In a time, long ago, Americans looked to their banker as a partner to assist them in their financial affairs. Often a small loan at a reasonable fee and a prompt payback resolved a pressing problem. At other times sage advice from a knowledgeable branch manager made the difference between distress and good fortune. And above all, the ability of a depositor to maintain a simple passbook account and receive a meaningful flow of interest income might provide just enough extra to make ends meet.
Circumstances change. During the past four decades banking morphed into a conglomerate industry, unimaginable when in August 1979 Paul Volcker assumed the Chairmanship of the Federal Reserve System. At the time President Jimmy Carter experienced the effects of a world turning hostile to the USA. Our alliance with the prominent mid-eastern nation of Iran disintegrated when, on January 16 of that year, the Shah fled the country, replaced by an Islamic regime. In addition, the OPEC cartel successfully engaged in a series of oil embargos depriving us of the inexpensive petroleum on which our economy thrived. And of particular concern, our nation found itself in the grips of an unacceptable inflation. Something needed to be done.
Chairman Volcker took control and steadily increased the prime rate into the 20% range (it topped out for a short time at 21¼%). Though it proved to be traumatic for many, it broke the inflationary spiral and conditions began to return to normal. And with the inauguration of a business-friendly President Ronald Reagan in January 1981, prosperity appeared to return, though in a less congenial world than before. Over the next twenty years our nation enjoyed – with but a few blips – a vibrant stock market and a real estate inventory systematically increasing in value. By the arrival of January 1, 2000, the American economy seemed poised for perpetual growth.
A funny thing happened on the way to nirvana. Many of those public corporations whose purposes related to technology – and mostly with astronomical Price-Earnings Ratios – ran into a fiscal brick wall. The bursting of the tech bubble – also known as the Dotcom Crash – began March 11, 2000. By its conclusion October 9, 2002, it wiped out countless would-be entrepreneurs. Many illusory fortunes disappeared. But the technology demise qualified merely as the hors d’Oeuvres; the main course was yet to follow. During the 17 month period from October 9, 2007 through March 9, 2009, the Dow Jones Industrial Average fell from its peak of 14,164.53 to a low of 7,924.56 – a loss of approximately 50 percent of its value. This constituted the worst sustained decline since the collapse kicked off by the Stock Market Crash of 1929 and the Great Depression that followed.
From this point on, American enterprise took on a regulatory overtone, with banking policies decreed by the federal government. The impetus for this oversight was the 2319-page Dodd-Frank legislation, enacted in 2010 during the Barack Obama administration, thereby establishing a myriad of regulatory committees promulgating programs to which banks thereafter adhered. Although those rules masqueraded as reform, most were as convoluted as they were arcane. The result of those imposed federal regulatory burdens were predictable: duplicative and often contradictory rules which rarely promote safety or soundness. In particular, mortgage lending became a nightmare due to the regulations and disclosures required. The layers of red tape became so burdensome, more and more potentially profitable firms simply abandoned the banking business. Only the mammoth institutions, with direct links to the federal regulators and the U.S. treasury, truly prospered.
Where are we now in the year 2017? Things have certainly changed in my home state of California. Of the nearly 500 banks headquartered here in 1994, less than 180 remain – and of these, even fewer will be around by year’s end. Quite simply, the smallest ones maintain too few assets to keep up with the ever growing compliance costs. It’s for this reason the community banks, accounting in 1994 for nearly half of the Golden State’s banking, are now down to just 11 in number. Most of America’s banking is now a monopoly, provided by a group you can count on your fingers.
We’ve finally arrived at this article’s title subject: interest. Do you remember when you once received annual interest on your savings account of five percent? If you maintained a balance of $100,000, you’d receive $5,000 in income, which often meant the difference between meeting all your bills or falling a bit short. So how do things shape up if you slip the same sum into a Chase Bank account today? You’ll receive an annual return of 0.01% – $10 is what you’ll see. Okay, let’s find a more competitive bank: Bank of America. Hmm, at the same 0.01% rate, that’s no better – and to make things even worse, they charge a $5 per month account service fee, so you’ll be $50 out of pocket every year.
There’s a justification the interest rates offered are in the basement. It’s because these institutions no longer need to match rates with a lot of competitors trying to get your deposit, for most of them are gone. The few majors retain an increasingly firm lock on the market; you’ll soon bank with them or there’s nowhere else to go. And don’t expect them to compete among themselves for your business. They’re now collectively in the driver’s seat, and will not cut each other’s throats for your money, for there’s plenty to go around for the handful of them remaining. It’s for this reason you may as well reconcile yourself to receiving minuscule interest on your savings. I see no changes in the foreseeable future.
