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House’s SECURE Act and the Senate’s RESA Act

Congress has been busily working on a much-needed way to improve Middle Class savings and growth over the span of their employment to boost their retirement.

Dueling bills to restructure IRAs and 401ks appear to be redundant. Better known as the “Setting Every Community Up for Retirement Act” (SECURE Act) H.R.1994 and the Senate has a similar bill, the “Retirement Enhancements and Savings Act” S.792 (RESA). Both bills were passed with bipartisan support.

For the ultra rich? A major outcome of the Trump tax bill were tax breaks for the wealthy and corporations. Besides much of the resulting income increases going to 1% of the household taxpayers, the same 1% were given the ability to shelter large amounts of income in gifts to their heirs. It is a great time to be rich in income and have the ability to shelter it by making gifts of it to your heirs’ tax free!

A little history on why Congress might take this up

From 1979 to 2017, the average annual income for the 1% of the household taxpayers has increased 156%, the top 1 hundredth of 1% income increased 343%, and the average American’s income did not increase at all. In spite of increased education from 1970 when half of Americans 25 years and older had a high school degree compared to today when the proportion of Americans having a college degree tripled, income has been stagnant for much of America. Even with the increased education, as Nick Hanauer in a recent Atlantic on this topic stated, the “Education is Not Enough” or was not enough to build, to build a vibrant middle class. Nick is also reiterating what Tom Hertz said in 2006 in his article; “Understanding Mobility in America.”

“The first aspect is the question of intergenerational mobility, or the degree to which the economic success of children is independent of the economic status of their parents. The second aspect is the short-term question of the amount by which family incomes change from year to year. One very clear conclusion is children from low-income families have only a 1 percent chance of reaching the top 5 percent of the income distribution versus children of the rich who have about a 22 percent chance.”

All the education in the world may not make a bit of difference in upward mobility as Nick and Tom Hertz concluded unless the income and the status is already there. A successful middle class with good income has to be present.

What Congress is doing.

The House passed the SECURE Act with an almost unanimous bipartisan 2nd vote. Prior to the first vote, Republican NC Representative Patrick McHenry made a motion for an affirmative vote (page H4147) stating they stand together against the anti-Semitic BDS movement. How this applies to the average citizen’s IRA is beyond me. It is a tagalong to the SECURE Act with the hope it would pass. It lost with 222 in opposition.

A few things about the House “Setting Every Community Up for Retirement Act (SECURE).

• It lengthens the amount of time a person can contribute to an IRA beyond 70.5 years of age.
• Raised the required minimum distribution (RMD) age to 72 from 70 1/2 years old.
• Increased the Safe Harbor percent from 10 to 15%.
• Allowed long-term, part-time employees to contribute.
• Put in place an small employer tax credit for enrollment.
• Revised how benefits are paid out to a non spousal from 5 to 10 years (page H4234).
• Allowed automatic enrollment.
• Etc.

“The House SECURE Act would eliminate the current rules allowing non-spousal IRA beneficiaries to use (stretch IRA) minimum distributions (RMDs) from an inherited account over their own lifetime (and potentially allow the funds to grow for decades). With the SECURE Act, all funds from an inherited IRA would have to be distributed to non spousal beneficiaries within 10 years of the IRA owner’s death (The rule would apply to inherited funds in a 401(k) account or other defined contribution plan, too.).”

Other than the elimination of the Stretch IRA, these changes were needed and they will improve the amounts accumulated for retirement. As I mentioned earlier, much of America has not incurred the same income increases as the 1% or the 1 tenth of 1% of the household taxpayers. Pre-inflation YOY income growth for non supervisory Labor has been ~3%. Subtract out inflation of 2% and income has grown by 1% for much of America not leaving a lot to put into a 401k. I am waiting for the next shoe to drop of increasing the age of when people can take SS.

The Senate RESA bill is similar in content except for a provision buried in it taking aim at the Middle Class. The Senate’s RESA Act shortens the time period for non-spousal beneficiary withdrawal who have inherited an IRA with greater than $400,000 (IRA, Roth IRA or 401k). RESA exempts the first $400,000 inherited to a life time of RMD withdrawals and then it forces beneficiaries to cash out over a 5-year period any amount greater than $400,000. It could have tax implications if the amount over $400,000 was large or one’s income tax bracket was high.

