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Tax Reform Illusion

There is no such thing as tax reform, at least when it is framed within the same Byzantine template that has bedeviled taxpayers for generations.

The primary objectives of any tax system should be to raise revenue, allow for efficient enforcement and encourage public compliance through simplicity. These goals have alluded the government at least since the passage of the Internal Revenue Code of 1954 and its 24 brackets.

If you are counting on Congress to get it right this time around, start recounting.

In my view, the only true reform would be something resembling a flat tax system.  See this earlier article of mine on the subject.

However, there are two chances of a flat tax system becoming law:  slim and none; I won’t waste time, then, on discussing it again.

As one would expect, the current package under consideration has become a partisan battle, with both sides playing to their loyal bases…. and too little weight given to economic and practical considerations.

There are many moving parts in play, but I will focus on just one – the mortgage interest deduction since it is the most complex of any.  It is as American as apple pie, but some developed countries have dropped it, including Canada, UK and France. There are limitations in others.  There has been no sustained impact on the real estate prices where it is not allowed.  Hey, just watch HGTV’s Househunters International for anecdotal evidence, assuming you can overlook the naivety of the buyers featured on the program!

We already have a limitation (also a topic I’ve covered in the past). It allows for the deduction of interest on $1M in mortgage debt used to construct, purchase or improve your home, and $100K for general purposes – basically cash draws to cover vacations, cars, boats or just plain, everyday self-indulgences.

The new proposal cuts the $1M in half to $500K and does not allow any interest deduction on second homes.  All existing mortgages would be grandfathered in at the $1.1M cap.

Presently, there are many people who are probably unaware of the current limitation, and many of them are equally unaware they are over the limit because they have not kept track of what their cash-out refinances or HELOC advances were for.

Don’t lose any sleep, unless your overall mortgage debt is high enough to appear on the IRS’s radar screen. It is at least as difficult to audit as it is for taxpayers to keep records and make the necessary adjustments.  The calculations are not a fun exercise, especially if there have been multiple borrowings.

One thing is for certain, by halving the cap more new borrowers, along with those who subsequently refinance, will fall under the new limitation. The IRS will be challenged to adequately deal with the increased load.  Taxpayer compliance will likely fall short of targets; accordingly, the projected deficit will be higher than expected, all other things being equal.

I would gladly trade all the deductions in the world for a much lower tax rate and an uncomplicated tax return. But the rate cuts for this package are no where near an incentive enough for me to get on board, especially if the loss of the state income tax deduction is also part of the deal.

Until there is real tax reform, America will continue to spend 6 billion hours per year on preparing their tax returns. I believe our personal time is worth more than a few dollars per hour, not to mention $2 billion we pay for individual tax software.

I think we have better things to do.

 

 

 

 

 

 

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Equifax SOX

Equifax  suffered one of the most significant data breaches ever, exposing confidential information stored within its network.  What’s more, three executives sold a fair slice of their personal shares in the company after the event was discovered and before it was communicated to authorities and the public.  Oh, and the sales were not part of a 10b5-1 arrangement through the SEC.  The purpose of this arrangement is to minimize the risk of insider training by scheduling sales in advance.

The company claims none of its executives knew anything about the breach when they sold.

Section 302 of the Sarbanes-Oxley Act (SOX) states that the CEO and CFO are directly responsible for the accuracy, documentation and submission of all financial reports as well as the internal control structure.

Every quarter, the CEO, CFO and others certify the effectiveness of the internal controls to the SEC.

One of the executives who sold his stock was the CFO.

Chief Financial Officer John Gamble sold shares worth $946,374 on August 1, two days after the hack was discovered. It is inconceivable that the breach was not escalated to his level within 48 hours, given the responsibility he has under the law. I have seen less significant internal control failures reported internally in that amount of time.

There will be investigations; if there was any cover-up, someone will talk, e-mail trails will exist.

But will anyone be convicted?  After all, no head of a major lending institution was sentenced criminally as a result of the mortgage meltdown.

There is yet a bigger question: how many credit rating services do we need?

Would the nation suffer if Equifax ceased to exist?

Think back to earlier scandals such as Enron and WorldCom.   Unlike Equifax’s, their’s were of a financial nature, but poor internal controls set the stage for the fraud. SOX was passed by Congress in response.

Both of those companies are gone. Are we worse off today without them?

 

 

 

 

 

 

 

As I wrote in an earlier article, State Senator Bob Hertzberg is a master of the English language.

According to his bio, as an undergraduate English major, he wrote a 400-page handbook titled A Commonsense Approach to English.

Unfortunately,  the senator has embarked on a course of language manipulation as his strategy to significantly raise taxes for all Californians. The people who can least afford it will bear the brunt of Hertzberg’s money-grabbing obsession.