So much for the interest you receive. Now, what about the interest you’re required to pay? Although Fed Chairman Janet Yellen is systematically increasing the prime rate, it’s not going up rapidly. This is not by accident. The one thing keeping the rate reasonably low is the more than $20 trillion in loans the US is on the hook for. It’s for Uncle Sam’s benefit rates remain low – the one thing we may be thankful for. Therefore, for those of you with a good credit rating, you needn’t expect your personal borrowing to become unsustainable, nor will your adjustable mortgage rate soon soar out of control. However, if your credit is below par – possibly in the 550 range or below – you may expect to be put upon at every opportunity. Be late with a payment on your credit card a couple of times and you’ll find yourself paying 25% or more on the unpaid principal balance. Incur the misfortune of needing a payday loan which must be rolled over and you’ll be the victim of rates rising to 300% or greater. Be aware this world is a hostile environment. There are many lenders who are not your friend.
Let me conclude on what I consider to be a humorous note. It’s relates to a newspaper display ad by a bank I’ll not name, offering an 18-month Certificate of Deposit that pays an annual percentage rate (APR) of 1.50 percent. The rate offered is printed in 72 point bold; the details are at the bottom in 8 point upper and lowercase. If you read carefully you’ll learn: the minimum CD amount must be $100,000; any existing deposit money they presently hold cannot be applied to the CD; fees may reduce earnings on the account; a penalty will be imposed for early withdrawal; additional terms and disclosures are available upon request. And under these conditions, you’re entitled to an APR of 1.5 percent. Perhaps you don’t consider this humorous, but I find it hilarious. Only in an investment environment gone mad might such an offering be made.
An article by Rob Nichols, president and CEO of the American Bankers Association, just appeared, titled “Why are small banks disappearing?” He reports most community banks throughout the nation no longer exist, the result of regulatory burdens imposed on the banking industry following implementation of the Dodd-Frank Act in 2010. He then explains that unless major changes are made to eliminate the duplicative and often contradictory rules by which banking must abide, the only banks to survive will be a small number of mammoth institutions. He concludes with a warning “the banking sector will continue to shrink and become less diverse,” and that “all Americans will pay the price in terms of lost opportunities.”
Mr. Nichol’s comments jogged my memory. For your interest I’ve reproduced an article I wrote nearly seven years ago when Dodd-Frank became law. You may draw your own conclusions.
WELCOME TO THE NEW ORDER
On Wednesday, July 21, 2010, President Barack Obama signed into law what is commonly titled the Dodd-Frank Wall Street Reform and Consumer Protection Act. This legislation, consisting of 2,319 pages, and designed to address the abuses plaguing the nation’s economy over the past several years, is the most radical overhaul of the U. S. financial sector since enactment of the Glass-Steagall Act of 1933 which, among other things, established the Federal Deposit Insurance Corporation (FDIC). Although I didn’t scrutinize each provision of Dodd-Frank, I did scan the entire text and read numerous reviews. I admit much of what is buried in the text is a mystery to me, but I’ll wager I understand it as well as most of the legislators who voted for or against it. For your enlightenment, I’ve summarized below some of the more notable provisions.
1) A most prominent feature of the law is the creation of the Bureau of Consumer Financial Protection, to be housed in the Federal Reserve, but operate independently from it. Its sole function will be as its title claims: act as a watchdog agency for consumer protection, with authority to write and enforce rules on all types of consumer products including, but not limited to, mortgages, credit cards and payday loans. In addition, it will exercise consumer protection powers over banks and credit unions with assets no greater than $10 billion.
2) A second group to be created is a ten-member council of regulators, headed by the Secretary of Treasury, with broad powers to monitor threats to the financial system. Its authority will extend to the review of banks, insurers, and credit unions, determining which shall survive and which shall not. If the regulators decide a company poses a threat to the system, they can dismantle it and dispose of its pieces. This council also possesses the authority to overturn new rules enacted by the Bureau of Consumer Financial Protection previously mentioned.
3) The authority of the Federal Reserve is expanded to include oversight of large companies whose possible failure is monitored by the council of regulators. At the same time the Federal Reserve will undergo increased scrutiny by the General Accountability Office (GAO), the investigative office of Congress. In general, the aim is to more intimately tie together all the branches of government in its oversight of the nation’s financial operation.
