Category: Taxes

Market Rallies Don’t Always Make Sense

Market Rally FollyStimulate Economy - Red Button

Can government infrastructure spending, or “fiscal stimulus,” create more wealth? The stock market certainly seems to think so. As financial publications have recently opined, the stock market has been hitting record highs (Dow 20,000!), at least partly because investors believe the new Administration will usher in an era of government spending on things like roads, bridges, telecommunications and defense. While this may give some companies a boost, it will be a drag on long-term economic growth.

The Seen Versus the Unseen

The art of economic thinking is always to consider the seen versus the unseen. In the case of infrastructure spending, what is seen is the widening of highways, the new suspension bridges and the faster internet cables being buried underground. It is easy to see how this spending could be a good thing because the wider highways and faster internet probably enhance productivity.

Furthermore, any government spending – even on bridges to nowhere – is seen as beneficial, due to the Keynesian idea of the “multiplier effect.” This theory posits that governmental spending gives the construction workers more income, who then go and spend the income on other goods and services such as restaurants or new cars.

This in turn gives those restaurant staff and car manufacturers more income, which they then promptly spend. Each dollar the government spends is therefore “multiplied” throughout the economy.  

The Unseen Hand

What is missing from this analysis is the unseen. For government to spend any money, it must first get that money from somewhere; taxes are the most direct method and borrowing is another option, but this only means higher taxes in the future to pay for the borrowing.

While the government technically can’t print money directly to finance spending, it can do so through other means, which cause inflation and which are – you guessed it – just another form of tax.

Therefore, since taxes can only be taken from those who are creating wealth (for example taxes on profits or income), or from the existing base of wealth (such as real estate taxes), then by definition, government spending can only be accomplished through the transfer of wealth.

But Isn’t Infrastructure Useful?

Proponents of government spending may agree there is a transfer of wealth occurring, but that wealth is being employed into productive uses, such as infrastructure. After all, the construction and maintenance of roads allows businesses to ship their goods all over the country more easily.

It is true that things like roads, bridges and electrical grids are useful. But the pertinent question is how useful? If money is taxed away from a business to build a road, that business may no longer be able to build another manufacturing plant and provide an increasing number of products at a lower price, employing more workers in the process.

In other words, infrastructure spending faces a calculation problem. While politicians can hazard a guess that a wider highway or a public transportation project has some value, it is impossible to know (or prove) that the project is more valuable than what the private sector would have spent those tax dollars on.

If this calculation problem were enough to give cause for concern, there is also a problem of incentives. Infrastructure projects that are likely to be funded are those that will create the most jobs or please the most constituents, not the ones that make the most economic sense.

This logic means that the Keynesian “multiplier effect” does not exist, because every dollar spent to begin with does not come out of thin air but must instead be redirected from something productive. In fact, some of the latest rigorous academic research has confirmed the government spending multiplier to be negative, not positive (see a nice summary of this research from Dr. Lacy Hunt of Hoisington Management).

Employee IncentiveWhat this Means for the Stock Market

The stock market is always forward-looking, and it is likely making new highs for a host of reasons on which financial journalists can only speculate. It is also true that increased fiscal spending could give select companies a lot of extra business in the short term.

However, valuation levels for broad market indices such as the S&P 500 are currently at some of the highest levels in history, exceeded only during the dot-com bubble and the brief run-up before the Great Depression. At current levels, the stock market would have to decline by anywhere from 40% to 60% just to return to historical norms!

To be clear, valuation tools are not timing indicators, and anything is possible in the short term, including a continued bull market in the months ahead. However, what valuation models of the stock market can reveal is that, over the longer-term (10-12 years), investors should expect very low returns (low single digits annually) if they invest at these elevated levels.

Diversify across All Asset Classes

The best strategy is to stick with a plan of being diversified across asset classes, including hard assets such as precious metals, other commodities and real estate.

And don’t let any infrastructure spending plans fool you into thinking it will be a huge boost for the economy and the stock market!

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Independent Workers AND Businesses: Be Damned!

 

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Over the past couple of months, I’ve been engaged in a spirited debate with a friend regarding how employers are increasingly classifying workers as independent contractors, instead of W-2 wage employees.

So what’s fueling our dialogue? In short, the practice she works for is currently facing a decision as to whether the independent contractors they’ve long relied upon to perform operational and administrative duties should now be reclassified as W-2 staff. This issue has surfaced largely due to recent evidence of a crackdown on the part of the IRS and other government agencies against employers who have utilized independent contractors in defiance of prevailing regulations. While disagreeing with the intent of the law requiring employers to serve as a de facto middle man for ensuring that tax revenues are consistently collected and accounted for, she is correct in asserting that violating the law opens her employer up to some serious consequences, including some pretty hefty fines.