As one reader pointed out, many people with 401Ks have less than $400,000 in their accounts when they retire. Then too with little growth in income occurring (mentioned earlier), one can see why people are not saving for retirement and why there is less in their 401ks.

Under today’s Stretch IRA rules, heirs of IRA owners were allowed to extend the taxable distributions of an inherited IRA over their lifetime, hence being called “stretch IRAs.” The proposed Senate bill labeled RESA—allows $400,000 of aggregated IRAs to stretch per beneficiary, but chops the cash-out period down to five years for the balance greater than $400,000.

What are the implications in the Senate bill? As I said it affects non spousal beneficiaries of the heads of families who have accumulated money greater than $400,000 over their lifetime to pass on as inheritance to their families. Non-spousal beneficiaries on inheriting sums of money greater than $400,000 could have a substance portion of the inheritance taxed by Uncle Sam and also end up in a higher tax bracket as a result. Ok, I said it enough times.

Similar would hold true for the House bill which eliminates the stretch IRA, does not have an exemption for 400,000 of inheritance, and forces a beneficiary to use up inheritance funds in 10 years rather than a lifetime or RESA’s 5 years. The proposed Acts do not impact spousal beneficiaries or minor children named as beneficiaries until pf a majority age, children with disabilities, etc.

The forced 5 year annual distribution of these savings and retirement plans by beneficiaries is the primary revenue vehicle (taxes) of RESA. Senate Finance Committee Chairman Chuck Grassley, (R-Iowa), who proposed the bill, said on the Senate floor recently that the RESA bill “is paid for” by this provision (as he takes his agricultural benefits resulting from tariffs).

No worries for the 1 percenters.

Back to the 1-percenters, Trump’s Tax Overhaul law doubles the estate-tax exemption to $22 million a couple and possibly avoiding taxes in dynasty trusts. The new law doubles the amount that can be passed to heirs without worrying about estate and gift taxes, to about $22 million for a married couple (redundant, I know). But the thresholds are in place only until 2025, and the ultra-rich are turning to a key tool — the dynasty trust — to secure the financial futures of their children, grandchildren, great-grandchildren, and beyond.

Assured wealth and income giving descendants a place on the ladder of mobility as being necessary to move upwards on that same ladder by Tom Hertz and Nick Hanaeur.

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WARNING: another “debt ceiling debacle” is looming, and could cause nearly immediate recession

WARNING: another “debt ceiling debacle” is looming, and could cause nearly immediate recession

It’s time to start to get seriously worried about another “debt ceiling debacle.” In 2011, the GOP refused to authorize a “clean” debt ceiling hike. The hike in the debt ceiling, for those who may not know, is necessary for the US government to pay debts that *it has already incurred.*

In 2011, as a result of the impasse, US creditworthiness was downgraded from AAA to AA. Consumer confidence plummeted:

Note the next largest spike downward occurred during the government shutdown at the beginning of this year.

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S&P 500 P/E

Friday evening the S&P 500 closed at 3013.77, up 20.2 % year to date. But much of that gain is just recovering from the drop in late 2019, as  it is only up some 3.4% from September, 2019.

This is the first time the S&P closed above 3000 and people are wondering if the market is overvalued. The S&P 500 PE is now at 19.6, almost exactly where my model implies it should be.  As the chart shows it is right in the middle of my estimated fair value band just as it was when Trump was elected.  But the PE was 21.3 in November, 2017 as compared to 19.6 now. Both the actual PE and the fair value band declined through 2017  and 2018 and the fair value band has stabilized so far this year.  Interestingly, this means that S&P EPS has been rising faster than the market since Trump was elected. So, aside from the tax cut, investors are not projecting that his economic policies will generate stronger earnings growth.

Figure one

But my model PE is strictly a function of interest rates.  It is an expression of what is the present value of a perpetual stream of earnings growth. You can see how the model said the market was very expensive in the 1990s when investors came to believe that we were in a new era of stronger growth  with out a significant  risk of recession. The early 2000s were just the opposite, when investors feared we were in a new era of permanent stagnation and very weak earnings growth. So the PE was very far below its fair value.