4) In an attempt to make the financial sector less risky for investors, mandates are included that ban proprietary trading by banks and limit their stake in hedge funds and private equity firms. This provision, referred to as the Volker Rule, is named after former Federal Reserve Chairman Paul Volker who worked diligently to limit excessive risk on Wall Street. In his arguments, he stressed the importance of restricting banks from making certain kinds of speculative investments if they are not in behalf of their customers, pointing out the havoc experienced during the past decade was the direct result of excessive speculation by banks.
5) The world of derivatives is not ignored in this bill. A wide-ranging set of restrictions are placed on this $600 billion market in an effort to make these complicated financial products more transparent. One of the more controversial edicts, sponsored by Sen. Blanche Lincoln (D-Ark), restricts derivatives trading by requiring bank holding companies spin off the riskier derivatives into separate affiliates receiving no federal taxpayer assistance. However, numerous exceptions are allowed, particularly those related to markets in interest rates, foreign exchanges, gold, silver and certain forms of credit default instruments. In addition, these restrictions only become effective on new derivatives contracts after a two-year phase-in period.
6) If one ruling escapes criticism, it is the permanent extension of the $250,000 FDIC deposit insurance coverage on accounts, previously scheduled to revert to $100,000 in 2014.
7) From this point on matters become considerably murkier. Various provisions provide for fragmented authority, with state and federal agencies sharing somewhat diffuse responsibilities. Economic uncertainty will be inevitable as bank and securities regulators begin to write and adopt the 243 rules ordered by the legislation, with some of these rules requiring years to implement. There are, of course, a myriad of other sinkholes masquerading as reform, most of them as convoluted as they are arcane. For those of you with curiosity, you’re invited to immerse yourself in the maze, though I warn you it’s not easy reading.
Now that you’re exposed to the highlights of Dodd-Frank, you’re entitled to my evaluation of what has become the law of the land. I admit up front: Reform of the nation’s financial labyrinth is long overdue. I also acknowledge the federal government bears a principal responsibility to ensure the banking and investment sector adheres to rules which do not jeopardize our economic well-being. The reason for this is fundamental; without effective oversight, our financial institutions will systematically loot the American public of all its assets. Bankers will gouge their borrowers and their depositors; there’s no upper limit to the interest rates they’ll charge nor to the lower limits they’ll pay. Similarly, mutual funds will skim from their investors’ portfolios and there is no limit to the depth they will dip. Not to be outdone, insurers will continuously boost premiums while reducing payouts; again, there is no limit. This is all the result of simple human nature. Only the federal government, with its enforcement authority, possesses the regulatory wherewithal to prevent systematic pillage of our citizens.
With this said, I nonetheless find little of value to recommend Dodd-Frank. Despite the mass of committees it forms, regulations it establishes, and procedures it embraces, its practical effect will be little more than intimidation of the industries it is meant to regulate, forcing them to render lip service to the rules while conducting business as usual as they continue to rip off the public. It’s my belief the sheer magnitude of the measure’s scope will prevent effective application of its stated goals, however well-meaning. Only through enactment of a manageable set of simple and well-defined rules with clear enforcement provisions, overseen by a limited number of experienced regulators, each possessing clear authority, can our government reign in the abuses endemic to the financial system. As intricacy of oversight increases, its effectiveness will decrease. Dodd-Frank is so complex, its regulatory effects will be nil.
I’ll conclude with a final thought. Although Dodd-Frank will not perform its professed function, it will certainly affect the industries it’s meant to regulate as well as the general public. In complying with the many rules to be established, I envision the following results: fees to pay, applications to submit, waivers to obtain, fees to pay, regulatory boards to petition, licenses to be issued, fees to pay, forms to file, circuitous procedures to navigate, and, most assuredly, fees to pay.
Treasury Secretary Steven Mnuchin certainly sounded positive on Wednesday, April 26th, as he outlined the administration’s tax proposals. As massive tax reform constituted one of the major planks of President Trump’s campaign platform, big things seem to be in the works. For those of you unaware of the sweeping changes being contemplated, I’ll give you a brief summary of the major items under consideration.
