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Tuesday, November 7, 2017

Investment Income Is No Tax Substitute

Friends - good news! At its meeting here in Cheyenne today, the Joint Revenue Committee postponed its hearing of testimonies - and, most important of all, its votes - on a series of tax-hike bills. They are scared to touch these bills; they are feeling the groundswell; your voices matter!

That does not mean they have given up. They are going to try again at their next meeting, in the first week of December. They are betting you will have forgotten about it by then.

But you won't.
After all, there is one thing that does not change with every postponement they make: you, me - we - are going to pay the taxes they want.

I picked up on another indication that they are scared of you: they are beginning to bend, almost break their own procedural rules. I am not going to bore you with the details, but there is clearly an effort under way to try to make the committee's work, and its efforts to pass tax-hiking bills, as convoluted as possible. This, again, shows that they are afraid to come clean and let you know just how much they are going to raise your taxes.

Don't let them get a way with it. We need to keep fighting, now more than ever, especially since we are not going to get nearly as much support from Congress as we need; the Republicans and their lukewarm tax reform proposal is still better than nothing, but that is not exactly a respectable standard to hold yourself to.

While we keep up the pressure on the Revenue Committee to back off from as many tax hikes as possible, we have another revenue issue to deal with. Our state is becoming increasingly dependent on investment income to pay its bills. Some think this is a good idea, because it helps us keep taxes down. I do not, for two reasons. First, the $20+ billions that the state has in the bank are originally tax revenue, shored up after having been taken out in excess of what the state needed. If government can afford to squirrel away money in savings accounts, then taxes are higher than they need to be.

Secondly, investment-based income is volatile, with swings that can present budget-balancing legislators with an even bigger headache than severance taxes. Yes, our state invests conservatively, but there is a considerable risk that if we are successful in stopping tax increases - and let us all pray that we are - there will be another effort from some corner of the legislature to push for more aggressive investment of the state's big investment portfolio. Last session, the legislature actually considered, but ultimately rejected, a bill with that content.

Rather than expressing concerns over our state government's growing dependency on the financial markets, some actually celebrate it. KGWN has the story:
During a time when Wyoming is facing significant funding shortfalls, the Wyoming State Treasurer's Office has released its annual report showing state investments grew by $1.17 billion over the past fiscal year. This marks the fund's best performance above the state's benchmark over the past ten years. "Wyoming relies on investment income more than ever before," said Wyoming State Treasurer Mark Gordon. "Already the returns have become one of the top three contributors to our state's general fund. They provide a significant part of financing for our education system, a crucial ingredient of assuring a bright future, and a means of assuring Wyoming will continue to be a low tax state far into that future." 
I am not going to repeat, again, the analysis showing why we are not a low-tax state. It is available, though, on this blog for everyone interested.

More important is Treasurer Gordon's joyful attitude toward investment income. Having an investment portfolio pay for our schools is not quite like spending the days at the race track to win money to pay your utility bill, but it is in the same ballpark.

More on that in a moment; first, we go back to the KGWN story and a few more words from Treasurer Gordon:
"The importance of these returns to our state's wellbeing will only grow in the years to come." 
Please note what he is saying here: investment income is going to grow as share of the state's revenue. Treasurer Gordon can see the writing on the wall. It says that we the taxpayers of this great state cannot afford even a fraction of the tax hikes that the legislature is working so hard to get through.

But why would anyone want to expand the state's reliance on investment-based income, when it is not possible to raise taxes?

Simple. Remember the creed of the welfare statist? "Cutting spending, like eating children, is wrong." Anything is better than cutting spending - which is why I predict yet another attempt to allow for a more aggressive investment strategy.

KGWN again:
From July 1, 2016 through June 30, 2017, the State's four permanent funds had returns ranging from 9.4% to 8.4%. The State Agency Pool, which might be compared to our state's checkbook, mainly invests in short duration bonds to maintain the ready cash needed to pay our bills. It had a return of 1.1%. The total assets for the period grew to $20.756 billion compared to $19.581 billion on June 30, 2016. The total of all funds had a return of 6.10 %. ... Five funds, the Permanent Wyoming Mineral Trust Fund, the Permanent Land Funds, the Hathaway Scholarship Endowment Fund, the Excellence in Higher Education Endowment Fund and the Workers' Compensation Fund may hold equities (stocks) under current law. The other two funds, the State Agency Pool and the Tobacco Settlement Fund, cannot. 
To get an idea of exactly what our state would depend even more on, here is a historical chart of the Dow  Jones Industrial Average:


People see this chart and think the stock market is an endless source of capital gains and dividends that will keep on flowing in for the proverbial eternity. That, of course, is not the case. The rapid rise in the DJIA right before the beginning of this Millennium was in good part driven by the extraordinary tech revolution in the 1990s, but the rise beyond that was fueled by the Federal Reserve's money printing. 

Likewise, the shocking rise in the index after the Great Recession has its origin in a combination of overtime money printing by both the Federal Reserve and the European Central Bank (which has expanded money supply aggressively since at least 2011). Add to that the de facto money printing in China as a result of their currency sterilization policies - cash that directly or indirectly has benefited financial investors in the United States - and we have three major rivers converging into a tsunami of cheap liquidity flooding the world's major stock markets. 

The Federal Reserve has changed course, away from quantitative easing, and the ECB has done the same. The Chinese economy is suffering from structural imbalances and an enormous over-supply of liquidity. There will be a downward adjustment of the Dow Jones at some point, and it may not be what our state legislators - and State Treasurer - would want to see. 

To further drive home this point, consider Figure 3, which shows how the Dow Jones has performed relative the U.S. economy. Since the mid-'80s the Dow Jones has grown faster than our GDP, something it should not be doing. The Gross Domestic Product is the most comprehensive measurement of economic activity we have; every non-financial transaction that produces value for businesses is included in it. When the stock market accelerates away from GDP - as the red trend line so clearly demonstrates - it simply means that there is speculative hot air being blown into the stock market:

Figure 2
Sources: Investing.com (DJIA) and Bureau of Economic Analysis (GDP)

Using this method to define speculative value, since 1985 about two thirds of the stock market value is speculative in nature. That is a somewhat crude definition, but it gives us an idea of what we have to look forward to in terms of stock-market performance, especially if we cannot sustain the current "Trump trend" of economic growth.

Let us not fall for the temptation to replace tax revenue with investment income. Let us use our state government's investment portfolio as a funding source for a transition from our big, unsustainable government to one that is fiscally slim, economically unobtrusive and philosophically acceptable. 

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