After he was elected to the State Senate in 2014, he did not waste any time in rolling out a new way to relieve residents of their hard-earned cash.  His first crack at it was SB8, which would have taxed most services – from the labor on repairs to haircuts. SB8 died quietly; it’s replacement, SB1445, isn’t going anywhere at the moment.

He had the hutzpah to refer to the bill as “tax modernization,” as blatant a euphemism as, say, calling a mass layoff a “workforce imbalance correction.”  It would “modernize” an additional $10B  per year from the people and businesses in the state, but disproportionately from low- and middle-income earners.

Hertzberg, the serial hugger, perhaps feeling the pain of unrequited love from that attempt, employed his wordsmithing skills again, this time to win passage of SB231. By redefining sewer to include stormwater,  the bill opened the door to flood property owners with expensive parcel taxes.  Since it is already legal to raise taxes to pay for sewer service improvements without a vote, taxes for stormwater mitigation projects will not require voter approval either.

Words have meaning, as Hertzberg knows very well.

They have even more meaning when they are embedded in the constitution. Any new interpretation or redefinition of language affecting state or local governments’ ability to raise taxes should require a formal amendment. The process of changing the state constitution should not be conducted like a game of Scrabble. To do so is disrespectful to the people of California.

Responsible leaders will do their best to mitigate tax increases with spending restraint.

You will not see Hertzberg deal with cost containment, including reining in excessive employee post-retirement benefits.

Neither he nor his colleagues will ever attempt to prioritize capital spending. We cannot afford to pay for every high-end project.

There was a time when Senator Hertzberg was a reasonable politician.  He probably would have made a good mayor, certainly a better one than Antonio Villaraigosa.  But somewhere along the line, his ego probably got the better of him.  He has ceased to be a responsible leader and now resembles the essence of what Thomas Nast depicted in his caricatures lampooning Boss Tweed.

State Sen. Bob Hertzberg, D-Van Nuys, pumps his fist in celebration after his storm water bill was approved by the Assembly, Thursday, Aug. 31, 2017, in Sacramento, Calif. If signed by the governor, Hertzberg's SB231 would let local governments charge residents for storm water management systems without voter approval. Photo: Rich Pedroncelli, AP / Copyright 2017 The Associated Press. All rights reserved.     Thomas Nast (1840-1902). The Power Behind the Throne "He Cannot Call His Soul His Own." 1870. Museum of the City of New York. 99.124.7.

 

 

 

 

 

 

The American Civil War essentially ended with the  retreat by General Lee’s Confederate forces from Richmond, Virginia on April 3, 1865.  Lee’s surrender at Appomattox came six days later.  The intervening week was characterized by a series of battles and skirmishes along the 90-mile route of retreat, but it was evident that effective resistance against Union forces would not be possible for much longer once the defenses of the capitol were abandoned.

So it seems fitting that today’s modern day conflict – between those who want to preserve memorials dedicated to the leaders and common soldiers of the Confederacy and those who want them removed – could be decided in Richmond.

I’m very familiar with the city and the 14 blocks comprising the Monument Avenue Historic District.   Stately Victorian era mansions, where mature trees provide a broad canopy, make it a highly desirable neighborhood.

The statues at the heart of the debate were erected to honor  Robert E. Lee, Thomas “Stonewall” Jackson, James E.B. “Jeb” Stuart, Jefferson Davis and Matthew Fontaine Maury.  There is also one honoring former tennis great Arthur Ashe, a native of the city who was barred from playing on the city’s public courts while growing up.

With the exception of Maury,  these names should be recognizable to many people  in the United States and in parts of the developed world.  More about Maury later.

The Mayor of Richmond, Levar Stoney, formed a commission of 13 diverse individuals to tackle the controversy. All options will be considered, from the complete removal of the statues, to retaining them, but with context added.

Two members will potentially play very influential roles in the process:  Christy Coleman, CEO of the American Civil War Museum and Dr. Edward Ayers, former president of the University of Richmond, my alma mater.  Dr. Ayers also chairs the board of the American Civil War Museum.

The new museum they shepherded will offer a comprehensive look at the war; not the Confederate-centric portrayal at the Museum of the Confederacy.  The displays there were mainly focused on the battles, leaders and equipment.  That’s not to say that there was a lack of interesting content.  For example, I recall an excellent exhibition several years ago about the CSS Hunley, the first submarine to ever sink a warship.  The tour of the Confederate White House shed light on the day-to-day functions of what was at the time the second largest military power in the world.

It is possible the commission’s recommendation might not go all one way, although, at a minimum, context will be added.  That much is already occurring in the city.

I can see a scenario where a couple of statues might remain.