٭Conversion of the seven existing personal tax rates, now topping out at 39.6%, to three rates of 10%, 25% & 35%
٭Elimination of all personal deductions except for charitable contributions and mortgage interest on a residence
٭Increase of the personal standard deduction for married couples filing jointly from $12,600 to $24,000
٭Elimination of the Alternative Minimum Tax
٭Reduction of the corporate tax rate from the current 35% to 15%
٭Elimination of the estate tax
Changes in the tax laws are nothing new. Since the enactment of the 16th amendment to the Constitution, when, in 1913, income tax became the law of the land, the number of brackets and the applicable percentages varied widely. Initially the tax set a flat 1 percent on incomes over $3,000 for individuals ($4,000 for married couples) with an additional 6 percent surtax on very high incomes. By the conclusion of World War II in 1945, numerous brackets existed, the lowest, between $750 and $2,000, taxed at 23 percent, with income over $200,000 at 94 percent. Thereafter the top rates periodically dropped. If the number, size, and tax rates of the brackets constituted the sole variables, income tax analysis would be a simple matter. However, it’s by the granting of various exclusions, exemptions, deductions, and credits that taxation of income takes on its true character, and it’s through the use of these devices the effective rates are distorted into a bewildering array of meaninglessness.
As for the Alternative Minimum Tax, the concept dates to 1969 when congress enacted, and the president signed, a law designed to ensure 155 multimillionaires did not utilize unconscionable loopholes to avoid paying their fair share of income taxes. In the nearly fifty years since its enactment, it devolved into a device which requires a tax filer, utilizing a prescribed formula, to calculate taxes both with and without authorized personal deductions. The taxpayer will then pay whichever method results in the greater amount. The effect of the ATM is no longer reserved for the super-wealthy. As the law incorporated no index to inflation, it now applies to middle income wage earners. What was once rationalized as a method to raise revenue from a small number of super-rich Americans is now a contrivance which, it’s estimated, causes 27 million taxpayers to pay $35 billion annually.
The last two items, the corporate and estate taxes, pose little significance for the average middle-class citizen. The 35% rate on the former applies only to net corporate income exceeding $75,000 yearly. Taxes on the latter are not assessed on estates less than about $5.5 million.
What truly matters is the percentage of gross income remaining in the hands of the mass of Americans after the tax collector gets his. From the standpoint of the citizen, things are not getting better. At its inception in 1913, only 2 percent of the U.S. population paid any income tax whatever. On the eve of World War II in 1941, the effective rate on the 82 percent of Americans with taxable income under three thousand dollars remained at single digit levels. Thereafter the escalation proceeded with no respite. Taking into consideration state and federal taxes, social security and Medicare contribution from both employee and employer, and payroll deductions such as disability and the like, the average middle-income American today gets to keep about half of what’s earned.
How may we now evaluate the intent of President Trump’s professed desire to simplify the tax system while lowering the rates we citizens pay? I suggest we tune back to our last massive tax reform of 1986, championed by another president with only the best of intentions, Ronald Reagan, who also desired lower rates and a simplification of the system. At that time the top marginal bracket for the taxpayer was 50%, while numerous personal deductions and a mass of complex provisions cluttered the tax laws. For months the legislators haggled over the details until they finally agreed upon “a massive tax reduction for the benefit of the taxpayer.”
Commonly referred to as the Reagan Tax Reform Act of 1986, enacted on October 22, 1986, and promoted on the basis of its reduction of income tax rates, it actually triggered a wholesale elimination of deductions, exclusions and credits constituting the average taxpayer’s only tax shelters. Foremost among these was the deduction for personal interest expense, which for those of you old enough to remember, enabled many persons with chronic personal debt burdens – particularly credit card debt – to somehow survive. While the easing of the tax rates, with top bracket of 38.5% lowered to 28%, did little to assist most citizens in their day to day bill paying, the elimination of the interest deduction constituted the straw which broke many a worker’s back. Its practical effect: an increase in the cost of carrying debt, often representing the difference between making it and not making it. Of course, as is customary when stripping benefits from the citizen, these changes phase in over a number of years. In this case only 35% of the interest deduction became disallowable in 1987. The disallowance increased to 60% in 1988, to 80% in 1989, to 90% in 1990, and finally to 100% by 1991. Understandably, the instigators presumed by the time a benefit is fully gone, most taxpayers will have forgotten who took it from them. And with the top marginal tax rate now in 2017 greater than the original rate, how did the average citizen actually fare? I think you can guess the answer to that question.