As a former human resources executive, now a business owner, who is well acquainted with the adverse bottom line ramifications of W-2 staffing, I believe that independent contractors are the way to go in terms of operational cost effectiveness. In reality, it can make all the difference in the world in terms of whether a company, such as the one at which my friend works, will ultimately survive financially. So for the vast majority of small and emerging businesses (which represent the fastest growing segment of the U.S. economy), the decision can come down to either breaking the law or keeping their doors open. It’s can be as simple as that.

Non-Compliant Businesses Face a Government Smackdown

Media buzz on this topic has been plentiful of late, as federal and state governments appear hell-bent in their efforts to stymie this independent contractor classification movement. On the other hand, the general consensus among business leaders is that this sort of crackdown will stifle innovation while making the cost of doing business onerously expensive. Many of these leaders say that this may force them to eliminate jobs in order for their businesses to remain buoyant and profitable.

Adding gasoline to this debate were the recent campaign speech comments made by presidential candidate Hillary Clinton, when she strongly endorsed redefining current independent contractors as employees. To me, this reflects the One Size Fits All Herd Mentality that statists constantly perpetuate. In a sense, what’s she’s saying to independent workers is ‘because we think businesses are out to screw you, let US define what a proper employment relationship looks like.’ Like a cow chewing over the same old cud, this view is another tired version of Industrial Age thinking that employees and the businesses for whom they choose to work are controlled by government as well as powerful side interests.

 

The Plight of Today’s W-2 Worker

And what about those who are currently W-2 wage employees? How do they really feel? Many with whom I cross paths tell me they appreciate having a steady paycheck and benefits. But in the same breath, I hear them howl like jackals at the onerous restrictions they are often placed under as a result of ‘working for The Man’. Many of them are quietly miserable yet hanging on for dear life because the work they are doing offers a sense of security. If you were to corner them for the truth, they would likely reveal their longing for a gig which allows them the freedom to do what they want to do, when they want to do it, and get well paid along the way. This mindset is particularly common among free-spirited millennials who see little value in the 9-5 Protestant Ethic, or retiring with the gold watch lifestyle that appealed to their parents’ generation.

Sadly, growing numbers of us independent contractors may be forced into choices that we may or may not want to make, if this W-2 movement gains traction. It’s here that political know-it-alls pretend to pose as advocates for today’s workers, while having little in the way of on-the-ground context in the larger economic milieu. For if the power elite in government gets their way, it will only serve to drive businesses to scale back and send work overseas in an attempt to remain financially viable. In the meantime, consumers could be harmed by reduced services and higher prices. And our nation’s independent contractors, well, this will simply be another sign that life, liberty and the pursuit of happiness is just a hollow mantra with no real substance.

Listen to your Lyft Driver, not Political Leaders

I happen to love the ride-sharing service Lyft. As a free-spirited city dweller, I revel in the thought of not owning a car nor having the cost and inconvenience of gas, maintenance, parking, auto registration and car payments. And, honestly, I get more real world information from the drivers in terms of how our economy really works than I do from all those sorry political leaders at the executive and legislative branches of government, replete with their single-digit approval ratings.

By way of example, I just talked to a 76 year-old driver a few weeks ago who discovered that his retirement isn’t quite what he thought it would be. Then there is the computer programmer who left a job he hated, and is now making just as much driving cars while having time on the side to start his IT business. And how about the single mom who is earning a little extra money on the side, fueling her endeavor to go back to graduate school.

This is just one example of how the the sharing economy, via flexible contract work arrangements, is boosting personal incomes as well as the overall economy in general. Thanks to mobile technology, the results have been nothing short of spectacular. Creative work arrangements, innovation, flexible jobs, and a fresh set of consumer options – all have ensued from this new normal of work relationships. But I do worry that one day this wonderful set of freedoms will no longer be available, due to status quo thinkers who want to see the independent worker-driven sharing economy destroyed. Whether it’s Lyft, Robert Half, AirBNB, or eLance, the impact in its full manifestation would be widespread.

So What’s REALLY Behind the Government’s Stance?

The rationale is pure and simple. Workers classified as W-2 offer a more efficient way for the federal and state governments to ensure timely collection and accountability for tax revenues. Period!

In some ways, I can’t argue with this because it is in the same vein as a for-profit business; the government wants its money pronto. In other ways, I get ticked when I hear about how this tax collection method has become a priority amid shortfalls caused by other forms of IRS inefficiencies.

The bottom line is that payroll taxes are a cash cow. The more workers who are classified as employees, the more milk and honey flows into government coffers, and the harder it is for workers to underreport or hide their income from the tax authorities.

Government officials lament the fact that independent contractor misclassification schemes deprive state and federal treasuries of billions of dollars in tax revenues. Moreover, they note that laws have existed for quite some time to clarify who is and is not an independent contractor. The key principle, according to the Labor Department’s 15-page guidance memo, is “whether the worker is economically dependent on the employer or truly in business for him or herself.”