Resigning form the US military to fight for the south, while treasonable in hindsight, did not amount to an unconscionable act in the minds of those who went down that path. The US Constitution did not address secession.  Many people of that era viewed allegiance to their home states as more important.  I would say that was generally more prevalent in the south and can be traced to the unfinished business of forming our new nation.  Permitting slavery in the Constitution was the devil’s compromise the Founding Fathers made.

Foreign threats, both military and economic, called for a critical mass of territory, resources and population to counter them, so compromise was a necessary evil to launch the republic quickly. But as the nation matured and grew stronger to the point where such threats diminished, internal  differences were reawakened and filled the vacuum.

For Lee and his southern colleagues, choosing sides with their home states was the right thing to do…..and the worst decision any of them ever made.  If Lee had stayed with the north, he may have succeeded Lincoln as POTUS.

If the only issue was secession, one could make a strong case for keeping the statues. However, the stench of slavery forever tarnished those who left the Union.

Still, I imagine some members of the commission will consider the importance of transparency in portraying history, however painful it may be.

They may consider other factors as well.

Matthew Fontaine Maury was a commander in the United States Navy at the time Virginia seceded.  He chose his state over the Union. He was assigned to port and inland waterway protection.

Maury was openly opposed to slavery and had even developed the framework for a plan to end it, but it never achieved any traction. In a letter to his cousin dated from 1851, “Imagine, waking up some day and finding our country free of slavery!”

He was also a brilliant scientist.  Oceanography, meteorology and modern navigation owe much to his research in the years leading up to the war.  He was internationally acclaimed for his contributions in those fields and was in charge of the Naval Observatory until he resigned over secession.

Jefferson Davis was not fond of dealing with Maury and sent him off to Europe to arrange for the purchase of naval vessels.

After the war, he found his way into academia, teaching physics at the Virginia Military Institute and later helped form a college which would eventually become Virginia Tech.

I felt it was worthwhile to digress and explore Maury’s career as an example of achievements both before and after the war which may be factors in the commission’s recommendations.

If retaining some or all of the statues with context is where this goes, the content will be as hotly debated as the statues themselves.

Removal of the statues would face legal challenges, notwithstanding the horrific events in Charlottesville, due to Monument Avenue’s designation as a National Historic Landmark. I could see years of litigation which could end up in the US Supreme Court.

I feel for the members of the Commission.  They will face a backlash regardless of the outcome – maybe from all sides.

And the Civil War will continue.

 

 

 

 

 

The town of Loyalton, CA is a short scenic drive north of Truckee and, seemingly, a world away from the financial strain facing Calpers. It is the equivalent of a gnat on an elephant’s back.

Yet, the town’s pension woes provide insight to the overwhelming crisis facing other – and much larger – municipalities whose employees are participants in Calpers.

An article in the Los Angeles Times reads like a case study in the dangers of unsustainable promises.

In summary, the last of the town’s covered employees retired; there are four retirees with a vested full retirement benefit.  Loyalton’s City Council elected to pull out of Calpers when the fourth one retired.

Calpers smacked the town with a $1.7M termination fee,

Why?

Because the long-term liability associated with future pension benefits was grossly underfunded. The article does not say that, but it is the primary underlying reason.  You see, if the town’s plan had been properly funded, there would have been sufficient assets to cover the four until the day they died, plus spousal benefits to the extent they existed.

Loyalton does not have anywhere close to that money lying around, so pensions will be slashed by 60%.

The retirees are screaming foul.  After all, they were promised a sum-certain benefit for life.

To be fair, the employees, council and mayor should have done the math a long time ago. The town itself was not managed well, but you can say that about many municipalities., including Los Angeles (LA does not participate in Calpers.  Nevertheless, it faces the same fundamental problem within its own retirement plans).

What Calpers is doing is financially and technically justifiable, but it demonstrates just how deluded many beneficiaries have become.  The promise of  guaranteed pensions for life is only as good as the assets backing them.

Loyalton could have weathered the crisis had it stayed in Calpers. What that points out, though, is the weakness in the assumptions underlying the entire retirement fund. It depends too heavily on contributions from current employees to cover past service.  It is a Ponzi scheme, in that respect.

But it does not have to be.  A defined benefit plan can work….if contribution levels are sufficient.  I accounted for several small defined benefit plans back in the day when I was just out of college. We used conservative assumptions and were straightforward in our projections to the employers and employees.

Employees throughout the state need to contribute more of their own money to close the funding gap.  It is unfair to charge the taxpayers for the state’s years of over-promising more than it could afford.

The good news is that higher contributions can be spread over many years.  The pain would be no worse than felt by private sector employees who do the math and decide to increase their 401-K payroll deductions.

If employees want a guaranteed benefit, they must pay a premium for the protection. That’s no different than when we choose  lower-yielding investments in return for less risk.

It is also essential to educate the participants in Calpers about what a promise really is.

