TAX CUTS AND MORE TAX CUTS

Big tax cuts are needed and big tax cuts are being considered!

It is hard to imagine that a democratic congress is considering tax cuts. Maybe they really are and maybe they really are not.

Charlie Rangel appears to have given up on making the grand deal to eliminate the AMT. Perhaps even his "give up" is negotiating strategy. Has he thrown out a carrot or just campaign fodder?


Charlie just split his AMT bill and his tax bill into two parts. Next week there will be votes on each. The tax bill will go nowhere even though he will propose that the corporate rates be reduced from 40% to 25%. The devil is in how he would pay for the reductions.

For the last few weeks, Hank Paulson has been negotiating with Charlie. The attempt was to come up with a massive income tax reform simplification bill. The latest "give-up" indicates that instead of reaching a compromise, the democrats will put forth a bill with some goodies attached that cannot be passed, the republican president will veto the bill, a weak compromise bill will be passed and the two parties will run against each other on what could have been.

BIG TAX CUTS ARE NEEDED BADLY

Near the end of the JFK-LBJ reign, the ever escalating tax system had run its course. By 1969, personal income taxes reached a peak of 10.8% of GDP. Trouble was at hand. The USA experienced a double dip recession with the second one, the 1973-74 being a humdinger. The "tax simplification act" in this particular cycle was a small compromise tax reform in 1969 that was added too piece meal over the next several years.

Near the end of the Jimmy Carter years, personal income taxes had reached another big peak of 11% in 1981. Another huge recession followed in 1982. The early Reagan tax cuts turned the situation around and the market malaise that had lasted from 1969 until 1982 was over. The big, big bull market started its stampede in the fall of 1982. Reagan continued the progress on lower taxes when the Kemp-Roth bill made it through congress in 1986.

Near the end of the Bill Clinton era, personal income taxes reached the highest peak of all with personal income taxes reaching 13% of GNP in 2000. As usual, once the government gets its hands on too much of the national economy, the public protest is a change in party. Bush took over, just as Nixon and Reagan right at the start of a tough recession. Once again it was clear that tax cuts were needed and the congress went along with the Bush cuts. The result of the tax cuts, in all cases (I should have gone back one more cycle to include the JFK tax cuts because they worked as well, but then so did those of Grover Cleveland) was to stimulate the economy and to ultimately increase the total tax revenue even at the lower rates.

Here we go again! The federal government is once again taking too big a piece of the pie. This year, personal taxes are pushing up hard. The current level is 10.8% of GNP. Because the democrats plan to increase the top marginal rates, billions of dollars will be pulled out of IRA accounts for the next three years. All investors should take a look at their marginal brackets and consider withdrawing a portion of their IRAs early. In particular those who are over 59.5 years of age should take a look. Because 100% of withdrawals from retirement accounts is taxable at ordinary rates, the advantage of tax deferral will become a disadvantage if rates are going to climb.

Let me mention once again that the simple explanation for the great depression was that the federal government held too large a share of the GNP. Today it is common for the average man to rail against the federal deficit without remembering that each of the recessions mentioned above came as a result of sharp pay-downs of government debt. Democrats love to mention that Clinton balanced the budget, what they do not like to admit is that as a result of the excessive level of personal tax the economy was in a recession by the time Bill left office. Saying that the down turn in the economy was a result of the tech bubble bust is similar to what is done to show that carbon is causing the warming of the earth. The very gradual rise in the temperature of the earth started before the rise in carbon but a graph of recent history shows the two numbers going up together.

In any event, our banking system is a fractional system and we actually need small levels of inflation to avoid disruptive allocations of resources. Indeed, the FOMC needs the leverage of debt to be able to stimulate the economy at those critical times of need.

TAX CUTS PROPOSED

Charlie Rangel would raise a lot of taxes in order to patch the AMT and to lower the corporate income tax. It is widely recognized that America needs lower corporate rates to "bring businesses back home". If any one of you were CEO of a multinational company, you would have to choose a European subsidiary for a new project given that the tax of 24% would yield a higher profit than the US tax of 40%. If patriotism for the US caused you to make a different choice, the shareholders would remove you from office pretty quick.

SIGNS, SIGNS, EVERY WHERE THERE ARE SIGNS

One of the big signs posted by the market place has been the cancellation of 16 new coal fired electrical plants in recent weeks. The AP reports that there is a growing belief that either a cap and trade carbon tax system or a straight forward carbon tax will be passed. My estimate of the probability of passage by the current congress was on the rise again until Charlie announced his split of the AMT bill. It will now be much easier for a one year patch to be reached with the big compromise being done after a hard fought election.