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Real average and aggregate wages improved in June

Real average and aggregate wages improved in June

Now that we have the June inflation reading, let’s finish out our week focusing on the labor market.

First of all, nominal average hourly wages in June increased +0.2%, while consumer prices increased +0.1%, meaning real average hourly wages for non-managerial personnel increased +0.1%. Together with upward revisions to prior months, this brings real wages up to 97.2% of their all time high in January 1973:

On a YoY basis, real average wages were up +1.6%:

On that score, this morning’s readings include this take by Prof. James Hamilton at Econbrowser indicating that the Phillips curve (the trade-off between inflation and employment) is still alive, together with this guest post by David Branchflower at Talking Points Memo on Jerome Powell’s acknowledgement that the Fed (and many others) failed to appreciate that we were not at full employment in 2016 as they began to raise rates, and stating that the evidence

shows that, now, wage growth is driven not by unemployment but by underemployment, which has still not returned to pre-recession levels. That explains the weak wage growth we see today, and why the U.S. is not yet at full employment.

This has been my point of view as well, and it gives me the opportunity to run a graph I haven’t updated in quite awhile – average hourly wages of non-managerial workers (minus 2.5% for easier observation] vs. the U6 underemployment rate [subtracted from 10% so that lower rates show as positives]. This shows that, following recent recessions, underemployment has had to fall below 10% before wage growth stops decelerating:

Last month I raised a concern that real aggregate wages had decelerated sharply this year, writing that “[w]hen we take the information in the above graph and chart the YoY% change, we see that real aggregate wage growth has typically decelerated by 1/2 or more from its 12 month peak just at the onset of recessions, although there have been 3 false positives coincident with slowdowns.” Well, with June’s revisions that concern has disappeared for now:

Finally, with the improvement in June, real aggregate wages – the total amount of real pay taken home by the middle and working classes – are up 29.2% from their October 2009 low:

For total wage growth, this expansion is solidly in third place, but behind the 1960s and 1990s, among all post-World War 2 expansions; while the *pace* of wage growth has been the slowest except for the 2000s expansion.

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The Rise of Global Innovation by US Multinationals

The Rise of Global Innovation by US Multinationals

Lee G. Branstetter, Britta Glennon, and J. Bradford Jensen of the Peterson Institute for International Economics provide an interesting discussion of the risks and opportunities from the following:

Total US R&D spending as a share of GDP increased slightly from 2.5 percent in 1999 to 2.7 percent in 2016.2 Multinationals are an important driver of aggregate R&D spending in the United States.3 Their share of total US R&D spending was 57 percent in 2015.4 US MNCs play a disproportionately important role in driving innovation within the United States. At the same time, US MNCs have dramatically increased their overseas R&D expenditures. Figure 1 shows that US MNCs’ foreign R&D expenditures increased from nearly $15 billion in 1997 to over $55 billion in 2015. In some industries, the growth of overseas R&D has been especially striking. R&D expenditures by overseas affiliates in professional, scientific, and technical services increased by more than a factor of 18 between 1999 and 2014, and the ratio of overseas R&D to domestic R&D by multinationals in this industry has increased from under 10 percent in 1999 to over 40 percent in 2015. While US MNCs’ foreign R&D expenditures have increased dramatically, they still conducted about 83 percent of their R&D in the United States in 2015 (down from 92 percent in 1989).

I wish to add one more wrinkle – that being the transfer pricing implications from these observations and the latest from the IRS:

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Destroying Social Security to Save It

Connecticut Representative John Larson Proposes Plan To Destroy Social Security In Order To Save It, by Dale Coberly

Connecticut Congressman John Larson introduces H. R. 860, Social Security 2100 Act which will cuts taxes, strengthen benefits, prevents anyone from retiring into poverty, and ensure Social Security remains strong for generations. larson.house.gov

It sounds good, but of course he wants it to sound good. In the past we have had to be worried mostly about plans from the “Right,” the crazy people who want to Save Social Security in order to destroy it. Their plans sounded good, too.

