The 10% Solution
Governments need more money, and the top tenth of households, measured by assets, has a lot of it. Next stop: a wealth tax.
Is this the Red Sox rally? With Boston a major hub of money managers and Connecticut the home to more than a few big hedge funds, euphoria swept through New England as the Sox took the World Series last week.
There were probably more than a few aching heads at trading desks around the region Thursday from celebrations the night before when New Englanders' beloved "Sawx" clinched at home in Fenway for the first time since 1918. Whatever the cause, Woody Dorsey reported that day from his home base in Vermont, his Market Semiotics polling had hit a 98% bullish reading on stocks.
Still, it's hard to pin the market's continued levitation on the euphoria in Red Sox Nation. Even before they nailed down the series in six games over the St. Louis Cardinals, BlackRock Chief Executive Larry Fink was warning of an "overzealous" market, which was mirrored in an array of sentiment indicators.
In particular, more than half of those surveyed by Investors Intelligence professed to be bullish, some 52.6% to be exact, which is still short of the heady levels of around 60% that have tended to coincide with market peaks. But bears receded to a mere 16.5%, about as low as it gets.
Taken together, the ratio of Investors Intelligence bulls to bears tracked by Yardeni Research is at a relatively frothy level of three-to-one, which was last breached before the 2011 correction, and prior to other pullbacks in the past decade. In addition, Citigroup's Panic/Euphoria gauge—which it dubs as "the other P/E"—clocked in at its most euphoric since 2008, which, if memory serves, saw a rather nasty episode in the market. That's corroborated by heavy flows into equity mutual funds—up big three weeks in a row, with $12.4 billion in the latest week, bringing the 2013 tally to $231 billion. All of which leads Bank of America Merrill Lynch's chief investment strategist, Michael Hartnett, to exclaim: "It's getting frothy, man!" in a research note.
The P/E usually referred to—the price-to-earnings ratio—is right in line with historical averages, writes Barry Knapp, chief strategist at Barclays, in his latest market missive. At 16.2 times trailing 12-month earnings, the market multiple is right in line with the median since 1946 at the middle of market cycles and close to the average of 15.9 times. Earnings gains, however, distinctly trail what was seen in those periods. He puts trailing 12-month earnings-per-share growth at 4.6%, well short of the median of 12.7% and the average of 13.3% at midcycle.
Which raises a question: Is the rally being driven by earnings expectations or improving outlooks for fiscal and monetary policies and the economy? Knapp thinks it's pretty clear it's the latter. In other words, with the market trading at an average P/E and below-average earnings growth, it's dependent upon policy. And like the Fed's quantitative easing, favorable policy can't go on forever, so something's got to give.
At last week's Federal Open Market Committee meeting, the policy-setting panel gave no indication of any change in stance or acknowledgment of the cooling in the economy, especially the slowing in the growth in payrolls. While the October employment report was delayed a week to this Friday by last month's government shutdown, ADP's estimate of private payroll expansion was a below-consensus 130,000. Moreover, the three-month average of official Bureau of Labor Statistics private payroll count has slowed to 150,000 from more than 200,000 at the beginning of the year, notes Shadow Government Statistics.
With the market dependent on the Fed, and the Fed saying its course depends on the data, the jobs numbers will take center stage. The consensus guess is for a 130,000 increase in nonfarm payrolls and perhaps a slight uptick in the jobless rate, although the government shutdown could distort the numbers. The first stab at third-quarter gross domestic product, due Thursday, also is likely to show a tepid 2% rate of gain, down from 2.5% in the previous quarter. None of which should induce the Fed to taper its $85 billion-a-month bond purchases before next spring.
WHETHER WILLIE SUTTON REALLY said he robbed banks because that's where the money is, his purported quip is as apt as ever. Governments looking for money are going where the dough is—rich folks.