This is a sad situation. Politicians need to do the peoples work. Instead we are going to hear endless advertisements about how bad President Bush is and about how bad the democratic congress is. We are going to hear a lot of that in any case but I had high hopes that the obvious compromise would be reached. A third grade student can tell you that the US needs to tax income less and dirty coal more.

BUT MAYBE, JUST MAYBE? I cannot imagine a bill going through that would retroactively tax power plants already constructed. There is still inconsistency among the signs. Games are being played to make the energy "crisis" seem worse than it really is. The bone thrown out by Rangel, of lower corporate rates, is surely at least a fishing hook.

Again, we all know that two bills will be vetoed. Anyone who has negotiated the purchase of a business or even a car knows that you have to be willing to "walk away" sometimes more than once before you can discover the best deal. Democrats could go a long way toward shedding their "tax and spend" label if they were to pass tax reductions that must eventually be passed anyway.

As regular readers know, I like the compromise of combining the Ryan bill with the Dingle bill. I do not like the Lieberman bill because the carbon cap and trade system is too easily gamed. Another "fishing hook" has been thrown out by republican negotiators. The original plan offered was acceptance of a 50 cent per gallon and $50 per tonne gas and carbon tax in exchange for a very simple, two bracket income tax; 10 percent on the first $100,000 of income and 25% on all over $100,000. The latest "hook" is acceptance of a 4% surcharge on all above $200,000. It was known from the beginning that democrats would not accept the 10/25 system, but republicans have reached out with the idea of a 4% surcharge in the same way that Rangel has reached out with the cut in the corporate rate. Please notice that Rangel's proffer is a 25% corporate rate which is in line with the 10/25 rate wanted by republicans. The idea is that real simplification can only happen if the corporate and the top personal rate is the same. This is key for the owners of farms and small businesses who might have the option of paying out more or less of the earnings as personal income.

GOOD NEWS TURNED TO BAD, NO NEWS TURNED TO HYPE, CAL, CAL, CAL AND GOOGLE, GOOGLE, GOOGLE.

CAL put out some great numbers but you would not know it by reading the news reports. For example, one article talked about a 2% rise in revenues and said that earnings dropped from $2.17 per share to $2.15 because the number of shares outstanding increased by 1.8%. The truth is that the $2.17 of 2006 included .86 of one time gains from the sale of securities and the $2.15 included a one time hit to the pension fund of 10 cents per share. Indeed, I suspect that earnings were further reduced by the massive amounts added to pension funds this quarter. The bottom line is that the 2 cent drop was really an increase in operating earnings from $1.31 to $2.25, at least. The year over year increase was 71%!

THE KEY POINT IS THAT THE MARKET IS GIVING US ALL A CAL BUYING OPPORTUNITY.

On the other hand, Google did about as well as expected but the news has been hyped and hyped some more. I am still in love with the company, with its products and with the direction I see its future products taking the world. Still, I do not plan to add to my holdings now. The stock has had a big run and it continues to trade at a very high price. It will take years of growth for this company to be "worth" its current valuation, however, because I expect it to grow for many years, it will continue to receive a premium even after it is "worth" the current price.

Over the next several years, Google will go head to head against the "big boys". The major telephone companies have been around for a long time and they are willing to play rough. The big media companies, such as Viacom, know how to play hardball. Microsoft is spending billions to be more like Google. The list goes on. Google will face stiff challenges.

Again, please do not get me wrong. For almost four years, I have strongly recommended Google. It was one of the first three stocks my 19 month old grand daughter purchased. I like it, I like it. However, the stock will probably continue to climb in a pattern similar to the last couple of years. After a good run, the stock will be in the news constantly. Then it will go sideways or fade back for a long stretch before the next run begins. It is impossible to catch these cycles accurately. The best policy is to buy and hold the stock. If the mobile phone becomes what I believe it will become, Google will help billions of people navigate life daily.

THE STEADY DRIP

Statistics show that those who invest regular amounts on a regular basis achieve higher returns than those who add money in chunks (when they feel good about the market). Last week I wrote that a pull back was likely because the sentiment had gotten too strong. This week, the sentiment is weakening. The talk about the 1987 crash and about $100 oil and war with the Turks is taking its toll. We need a little more fear to set up another great run. Congress will most likely finish its October 1 fiscal year budget before the Thanksgiving Holidays (Harry Reid says he is willing to call the folks back for a December session if necessary but I doubt it will happen). Chances are a weak budget will be passed by November 14. I still give a strong bill with great compromises a 20% chance.