No sense in trying to teach that to our legislators.  They have been in bed with the public union leaders for way too long.

 

 

 

In several of my articles, I’ve characterized the City of Los Angeles’ finances as being in a state of virtual bankruptcy.  Pension costs are the key drivers of the city’s unsustainable model. Growing pension costs are plugged by reducing service levels or holding them flat in the face of higher demand.

It appears as if I am not the only one to coin a term for this form of neglect.

An article published by the California Policy Center describes it as “Service Insolvency.

I like mine a little better.  It’ packs more punch.

No problem, though. Service Insolvency gets the point across.

One need not look much further than police staffing to understand what it all means.

The city’s population grew from 3.7M in 2010 to 4.0M in 2017….and the trend will continue.   The 300-thousand increase is the equivalent of a small city.

Violent crime grew 38% over the two-year period ending December 2016, after a period of stability going back to 2010.

Robberies increased 14% since 2015 citywide.

The LAPD ranks have fallen below the 10,000 achieved in 2013.  Its per capita numbers rank way below New York’s and Chicago’s.

Despite the widening gap between higher crime and LAPD’s resources, there has been no serious plan offered to narrow it.

City Controller Ron Galperin’s recommendation to reassign officers from desk jobs to the streets was a good one, and has the potential to free up 450 officers.  But the city requires a force of 12,500 to perform effectively, that’s according to our current police chief, Charlie Beck, and his predecessor, William Bratton. That level requires a bit more than what Galperin’s proposal would cover.

One can argue about the exact size of the force required to maintain an acceptable level of service, but trends clearly support the need for a sizable increase.  Let’s not forget the additional civilian jobs needed to support a larger force and those hired to backfill the desk jobs.

The problem is money; that has always been the case.

To put it in perspective, if you assume the LAPD has a budget of $1B, a 25% staffing increase would add $250M per year.  That’s a very raw number and does not factor in economies of scale. Still, an overall increase of well north of $100M would not be a surprise.

A key factor which limits how much can be budgeted is the city’s share of pension costs. They consume 20% of the general fund budget, up from 5% in 2002. In 2008, the beginning of the great recession, it was 15%. So, despite a robust recovery, the slice has increased in size.

And let’s not get into the unfunded liability, which has also grown significantly since 2003. It is a leading indicator of more financial stress in the years to come. Citywatch’s Jack Humphreville could teach a course on the subject.

It is difficult to increase the level of service while lugging that much baggage.

Former Mayor Antonio Villaraigosa promoted a trash fee hike to pay for an additional 1,000 officers (although it fell far short of that number).  But the public is not going to tolerate a layer of expensive new fees, especially if they disproportionately fall on property owners.

Until City Hall pushes back against the public unions and demands higher employee contribution levels to go towards their incomparable retirement benefits, look for the mayor and City Council to propose fees. Probably not all at once – that would never fly – but over time.  A parcel tax here, a sanitation fee there.

Outsourcing many civilian jobs to the private sector would also help to decrease the benefit load.

Restructuring the labor force and increasing employee contributions are not going to happen given the composition of our current city council and the grip the unions have on its members.

Diminution of vital public safety services will continue until reaction time and effectiveness become intolerable.

And for many, that is probably the case today.

If only they voted.

 

 

 

LA unFitness

I am a member of LA Fitness.  I most often use the facility at Universal City because it has a hardwood basketball court.

Although my recreational playing days are over – no semblance of speed left in me – I derive much fulfillment  from moving the ball around the court, going in for a layup and nailing a 3-pointer from the corner.  Actually, I still have a pretty good shot.

Overall, it amounts to an enjoyable form of exercise and loosens me up for the rest of my routine…..and I can pretend to be any guard in the NBA,  although delusion might better describe my thoughts on the floor.

My basketball activities are best suited for times when the court is not crowded, usually late Saturday and Sunday afternoons and early evenings; and that’s when I notice it.  It was particularly evident today.

The sidelines were lined with empty water bottle and energy drink containers,  with partially eaten food items, too- I saw two banana peels just today.  Based on the volume of refuse, I estimate about 30 people were responsible .

I have complained to LA Fitness about this before.

I did so, again, today.

This time I made a suggestion that the facility’s management place signs in the gym reminding players to clean up before they leave. Even then, there will probably be those who ignore the message.

If that doesn’t work, LA Fitness should threaten to close the gym for, say, a week. Then do it again, if necessary. Maybe then there will be some peer pressure by responsible members to get the slobs to perform the simple task of tossing waste in a trash can.  Even the worst players can make that shot.

I know this solution sounds like a form of parochial school discipline one might expect from the Sisters of Perpetual Abuse, but we are dealing with those who lack basic respect for other members, and especially for the maintenance crew assigned to clean it all up at the end of the day.