Clear enough? Well, not so fast, as there is certainly an argument to be made that many businesses that misclassify their workers do so unintentionally, because the guidelines – when you put a shovel to them – are as clear as mud. Then when it is revealed that a business is in violation, the employer is reluctant to make the change, largely because for every contractor who is reclassified as an employee, there is an additional 20-30% in payroll and benefit costs assumed by the business.

This reminds me of a past client of mine, a weight-loss practice that elected to follow the rulebook by the letter and classify all staff as W-2 wage earners. Sick of hearing all of the griping and complaining among her team regarding how little they were being paid, the owner took the extraordinary step of revealing all of the financials of the business at one of their staff meetings. One of the employees, after a meticulous review of the report, immediately chimed in with what she detected was the reason for their paltry pay scale. “What’s this expense?” she blurted out. “If you made a cut to this, you could give us all a $2-3 raise.” Bemused, the owner retorted, “Well, those are the taxes I have to pay to the IRS on behalf of each of you team members, every pay period.”

As a postscript, it should be noted that this highly acclaimed weight-loss practice went out of business.

My Proposed End Game

So let’s conclude with two opposing end game scenarios, along with a third option.

First, if the government powers that be force an end to the contractor designation, employers will have to take on massive new burdens like withholding tax, providing health insurance and offering unemployment insurance, in addition to being subjected to myriad other onerous rules and regulations. And startups and early-stage businesses, needing additional talent while facing low profit margins, will be dead on arrival.

The second and more reasonable scenario in my estimation is to continue to allow some fluidity in the prevailing contractor laws. That way the workers become the real capitalists. They have the freedom to work when they are most productive, maintain their own equipment, and they have the flexibility to take time for family and other leisure pursuits. This arrangement also allows a flexible staffing model that’s amenable to fluctuating workloads. Businesses can hire people for short-term tasks and projects without having to endure the trauma, expense and legal issues associated with firings and layoffs.

Finally, there is a hybrid option where the federal government could require contractors to set up a business entity and bank account where they are paid under the business name. Then either on a bi-weekly or monthly basis, that contractor would initiate a W-2 payroll check from their business (through the use of an inexpensive payroll service) with the requisite taxes taken out. The benefits of this option would be the following triple-win proposition:

(1) IRS gets their money on a timely basis.

(2) IRS would no longer have to track and match up 1099s to ensure that they are not being stiffed by underreporting subcontractors, a loophole they are policing rather poorly.

(3) Contractors receive often overlooked tax deduction advantages as a result of having all of their money funneled through their business entity.

(4) The business owner has the freedom to manage their own destiny by becoming their own form of venture capitalist.

In the end the goal here is to provide thoughtful middle ground that offer a measure of worker freedom along with IRS compliance without being onerous to the employer.

Michael Scott is a Denver based writer specializing in feature stories targeting the intersection between free markets and social and economic freedom. He can be reached on Twitter @biz_michael

Major Tax Reform: A Good Idea or Fuel For Cataclysmic Upheaval?

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Tax expert and author of Tax-Free Wealth Tom Wheelwright has never been one to mince words about tax reform. And he certainly didn’t disappoint in a recent radio interview about a spate of ideas being bantered about by some of the 2016 Presidental candidates. So does Tom think that major tax reform, which would involve slicing and dicing through the 74,000 pages of tax code regulations that currently exists, is a good idea? Listen to this five minute video to find out more.

Expert Interview: Tom Wheelwright, Tax Free Wealth

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When we hear the word “taxes” it immediately captures our attention. For some, it conjures up fear and dread. But according to tax expert Tom Wheelwright, the word represents significant financial advantages for those savvy enough to capitalize on key provisions in our tax law.

As a tax authority and Rich Dad Tax Advisor, Tom is fond of a saying espoused by Robert Kiyosaki, author of the book Rich Dad, Poor Dad. Robert says, “Debt and taxes will make you rich.” Following on this point, Tom recommends having a great tax advisor who is knowledgable about tax law and real estate investing. In his book Tax Free Wealth, he offers a treasure trove of strategies that create tax favorability for your business and personal income. Tom is CEO of ProVision Wealth where he and his team works with successful small businesses and entrepreneurs in 30 countries, helping them build long-term sustainable wealth. He is a frequent speaker for groups both nationally and internationally and has been featured in Accounting Today, Investors Business Daily, Deseret News National, and CEO Blog Nation.

I had the pleasure of interviewing Tom for this piece, and found his approach to taxes and wealth building to be quite refreshing. Check out the discussion below for his no-holds-barred thoughts on how we can keep more of what we earn personally as well as in our businesses.

 


Tom, what prompted you to write a book on taxes, of all things?

[Chuckle] It seems like wherever I turn, I tend to hear about the tax law being bad and terribly complicated.