrary to trickle-down theory, the wealthy do not create jobs or boost the economy at a pace in keeping with their increased wealth.  A reasonably disciplined person of wealth is likely to double his wealth every 5 years while not working quite as hard as he had worked to earn his first million.  This is the very reason why the wealthy are supposed to be taxed at a higher rate than the middle class.  As it stands, though, they are not.  Most wealthy do not pay much in payroll taxes or income taxes.  The taxes that they do pay, corporate tax and capital gains, are assessed at a lower percentage than the taxes paid by the middle class.  Consequently, over the past 12 years, the wealthy have amassed added wealth at an extremely accelerated pace while average middle class earnings have been reduced.

Is higher taxation the same as class warfare?  Absolutely not.  In fact, it is not even an attempt to redistribute wealth, which implies an effort to take from the rich.  Leveraged taxation is simply an effort to regulate the pace in which the wealthy continue to grow wealth.  It does not make them less rich.  My friend will continue to grow wealth because he takes the right steps to earn.  I only argue that he should get wealthier at a slightly slower pace than his increased leverage will allow.

Tony F.  2013

Bad Timing

This week our Federal government has enacted a sequester due to their stalemate over the Federal budget.  The left believes we need to remove tax deductions for the rich; while the right believes we should focus solely on reforming Medicare, Medicaid, and Social Security, negatively referred to as entitlements.  Until this standoff is resolved, we are held hostage with threats of government layoffs, shutdowns, and economic decline.   

The truth is, both sides are right.  If done correctly, these solutions could become the perfect grand bargain.  In fact, Barack Obama and John Boehner came very close to agreeing on it.  We now know that this solution is not very likely, as it fails to appeal to the extremists.  The actual solution will probably look more like a series of deadlines and capitulations that slowly chip away at the problems.  In the meantime I need to offer a few complaints and conclusions about our congress. 

First of all, why are entitlements the primary focus of the right?  Believe it or not, these programs have very little to do with the national debt.  All of the entitlement programs (Social Security, Medicare, and Medicaid) have operated at or near break even throughout the Great Recession.  The largest, Social Security, is fully funded through 2036.  Yes, it is true entitlements are projected to go under water in the next 10 years due to a huge increase in the number of elderly who will enter the system, but the great distraction of entitlement reform is that if they had been corrected 10 years ago it would have had very little effect on the current deficit.  Because entitlements only threaten future debts, making major moves to correct entitlements today would amount to bad timing.  As it stands, the CBO predicts our national debt will actually decrease if we make no changes to budgetary law over the next 10 years.

So, why won’t Democrats go to work on entitlements anyway?  Several viable proposals have been presented, but the Democrats prefer to stand off instead of doing what is prematurely asked.  I have a theory:  The most likely solution to entitlement futures is to raise the tax for entitlements, specifically on the wealthy.  Note that this is not necessary today, but it will be necessary 10 years from now.  Most entitlement revenues do not apply to those earning over $120,000 per year, so an easy solution to the future shortage is to raise the exemption for higher wage earners while also instituting an incremental raise in the retirement age.  In other words, future high income earners will pay a little more, while future workers will wait a few more years to retire.  Problem solved, right?  Wrong.  If the Democrats make this move before correcting budget deficits, Republicans will scream that Democrats have raised taxes on the rich - not once, but twice - while making no correction to the deficit!  And it all happened because Republicans forced the Democrats to raise revenue on systems that did not need to be fixed - at least not yet - and had very little to do with the national debt.

Republicans know that it is inevitable that this solution for entitlements will be needed over the next 10 years, but they don’t want to be the party who does it.  It is vitally important for the GOP to make sure the left is blamed for raising taxes while also raising the retirement age, and making no progress on the deficit.  Who could support a party who gives you so much less for so much more?  In fact, this bad timing is so important that Republicans are willing to hold other programs hostage until this dirty work gets done.  In a political climate full of scare tactics and standoffs, the most important thing for the GOP is to generate bad timing for the left, so the Democrats will appear as wrong as possible.

Tony F.   2013