I now confess to having no idea how this tax reform proposal will play out. The leaders of the minority party seem dead set against anything the president favors. Senate Minority Leader Chares Schumer, D-N.Y., claims: “That’s not tax reform. That’s just a tax giveaway to the very, very wealthy that will explode the deficit.” Steven M. Rosenthal, senior fellow at the liberally-oriented Urban-Brookings Tax Policy Center, predicted “wealthy and sophisticated taxpayers would exploit the drop in the corporate tax rate to pay less in taxes on their income.” Oregon Senator Ron Wyden, top Democrat on the Finance Committee, called it “an unprincipled tax plan that will result in cuts for the 1% and crumbs for the working people.”
It’s also probably accurate to suggest many Republican legislators are no more enamored with Donald Trump than are the Democrats, partially due to the castigation a number of them received from him during the election. For this reason, as well as the indescribably intricate set of tax arrangements all negotiated over the years between every conceivable interest group, the entire tax reform measure may collapse in much the same way as did the attempted repeal of Obamacare.
A final thought: Tax reform is not an altruistic balancing of noble intentions with the good of the nation at heart. It is, instead, cold-hearted scheming where the participants strive to secure the most favorable results possible for themselves and their allies. And while you, as a taxpayer, are haggling and wangling, never ignore what it is the government wants from you: It wants your money.
Greetings to those of you either paying into or collecting from the Social Security system – and that’s whole lot of people. You should be aware things are changing. For payors, the costs may be going up; for collectors, the payments may be coming down. The system is in flux as the federal government tries to figure out how to make ends meet.
For you payors, whose annual earned incomes are in six figures, the amount on which the federal government will be assessing the FICA tax has risen from $118,500 in 2016 to $127,200 this year. This means 15.3 percent on as much as $8,700, or up to $1,331.10, will be added to your tab. Employees will pay half the bill, with employers picking up the other half; the self-employed must handle it all up by themselves. And in case you want to know who to blame for this, you may glance in the direction of prior Federal Reserve Chairman Alan Greenspan who, in 1981, headed the commission recommending these annual raises as a way to keep the system in business. He’s still around at the age of 91, so if you’d care to express an uncomplimentary remark, he just might hear you.
For you collectors, the amount in social security benefits you receive is tied to a variety of factors, some of them quite abstract. In theory, the FICA taxes you paid into the system over the years should relate to the monthly payments you receive. But, in reality, the amount may vary based upon all sorts of regulatory provisions. Though it might be helpful if the administrators made this information readily accessible to the public, this is asking for something not meant to be. If you request specific details from a Social Security employee, you’ll possibly receive them; if it’s general advice you want, it’s not there for your benefit. I can only guess why this situation exists – and it’s not encouraging.
If there’s a fundamental defect in the Social Security system, it’s what you’d expect from any other pyramid scheme. For those of you unfamiliar with the term, this is a type of business model which recruits members via a promise of payment in exchange for enrolling others into the scheme, rather than actually investing in or marketing anything in particular. As the number of participants increase, recruiting new members becomes ever more difficult. In time the pyramid scheme proves to be unsustainable and the latter enrollees lose whatever they may have contributed. This sort of contrivance was appropriately ridiculed in a comment attributed to the late British Prime Minister Margaret Thatcher concerning governmental programs, to the effect: “Eventually you run out of other peoples’ money.”
This now gets us to a fundamental question: What can we Americans who are impressed into the system do to rescue ourselves? Let me respond by saying I have some good news and some bad news. First, the bad news: For most of you there’s nothing you can do. If you’re an employee receiving wages, salary, tips or other taxable employee pay, it’s classed as “earned income,” If you’re self-employed, and your source of income is either from a business or a farm, it falls into the same category – and as such, subject to FICA tax. If it’s to escape the 15.3 percent burden, it must fall into the category of “unearned income,” generally comprising interest, dividends, rent, retirement payments, social security, unemployment benefits, alimony or child support. Unhappily, it goes without saying for those of you earning a living in the customary manner, FICA has you tied hand and foot. There’s no legitimate way you may escape.
We’ll now move on to the good news I alluded to. Among the many who cannot avoid mandatory contribution to the Social Security system will be persons with flexibility. These are generally the self-employed, with a certain amount of investment or other non-earnings income, who possess the ability to opt out of the system, either wholly or partially. The method employed is essentially conversion of income subject to the FICA tax into income not subject to the tax. As manipulative as this may seem, if done fully in accordance with the rules and procedures presently in effect, it can be accomplished in a thoroughly acceptable manner. For the arrangement to be fully effective, there are details to be adhered to. You’ll find a general discussion of the procedures in a Newsletter on my website, www.roadwaytoprosperity.com. At the bottom of the entry page, click the Newsletter link and scroll to the article titled “Social Security Prognosis.”