Democrat Bill de Blasio is all but certain to be elected the next mayor of New York City on Tuesday on a plank to hike income taxes on Gothamites earning over $500,000 to fund early education and after-school projects. The odds of getting that levy enacted are rather longer because it's up to the New York State Legislature in Albany, not the New York City Council, for reasons not worth delving into here.
Still, the proposal is in line with recent increases in taxes on high earners, from the hikes at the federal level, including raising the top bracket to 39.6% and ramping up levies on investment income such as dividends and capital gains, to California's Proposition 30, which boosted top tax brackets to fund education.
In his weekly New York Times column on Oct. 26, James B. Stewart suggested that the plan to tax New York's rich "could aim higher." Folks who live and work in the Big Apple and earn more than $500,000 a year already face high federal, state, and local income taxes, plus property taxes, he pointed out. To which it might be added that, given the area's exorbitant cost of everything, especially housing, the half-million that would let you live like a king or queen most anywhere else doesn't go that far, especially in Manhattan.
But, Stewart continues, New York City residents, by and large, aren't the ones buying trophy apartments priced in the sky. They are "the ultrawealthy with a primary residence elsewhere, for whom a $55 million condo is a pied-à-terre and just another place to park their wealth." And the property taxes are relatively trivial, given the low assessed valuations—including an $88 million condo purchased by a Russian billionaire, on which taxes were just $59,000 last year. That's less than the property taxes on homes worth a tenth as much in some New York area suburbs.
The owners of these posh pads don't pay New York City income taxes if they spend more than 183 days a year outside of the city. And foreign residents who stay out of the country for 183 days owe no U.S. income taxes, he adds. Stewart proposes raising taxes on these wealthy transients. After all, if they're willing to pay exorbitant prices for flats that sit empty all but a few days a year, it's unlikely that they'll care about kicking in a few more thousands to the city's coffers. That's a small price to pay for a safe-harbor asset beyond the reach of mercurial dictators, especially with the property likely to more than maintain its value in real terms.
The International Monetary Fund offered its own immodest proposal to tax wealth, whether on property, transfers of property, financial transactions, or other assets. The IMF's Fiscal Monitor (kindly passed along by John Brady, rates maven at Chicago futures specialist RJ O'Brien & Associates) suggests that wealth actually is a better measure of the ability to pay than income. While the top 10% of earners own more than half of the wealth in major industrialized countries, and over 75% in the U.S., the take from income levies has fallen in recent years, to under 2% of gross domestic product on average in those nations.
So, the IMF sees scope to hike wealth taxes. Property taxes are the cornerstone of many U.S. localities, but could be increased outside of Anglo-Saxon nations. Transaction taxes can be "administratively appealing," because governments can track them readily, but could impede beneficial trades. Transaction levies are often proposed to reduce price volatility—the "Tobin tax" on currencies was meant to damp exchange-rate swings—but might actually lead to thinner, less efficient markets, the IMF publication observes. Estate taxes, meanwhile, yield relatively little because of low rates and exemptions, but could be expanded.
Finally, taxes on net wealth could be added, perhaps in addition to capital-gains levies, which may be low or easily evaded. One study suggests that a 1% tax on net wealth of the top 10% of households could raise 1% of GDP per year. So, readers of Penta—which is aimed at those with assets of at least $5 million—presumably would write a check for an additional $50,000 or more under such a scheme. It might be a one-time hit to reduce debt—or it could be ongoing. The IMF admits that the modern history of such levies, especially on estates, isn't encouraging, given relief and exemptions for, say, land or family-owned businesses. Financial wealth, moreover, is mobile, so it would be better to lean more heavily on nonfinancial assets, which the organization says are very important for the ultrawealthy.
"Although these initiatives face difficulties that should not be underestimated, over the longer term they have the potential to make much fairer tax systems," the IMF publication concludes.
Whether you agree that such levies would increase fairness to correct growing inequality, or think that such redistribution takes away from the productive private sector to fund bloated government spending, don't be surprised if Penta readers are among the targets. Regardless of one's philosophical viewpoint, governments have deficits to close, and wealth is where the money is.