To make it easier on myself, I am going to just list Larson’s points and offer a few words about them in the hope you will think twice.

Larson: The Social Security 2100 Act Expands Benefits

There is a benefit bump for current and new beneficiaries — Provides an increase of 2%.

Me: A 2% increase in benefits would mean nothing to beneficiaries. Unlike the reduced inflation indexing the bad guys were proposing, this increase will not accumulate over time.

What Social Security faces is a potential 20% cut in benefits if the payroll tax is not increased to keep up with increases in life expectancy. The increase needed would be about 2% of payroll. 2% of payroll becomes 20% of benefits because the 2% you pay is matched by 2% your employer pays for. That extra 4% over 40 years of working becomes 8% over 20 years of life expectancy, and that 8% becomes roughly 20% due to the effective interest that arises automatically from pay as you go financing.

Larson: Protection against inflation. Increases the COLA formula to better reflect costs incurred by seniors.

Me: Probably a good idea. But the “normal” inflation adjustment, if paid for by that 2% increase in the payroll tax, will provide increased benefits that may be adequate. The question is how are we going to pay for a higher COLA? My suggestion is that a tiny bit larger increase in the payroll tax would not be felt, and would avoid the politically suicidal “make the rich pay” part of Larson’s plan unnecessary.

Larson: Protect low income workers. A new minimum benefit will be set at 25% above the poverty line.

Me: Again, probably a good idea. But not if it changes the “worker paid” feature which is so important to Social Security’s political future.

If the workers want to pay more for a higher benefit dedicated to those who paid for the insurance against ending among the poorest, then that’s fine. It’s not so fine if the increase is paid for by “the rich,” because the rich will not pay for it. And it’s not so fine if it becomes subject to increased hiding of income to free-ride on others paying the tax. Not to mention the costs of managing the means testing that this implies.

Larson: Cut taxes for beneficiaries.

Me: Social Security is supposed to be insurance against ending up poor. Currently no one pays taxes on their Social Security income unless they have other income over $25.000 per year. Combined with their SS income this would suggest an income in retirement of about $45,000. This is not poverty.

There are other ways to jiggle around the SS ‘break points” or taxing of benefits. The tax on part of SS income for those with enough other income to stay out of poverty turns out to be the simplest and fairest. Might be important to remember that SS is not only “what you paid in,” but is about double what you paid in because of the effective interest of pay as you go.

You pay taxes on gains from every other investment. So there is nothing immoral or counterproductive about taxing part of SS benefits for those who otherwise have sufficient income. This tax is returned to the Social Security trust fund and is part of what helps pay those increased benefits for the poor.

Larson: Strengthens the Trust Fund

Have millionaires pay the same rate as everyone else.

Me: This is the bit that destroys Social Security. Currently millionaires pay the same rate as everyone else: 12.4% of the first $130 thousand per year. This is enough for them to pay for what they get from Social Security… an effective real interest of around 1 or 2 percent, plus the insurance value in case their millions of dollars disappear before they retire, or when they become disabled or die leaving dependents.

They only get that 1 or 2% compared to your 2 or 3% and the poorest up to 10% or more because the money they would get if everyone got paid the same interest is what enables SS to pay the bigger “interest” needed to pay for basic needs of the poorest.

“Making” them pay 12% on ALL of their income would be a huge tax increase they would get nothing out of. They would fight it forever.

It would be like having a cop watch the check-out line at the grocery and demanding every customer show their tax returns and “making” anyone with “too much” income pay for the groceries of the next ten people in line.

This sounds fair to some people who think that the “rich” stole their money from the “poor.”
Maybe some did, but this is not the way to fix that problem. If you want to tax the rich more, fine. If you want more welfare, fine. But don’t do it to Social Security, which works, and has worked for eighty years exactly because it is NOT welfare. NOT “soak the rich.”

Larson: 50 cent per week to keep the system solvent. Gradually phase in an increase in the tax by an average of 50 cents per week.

Me: Sounds familiar. Question is why stop at 50 cents when a dollar will keep the system solvent forever without the political dangers of “make the rich pay”?