This seems an appropriate time to make a disclaimer of sorts. Despite my general aversion to the Social Security system as it evolved over the decades to penalize the nation’s middle class, it nonetheless offers a vital benefit to a certain portion of the general public. There’s a substantial segment of the American population consisting of modestly paid workers, who live frugally while regularly paying their bills, but never accumulate an appreciable amount of wealth. At best, they will have, early in their lives, purchased a small home with a minimal down payment, and systematically paid off its mortgage one installment at a time. Thanks only to a home, free and clear of any loan, and receipt of a regular Social Security check each month, supplemented by their accompanying Medicare health coverage, they can manage to get by satisfactorily. These are the people who are well served by the system as it functions today.
Before I leave the subject of benefits derived from the system, I must acknowledge the health provision tie-in offered through Parts A, B and D of Medicare. All system recipients sixty-five and older automatically receive hospitalization entitlement under Part A, for a reasonable monthly premium there’s physical and other medical services under Part B, and pharmaceuticals under Part D. The extent of services is unrelated to the amount of social security payment received; mere qualification, requiring 40 calendar-quarters of contribution, provides full Medicare benefits. Where else can equal medical coverage be obtained at such a favorable price?
I’ll conclude this topic with a troubling prognosis. There’s no way the majority of future recipients of the system can avoid the unhappy future in store for Social Security. It will ultimately morph into a pseudo-welfare system to which all will contribute, but from which only the most modestly endowed will collect. Whatever you can do to avoid its grasp will be to your individual benefit. Unfortunately, those of you who are unable to escape will have no choice but to simply hope for the best.
For you viewers here in 2017, I’ve inserted an article concerning the Social Security and Medicare systems I wrote in early 2012. I’d like to say things look much more favorable today than they did back then . . . but I’m afraid they don’t. Please read on to get a feel for your future retirement and what the government has in store for you.
Social Security: A Misfortune in Progress
On April 23, 2012, the Trustees of the Social Security and Medicare trust funds issued their 2012 report to the public. In it, they acknowledged the long-run actuarial deficits of both programs worsened in 2012, warned that both funds are on “unsustainable paths” and will be exhausted by 2024 and 2033 respectively. After describing in some detail the inherent problems which are bleeding the system, notably the baby-boom generation’s imminent retirement requirements, the 2011 and 2012 reduction in the Social Security payroll tax rate, and the Disability Insurance component fund exhaustion scheduled for 2016, they concluded with the following recommendation: “Lawmakers should address the financial challenges facing Social Security and Medicare as soon as possible. Taking action sooner rather than later will leave more options and more time available to phase in changes so that the public has adequate time to prepare.”
The trustees are correct; the systems face serious problems and timely action must be taken to correct the problems. So what’s the likelihood lawmakers will promptly address the financial challenges? Perhaps a more fundamental set of rhetorical questions are in order. (1) What’s the likelihood the Republican-dominated House of Representatives and the Democrat-dominated Senate will cooperate amicably to solve this or any problem? (2) What’s the likelihood the senior citizens’ lobbying groups will look favorably on a reduction of benefits to their members as a means of reducing the costs of the program? (3) What’s the likelihood middle-class, middle-income, young and middle-age workers will support an increase in their payroll tax rate so to increase the money flowing into the system? (4) And as a final query, what’s the likelihood a sufficient number of legislators will be willing to enact laws which alienate their constituents today so the systems will not default a couple of decades from now? As I said, these are rhetorical questions; they deserve no answers.
At this point I’ll try to provide a touch of reality for you current contributors to the system, meaning those of you from whom FICA taxes are regularly taken despite the fact you’ll see no return of any sort for many years. As you’re now aware of what our elected representatives will be doing to safeguard your long-term interests—essentially nothing—you’d better be prepared to do something for yourself. Unfortunately for the majority of you, you’re without recourse. If you earn a salary, your employer automatically withholds FICA payments from each paycheck. Like it or not, you’re a contributor to the system. When you reach retirement age, whatever the number, you’ll discover what the authorities determine to be your fair share of the retirement pot. The probability is if you’ve worked hard, saved systematically and accumulated some assets your share will be little or nothing.
If there’s any good news, it‘s for that small but select group of persons with the ability to opt out of the system, either partially or wholly. These are generally the self-employed, with a certain amount of investment or other non-earnings income. The following scenario describes how this escape is possible.
Carrie D. Offeré, self-employed real estate broker and investor, age forty-five, unmarried, $70,000 net annual investment income from rents, mortgage interest, and dividends plus $50,000 net business income from real estate brokerage.
Only the $50,000 of business income, reported on Form 1040 Schedule C, is subject to Social Security tax. Currently at 12.3 percent this amounts to $6,150 per year. However, she can avoid this cost by simply forming a corporation from which to operate the brokerage. As corporate income, it’s FICA exempt.
Concurrently, another benefit is a more favorable income tax rate. Corporate income is taxed federally at 15 percent on the first $50,000, this far preferable to the 28 percent rate superimposed on $70,000 of other income. The tax reduction on her $50,000 of income is 13 percent [28 percent – 15 percent] for an additional savings of $6,500. Taking into account both FICA and federal income taxes, an annual $12,650 in reduction is possible.
As simple as this may sound, there are other matters to consider. Foremost among them is the question: what becomes of the corporate income? If passed on as salary it becomes taxable at 28 percent plus an FICA obligation of 7.65 percent to corporation and 5.65 to Ms. Offeré; there’s no advantage in this. A second possibility is a periodic dividend distribution. Although this avoids the Social Security consideration, it raises the specter of double taxation: 15 percent to the corporation plus her 28 percent bracket rate. Once again there’s no benefit.
How then can the problem be resolved? For this technique to work, the income must remain in the corporation as undistributed earnings, meaning it not be required for personal living expenses. With Ms. Offeré’s investment income, and reasonable frugality, she can pull it off. Thus the corporation will, over a period of years, accumulate net worth. That, however, raises an additional hurdle called the accumulated earnings surtax of 15 percent. The Internal Revenue Service does not like to see corporations hoard earnings as it interferes with the double taxation they understandably find to their liking. Fortunately there’s some leeway. An accumulated earnings credit of $250,000 prevents assessment of the tax until the aggregation reaches that amount. Also, any portion of the cache used for reasonable needs of the business may be further excluded. With prudent management, “reasonable needs” can be found for these funds. What sort of purposes, you might ask? Here is where it gets stickier. To avoid personal holding company status, and yet another 15 percent surtax, the corporation must restrict its investments so not to exceed specific percentages of certain types of income, most importantly interest, dividends, rents, and royalties.
I’ll conclude this topic with a troubling prognosis. There is no way future recipients of the system can avoid the unhappy future in store for Social Security. It will ultimately morph into a welfare system to which all will contribute, but from which only the destitute will collect. Whatever you can do to avoid its grasp will be to your individual benefit. Unfortunately, those of you impressed into the system have no choice but to hope for the best. As with so many other misfortunes flesh is heir to, each of us must fend for ourselves, as best we can.
You’d better watch your step if you’re involved in any way with a charter school. It’s now open warfare between the establishment forces and the charter interlopers. At the behest of Ken Bramlett, Inspector General of the Los Angeles Unified School District (LAUSD), on January 25, 2017, agents of the Federal Bureau of Investigation (FBI) and the Department of Homeland Security raided the offices of Celerity Educational Group, a company which manages seven charter schools in Southern California, in search of evidence of fraud or financial mismanagement. Mr. Bramlett is no stranger to law enforcement raids, with 23 years experience in various police positions as well as affiliation with the FBI National Academy Associates.
The ongoing conflict between the two groups is reaching a fever pitch, particularly in Los Angeles, where over the past eight years charter schools drained away tens of thousands of students from the L.A. Unified schools. The problem is that as students leave the public schools, their allocated public funds go with them. With the continuing loss in enrollment, the school district fears for its financial survival.
Perhaps a few comments on the basic conflict is called for. The charter school concept, which originated in Minnesota in 1991, promotes tuition-free public school receiving waivers from various regulations so it may pursue a program with more freedom in organizational structure, curriculum and educational emphasis than a traditional school. The fly in the ointment is the emphasis by charter schools to increase profitability by operating as non-union shops. Understandably, they are vehemently opposed by the United Federation of Teachers, which accuses them of “. . . privatizing public education and breaking the power of teacher unions,” adding “. . . we adamantly reject the idea that anti-unionism has any place in real education reform.” With massive sums of money at stake, the conflict is inevitable. As long as taxpayer funds continue to flow into schooling, with each competing group relegated to getting its share however it can, advocates for both traditional and charter schools will continue to fight it out for the loot.