Do we think an extra 50 cents per week out of an income of 50k per year is going to be felt? Note that for the poorest people making 20K per year, the “dollar per week” turns out to be 20 cents per week (The increase needed to keep SS solvent forever is one tenth of one percent of income per year.)

This is mindless greed. Greed so stupid it defeats itself.

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Housing: Elizabeth Warren v. John Cochrane

Housing: Elizabeth Warren v. John Cochrane

Noah Smith has a lot of praise for the economic policy proposals from Elizabeth Warren. I’ll mention only one:

With costs for shelter eating a bigger piece of Americans’ paychecks, and local government paralyzed by incumbent homeowners, the country needs a big solution. Warren’s would combine incentives for raising zoning density with increased public construction”.

This is interesting in light of John Cochrane’s rant attacking the Democrats on the housing issue. Read it for yourself. Cochrane only noted the increased public construction aspect and tried to tell his readers that only Cory Booker wanted to reform zoning issue. While Cochrane admitted increased housing supply would be a good idea – he slandered any government efforts to do so. No wonder he’s the “grumpy economist”!

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The consumer is alright

The consumer is alright

One of my big themes this year is that low gas prices can hide a multitude of economic sins. This morning’s data on personal income and spending confirms that the consumer side of the economic ledger is doing OK.

Nominal personal income rose +0.4%, and nominal personal spending rose +0.5%. After adjusting for inflation, the numbers are +0.3% and +0.2%, respectively. As a result, the positive trends for both continue:

On a YoY basis, we can see that spending slightly leads income (similarly point to the way consumption leads employment, not the other way around), and is also more volatile:

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Initial jobless claims: positive this week, but close to crossing two thresholds for concern

Initial jobless claims: positive this week, but close to crossing two thresholds for concern

I have started to monitor initial jobless claims to see if there are any signs of stress.

My two thresholds are:

1. If the four week average on claims is more than 10% above its expansion low.
2. If the YoY% change in the monthly average turns higher.

Here’s this week’s update.

The four week average is 9.8% above its recent low:

On a weekly basis, YoY the average is +0.3% higher than this week last June.

Last June the monthly average was 222,000. With one week still to go this June, it is 221,250:

 

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Ali Velshi Interviews Arthur Laffer

Ali Velshi Interviews Arthur Laffer

Today I endured listening to Arthur Laffer lie serially to Ali Velshi today. Skip the first 36 minutes of this Youtube as the interview begins there. Never mind the praise for Laffer’s cheerleading for Trump. Laffer actually claimed that the FED’s low interest rates after the Great Recession began was the cause of the Great Recession. OK! But then he pivots and advocates we should have low interest rates now that Trump is President. I know – WTF?! OK – don’t trust Laffer on monetary policy but the real fun was when he claimed that the Reagan tax cut of 1981 led to average annual growth rates of 8% during his first term. I think that is what Laffer is claiming but BEA data suggests much lower growth rates for real GDP. OK – we all know that Laffer lies a lot but why on earth does MSNBC bother to let Ali Velshi just sit there and thank him for such dishonesty.

Arthur Laffer lying to Ali Velshi on low Fed Rates after the Great Recession actually were the cause of it.

UpdatePaul Krugman explains Laffer’s bizarre monetary theory well before this interview:

The Trumpification of the Federal Reserve: In late 2015 then-candidate Donald Trump accused Janet Yellen, chair of the Federal Reserve, of being part of a political conspiracy. Yellen, he insisted, was keeping interest rates unjustifiably low in an attempt to help Hillary Clinton win the presidency. As it happens, there were very good reasons for the Fed to keep rates low at the time. Some measures of the job market, notably prime-age employment, were still well below precrisis levels, and business investment was going through a significant slump — a sort of mini-recession. Fast forward to the present. The employment picture is much stronger now than it was then. There are hints of an economic slowdown, partly because of the uncertainty created by Trump’s trade war, but they’re considerably fainter than those of 2015-16. And Trump himself keeps boasting about the economy’s strength.

But of course Trump insists we need to lower interest rate because??? And of course Art Laffer has to agree with his political master.

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