You may ask why large numbers of students are leaving the public schools and enrolling in charter schools. The justification comes as no mystery. In general, charter schools throughout the nation developed a reputation of providing superior education. Whether this is so is hotly debated, but it’s nonetheless believed by many. You might note Celerity schools posted higher test scores than the L.A. Unified average. In 2016, 55% of Celerity students who took the state English exam scored at or above grade level, as opposed to only 39% throughout the district. It can be claimed a student’s superior performance may not be attributable to the proficiency of the school attended, but it’s nonetheless an effective arguing point.
Despite the bad press reported on learning in America, let me spread a little favorable light on this subject. Education in the United States is not as grim as reported. The continual focus on the failing school distorts the picture. By definition, a school is “failing” if it’s in the bottom 5% of schools across the state based on combined English Language Arts and math scores. By mathematical necessity, five percent of the schools in every state must be designated as failing, and this is so regardless of the quality of teaching, the condition of the campus or a positive attitude of the students. If a school falls into this category because a large portion of the student body is not proficient in English, or perhaps not inherently scholastic by nature, or that many must work to help support their family, it will remain a failing school. So, despite the stigma assigned to a failing school, there’s no reason why highly-motivated pupils cannot do well in such a setting. Provided no actual hostility to education exists, a relatively bright and attentive student can both master the required subjects and maintain a high academic standing in the class. The fact a school may be designated as “failing” need not rub off on those who attend. If the media would concentrate on the ninety-five percent of schools which are not failing, we’d discover there are many fine institutions, a huge pool of dedicated instructors and a nation brimming with educated youngsters.
In this brouhaha, a fundamental question must be answered: Does the reputed benefits and techniques the charter schools claim to offer actually enhance the educational process, or are the differences between the two systems mostly contrived as the participants haggle over the money. I contend it doesn’t matter much how a school functions or whether the faculty is particularly competent. As a chemistry instructor some years ago, I made an interesting discovery. My bright and industrious students did well. Those who were bright, though not particularly motivated, managed to get by. The dull ones who applied themselves also managed to get by, but the dummies who fluffed off invariably failed. It became clear to me: Bright and motivated students will do well while those who are dull and lethargic will do poorly, regardless of how instructors perform or the school is administered. In this regard, nothing will ever change.
I’ll now share with you my beliefs concerning the school wars in progress. The belligerents phrase their arguments in grandiose ways: “Children of working-class families possess the right to demand quality education,” as opposed to “Parents must have the ability to transform their chronically underperforming schools.” But the conflict is far more profound than the hyperbole suggests. The root of the problem is that massive amounts of taxpayer dollars follow the student, where under the formulas predicated upon Average Daily Attendance (ADA), fortunes will flow to those whose schools can be governmentally sanctioned. It’s this perennial conflict over the money which causes the battle to rage on as it does.
I’ll offer a final thought on this matter. There’s a fundamental flaw in the American public school system the professional educators dare not acknowledge. It’s that millions of youngsters are impressed into a system for no legitimate reason. Legions of youths will grace the seats of countless classrooms and never learn much of anything. How, you may ask, can an establishment employing a huge work force and consuming a staggering amount of the nation’s resources be permitted to function in this manner? It’s because the school system is neither designed nor does it operate primarily to deliver an education to its students. Instruction in America is, at best, a peripheral goal of the public schools. In reality, the institution exists for the benefit of many diverse and conflicting groups including elected public officials, administrative hierarchy of the schools, the teachers and their representatives, non-credentialed employees, textbook publishers and distributors, and a host of groups and individuals too numerous to mention. The brutal fact is students are not among the many groups to whom benefits are bestowed. They’re children and, as such, are in no position to enforce demands. They can be safely ignored by the establishment. And so, the school system is what it is: an institution where money is passed around to those who are favored.
Roadway to Prosperity embodies the heart of the author’s last ten years of newsletters, written monthly under the heading On the Money Trail. Those articles prominently displayed in numerous publications, both in print and online, directed attention toward financial matters, normally with an emphasis on personal achievement in a variety of endeavors. Whatever your age or background, the revelations disclosed in this book will empower you to deal with the world in a more effective manner and employ the tool and techniques the book describes.